Strategic Implications of Online Retail Platforms' Membership-Based Free Shipping Programs

Product shipping is an indispensable but costly operation in online retailing. Although several initiatives are underway to reduce the shipping cost, an important innovation is the membership-based free shipping (MFS) program, in which a retail platform that allows third-party sellers to sell their products for a commission bears the shipping costs for purchases made by members who have paid an up-front fee. We identify several strategic impacts of MFS programs that are the key drivers to their success from the platform's or other stakeholders' perspectives. For example, we find that the membership fee collected by the platform does not cover its shipping cost, which suggests the MFS program benefits members and hurts the platform if the program is evaluated based on direct operational considerations only. However, we also show that the MFS program actually benefits the platform and hurts consumers when the shipping cost is less than a threshold. Moreover, the platform's benefit from the MFS program follows an inverted U shape with respect to the shipping cost, suggesting that the program enjoys the greatest benefit for products with a moderate shipping cost. Even though the MFS program enhances the overall consumer demand and consumption, it could hurt society because the MFS program stimulates demand from consumers who have a low consumption utility relative to the shipping cost. Our results demonstrate that the MFS program is not just a shipping cost-transfer mechanism; rather, it is a strategic initiative by online retail platforms to exploit the need for product shipping to their advantage.