Reference no: EM133078280
The Chief Marketing Office (CMO) had a great idea: Free Shipping.
A recent research study shows that consumer like to get things that are free: it is as if their tastes change and that would accept a higher price. If used strategically, that means more profit.
The company has known for a long time that they have a competitive advantage in the area and face no competition. The CMO talked to shipping and concluded that recent developments have reduced shipping cost by 25 percent: what used to cost a consumer $4/km would cost the company $3/km. The Chief Financial Officer (CFO) worried about the extra unlimited cost if they were to promise to ship anywhere. The CMO and CFO negotiated and the CEO decided to limit the free shipping offer to consumers who are located no more than 100 km from the factory. That along would double the number of customers. The CEO also agreed to raise the price charged to a consumer by 20 percent, for $1000 per unit (last year, i.e., if bought at the factory) to $1200 (to anybody, i.e., delivered or at the factory). And to revisit the question after 12 months.
At year end, the CFO looks at the numbers. The number of sales doubled, and that one-third of sales are unprofitable because the price increase does not cover the cost of shipping that far. The sales reps confirm that the CMO's hypothesis that consumers really like the idea of free shipping. In fact, one third of all customers say that they would never have bought from the company before. Sales reps say that one-sixth of all customers had thought about buying from the company two years ago and are buying now only because of the offer; they like the "Free Shipping" but would refuse to pay even a slightly higher price.
The CMO says that the increase in sales is proof that free shipping is equivalent to a 50 percent increase in the willingness to pay by a consumer. The CFO says that the increase is less than 10 percent and might be 0.
Is the CMO right? Is the CFO right? Or are both wrong about the effect of "Free Shipping" on a consumer's willingness to pay for the product? (As discussed in class, assume that all consumers have the same taste and income and that they do not vary by location.)