Why The End Of Free Shipping Is Inevitable

Starting in 2020, a new rule (announced to little fanfare outside the shipping industry) will take effect: the International Maritime Organization (IMO) will lower the allowable amount of sulfur in fuel emissions from 3.5 percent to 0.5 percent. For those of us that don’t think about fuel until it’s time to gas up a car, this sounds negligible. But Reuters called it the “biggest shake-up for the oil and shipping industries for decades,” and Reuters is right. In the near-term, this will increase costs, cause delays, and reduce profit margins for shippers. In the long-term, this is a portend for all of the factors that together will end free shipping.

Freight, whether on ships or in trucks, has an enormous environmental impact. It’s also big money: $1.5 trillion in the United States alone. For a closer look at this, let’s examine the business model of Amazon Prime — the largest provider of free shipping in the country. “Free” shipping is, of course, not really free — it entails an enormous infrastructure and costs, which we will get to in a minute. Like other e-commerce companies, Amazon operates on slim margins so those costs get passed on to the consumer, and since it does not charge for shipping, the cost is built into the price of the good. For consumers, the price is the same whether you put 20 items in one box or order an item every day for 20 days.

But it’s not the same to Amazon. The cost to ship varies, but one study estimated around 2-3 percent of sales for a large company. That number includes companies that don’t ship to consumers and doesn’t factor in free shipping, so for Amazon, we can assume it’s much higher. Still, that’s a low number. So why is shipping so cheap?

Simply put, it’s the same reason everything around us is so cheap: it’s totally unsustainable. It depends on a network of various subsidies and is fully reliant on an enormous amount of fossil fuels. This means that, as with most of our practices, the clock is ticking.

Let’s dig into why. For starters, restrictions on greenhouse gas emissions are likely to increase. Climate change is now a priority for voters, and the current Congress has made it clear it plans to act, and this means a big impact on fuel costs. It’s easy to forget when paying for a tank of gas, but fuel is simply too cheap. The International Monetary Fund calculated the country-by-country difference between the cost and impact of fuels and the prices paid and found a “subsidy” of $649 billion in the United States. Fossil fuel producers in the United States have long been free of efforts to price out and tax their impact on the environment, but 2020 election rhetoric has shown that the tide is turning.

The IMO rule isn’t focused specifically on climate change, and that matters. The rule centers not on greenhouse gases but on sulfur, a major threat to the air quality and pulmonary health of those near shipping lanes. The IMO is acknowledging that the 570,000 lives this rule will save are critically important and worth enormous expense to shippers. Indeed, maritime companies will likely have to spend a substantial sum of money on fleet upgrades and may be totally stymied if, as some fear, there is not enough compliant fuel available. The IMO has decided that major costs to shippers are less important than the lives of half a million people. What happens when the IMO sets its sights on climate change? 

Well, in 2018 the organization announced plans to end greenhouse gas emissions as soon as possible, at a minimum reducing them by half in 2050. While its strategy is vague on specific actions, the sulfur rule shows a new willingness to act that could spell hard, unpopular targets in the future, and with them new expense to shippers.

About three percent of global carbon dioxide emissions can be attributed to ocean-going ships. That’s roughly the same as the entire nation of Brazil — a number that includes both its extensive oil production AND its wide deforestation. “Slow” shipping can reduce costs and slash emissions, but it adds about ten days to shipping time — way more than a logistics company that promises fast delivery can afford in its supply chain. Shipping is likely to fall under fire for its environmental impact; this opens it up as a target for new fees, taxes, and regulations, all of which bring added costs.

The industry can design and purchase new compliant fleets, but container ships are really, really expensive. They can cost $100 million or more, depending on size. And getting a fleet in line with new rules will also be really, really expensive, simply due to the scale of these fleets. Maersk alone has nearly 800 of these enormously expensive container ships. But the new sulfur rule is in part mandating entirely new scrubbing systems in entire fleets, so Maersk and its competitors are unlikely to escape rules curbing greenhouse gas emissions.

