- How Drop Shipping Works
- – Low Funding requirements
- – Low-risk Validation
- – Manage From Anywhere
- – Private Label Drop Shipping
- – Highly Competitive
- – Lack of Unique Selling Proposition
- – Insufficient Quality Control
- – Thin Margins
- – Out of Stock
- – Passive Income Machine
- – Eliminate the Middleman
- – Non-Customizable
- – 3rd-Party Fulfillment
- – Research and Development
- – Retail Arbitrage
- – Private Label Brand
- – Supplier Search Engine
- – Point of Sale
- – Email Automation
- – Customer Relationship Management
- – Research Industry and Niche
- – Negotiate With Suppliers
- – Choose Your Market Strategy
- – Follow Best Practices
- – Advertising and Promotion
- – Customer Service
- – Quality Issues
- – Product Descriptions
- – International Orders
- – Shipping Costs
What is drop shipping?
Drop shipping is a process of product fulfillment that occurs when items are shipped directly from the manufacturer or wholesaler to the customer. A third-party retailer facilitates drop shipping through their website and digital marketing efforts, and is able to profit off the margin created by circumventing the traditional retail supply chain.
The practice of drop shipping was first introduced around 1928 but lost momentum due to the Great Depression. Toyota then implemented a Just-In-Time (JIT) supply chain in the 1950s. The benefits of JIT inventory management soon became evident. The modern drop ship business model mirrors the major themes of the JIT supply chain by eliminating expensive inventory transportation and storage costs for retailers.
How does drop shipping work?
When an order is placed through your website, it is immediately routed to your manufacturer, distributor, or wholesaler to be packed and shipped, removing the most expensive component of the traditional brick and mortar business model.
Although you may expect the drop shipper to be the manufacturer of the product in question, there exists a market for wholesalers to drop ship products and even offer customization. For example, let’s say you start an apparel brand offering t-shirts. You could go the traditional route, ordering hundreds of shirts with your designs screen printed. But this runs the risk that your products do not sell well or at all. Or, you could explore working with a drop ship partner who offers custom printing services. In this scenario, your customer orders your new shirt which is routed to your partner to print and fulfill. Note that this may or may not be the actual manufacturer of the product, or the t-shirt in this example.
Why the Drop Ship Business Model?
Low funding requirements
If you pursue the drop ship business model, you will be pleasantly surprised by the financial projections. When you start a company that fulfills orders through drop shipping, you will not typically research and develop a new product, manufacture the product, or stockpile inventory. This limits the capital requirements to expenses mostly pertaining to legal business formation, the technologies required to operate your company, and marketing the products you sell.
Drop shipping uniquely offers the advantage of testing the waters before diving in. If you are uncertain whether your shirt design will sell, or any product for that matter, it’s best not to sink all your resources into it. Although drop shipping can be more expensive on a per unit basis, overall the financial risk is limited. Drop shipping is also a great way to test the quality of a new supplier since you will not be forced to purchase hundreds or even thousands of units that may be defective.
Manage from anywhere
If you negotiate with a supplier that also handles returns, your only physical tie to the company is a computer. If you will be handling returns, it may be necessary to rent a storage unit, office space, or even co-working space to handle these eCommerce returns.
Private label drop shipping
Some drop shipping suppliers even allow you, the retailer, to project the status of an established brand. This is achieved through custom printing and on-demand production. When your customer orders, the supplier will start the production line and manufacture your product on demand. If you want to drop ship private label products, or products labeled and packaged with your company’s branding, you will need to partner with an on-demand supplier.
Are There Drawbacks to Drop Shipping?
According to Google Trends, awareness around the drop shipping model doubled in 2016 after years of stagnation. Interest in January 2020 was nearly nine-times higher than in January 2016, and it is a growing global trend. Although the consumption of goods has not slowed, the marketplace has shifted from brick and mortar to eCommerce. This is especially true after the COVID-19 pandemic. ECommerce has allowed for the true decentralization of market share. Consumers are now spreading their budgets over many sellers instead of shopping at only a few retailers.
Lack of unique selling proposition (USP)
Although drop shipping can allow for minor product customization, the extent of this customization is very limited. Unless you are driving enough revenue for the supplier, your product will be functionally identical to the supplier’s many other drop ship customers. If your product cannot stand out as unique when compared to the competitive landscape, you will likely be forced to compete for the lowest price.
Insufficient quality control
All manufacturers experience a percentage of defective finished goods, even if less than one percent. In the past, manufacturers would inspect for quality with the knowledge that the retailer will also scrutinize when unpacking. When retailers forfeit this direct oversight of quality assurance, manufacturers may relax their standards resulting in more defective products. This can threaten your business as returns will almost certainly increase.
Since mass production leverages economies of scale, suppliers offer discounts for high quantity orders. The economic exchange for low-scale production when drop shipping is a higher unit cost, thereby reducing your margin.
