If you are considering setting up an online business or e-commerce business, you may have come across the term drop shipping but not have a full understanding of what it means. In this post, we will explain what drop shipping is, how it works and how, if done correctly, it can be a lucrative way to make money selling online.
What is drop shipping?
In the traditional, e-commerce supply chain, the retailer buys products in bulk quantities from a wholesaler. The wholesaler then delivers products to the retailer who sells and delivers them to the end customer.
With drop shipping, the retailer sells the product to the customer first. Only after the order has been taken does the retailer order it from the wholesaler. The wholesaler then delivers the product directly to the customer.
Risk-free product sourcing
As a consequence of the way orders are taken and delivered, one significant benefit of the drop shipping model is that, instead of paying for products in bulk, the retailer pays for them one at a time – and only after they have been paid for by the customer. This makes excellent business sense for the retailer because there is no risk. In the traditional supply chain, buying in bulk can be risky; if products can’t be sold, profits can be lost and buying in bulk can lead to cash flow problems. With drop shipping, all this risk is avoided.
Drop shipping offers online retailers the ability to compete with traditional retailers as there is a significant reduction in overheads. As delivery is done by the wholesaler on the retailer’s behalf, the retailer will not need to pay for warehousing, shipping or insurance. In addition, there will be no need to pay for staff to undertake warehouse or dispatch duties.
As wholesalers generally have superior delivery systems in place than small retailers, it means they can deliver the goods much faster. For smaller retailers that need to individually package each item and then arrange delivery using a delivery service, dispatching goods can take up a lot of human resources and mean longer delivery times.
This can be done much better by a large wholesaler which is used to sending out thousands of products at a time and has the systems in place to make sure it happens effectively.
Why do drop ship wholesalers offer smaller margins?
There are a two reasons why you will get a smaller margin if you use a drop shipping service compared to traditional supply method. Firstly, if you are buying products one at a time you are not as important to the wholesaler as someone who regularly buys 10,000 products at a time. Those companies will demand good margins or they will take their business elsewhere.
The second reasons is that your reduced margin is simply another way to pay for the work the wholesaler is doing on your behalf and the costs they incur from doing them. They have to pay for insurance on the stock, warehouse staff, drivers, packaging, vehicles and fuel. They have to handle all the administration which goes into making the dispatch happen. They can’t afford to do all this and pay you the same margin as a regular retailer who does all the shipping themselves.
Smaller margins don’t mean smaller profits
A product with an RRP of $100 might wholesale at $60. A company that uses the drop shipping service might get it for £80. Whilst it appears that the regular retailer is making $20 extra on the item, that $20 has to pay for all the things mentioned in the paragraph above. By the time all those costs have been taken into account, much of the $20 may have been used up. Any difference after that will be that retailer’s reward for being able to negotiate a deal for buying in bulk. Their purchasing power has helped them to get the extra. This does not mean, of course, that they will try to undercut retailers in the marketplace. Chances are, they will want to sell the products for as much as possible and make more profit rather than give it away to the customer.
At the end of the day, if retailers don’t have the cash to buy in bulk or the set up to warehouse and dispatch lots of products, then drop shipping is by far the best supply method to use.
Are there disadvantages to drop shipping?
Whilst the drop shipping supply model has no disadvantages in itself, there can be problems which arise with individual wholesalers.Some wholesalers will be poor communicators and will fail to let retailers know when a product is out of stock, others will be poor at delivery, either with delays or breakages. The two worst kinds of wholesaler are the ones that will retail products themselves and undercut their customers in the marketplace and others who will try to charge retailers a fee just to see the wholesale prices and join in their wholesale service. Make sure you research your wholesalers well and stay well clear of these latter two examples.
If you are starting out in online retail and have very limited resources then, provided you find a good wholesaler to buy your products from, then this is the perfect solution. It’s a low cost, low risk model to begin building your online brand and business.