What Is Dropshipping?
Dropshipping (or drop shipping — both are correct) 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 by placing items for sale on its website. The retailer pays for inventory only after a customer buys the item on its sales platform. In this business model, the manufacturer or distributor, not the retailer, takes responsibility for warehousing and eCommerce fulfillment.
The practice of dropshipping 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 2023 drop-ship business model is similar to the JIT supply chain and goes even further by eliminating expensive inventory transportation and storage costs for retailers.
How Does Dropshipping Work?
It’s safe to say that dropshipping works well in 2023, and continues to be a very profitable way of running an ecommerce business. The way it works is when a customer orders through your website, your sales automation software routes it to your drop shipping 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, wholesalers also drop ship products and even offer customization. For example, let’s say you start an apparel brand that sells printed t-shirts. You could go the traditional route, ordering hundreds of shirts with your screen-printed designs, but you risk some of your designs not selling well. Instead, you could work with a dropshipping partner that offers on-demand t-shirt printing. When customers order one of your t-shirt designs, the order goes to your partner to print and fulfill. You don’t have to stock shirts, worry about which sizes to buy, or pay for printing until you sell a shirt.
What Is A Drop Ship Order?
A drop ship order is any order that goes through the fulfillment and delivery process described above. Each drop ship order has three important parties:
- Customer A: The customer purchasing from Seller B.
- Seller B: The marketplace or website selling products to Customer A and buying them from Provider C.
- Provider C: The manufacturer or wholesaler who receives a purchase order from Seller B and ships the products in that order to Customer A.
From the customer’s perspective, they generally can’t tell they’ve made a drop ship order. They’ll interact directly with the seller throughout the process. The seller will also provide all the support for the customer if there’s a shipping concern. The only real clue that this is a drop ship order is if the shipping label mentions a company name different from the seller.
4 Benefits of the Drop Ship Business Model
1. You Can Start a Drop Shipping Business with Minimal Capital
When you start a drop shipping eCommerce business, you typically don’t need to research and develop a new product, manufacture the product, or stockpile inventory. That lowers the capital requirements for starting your business — your expenses will primarily relate to the legalities of business formation, the technologies required to operate your company, and the platforms where you will market your drop shipped product line.
2. The Drop Ship Business Model Allows Low-Risk Product Validation
Drop shipping offers the unique advantage of testing the waters before diving in. If you are uncertain whether a shirt design will sell, or any product for that matter, drop shipping lets you list the item for sale without investing in inventory. You only pay for merchandise if consumers buy your product.
Although the wholesale price of drop shipped products is generally higher per unit than stock you purchase in bulk, your overall financial risk is limited because you don’t invest in inventory that doesn’t sell. Drop shipping is also a great way to test the quality of a new supplier — if you find the products are defective, you can drop the supplier, and you won’t be stuck with hundreds of units of defective merchandise.
3. You Can Manage a Dropshipping Business from Anywhere
If you handle your own returns, it may be necessary to rent a storage unit, office space, or even co-working space to manage drop shipping returns. However, if you partner with a supplier that handles reverse as well as forward logistics, your only physical tie to your dropshipping eCommerce company is a computer. That frees you to manage your business from anywhere. Dropshipping eCommerce can be an excellent business for a digital nomad.
4. Private Label Dropshipping Can Help You Grow a Brand
Some dropshipping suppliers even allow you to develop a distinct brand through custom printing and on-demand production. When your customer orders, the supplier starts the production line and manufactures your unique product on demand.
Another way to build a brand through drop shipping is a private label. A white-label company that provides drop shipping services can deliver products in your branded packaging. You might have to pay up front to print the packaging, but that’s a small investment compared to the cost of buying and warehouse stock.
5 Cons of Drop Shipping
Drop shipping can be a terrific way to start an eCommerce business, particularly if you’re bootstrapping and don’t have a lot of cash to invest. But it’s not a free ride. Expect to put in some work to overcome the challenges of the drop ship business model and build a profitable operation.
As your business grows, you may find it makes more sense to move it to a more traditional supply chain. However, if you know the drawbacks and prepare for them, you can succeed with a drop shipping business.
