Value of membership‐based free shipping in online retailing: Impact of upstream pricing model

Abstract

A consumer‐side innovation in online retailing is membership‐based free shipping (MFS) in which a retailer bears the shipping cost for purchases made by members that have paid an upfront membership fee. On the supplier side, the agency model of selling, where a retailer allows a third‐party manufacturer to sell his product on the site for a commission, has been gradually replacing the wholesale model, where the retailer buys from the manufacturer at a wholesale price and resells to consumers at a retail price. We show that the shift to the agency model enhances the value of the MFS program to the retailer in the sense the retailer gains more from the MFS program and MFS is profitable to the retailer in a larger region of the parameter space under the agency model than the wholesale model. The retailer's gain from MFS comes at the expense of consumers and the society under the wholesale model, but the consumers and the society can also benefit from MFS under the agency model. The key driver of these results is that, under the wholesale model, the MFS program increases the severity of the double‐marginalization problem because the MFS program increases the retailer's marginal cost; however, under the agency model, the MFS program reduces the impact of marginalization at the manufacturer end because the manufacturer faces consumers with lower purchasing cost on average. Thus, the MFS program hurts channel coordination in the wholesale model but helps it under the agency model.

The Effectiveness of Membership-Based Free Shipping: An Empirical Investigation of Consumers’ Purchase Behaviors and Revenue Contribution

“…In contrast, MFS effectively enhances light and moderate buyers' purchase and revenue contribution. These findings also reconcile prior inconclusive results on the profitability of MFS from theoretical studies, which suggest that the adoption of MFS could make retailers either gain (Sun, Cavusoglu, and Raghunathan 2022) or lose (Fang et al 2021). Furthermore, our work adds to this stream of literature by examining the effect of free shipping on purchased product types.…”

“…A limited number of game-theoretical studies have started to examine the performance of MFS. Sun, Cavusoglu, and Raghunathan (2022) study how MFS affects a single shipping platform (e.g., eBay) and its third-party sellers’ profits. They find that MFS can induce high demand and product price, benefiting both sellers and the platform.…”

“…Net customer revenue. Free shipping may increase demand but shift high shipping costs to retailers (Sun, Cavusoglu, and Raghunathan 2022). Thus, NCR is not apparent, as it is determined by the balance between the revenue generated from sales and membership fees and the costs of free shipping.…”

“…Retailers hope membership fees can recoup shipping costs. However, the value implications of membership programs are inconclusive in the literature (Fang et al 2021; Sun, Cavusoglu, and Raghunathan 2022) and in real-world business. For example, Costco's annual membership fees account for 80% of Costco's gross margin (Lewis 2016), while an estimate for Amazon Prime shows that it lost at least $11 per member after accounting for the membership fee (Tuttle 2013).…”

“…The free shipping benefits of MFS bring enormous shipping costs to retailers, especially when consumers have their orders shipped in a myriad of small packages (Sun, Cavusoglu, and Raghunathan 2022). Retailers hope membership fees can recoup shipping costs.…”