Amazon free shipping isn’t actually free. Many consumers and brands are unware of just who foots the bill when it comes to “free” shipping provided by Amazon. Someone pays for the shipping – and it’s not who you think. Discover if the consumer, brand, or Amazon ultimately pay for the cost of free shipping.
“There’s scarcely tastier bait for American shoppers than free shipping,” according to a recent Atlantic article, “and it’s been transformed from an occasional incentive into something that closely resembles a consumer requirement.”
As consumers, we expect delivery. We really, really, need delivery. But pay for it? No way.
When is shipping truly free for the customer? When is it not? Who pays, and why? Is this sustainable? Let’s find out.
The History of Amazon Free Shipping
Back in the olden days, people rode their horse and buggy to the physical stores for all our needs. If the physical store didn’t have what we needed, we’d go without (a concept my kids still can’t wrap their heads around). The product price was a “box price” which is the price of the item only. Alternatively, people could order from a catalog. For the privilege of ordering a seemingly endless assortment (often from a rotary phone or fax machine), we paid a “landed price”, which is a box price plus a shipping fee.
Then along came eCommerce – where competing for sales is hard, and the delivery fees for space heaters, diapers, and big screen TVs are expensive. However, shipping costs are a major deterrent to online shopping (still the largest driver of all cart abandonments.) If customers were responsible for the actual, itemized delivery fees, they would feel guilty and lazy for paying to shop in their pajamas. They would go to the store.
Barbara Kahn, Professor of Marketing at Wharton, calls this the “pain tax”: “If the shipping price is incorporated in the price of the good and customers don’t have to think about that pain tax, they would definitely prefer it.”
To get people to shop online, retailers must make shipping free. So, who pays for it?
Does the Customer Pay?
Let’s say an item’s retail price is $20, and it costs $5 to ship. If the retailer charges $25 and announces, “free shipping”, then the customer is paying.
This approach is still common among many third-party sellers on sites like Amazon and eBay. These sites have toggle buttons to help customers filter for items with “free shipping”, and you want your products to show up. (On Amazon’s web site heatmap, for example, those filters are the hottest places on the page.)
Alternatively, retailers or sellers will charge shipping overtly, in the form of a shipping charge (i.e., Land’s End). Order minimums (i.e., Free Super Saver Shipping) are also a way of having the customer share the burden. Larger orders drive incremental revenue and profits for the retailer.
In these cases, the customer pays for the benefit of having products delivered to their homes.
Does the Retailer Pay?
Many eCommerce players got their start this way, matching competitors’ in-store, box prices, AND offering free shipping. In this case, the cost of the shipping comes out of the retailer’s profit margin. This helps the retailer buy customers, but it is not sustainable as a long-term strategy. If you operate in a margin-rich category, this works. It also works if your shipping costs can be reduced over time by economies of scale. Yet Amazon’s retail business is profitable…likely even before advertising.
However, cat trees, toilet paper, and Campbell’s soup carry high shipping costs. Contrary to popular belief, Amazon and Walmart have moved away from this. While Amazon has economies of scale, it would be difficult for them to ship most of their merchandise profitably – especially with One-Day shipping – without some help.
Doesn’t Amazon’s Prime Revenue Help?
It helps, but it’s likely not enough. It’s estimated Amazon spent $5-6B last year on digital content for Amazon Prime, or $40 per Prime customer. That leaves only $79/customer to allocate to Amazon’s shipping costs. This probably doesn’t cover the 24 orders per year that Prime customers place. Of course, the math is more complex, LTV, etc., but you get the picture…
So, you guessed it, someone else is subsidizing shipping.
The Manufacturer Pays (ding ding!)
Amazon is in the middle of Annual Vendor Negotiations with vendors. This year’s top request by Amazon? To increase funding, especially freight, to help pay for Amazon’s launch of One-Day shipping.
Manufacturers heavily subsidize the cost of both the pricing war between Amazon and Walmart AND their free shipping programs.
Manufacturers are also feeling the squeeze of Amazon and Walmart.com to keep on subsidizing.