1. The Drop Ship Marketplace Is Highly Competitive
You aren’t the only online retailer sourcing products from your drop shipping supplier. Hundreds or thousands of other online stores offer the same products, so you have to get creative to stand out from the competition. Some of the money you save by not buying stock will need to go to marketing and website design to make your business stand out from the crowd. You can also set yourself apart by sourcing merchandise from several different drop ship suppliers and offering a unique product range.
2. Drop Shipped Products May Lack a Unique Selling Proposition (USP)
Although drop shipping can allow for minor product customization, the extent of this is very limited. Unless you drive a large amount of revenue for the supplier, your product will be functionally identical to those of the supplier’s many other drop ship customers. If your product doesn’t stand out in the competitive landscape, you will likely be forced to compete for the lowest price.
3. Quality Control for Drop Shipped Products Is Difficult
All manufacturers have some percentage of defective finished goods. With good quality control, a factory can pull most or all defective items from the supply chain. In the past, manufacturers would inspect for quality with the knowledge that the retailer will also scrutinize each product when unpacking an order. However, drop shipped items go directly from the supplier to the end consumer, so the manufacturer has less incentive to do a thorough inspection. Drop shipped goods can have a higher return rate because of this.
4. Drop Shipped Items Have Thin Margins
Mass production leverages economies of scale, and suppliers offer discounts for high-quantity orders. In the dropshipping eCommerce model, you buy items in quantities of one or a few at a time, so your wholesale price will be higher. The tradeoff for buying only the merchandise you sell is thinner profit margins. In some cases, dropshippers can find suppliers that offer higher margins. For example, Tanya Zhang, founder of Beautiful Chopsticks said, “depending on the product, margin can vary between 30-50%. From dropshipping, we can make around a 5-to-6 figure business depending on the year. I also have a separate direct-to-consumer e-commerce business that is inventory-heavy that also makes over 6 figures but requires a lot more capital for inventory and overhead costs.”
5. Products Going Out of Stock Is More Common with Dropshipping
Turning over the inventory management responsibilities to a supplier also means blind faith in their inventory management for goods you sell on your website. If your 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 set up robust communications channels. Once your business has some sales history, create demand forecasts to share with your suppliers to help them maintain adequate inventory levels.
Debunking Dropshipping Myths
When you research the best model to use to start an eCommerce business, you will find no shortage of people trying to convince you their methods will mint you an easy fortune. But most of the self-help gurus and business coaches have made their money selling services, not products, to consumers. Advice from eCommerce business “experts” has created interest in dropshipping but also led to misperceptions about the business model.
Dropshipping Is a Passive Income Machine
It’s a common belief that dropshipping is a good way to get rich quick. Unfortunately, this is not the case. It’s true that dropshipping makes it easy to list products for sale on your site, but you still need to attract enough traffic to support your desired sales volume. Building a brand that consumers trust can take a substantial advertising budget and a lot of time in the crowded online retail space.
Plus, once you get consumers to your site, you need clear, appealing product listings, competitive pricing, and an easy-to-navigate checkout process to drive conversions.
You Can Eliminate the Middleman
Although it is often the case that a drop shipper is also the manufacturer, some wholesale distributors will also drop ship products purchased from manufacturers. These wholesalers add their cut to the manufacturer’s unit cost, leading to a higher wholesale price for you. A distributor or wholesaler middleman can be an attractive partner if it handles returns, offers customization services, gives you a wider range of products to choose from, or adds value in another way.
You Cannot Customize Drop Shipped Products
Another common myth of dropshipping is that your products will be indistinguishable from those of your competitors who partner with the same supplier. Although drop shipped products are usually standardized, some suppliers offer customization. Your manufacturer might even be able to offer the custom experience you envision for your customer.
All Third-Party Fulfillment Services Are Drop Shippers
You may assume that all fulfillment or 3PL companies offer dropshipping services, but this is not true. A 3PL, or third-party logistics provider, is a company that handles storage, order fulfillment, and shipping for eCommerce companies. In general, fulfillment companies do not take on the risk of owning the inventory, so you’re more likely to find a drop-ship partner that is a manufacturer.
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Is Dropshipping the Right Business Model?