Out of stock
Turning over the inventory management responsibilities to a supplier can also mean blind faith on the oversight and communication of inventory levels for goods you sell on your website. If a customer orders a product that is out of stock, it can be a frustrating experience for all parties. It is best to discuss inventory management during partnership negotiations and have a procedure in place for refunds or replacement.
Myths of the Drop Ship Dream
When researching the best model to use when starting a business, you will find no shortage of people trying to convince you their methods will certainly mint you an easy fortune. Most of the self-help gurus and business coaches have made the majority of their money selling their services, not selling a product in the manner they promise you will succeed in. That has created a lot of interest in drop shipping but also led to significant myths that should be busted.
Passive income machine
It is a common belief that drop shipping is a viable way to get rich quick. Unfortunately, drop shipping is a business model where this is not the case. Despite the ease with which you can list products for sale on your site, you will still need to attract the traffic for a meaningful conversion rate. It can take a substantial advertising budget and a lot of time to build a brand customers can trust.
Eliminate the middleman
Although it is often the case for a drop shipper to be the manufacturer of the products, some wholesale distributors also offer to drop ship products they purchased from the manufacturer. This means that the wholesaler will add a profit margin to the manufacturer’s unit cost and therefore limits your potential profit. The middleman can be an attractive partner if they handle returns, offer customization services, or add value in another way.
You cannot customize drop shipped products
It is another common myth of drop shipping that the product will be indistinguishable from your competitor who partners with the same supplier. Although it is a common occurrence for the products to be uniform, some suppliers offer customization. It’s even possible that your manufacturer is capable of providing the experience you envision for your customer.
All third-party fulfillment services are drop shippers
You may assume that all fulfillment or 3PL companies offer drop shipping services, but this is not true. If you’re asking yourself “what is a 3PL?”, it’s a company that handles the storage, fulfillment, and timely delivery of your inventory. The difference here is that 3PL fulfillment companies do not take on the risk of owning the inventory. This is why it’s more likely you will find a drop ship partner that is a manufacturer.
Is Drop Shipping the Right Business Model?
When you consider starting a physical product business there are many methods to choose from. Depending on your desired industry, product, and budget, you will be able to limit your approach to building your company. Here are a few examples of the alternatives to the drop ship business model:
Research and development
If you have a genius idea for a new product, it’s likely going to require you to take on risk when having it manufactured. Manufacturing a new product, will require you to invest substantial capital to reach a finished product, manufacture, and stockpile inventory. Suppliers who participate in drop shipping are already exposing themselves to risk and presumably unwilling to add the uncertainty of innovation and inventory to their risk profile.
In economics, arbitrage is the practice of profiting from the difference in the purchase and sale price of an asset. Retail arbitrage is the exploitation of a price discrepancy between various supply channels. For example, if customers on eBay are willing to pay $2 for a product you can purchase from a dollar store, you will be profiting from retail arbitrage. Amazon arbitrage is one popular place to use this method.
Private label brand
The reason why people are willing to pre-order the next iPhone before ever seeing it is because they trust Apple will provide a quality product. This is why brand equity, or the value in how a company’s brand is perceived in the marketplace, is so important to the bottom line. When you private label or white label products, you differentiate from your competitors with your brand name and packaging.
The Drop Ship Technology Stack
Supplier search engine
The first tier of technology in the drop shipping ecosystem is the line of communication between you and a potential supplier. For example, AliBaba allows you to find products, pricing, minimum order quantity, and verifies the manufacturer. AliBaba’s sister company, AliExpress, is also another great tool for finding a supply partner. You can use these resources to limit your search to suppliers actively drop shipping. Most eCommerce platforms have added tools to let you find drop shipping suppliers within their systems.
Point of sale
Once you have a reliable supplier willing to drop ship products directly to your customers, you will need a gateway for these customers. You can choose to build your brand’s website with an eCommerce platform or utilize a marketplace platform, or both. Shopify is a great tool for building eCommerce websites with built in payment processing and fraud detection, as well as seamless integration with fulfillment services. If you think your target customer is more likely to buy from a marketplace like Amazon, eBay, or Etsy, then it will be more beneficial to optimize for these platforms.
Integrating automatic emails after the order has processed is another crucial component to drop shipping. When your customer successfully makes a purchase, this order needs to be immediately routed to your supplier for seamless fulfillment. It’s possible your customer is not aware of your detachment from the fulfillment process and although you want to be transparent, if the process is seamless it will be indistinguishable from the processes of the past. Tools like Ordoro and Modalyst are powerful tools to handle email workflow.
Customer relationship management (CRM)
Since you are relinquishing the fulfillment of your products, you will be able to focus more time on customer service. In some cases, however, you sacrifice the customer experience because you have surrendered product fulfillment, resulting in more returns and dissatisfied customers. It’s best to always have a clear and open line of communication for your customers to contact you. Customer Relationship Management (CRM) tools will aid in this process. There are free CRM tools available like the one from HubSpot. They scale up to the enterprise level, like Salesforce.
