As online shopping continues to skyrocket, e-commerce businesses are seeking ways to drive profitability while keeping costs low. That’s where one type of business model, drop shipping, comes into play.
What Is Drop Shipping?
Drop shipping is an agile business model where products are shipped directly from a wholesaler or manufacturer to the customer. While the retailer places items for sale on their website, they aren’t responsible for holding or handling inventory. Instead, the seller only pays for the inventory once a product is purchased on their e-commerce site. That means the distributor or manufacturer takes ownership of the warehousing and fulfillment processes in place of the seller.
Understanding Drop Shipping: How It Works
For certain e-commerce stores, drop shipping offers a cost-effective way to sell products without assuming the burden of handling fulfillment or physical inventory. Let’s break down how it works. When a customer visits your website and places an order, your sales automation software will transmit purchase details to your drop shipping distributor, manufacturer, or wholesaler.
Once received, your drop shipping partner will pick, pack, and ship the order, eliminating the complex, labor-intensive, and costly process of handling fulfillment in-house. While you might expect the drop shipper to be the product's manufacturer, wholesalers also engage in drop shipping, providing an added dimension of customization.
Consider this scenario: you’ve launched a new apparel brand specializing in printed tees. The conventional approach involves bulk ordering with pre-printed designs, risking unsold inventory. Alternatively, you could partner with a drop shipping service that provides t-shirt printing on-demand, eliminating the need to stock shirts, decide on sizes in advance, or incur printing costs until a shirt is sold. Essentially, when a customer orders one of your t-shirt designs, the fulfillment process, including printing, is seamlessly handled by your drop shipping partner.
From the customer’s perspective, the purchase will seem like any other online order they place. In other words, they won’t know drop shipping is happening behind the scenes. They’ll communicate directly with the seller during the order process and if any concerns arise.
Benefits of Adopting a Drop Shipping Business Model
1. Minimize Capital Needed Up Front
Launching an e-commerce drop shipping business typically eliminates the need for processes like research and development, product manufacturing, and inventory storage. Circumventing these operations can significantly lower the capital needed to launch your business. Instead, your expenses will revolve around the legal requirements of forming your company, technologies integral to operating your business, and the platforms needed to market your line of drop shipped products.
2. Low-Risk Product Validation
Adopting a drop shipping business model presents a distinctive advantage: the opportunity to dip a toe in the water before taking the plunge. In other words, if you’re hesitant about whether a product (like a certain t-shirt design) will be profitable, you can introduce it to the market and list the item for sale without having to invest in physical inventory. With drop shipping, you’ll only be charged for goods once a customer places their order.
While it’s worth noting that drop shipped merchandise carries a higher price-per-unit than stock purchased in bulk, your exposure to financial risk is minimal, as you avoid investing in unsold inventory. Similarly, you have the flexibility to assess your supplier's quality via drop shipping. If consumers are receiving defective or poor-quality merchandise, you can procure a new supplier without having boxes of defective products on your hands.
3. Drop Ship From Anywhere
Unless you’re overseeing returns—which typically requires storage or office space—you can opt to utilize a supplier to handle reverse logistics. That means you’re not tied to any physical location to operate your e-commerce drop shipping business. All you need is your computer, and you can manage your business from anywhere.
4. Create A Brand Identity via White Labeling
Some drop shipping suppliers offer white labeling services. This means they will rebrand the product—a.k.a. customize it with your logo, company name, etc.—to look like the product came directly from you, including custom packaging. White labeling carries an extra cost but allows your company to develop a unique brand identity to help foster customer loyalty and repeat business.
The Disadvantages of Drop Shipping
1. It’s a Highly Competitive Marketplace
There are hundreds of thousands of other online retailers leveraging the drop shipping model and offering the same types of products as you. To be successful, you’ll need to invest in marketing, advertising, and website design to ensure your brand is memorable, unique, and stands out among competitors.
2. There’s No Real Unique Selling Point
While there are some opportunities for customization of drop shipped products, it’s incredibly limited. Functionally, your merchandise will be identical to the loads of other customers working with your supplier. If you don’t have a strategy to separate yourself from competitors, you’ll be forced to compete for business based on the lowest price offered, which can hurt your chances of being profitable.
3. Inferior Quality Control
Defective goods are unavoidable in manufacturing, but effective quality control can identify and remove most defective items from the supply chain. However, when items are drop shipped directly from the supplier to the end consumer, the lack of intermediary inspections may lead to a higher return rate due to potential quality issues.
4. Smaller Profit Margins
Mass production benefits from economies of scale, which allows suppliers to provide discounts for large-quantity orders. In drop shipping, however, you’re purchasing items in small quantities, buying inventory only once a sale is made. The result? Higher wholesale prices and thinner profit margins.
5. Stockouts Aren’t Uncommon
You're relinquishing control over stock visibility by delegating inventory management to a supplier. Stockouts can negatively impact the customer experience—leading to poor reviews and loss of business. It's advisable to address inventory management and establish clear communication channels with your supplier before finalizing your partnership. As your business gains sales history, you can share demand forecasts with the supplier to ensure optimal inventory levels.
Beyond Drop Shipping: Fueling Your Success
Drop shipping offers a cost-effective way to assess new products or suppliers. From a long-term business perspective, however, it can truly limit your success. It’ll become difficult to compete on price alone when each item sold carries a high wholesale price. The most strategic approach you can take is to leverage drop shipping to find and reach your target market.
Once you’re established, partnering with a third party logistics (3PL) provider will allow you to implement solutions designed to increase revenue, strengthen the customer experience, and drive repeat business. To learn more about how the Smart Warehousing team can create a custom strategy to fit your e-commerce goals, contact us today.