When starting a physical product enterprise, you have many business models to choose from. Your target product niche, markets, and budget will determine the optimal approach to building your company.
Here are a few alternatives to the drop ship business model that every aspiring eCommerce entrepreneur should consider.
Original Product Development
If you have a genius idea for a new product, you’ll need to set up a manufacturing supply chain to deliver your merchandise to market. Expect to invest substantial capital in developing a finished product, manufacturing stock, and building up inventory. You’re not likely to find a dropshipping partner willing to take on the expense and risk of manufacturing and storing an untested product.
In economics, arbitrage is the practice of profiting from the difference between 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 make $1 on the sale from retail arbitrage. Amazon arbitrage is one popular example of this online retail strategy.
Private Label Brand
People are willing to pre-order the next iPhone sight unseen because they trust Apple to provide a quality product. Brand equity, or the perception of your company’s brand in the marketplace, is critical to your bottom line.
In the private label business model, you take products that were developed and manufactured by others and differentiate them from those of your competitors using your brand name and packaging. One example of this is the Trader Joe’s supermarket chain, which, in addition to manufacturing its own goods, sells various private-label products from other producers. People who know and trust the Trader Joe’s brand are more likely to buy those products.
The Drop Ship Technology Stack
Dropshipping, like all online retail, is as much about IT as it is about physical consumer goods. Putting a robust drop ship technology stack in place is vital to the success of your dropshipping company.
Supplier Search Engine
The first technology you need is a search engine for finding dropshipping suppliers. For example, the AliBaba platform allows you to search for products, pricing, and minimum order quantity while verifying the manufacturer. AliBaba’s sister company, AliExpress, is also a great tool for finding a drop ship supply partner. When you search on these sites, you can limit your search to suppliers actively doing drop shipping. Many other eCommerce platforms have added tools to let you find dropshipping suppliers within their systems.
Point of Sale
Once you have a reliable supplier willing to drop ship products directly to your customers, you need a gateway to market those products. You can build your brand’s website with an eCommerce platform, use a marketplace platform, or both. Shopify is a great tool for building eCommerce websites, with built-in payment processing and fraud detection. If you think your target customer is more likely to buy from a marketplace like Amazon, eBay, or Etsy, then that’s your starting point for your dropshipping business.
After a customer makes a purchase, your software needs to immediately route the order to your supplier. You’ll need to test integrations to ensure that your order management software communicates seamlessly with your dropshipping supplier so there’s no delay in orders shipping to your customers. Supplier communication may be the most important element in your backend tech stack because fast order fulfillment is crucial to eCommerce success.
Customer Relationship Management (CRM)
Since your supplier handles product fulfillment, you can focus more time on customer service. The dropshipping business model can result in a higher return rate than traditional eCommerce, so excellent customer service is vital. Use CRM software to give your customers a clear and open line of communication to contact you if they have questions or problems. CRM apps range from free software to enterprise-level tools, so you may need to adopt new applications as your business grows.
Tips When Starting a Dropshipping Business
There’s a lot to do when you start a dropshipping business. Here are five essential tips to help you build a solid foundation.
Research Your Industry and Niche
When you begin exploring the products you want to sell, remember you’ll increase your chances of success if you focus on and target a small subsection of the larger market. As you research your niche, evaluate issues likely to impact your sales and assess the likelihood of overcoming those issues.
For instance, you will want to ensure that 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 good to analyze the average price your niche product sells for and get multiple quotes from suppliers to estimate your gross margin. Make sure you can sell at a profit before you invest time and money into setting up your sales platform.
Negotiate with Dropshipping Suppliers on Unit Prices, Shipping Terms, etc.
Once you choose a product to sell, you need to find the perfect dropshipping supplier. When exploring a potential partner, start with a discussion about pricing. In his book Never Split The Difference, Chris Voss tells businesses to suggest a very precise number when negotiating a price since your supplier is likely to perceive this as calculated and inflexible. Other areas you will want to discuss include quality control, returns, inventory management, and customization.
