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Quantitative Marketing and Economics

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02-04-2020

Can free-shipping hurt online retailers?

Authors: Ricard Gil, Evsen Korkmaz, Ozge Sahin

Published in: Quantitative Marketing and Economics | Issue 3/2020

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Abstract

In this paper, we investigate optimal pricing strategies for an online grocery retailer that derives its profits from delivery fees and grocery sales. We base our theoretical framework on the well-established work of Schmalensee (Bell Journal of Economics12(2), 445–466, 1981) in two-part pricing, while allowing for repeat purchase occasions. We derive testable implications that we take to data using a unique dataset detailing transaction information from an online grocery retailer in a Western European country. We find that an increase in the number of deliveries is associated with a greater-than-proportional increase in grocery sales, implying that preferences for deliveries and groceries are negatively correlated. Therefore, counter to the current popularity of free shipping, the observed strategy of discounting groceries and charging high delivery fees appears to be optimal in our empirical setting.

previous article The Effect of Sales Assistance on Purchase Decisions: An analysis using retail video data

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This forecast is based on a report published by Forrester Research, “US Cross-Channel Retail Forecast, 2015 to 2020” by Mulpuru et al. (2016).

Due to a data confidentiality agreement, we cannot reveal the identity of the retailer.

Our detailed transaction data involve another level of heterogeneity on delivery time slots, because they have different delivery fees to steer the demand across time slots.

Examples in the popular press also cover the hotel industry (Landsburg 2006) and the airline industry (Saporito 2011; Rane 2013). Additionally, our paper shares a few insights from the literature that studies the impact of transaction costs on shopping frequency, such as Bawa and Ghosh (1999), Lal and Bell (2003) and Ma et al. (2011).

Other representative papers on the same topic are Oi (1971) and Rosen and Rosenfield (1997).

Consumers may consume more if they receive more frequent deliveries of certain goods such as perishables (milk or egg) due to availability. On the other hand, if a consumer receives deliveries sporadically, due to storage capacity or costs, at any order instance, the consumer does not order more than the available storage capacity. Therefore, the demand (consumption) is bounded above by the storage capacity. Therefore, as the number of purchase occasions increases in a given period, total demand in that period may increase.

Throughout the paper, we use single letter subscripts to denote the partial derivative of the corresponding function with respect to the denoted parameter. For ease of exposition, we also assume n, θ, and p take continuous values (discrete case can be studied similarly). For example, S_y is the partial derivative of S with respect to y, and S_yz is the cross derivatives with respect to y and z.

The description of the five major product categories as defined by OG are as follows. The cooled group is meant for refrigerated foods (cold items), such as meat, packed vegetables and fruit, ready-meals, and dairy products (milk, cheese and yogurt). The inedible group represents items such as magazines, DVDs, batteries, cigarettes, and pharmaceuticals. The deep-freeze group includes items such as ice cream, frozen pizza, fries, meat, fish, and vegetables. The group 2 category includes crates of beverages, mostly beer. Finally, group 1 includes are the rest of the products.

Following Berry (1994), we can derive the above specification departing from a multinomial logit model. This derivation alleviates concerns about results being driven by consumers switching to time slots and days with lower delivery fees.

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Title: Can free-shipping hurt online retailers?
Authors: Ricard Gil
Evsen Korkmaz
Ozge Sahin
Publication date: 02-04-2020
Publisher: Springer US
Published in: Quantitative Marketing and Economics / Issue 3/2020
Print ISSN: 1570-7156
Electronic ISSN: 1573-711X
DOI: https://doi.org/10.1007/s11129-020-09225-8