Tips When Starting a Drop Shipping Business
Research industry and niche
When you are investigating what product you plan to sell, you will want to research and target a small subsection of the larger market. As you research your niche, try to evaluate issues that are likely to impact your sales, and assess the likelihood of overcoming those issues. For instance, you will want to ensure your customer base is not particularly brand sensitive, in other words, how likely are they to buy from a brand that has not yet established trust. It is also a good analysis to see what the average price your niche product is selling for and get multiple quotes from suppliers to estimate your gross margin.
Negotiate with suppliers on unit economics, shipping terms, etc.
Once you have chosen a product or market in which you plan to sell, you will likely begin the process of choosing a drop shipping supplier. When dealing with a potential partner, the first discussion is typically about pricing. In his book Never Split The Difference, Chris Voss suggests when negotiating on price to suggest a very precise number since this will likely be perceived as calculated and inflexible. Another important question for your supplier is whether or not they provide drop shipping services. Other areas you will want to discuss include quality control, returns, inventory management, and customization.
Choosing your go-to-market strategy
When deciding what channel you will sell through, you will want to research your ideal customer’s purchasing habits. Assess if your customer is more likely to shop on Amazon, eBay, or an unknown site. You will want to think about transaction fees, listing fees, and subscription fees. For example, Shopify charges a monthly subscription fee and transaction fees to accept payments.
Follow all laws and best practices when starting a company
Despite how seemingly apparent this point may be, it’s important that you use extreme caution and attention to detail when forming a business. Corporate structure, taxes, permits, and licenses are among the many legal concerns you will need to research in your city, state, or country, and any regions you may be selling products.
Advertising and promotion
The often forgotten, or at least postponed, challenge when starting a business is how you will attract prospective customers to your store. It’s best to have a basic marketing plan to outline how customers will find their way to your listings. If you have chosen a platform such as eBay or Amazon, you can take advantage of their built-in advertising tools. Other advertising platforms also exist for selling through your own website. For example, you can use Facebook and Google to advertise your website. Advertising costs should also be taken into account when estimating your net profit margin, which is the percentage remaining after all expenses, interest, and taxes have been deducted.
Frequently Asked Drop Shipping Questions
To ensure your customer receives the highest level of service, it is recommended you communicate directly with the customer. If you are working with a manufacturing partner to drop ship your orders, they are also likely ill-equipped or unwilling to handle returns. Manufacturers have experience shipping case-packed pallets of goods versus individually packaged shipments. Returns can be a complicated process for drop shipping businesses, especially when you, your supplier, and your customer are all in different locations. A system to handle returns is something you will need to have in place and may require further discussion with your supplier.
When you partner with a drop shipping supplier, you are relying on their quality checks to identify defective products before they are shipped. This can become a major pain point for your business if the manufacturer does not conduct regular checks for quality or feel responsible for defective units. If you begin to see an increase in returns, you must communicate these concerns to your manufacturer. It’s a good idea to routinely order a unit to check on the full user experience, including fulfillment time and product quality.
In many cases, the manufacturer will have taken product images and may be able to provide you with descriptions. These may be great as placeholders, but will likely need to be updated. Finding a freelance photographer with product photography is easy with sites like Freelancer, Fiverr, and Upwork. If your supplier is from another country, you can expect the product descriptions to read as such. Once you have had the chance to use the product yourself, you will likely be able to write the description. You can also find a freelance copywriter to craft an enticing description of your product.
The major shipping providers today deliver to most of the countries in the world. Most of these major countries have customs agencies when importing international goods, which adds risk that your package will be delayed if not seized entirely. The U.S. Customs and Border Protection warns that international imports are your responsibility and liability. Be sure to review each country’s required declarations before shipping there.
Most often the supplier will invoice you for all shipping costs relevant to your business. It is your decision if you will incentivize prospective customers by offering free shipping. Many eCommerce businesses choose to let the shipping costs trickle down to the customer. Shipping terms and costs should be clearly communicated and reviewed with your supplier. It’s possible a supplier lacking ethics could invoice you for a premium shipping rate when they actually use the most basic shipping option.
Yes, drop shipping is completely legal. There are some issues to be aware of, however:
– Vet your drop shipping supplier carefully. If the supplier is doing something illegal, such as violating another brand’s copyright, it may impact you. You might even have some legal liability (responsibility) for selling the drop shipped products.
– Make sure your drop shipping business complies with the rules of your eCommerce platform. Amazon and eBay don’t allow drop shipping arbitrage. While this isn’t a legal issue, it could get you kicked off the platform.
Although drop shipping is a great way to test a new product or supplier, it has limitations as a viable long-term business model. As the marketplace gets saturated with competitors, it’s likely you will be forced to compete on price. Unfortunately, the drop shipping model is not conducive to a low price strategy with the inherent high cost of goods. Once you have proven you can reach the target market with your product, it may be in your best interest to transition to a private label strategy and partner capable of 3PL services like Red Stag Fulfillment.