Choose Your Go-To-Market Strategy
Before you decide what channel to sell through, research your ideal customer’s purchasing habits. Is your customer more likely to shop on Amazon, eBay, or another site or marketplace? Understand transaction fees, listing fees, and subscription fees for the platforms you choose because those costs will come out of your profit margin. For example, Shopify charges a monthly subscription fee for a storefront, plus a transaction fee on each sale.
Invest in Advertising and Promotion
Perhaps the biggest challenge when you start a new online retail business is attracting prospective customers to your store. Before you launch, develop a basic marketing plan that details how customers will find their way to your listings. If you have chosen a marketplace such as eBay or Amazon, you can take advantage of their built-in advertising tools.
If you want to sell on your own website, you can use Facebook and Google to advertise your products. Consider advertising costs when estimating your net profit margin (the amount of money you have left after deducting all expenses, interest, and taxes).
Follow All Laws and Best Practices
It’s easy to forget that an online business is still a business and subject to local, state, and federal regulations depending on where you’re based and what you sell. Corporate structure, taxes, permits, and licenses are among the many legal concerns you will need to research in your city, state, and country of origin. For some products, such as alcohol or CBD, there may be limits on where you can sell and ship orders. Make sure you and your dropshipping supplier understand and comply with all regulations on your products.
Frequently Asked Drop Shipping Questions
Is Drop Shipping Legal?
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 could impact you. You might even have some legal liability for selling those products.
– Make sure your drop shipping business complies with the rules of your eCommerce platform. For example, eBay no longer allows dropshipping arbitrage. While this isn’t a legal issue, it could get you kicked off the platform.
Direct Ship VS Drop Shipping: What’s The Difference?
The core distinction when you think about a direct ship vs drop shipping business is about who controls inventory before a purchase.
In a direct ship model, one company buys and holds inventory directly before any customer orders those products. You would purchase inventory and store it — or use a 3PL like Red Stag to store it for you — sell it, and then ship it to the customer. You’re investing your own money in inventory, which requires more capital but typically yields larger margins. The downside is that you have to have the space to store goods and may end up paying more money over time if some products don’t sell quickly.
When you drop ship, you create a storefront but never need to worry about managing inventory. You sell products to customers. When someone makes a purchase, you turn around and buy that item from a wholesaler or manufacturer. Those companies then ship the goods to your shoppers. Thankfully, many integrations make this process instant.
So, from the customer perspective, not much seems different in direct ship vs drop shipping. From the business side, you’re spending less on inventory and may be able to achieve other benefits thanks to lower cost barriers.
Who Pays the Shipping Costs for Drop Shipped Orders?
Most often, the supplier will invoice you for all shipping costs relevant to your business. You can offer free shipping and eat that cost or charge it to your customers at checkout. Make sure you understand your supplier’s shipping costs and terms, so you can charge your customers and price your goods appropriately. Place periodic test orders from your online store to make sure that your supplier isn’t invoicing you for a premium shipping rate when they actually use the most basic shipping option.
Who Handles Customer Service and Returns in Dropshipping?
To ensure that your customer receives prompt, responsive customer service, the best practice is to provide this yourself. Your manufacturing partner is probably ill-equipped or unwilling to communicate about returns and customer service issues directly with consumers. Dropshipping returns can be complex, so make sure you have clear procedures in place with your supplier before you launch your eCommerce business. You’ll want a process for getting refunded if a customer returns an item, particularly if the return is due to a manufacturing defect.
Can I Use Special Packaging When Drop Shipping?
Whether you can use special packaging when drop shipping depends entirely on your wholesale or manufacturing partner. Your partner will discuss options for you and set any requirements. In cases where this is possible, typically, the company that ships these goods will require you to send any special packaging to them. That way, whenever you send them an order, they have this packaging in stock and can apply it. If that runs out before you resupply the company, they will likely switch to generic packaging.
Note that you will likely face an increased cost for using special packaging, even if you supply all of the materials. That is because the wholesaler or manufacturer will need to store these items and train their teams to use your materials only for your orders.
Do you want to use special packaging for every order to build your brand? It might be time to consider switching from a drop shipping model to a traditional sales model and relying on a 3PL like Red Stag to handle order fulfillment, including the special packaging.
How Do I Deal with Product Quality Issues in Dropshipping?
