Drop shipping is one of the newer ways to support a full catalog and e-commerce businesses and is becoming a go-to as businesses expand. You’ve likely been Googling the term to see if it fits with your business model and if it could save you money.

Drop shipping is often a good choice for businesses as they launch, start to grow, or diversify their product lines, but there are many considerations that need to be made to see if it’s right for your company. We’ve put together this primer to help companies find the answers they’re looking for, without a sales pitch or an attempt to dissuade you from doing what’s best for your business.

The Drop Shipping Model

What Exactly Is Drop Shipping?

Drop shipping is a fulfillment service where your business doesn’t actually own the physical product you’re selling.

You are essentially acting as a middleman, where customers visit your store, catalog or website and place an order. After the order is placed, you pay a third-party (your drop ship fulfillment or manufacturing company) to ship the item directly to your customer. Your profit is the difference between the price you sell the item for and what you pay for it wholesale plus shipping.

It’s a pretty unique shipping and fulfillment model. You might’ve experienced it with things you’ve bought online because packages are typically shipped under the name of the store, not the company who does the fulfillment.

3 Steps to Drop Shipping

Drop shipping is a very simple process, which is appealing for many businesses who want to try out a new product line or need to operate on a very lean budget. The entire ordering process can take as little as three steps:

  1. A visitor makes a purchase order with you. Typically, this is on your e-commerce site, but it can also happen through catalogs and phone calls.
    • Let’s say you use a drop shipping model to sell a couch for $500. You can list that couch on your website, or offer it for order in your furniture store, without having to carry the couch as inventory or buy it ahead of time.
  2. When an order is placed, you process the payment, and then you forward the order to your drop shipping fulfillment partner or manufacturer.
    • Your customer pays you $500 for their order, and you, in turn, place the order for their product with your manufacturer or fulfillment partner.
  3. The drop shipper charges you, packs the order, and sends it to your customer.
    • Let’s say it costs you $250 to buy order a single couch, and another $50 to ship. You’re going to make a gross profit of $200.

It’s a pretty unique shipping and fulfillment model. You might’ve experienced it with things you’ve bought online since packages are typically shipped to customers under the name of the store, not the company who does the fulfillment.

Benefits of Drop Shipping

3PL Model

  • Simplicity. You can run your business with much less effort and, sometimes, fewer employees. Drop shipping simplifies your process by removing the need to keep an accurate count of inventory, resupply or restock, manage a warehouse, pack-and-ship orders, or handle returns.
  • Lower Overhead. Your expenses for each unit tend to be higher than buying inventory in bulk, but you only pay for inventory that you sell. Everything is included in your cost of goods sold, making it easier to plan and work out of your office or home.
  • Expanded Product Range. Drop shippers often work with a wide range of products. You will typically be able to expand your sales to include these other products with minimal extra costs. You can also work with multiple drop shippers to offer a broad range of products without running into problems finding the space to store them.
  • Fewer Geographic Limitations. E-tailers using drop shippers can run their store from nearly any location with an Internet connection. That makes it easier to maintain a business if you move, travel, or go on vacation. You can also operate from a state that has favorable business laws, no matter where your drop shipper is located.
  • Easy Scaling Early On. The hardest part about scaling a business early in its life is affording the workforce to grow and diversify products, or offer the same products to more customers. Using a drop shipper will put the majority of this burden on your fulfillment partner, while you focus your investment on customer service.

Growing with Drop Shipping

One reason companies are turning to drop shipping is that they’ve identified a small area of growth for their business, which they want to offer without having to make a significant investment. Imagine a company that sells vacuum replacement parts. Their new website also offers some extremely high-end vacuums, hoping to capitalize on the customer trust they’ve built by selling reliable replacement parts.

Since only one or two people may be the high-end vacuum each quarter, there’s little incentive to carry a large stock. By using a drop shipper, the company can sell the vacuum and then have that fulfilled by the drop shipper.

Each sale isn’t as high-margin as it would be if the company outright owned the vacuum, but it avoids all of the extra space the product requires (not only storing each unit for long periods but also its unique packaging and boxing elements that likely wouldn’t fit its standard small-parts delivery).

Are There Disadvantages to Drop Shipping?