Climate change also brings a bevy of extreme weather events, and these will increase in the next two years. Ships are extremely vulnerable to major storms, which bring delays on the open water and potentially catastrophic damage to ports. 

Given all these increased costs (fuel price increase, ship retrofitting, delays), perhaps automation can offset costs? Nope. Not only is labor a fairly small portion of shipping costs (which are almost entirely fuel and fleet), long stretches with no access to wifi leave the equipment outside the control and access of the shipping company, limiting its usefulness. It would also require an enormous network of IT workers, largely offsetting any gains in wage costs.

If we examine the costs of shipping by truck [pdf], the most common method of freight in the United States, it’s true that humans cost a lot: 17.8 percent of the total, to be exact. But if automation drives those costs down, can we be sure we’ll keep cheap freight? Nope again. Let’s look at the other two biggest costs: fuel and tolls.

We have already examined why the costs of fossil fuels are likely to rise in the near-term. These comprise about 9 percent of the cost of trucking. As these costs increase, that will comprise a larger and larger portion of trucking’s operating budget. What about the other one? Tolls, obviously, are necessary to pay for roads. This is especially true since the federal gas tax rate, set at 24.4 cents per gallon for diesel in 1993 and never indexed to inflation, has paid for a dwindling portion of road maintenance as inflation and fuel efficiency drained its value. Trucks are tough on roads; so is climate change, which brings severe storms and major temperature fluctuations to already strained pavement. Roads (already in historically bad condition) will continue to crumble. As federal, state, and local governments scramble to find new revenue streams to fix broken roads, what are the chances they will exempt the source of the most road damage from new taxes and fees? 

Let’s answer that question with a question: have you ever paid serious attention to the toll rate for trucks when you’re driving through with your E-ZPass? On average, trucks pay three to six times what a passenger vehicle pays for entry to the same roads. Even that is a huge underpayment as, according to one estimate, the impact caused by trucks is hundreds of times that of a car. While it’s unlikely that jurisdictions will levy a $400 toll, and while it’s true that truck shipping is a powerful lobby, we’re safe in assuming tolls will not go down for trucks. We can also assume that new tolls will appear in places that don’t yet have them.  And if you’re thinking automation will substantially lower road maintenance costs, you’re wrong- not only are the jobs still performed by human workers substantially harder to automate than other labor, it’s commodities prices [pdf], not wages, that are driving cost increases.

A safe estimate is that fuel, fleet and toll costs will rise; a fair assumption is that they will skyrocket. Someone has to pay the costs of that shipping, so let’s return to Amazon’s Prime business model. 

The benefit of this model to Amazon is that, if you’re a Prime subscriber, you order items more frequently than you otherwise might and are likely to order through Amazon without price comparing on other sides simply for the convenience. But there is a breaking point in that plan: we’re willing to pay for convenience, but only to a certain price. The exact number varies from person to person, but rising shipping costs will eventually turn consumers off with high per-item prices- especially if you’re not a Prime member and have to pay for shipping anyway.

This, in turn, creates an entry point for competition from online retailers that have struggled to gain Amazon’s shoppers. As free shipping costs a higher and higher percentage of Amazon’s sales, prices will rise along with them. And as long as aggregators like Google Shopping or browser add-ons make it easy to price compare with a few clicks, our desire for convenience will fall in direct proportion to Amazon’s increased prices. As long as we can group shipments on other sites it will be cheaper to wait and buy a few items at once. Our preference right now may be to order and receive items right away, but our preferences change with incentives-and there’s no incentive like cold hard cash. If a small amount of price difference is enough to make us shop around first, then it’s certainly enough to make Amazon drop free shipping.

Amazon Prime has a very real impact on the environment, which is not reflected in its costs. Basic economic theory teaches us that externalities will exist beyond the price of goods. However, the practice of refusing to price any environmental externalities appears to be on its way out. And it’s taking our free shipping with it.

Related News