When you partner with a dropshipping supplier, you rely on its quality checks to identify defective products before they ship. If the manufacturer does not conduct regular checks for quality or feel responsible for defective units, defective merchandise can become a significant pain point for your business. If you begin to see an increase in returns, communicate your concerns to the manufacturer right away. It’s a good idea to routinely place orders yourself to check on the full user experience, including fulfillment time and product quality.
How Do I Handle Product Photography and Descriptions for Drop Shipped Product Listings?
In many cases, the manufacturer will have product images and may also be able to provide you with descriptions. That’s an easy place to start, but you’ll want to quickly replace those shots with your own product photography to make your product listings stand out. Find a freelance photographer that specializes in product photography.
Expect to rewrite your product descriptions to match your brand persona and voice and appeal to your target market. You can write the descriptions yourself or work with a freelance copywriter to craft enticing descriptions of your products.
Can International Orders Be Drop Shipped?
Most major shipping providers today deliver internationally, so drop-shipped orders can cross borders. However, international orders may need to go through customs, which can add to shipping time and cost. U.S. Customs and Border Protection warns that international imports are your responsibility and liability. Be sure to review each country’s required customs declarations and tariffs before shipping there.
Can I Do Dropshipping on Amazon?
Yes, Amazon allows dropshipping listings, as long as you comply with the marketplace’s rules.
Is Dropshipping a Pyramid Scheme?
No. Dropshipping is a valid eCommerce model where online retailers work with dropshipping suppliers to sell products. You can run a profitable store selling drop shipped goods without recruiting other sellers (as in a pyramid scheme) or even interacting with other sellers.
That said, some multi-level marketing (MLM) companies may utilize a dropshipping business model, where salespeople sell the product but the parent company ships product to customers. MLM can be seen as a pyramid scheme because sellers make more money by recruiting others to sell the product. However, MLM is not a typical dropshipping business.
Is Dropshipping Bad for the Environment?
A dropshipping eCommerce business doesn’t necessarily have a bigger carbon footprint than other online retail, so drop shipping isn’t bad for the environment.
In fact, the dropshipping model could have environmental benefits by reducing waste since sellers only purchase inventory they know they can sell. For instance, suppose 10 online retailers market the same SKU. In the traditional eCommerce business model, each of them orders 100 units of that SKU and, on average, has 20 units left over at the end of the season. That item goes out of fashion and 200 units end up in the landfill. In the dropshipping model, each online retailer would only order what they sold and, if the manufacturer manages inventory well, fewer units will get trashed at the end of the season.
On the other hand, packaging can be a significant source of eCommerce waste. Since you have little or no control over how your products are packed and shipped, dropshipping could appear less environmentally conscious. Work with your dropshipping suppliers to ensure that they follow best practices for sustainable packaging.
Although dropshipping 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, you will be forced to compete on price. Unfortunately, the dropshipping model is not conducive to a low price strategy because you pay a higher wholesale price for each item.
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 with a capable 3PL like Red Stag Fulfillment.
What Is Dropshipping?
- – How Does Dropshipping Work?
- – What Is A Drop Ship Order?
4 Benefits of the Drop Ship Business Model
- 1. Start with Minimal Capital
- 2. Low-Risk Validation
- 3. Manage from Anywhere
- 4. Private Label Dropshipping
5 Cons of Drop Shipping
- 1. Highly Competitive
- 2. Lack a Unique Selling Proposition
- 3. Difficult Quality Control
- 4. Thin Margins
- 5. Out of Stock
Debunking Dropshipping Myths
- – Passive Income Machine
- – Eliminate the Middleman
- – Non-Customizable
- – Third-Party Fulfillment
Is Dropshipping the Right Business Model?
- – Original Product Development
- – Retail Arbitrage
- – Private Label Brand
The Drop Ship Technology Stack
- – Supplier Search Engine
- – Point of Sale
- – Order Processing
- – Customer Relationship Management (CRM)
Tips When Starting a Dropshipping Business
- – Research Industry and Niche
- – Negotiate with Suppliers
- – Choose Your Go-To-Market Strategy
- – Advertising and Promotion
- – Follow All Laws and Best Practices
Frequently Asked Questions