Free Shipping Erodes US Retailers' Profits

21 Nov, 2011

Free shipping for online purchases is eroding the profitability of US retailers as they are compelled to offer the service – pioneered by Amazon – by fierce competition for the dollars of seasonal shoppers.

With end-of-year sales starting after Thanksgiving this week, on the day known as Black Friday, retailers including Walmart, Target, JC Penney and Macy's have already reported reduced profit margins after introducing free shipping.

The proliferation of free shipping, albeit with restrictions, is a sign of retailers' anxious attempts to woo consumers on tight budgets who have been hit hard by the weak US economy.

It also reflects the ability of Amazon "the dominant online-only retailer – to set a bar for price and other services that squeezes bricks-and-mortar rivals trying to capture a share of growing online sales. Wall Street expects their margins to shrink further before Christmas.

"The cost of getting the customers' attention is going up, whether it's because of free shipping, marketing or promotions," said Adrianne Shapira, managing director at Goldman Sachs.

"What's concerning to us is that as costs go higher, the flow-through from an incremental sales improvement to the bottom line is not as great. You get less bang for your buck."

In the past two weeks, two-thirds of the retailers tracked by Goldman reported a year-on-year decline in quarterly gross profit margins, a key metric that shows how much revenue a retailer retains after the direct costs of procuring and shipping goods.

Faye Landes, managing director of Consumer Edge Research, said: "Everyone has to do [free shipping] because Amazon has trained people to expect it. And with most things like this, there's no going back." In the US, Amazon offers free shipping on orders of at least $25.

Walmart, the world's biggest retailer by sales, is offering free shipping for electronics, clothes, cosmetics and household goods with a minimum order of $45.

In the three months to the end of October the company's gross margin fell 0.44 percentage points from a year ago to 24.6 per cent of sales, unnerving investors.

Gross margin declined 0.18 percentage points at Target, a Walmart rival. Among department stores, it fell 1.68 percentage points at JC Penney and by 0.5 percentage points at Macy's.

As smartphones accelerate the growth of ecommerce, mass-market discount chains and department stores are stepping up investments in their online businesses to staunch a loss of market share to Amazon.

According to estimates by eMarketer, online holiday sales in the US will rise 16.8 per cent this year to $46.7bn, more than five times as fast as overall retail growth.

Kasey Lobaugh, head of ecommerce at Deloitte, said most retailers still had higher margins in their online businesses than their stores.

But he said there was a risk that free shipping could become a costly commodity service that triggered a "race to zero" profit. "You haven't differentiated yourself or created unique value. You've just said 'me too'," he said.

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