“Dropshipping.” Anyone who has ever looked into how online businesses work has probably come across this term.
Yet, even fewer people actually understand how it works.
To someone who is new to the online business world and looking to break into the eCommerce scene, the dropshipping process can seem a little intimidating as it can be difficult to find a reliable source that tells you everything you need to know.
WHAT IS DROPSHIPPING?
Dropshipping is a type of business model which enables a company to operate without maintaining inventory, owning a warehouse to store their products, or even having to ship their products to their customers themselves. How it works is that the retailer partners up with a dropship supplier that manufactures and/or warehouses products, packages the products, and ships them directly to the retailer’s customer, on the retailer’s behalf.
In simpler terms, this is how dropshipping works:
- The customer places an order for a product on the retailer’s online store.
- The retailer automatically or manually forwards the order and customer details to the dropship supplier.
- The dropship supplier packages and ships the order directly to the customer in the retailer’s name.
This kind of business model is extremely attractive as it eliminates the need for the store owner to have a physical business location such as an office space or warehouse—instead, all they need is a laptop and an internet connection.
Note: Many businesses that do own physical spaces (offices or warehouses) of their own also use drop shipping for some of their goods as it helps free up resources and space for other products.
PROS OF DROPSHIPPING
As a business model, dropshipping has several different aspects that prove to be beneficial, such as:
- It’s Easy to Set Up: It doesn’t take an entire village to set up since it essentially involves just 3 steps—find the supplier, set up your website and start selling the goods! To someone who is new to the eCommerce industry, this business model is relatively easy to understand and implement.
- The Cost of Setting Up Your Dropship Business is Next to Nothing: In traditional business models, the majority of the costs are related to setting up and running the retail operations, such as purchasing inventory. Since dropshipping eliminates that step, and thus the cost of it, all you have to pay for is the associated costs of running your website (hosting, theme, apps, etc.).
- You Don’t Have to Worry About Exorbitant Overhead Costs: As previously mentioned, the business owner is not required to purchase inventory thus the costs of renting or buying warehouse/office space and the other smaller yet substantial costs pertaining to it (electricity/phone bills, stationery, etc.) aren’t an issue. The fixed costs of managing the website is all that a business owner has to worry about.
- The Risk of Dropshipping as a Business Model is Significantly Lower: If the business doesn’t sell products it still doesn’t lose anything, so there is little to no pressure about having to sell your inventory.
- The Business Can be Run from Anywhere & is Location Independent: No office, no warehouse, no employees and no hassles. Little to no commitment to a physical space means that you could be sitting at a beach, sipping on mojitos while still turning profits. All you need is your laptop and the internet.
- There is Lots of Variety When it Comes to the Products You Want to Sell: There is a drop ship supplier for almost anything that you would like to sell! You can rely on one great product, sell several products at once or mix it up; it’s all up to you. Find your niche and there is bound to be a supplier that caters to it.
- More Time & Resources to Scale Your Business: In traditional retail business models, if you want more profits you have to do more work and invest that much more of your resource pool. With dropshipping all you have to do is send more orders to your dropship supplier and then let them handle everything else while you earn the profit and are left with more time to develop your business plans and scale!
- Reduced Losses on Damaged Goods: Since the shipment goes directly from the supplier to the customer, there are fewer shipment steps involved which drastically reduces the risk of damaged items while moving from one physical space to another.
CONS OF DROPSHIPPING
Just like everything in life, there are some disadvantages that come along with the many advantages of dropshipping. Here are a few cons to the dropship business model:
- Slightly Lower Profit Margins Comparison to Wholesaling or Manufacturing: Depending on your niche, location or requirements, suppliers and vendors will charge you higher prices for dropshipping products, which does eat into your profit margins.
- Complete Liability When Something Goes Wrong: Since the customer is purchasing the product from the retailer’s website if the supplier messes something up, it’s still the retailer’s fault as the brand is the face of the retail process. This is one of the reasons why it is incredibly important to choose the right supplier.