Drop shipping is a top method for many online stores to test expansion options, so it is well suited for start-ups. However, it does have its disadvantages, and these grow more pronounced as your business begins to get larger.

Here are some of the chief disadvantages to consider for drop shipping:

  • Low Margins. The margins for using a drop shipper tend to be relatively small, averaging roughly 20%. Low margins can make it hard to grow when you’re paying for other expenses to manage your website, perform customer service, and market your business. You’ll also face plenty of competition from larger retail businesses or even the manufacturers themselves who can afford slimmer margins.
  • Customer Experience Concerns. The customer’s experience is at the heart of your brand’s reputation. Using a drop shipper does little to differentiate your business and often they’ll ship generic packages without specific branding. If your partner doesn’t have a quality control guarantee, you could see significant harm to your brand due to returned items, incorrect shipments or damaged goods.
  • Differentiation Is Difficult. If you can use that drop shipper, so can your competitors. You will typically have to compete as a commodity, which makes price your biggest differentiator. There’s only so much you can cut, meaning your pricing is likely to be along the same lines of your competition.
  • Reduced Inventory Control. If you handle your own stock or maintain your inventory with a high-quality fulfillment partner, then you know what you have and when you need to reorder. When you work with a drop shipper, you typically won’t have visibility – and this becomes more of a concern when using multiple drop shippers. That means you may run into problems with inventory shortages that you didn’t see coming, causing backlogs and harming your business.
  • Costs Can Increase. Shipping three items in one box to your customer comes with one cost. Sourcing three items from three different warehouses and shipping them in three different packages comes with three costs. You’re only charging your customer a single shipping fee, meaning that you have to absorb all of those extra charges. The more charges, the slimmer the margin becomes.

So, Is Drop Shipping a Good Idea?

Answering that question really depends on your business’s current efforts and growth path. If you find yourself struggling to manage inventory and get shipments out the door on-time, or if your customers want access to more products than you can reasonably afford to stock, it can be a good time to consider drop shipping.

Also, if you are competing largely on price in your current operation, then drop shipping can be a good idea. It will take care of many headaches. The main trade-off to consider is that your brand experience will only be linked to the website.

Remember that customers are expecting more out of the delivery process for high-end goods and from growing brands. YouTube notes that there are millions upon millions of searches for unboxing videos that are based entirely on how a product arrives. We say this just to let you know that the drop-shipping decision making is about balancing your brand goals today with where you want to take your company tomorrow.

Growth and Branding: When Should I Stop Drop Shopping?

There are a few broad categories of retailers and e-tailers who might not be well-suited to drop shipping, based on our experiences and those of our customers. These categories are a little broad because some brands who fit each section may be successful with drop shipping if they are able to identify other competitive advantages that they make core to their business.

Custom Products: Any time a product needs to be customized, you may face additional costs from your drop shipper. Some may not support customization while others can charge more for the assembly process. If you want to grow into creating custom products or packages, drop shippers may not be able to support your demands.

Experienced-Focused Brands: This type of brand is best thought of as the monthly supply/subscription boxes that are the current kings of social media. Everything is specifically selected and packaged together to create an appealing combination – often with a mix of high- and low-margin goods. Packaging is what creates a unique value proposition for these brands, but most drop shippers can’t support rotating customized combinations in specific packaging branded for you.

Margin-Sensitive Businesses: Brands that rely on drop shipping fulfillment typically have margins between 10% and 20% on each sale. Now, add in the cost to advertise, pay transactional fees, have the software to run your business, and perform customer service. Profits can drop into the single digits. This isn’t bad if you’re hitting a multi-million-dollar sales figure, but would be hard to run if you’re not.

Growing Businesses with Tested Products: One of the biggest benefits of drop shipping is the ability to expand your product offering quickly and easily. It allows you to offer complementary products or test out new offers with minimal risk. However, if you’re planning on creating custom offerings or expanding on your existing models (even if they’re just product combinations), you may run into difficulties with finding a single partner who can source your expansion.

You also can be limited in your expansion by what your drop shipper has to offer if you want to keep everything in the same package. Your drop shipper partners can control – and sometimes limit – your growth opportunities by restricting where you can expand your offering.

This article was originally posted at Red Stag Fulfillment