Years ago, these (1P) manufacturers happily loaded their products onto Amazon with minimal trade funding. Amazon came to represent their primary eCommerce customer and a profitable growth channel.
However, in the past five years, manufacturers have consistently told me that Amazon’s gone from their least expensive channel to their most expensive – by a long shot. That’s because over time, sites like Amazon have shifted the burden of price matching and shipping costs to the manufacturers.
Amazon reports vendor profitability numbers back to vendors, requesting to be compensated when their item-level profits aren’t hitting targets. They receive this funding in the form of margin guarantees, freight allowances, accruals, CRaP allowances, straight payments, AVS/SVS programs, and Amazon Advertising. If Amazon can’t get subsidies for these products, the products are often deemed CRaP – in which case, you can’t advertise, you fall out of search, and Amazon may stop ordering. Why would Amazon drive sales of unprofitable products?
If you’re a typical manufacturer that does more than half of your eCommerce sales on Amazon or Walmart, they yield a tremendous power over your business.
In Amazon and Walmart’s defense, I don’t think anyone could have predicted how technology would drive such a pricing race to the bottom. Price matching in-store box prices carries a huge burden for an eCommerce retailer, who must ship products. Not being beat on price is an expensive proposition. On the flip side, not being competitive on price is a major trust buster for someone like Amazon or Walmart.
Please, please have a channel strategy
Manufacturers’ channel strategy – or lack thereof – plays an integral role. If you’re tied to an old-school promo calendar that gives each retailer their “turn”, you’ll always be on sale online.
If you think Amazon is your most expensive channel, take a hard look at your promotional strategy.
Also, pay attention to which retailer drives pricing in your category. Consider whether you want everyone to have the same assortment. Best-in-class manufacturers are differentiating. If you give everyone the same thing, expect a race to the bottom and a bunch of emails from eCommerce retailer buyers asking for help with profits.
Major retailers are still competing over eCommerce customers. However, over time, manufacturers are going to run out of money to subsidize retailer profits. When that happens, I believe we’ll eventually see eCommerce pricing adjust up to reflect the true cost to serve customers. (Sorry, customers.)
In the meantime, the customer wins
Unless it’s clear the customer is paying shipping, someone else is. Therefore, the customer wins. Yay customers!
One thing’s for sure – you’ve got to appreciate Bezos’ customer focus. In a recent shareholder letter, he said, “There are two kinds of companies: those that work to try to charge more, and those that work to charge less. We will be the second.”
We recently outlined some perspectives and tips on the AVS (Amazon Vendor Services) vendor-funded support service. Whether you are considering the value of the service or have already signed on and want to ensure you’re making the most use of those funds, this video provides information on how to avoid the six most frequent mistakes brands make when utilizing the AVS program. Also, this chart explains the possibilities for utilizing your AVS resource:
News and industry discussions are swirling around the rumor that Amazon is shaking things up with smaller suppliers and planning to cut all 1P manufacturers under $10M in annual sales. If you read the Bloomberg article or have heard of this elsewhere and you’re concerned, please don’t worry because we have you covered!
Here’s the gist of why you shouldn’t worry: First, there have been no confirmed timelines associated with this change – so it’s possible you’ll never be affected. Second, there are tremendous advantages to a being third-party seller on Amazon, and we can readily help you get set-up. If you already have a hybrid 1P/3P arrangement, we can help you optimize your seller central account and product assortment as a precaution to best mitigate risk.
First, it’s helpful to understand what’s likely driving Amazon’s motivations behind the rumored transition:
Having lots of smaller suppliers introduces risk to Amazon
For Amazon, holding and managing inventory for smaller suppliers with less predictable product movement represents a financial risk. Also, it’s difficult to properly vet, police and remove (when necessary) the smaller suppliers who may be selling counterfeit or otherwise unauthorized product. Similarly, smaller manufacturers who may not have met certain safety or testing standards can clearly become problematic for Amazon. We realize our clients don’t fall into these counterfeit or safety-risk categories, but Amazon may not.