- The Brand has a Significantly Lower Level of Control: Customer satisfaction is often linked to the details—personalized packaging and branding of the shipped products, freebies and notes accompanying the order—its almost always the smaller things that count. Unfortunately, the dropshipping model seldom affords retailers the opportunity to control how their brand is presented during the delivery and fulfillment process as the supplier is the one who ships the products. However, there are some suppliers who may be willing to go that extra mile—be advised, it may cost you though.
- Certain Issues May Arise Due to Complexities with Shipping: selling multiple products may seem like a good way to drive up sales and make a substantial profit, but this could actually be counter-intuitive if the retailer has multiple suppliers for these products. Different suppliers will charge different shipping costs depending on factors like location, type of products, etc. If a customer orders multiple products that ship from different suppliers, the retailer will have to work out and pay the shipping costs separately. Transferring these varying shipping costs to the customer may negatively affect conversion rates, thus, in turn, impact the profit margins.
- Level of Competition is Relatively High: The attractiveness and popularity of the dropshipping business model mean more and more retailers in every segment and niche. Unless a retailer is catering to an extremely specific segment or niche, the competition could possibly be detrimental.
- Managing the Inventory Can be Tricky: keeping track of the stock of the supplier is nearly impossible. Miscommunications can cause issues such as cancellations and having to place orders on backorder. This aspect can, of course, be managed with software these days but those too come at a price and may increase your overhead and fixed costs
HOW VIABLE & PROFITABLE IS DROPSHIPPING?
Typically, the profit margins for dropshipping can range from 15%-45%. However, the profit margins for consumer durables and luxury items (for example, electronics, jewelry, etc.) can yield a profit margin of up to 100%. It’s about finding the right niche and supplier while entering a market that isn’t already overly saturated. A good way to ensure higher margins can be to source directly from a manufacturer instead of a vendor/supplier, thus effectively cutting out the middleman.
Once the business is off the ground and gains a little traction, it can quickly turn into a money-making machine that only requires minimum input. Successful dropshipping businesses such as that of Irwin Dominguez, an accountant turned eCommerce entrepreneur, have made USD $1 million in sales in just 8 months of launching the online business! This won’t be the case for every dropshipping business, but the potential exists.
AREN’T DROP SHIP MANUFACTURERS, WHOLESALERS & AGGREGATORS THE SAME?
No. Even though these terms are often used interchangeably in the eCommerce world, they aren’t the same. Let’s clear up the confusion:
- A manufacturer is someone who actually produces the products themselves. They may or may not have a dropshipping program, but the retailer is lucky if they do as it removes the hassle and inflated costs of the middle man, giving the retailer the best possible prices. These reduced costs translate to larger profit margins.
- A dropship wholesaler/supplier is someone who purchases one type of product from the manufacturer in bulk and helps to package and ship it to buyers online through the retailer’s eCommerce businesses.
- A dropship aggregator, on the other hand, is someone who buys different products from multiple manufacturers to provide the retailer with a variety of products to sell. Several disadvantages of drop shipping can be solved when an aggregator is used—no multiple wholesaler shipping costs, less time sending out multiple orders to multiple vendors (therefore preventing a mix-up and delay in the orders and shipment)—however, do bear in mind that aggregators take a higher cut which could adversely affect your profit margins.
Who is Dropshipping For?
Dropshipping is a pretty great business model for a first-timer who is just dipping their toes into the online business world. It’s attractive to a novice as it’s a low-risk and low-investment way of starting your own business, thus, it doesn’t feel like so much of a gamble.
Since the amount of capital that needs to be invested into this business model is minimum, it is also ideal for someone who is already a store owner with an inventory but is looking to try out particular products in the market to see how well it does before stocking up on it. If you’re interested in learning more about this, check out our How to Test Product Ideas with Dropshipping When You Don’t Dropship post.
For someone who is expecting amazing margins right off the bat, this business model may be disappointing. If profit is your primary interest then you’d be better off going straight to the source—such as the manufacturers—but manufacturers don’t always facilitate dropshipping. Since dropshipping profit margins are also considerably lower in comparison to other business models such as manufacturing and wholesaling, dropshipping would perhaps not bode well with a brand that is a new startup, as the business doesn’t have the ultimate control when it comes to customer satisfaction through branding and brand experience.
There are a few types of entrepreneurs that the drop-shipping model will work well for. Let’s take a look at some of them:
- Validating Entrepreneur: Dropshipping can be a great way to test new products, or even a new startup, before investing heavily into inventory that may not sell, making this the perfect business model for the entrepreneur that requires a high level of business and product validation before investment.
- Budget Entrepreneur: Drop shipping is definitely the least expensive method of selling online because you don’t have to purchase any inventory upfront. Because of this, the drop shipping method works well for entrepreneurs who have a limited budget or would prefer to keep startup costs as low as possible.
- First Time Entrepreneur: The drop shipping model for selling online also is a good business model for someone just starting out selling online. The fact is, selling online isn’t easy. Driving traffic and converting that traffic for the average marketer can take a long time to figure out and optimize. Because of the low costs associated with starting a drop shipping business, it allows new entrepreneurs to start to learn the ropes of setting up a store, driving traffic and conversion optimization before investing thousands (or more) in inventory that you may get stuck with.
- Walmart Entrepreneur: Drop shipping is also for the person that wants to sell a wide variety of products and models. Depending on what the price range is of the products you intend to sell, or if you want to sell hundreds or thousands of different products, it’s nearly impossible without massive funding to acquire all that inventory. In this case, dropshipping would be the appropriate model because, again, you don’t need to purchase inventory upfront.
Who Isn’t Drop Shipping For?
There are also a few types of entrepreneurs that dropshipping isn’t for:
- Brand-Centric Entrepreneur: Building a long-term sustainable brand is difficult but the rewards can be incredibly worthwhile. However, building a brand while utilizing the drop shipping business model is exponentially more difficult as there are so many elements of the entire customer experience that you won’t be able to control. For example, many times you may find out that after a customer has purchased something from you it’s sold out with your drop shipper. This leaves you in the uncomfortable and frustrating position of trying to coordinate between your customer and your drop shipper and can become a really poor experience for your customer. Another point to keep in mind is because you’re not shipping the product yourself you don’t have any control over the experience of your customer receiving the package. Almost 100% of the of time it’s going to be the product in a big brown box with packing peanuts. You need to ask yourself if that’s the experience you want your customers to have. Finally, because you don’t ship the products yourself you don’t own the relationship with the shipping companies. When something does go wrong and your customer doesn’t receive the package you can’t simply call UPS and get the situation corrected. You need to coordinate this with a busy account rep which could take days to sort out, again, leaving your customer with a bitter taste in their mouth.
- Margin-Focused Entrepreneur: Probably the biggest problem with the dropshipping business model is the razor-thin margins. Generally, for traditional drop shipping products and companies your gross margins (the price you sell it for minus the cost you pay your drop shipper) are around 10-20%. At the end of the day when you pay your credit card transaction fees, shipping cart, email service, and other app fees you will be looking at only a few percent. There is a fair share of online entrepreneurs running 1 million dollar revenue per year drop shipping businesses that at the end of the day are making a 40-50k profit.
- Non-Creative Marketers: Most manufacturers (which can also be drop shippers of their own products) have sales goals in which 30% of the sales need to come from direct-to-consumer sales, usually through their own eCommerce site. This means that if you’re selling their products, you will be competing directly with your own supplier, a supplier that is able to have much higher margins than you on the very same products. Any chance of competing head-to-head against them is pointless. They will almost always win because they can afford to. If you’re going to beat your own supplier you need to be creative and find and exploit channels they aren’t using to acquire customers. If your only ideas are to use Google Ads and Facebook Ads, you’re likely out of luck.