First-party vendors are more high-maintenance for Amazon
As with any business, a company must consider how employees’ time spent generates revenue and constantly evaluate the value of each employee. Considering the time involved in onboarding and managing first-party platform vendors and items (even with scaling and automation efforts), Amazon finds that the arrangement comes at a high cost to serve compared to the realized revenue.
Amazon’s investment into one-day shipping means they must find ways to shift to more profitability elsewhere. Third-party vendors create “easier” profit for Amazon, and better selection for customers
Without the maintenance mentioned above, Amazon still earns commission on every sale through the 3P platform – so it’s guaranteed earnings at a lower cost to serve.
Having a large stable of 3P sellers allows Amazon to offer their customers a larger selection, without the heavy burden of directly managing them.
With Amazon’s “hands off the wheel” price matching algorithm for 1P vendor items, the items and even entire brands may become exposed to a CRaP out situation, which presents a loss for Amazon as well as vendors. Vendors moving to 3P gain the control to price their products more sustainably – creating a win/win for vendors and Amazon.
Here are some advantages of the third-party seller central account:
A seller central account gives you the ability to set your own retail prices (avoid CRaP status), manage your own inventory and marketing. And because you manage your own data, you have access to superior reporting.
There’s a tremendous community of experienced Amazon third-party seller forums that share best practices and help others troubleshoot. You will be amazed at the plethora of resources available.
What you should do
If you don’t already have a seller central account, let us help you set one up. For reference, we have published an FBA playbook that you can request here if you don’t have it already. (Or, if you’re an existing client, reach out to your account manager.)
We can help you create and manage a pricing strategy. Be aware that in your seller account, you will have to manage sales tax remittance in all states.
If you receive communication from Amazon regarding hybrid selling, or selling as a third-party seller on Amazon, we recommend that you don’t respond immediately. Please consult first with your Ideoclick Account Manager. We will help you craft a strategy and response that serves your best interests.
You will find the seller community a very welcoming place and the third-party arrangement an incredible opportunity to continue growing your business, and we look forward to helping you through this transition!
This isn’t a sudden or extreme move, and it’s nothing new. Amazon is continuing its gradual and ongoing shift to automating roles and making the experience of selling on Amazon more self-service for brands. It started several years ago when Amazon launched their first HOTW (Hands Off the Wheel) programs internally, and began holding employees accountable for automation improvements. So don’t worry, the Amazon Vendor Managers are certainly still there…and they still want your money.
The Vendor Success Program, or VSP, described in these articles isn’t new either – it’s been around since about 2014 and has traditionally applied to brands whose sales are below about $10M/year. Chris Brugos, the previous manager of the Vendor Success Program and now Ideoclick’s leader of Catalog and Content services teams, characterizes the program as a little bit of a “middle finger” for brands.
“What it really means is Amazon has reduced the work of a Vendor Manger to a series of algorithms and Standard Operating Procedures, all executed by a team of offshore associates and customer service agents.” According to Chris, “It can work in your favor if you know how to game the system.”
Your Vendor Manager probably isn’t your key to success on Amazon, anyway.
Contrary to a buyer at a traditional retailer, the Amazon Vendor Manager is unlikely to deliver category insights, collaborate on new product development ideas, or help you engage with Amazon’s senior leadership. Instead, they’ll assist with the occasional purchase order or receive-related issue, terrorize you about CRaP, and try to sell you expensive merchandising packages. This person isn’t typically not your biggest advocate at Amazon, and this is by design – a Vendor Manager’s function isn’t to help manufacturers or make it easier to sell on Amazon; it’s to drive growth in profit and sales, optimize the selling platform, and provide a multitude of internal reporting and project management functions. In addition, given the turnover at Amazon, more and more manufacturers are more platform savvy than newer Amazon employees.
A better advocate for your brand is likely your Amazon Advertising Account Executive. Our clients typically receive better insights, data, and follow-through on their Amazon business from the ad team. Apparently, advertising sales are still a relationship-driven business!
If you’re smart, you’re already educating yourself, hiring a team, and becoming self-sufficient on Amazon
There are droves of agencies (ours included), educators, and third-party firms and software – much of it free – that are in the business of educating and executing business on Amazon. Once you understand the Amazon engine, it’s not hard to develop your growth strategy, predict Amazon’s moves, and staff a team correctly to support the business. With the right strategy and tools, many manufacturers – small and large – are plenty effective on Amazon with little to no contact with the Amazon retail team. You can do it, too!
What Q4 Earnings Mean for Manufacturers – What Amazon Will do with Pillpack
Written by Andrea Leigh, VP of Strategy and Insights
IN THE NEWS
Amazon announced their Q2 earnings, and the big story is that they posted their largest quarterly profit ($2.5B)…ever. Wall street is happy, as they’ve now been profitable for 13 straight quarters – thanks in large part to their ad business (growing at 100% Y/Y), AWS, and the “squeeze” they’ve been putting on all of you, manufacturers. (Keep that in mind when they ask for terms improvements this fall!) External hiring has slowed, as they have consolidated their Retail and Third-Party teams and are filling open roles with internal transfers. They also indicated a slowdown in fulfillment center expansion, signaling growth fueled by third-party sales. Expect greater integration and consolidation across the retail and third-party platforms, teams, and strategy and increased reliance on third-party for inventory (see “Word on the Street” below).
Amazon acquired the online pharmacy, Pillpack, for just under $1B. In addition to prescription pharma being a robust, $450B/year business opportunity, this move will also enable Amazon to steal repeat foot traffic from the Walgreens, Rite Aid, and CVSs of the world…driving down the value of these retailers and making them prime potential future acquisitions. Each drugstore chain represents a large number of small-format, potential pick-up points for grocery products and/or AmazonGo stores. This will also give them a ready market for new private label products typically sold at pharmacies, which they’ve already begun developing. And you can bet there will be some special prescription service for Prime customers.
WORD ON THE STREET
Can Amazon turn off your hybrid selling account?The short answer is, yes. The Product Availability Policy for Manufacturers (commonly known as the Manufacturer on Amazon policy or MOA), has recently changed (changed portion is underlined): “If you are a manufacturer and your products are sold by any other retailers or distributors, we expect you to offer Amazon Retail the option to source those products at competitive terms for sale as Retail items only.” Amazon is applying this policy inconsistently across categories – right now, hard goods categories seem to be getting hit the worst. If your behaviors flag Amazon’s attention – such as holding back portions of your assortment for FBA-only (vs. retail), using FBA to drive Amazon’s retail prices down, or trying to move your business from retail to FBA – you’re at risk for a review.
What we learned from Prime Day (well, when Amazon’s site was up, that is)… It isn’t enough to run a deep (think 30%+ off) discount anymore – you have to drive external traffic to it, too. The deals that performed best across our client base all included some traffic-driving activity on the client’s side, such as promotion through social channels, AAP, AMG, and/or other advertising. Many clients had deals shut off due to profit or inventory concerns, or because Amazon did some price matching leading up to the event (rendering the deal invalid). Takeaways for next year: Given the new-for-2018 item-level participation fees, go big on a few items, and have an external marketing plan. Missed the cutoff or don’t want to fork up the fees? Use a Vendor Powered Coupon to improve conversion.
WHAT’S COMING UP
Holiday, that’s what! It’s time to start thinking about your deal calendar, internal resourcing to support more vigilance in everything from auditing detail pages to monitoring chargebacks (expect an increase) and making sure your warehouses ship products quickly and correctly to Amazon. The window is also closing to open and generate enough credibility with your seller account in time for holiday, so set up those FBA accounts now! (Amazon doesn’t usually allow brand new sellers to sell product during Q4).
Annual Negotiations…Starting in September, Amazon will begin sending out their annual terms requests. Here’s how to not get eaten alive. Need to talk it out? Clients, please schedule a “negotiations consult” with your Account Manager.
New Items? – Now is the time to set them up to get the flywheel going before Q4. Contact your account manager and we can get the new assortment rolling.