Drop shipping is a chain supply technique in which a retailer does not keep goods in stock, but transfers customer orders and shipment details to either manufacturer goods directly to the customer. The retailer is paid on commission at an agreed percentage with the wholesaler.
How it works
A small retailer who typically sells in small quantities to the general public receives a single large order for a product. Since the retailer does not have the goods in his/her store, they will arrange with the manufacturer to ship the goods directly to the customer. This type of business is common in steel building. Drop shipping is also very common with big ticket items like steel buildings where the retailer will take a deposit and have the steel shipped direct to the buyer’s building site from the supplier’s manufacturing facility. Online auction sites like eBay are also good examples of drop shipping business.
Benefits of drop shipping
- Less capital is required to start up a drop shipping business in comparison to traditional retail businesses. This is because one does not have to invest a lot of money in inventory up front. Further the retailer will only purchase a product once he/she has a guaranteed a sale.
- It is easy to start and manage. This is because you do not have to worry about stock holding costs, reorder levels, stock obsolescence or packing and shipping. Further eliminates some duplication of effort, since only one warehouse will pick, pack and ship the product.
- Flexible location. A drop shipping business can be run from just about anywhere as long as you have a reliable internet connection. As long you can communicate with your customers, you can start this kind of business.
- There is a wide variety from which customers can choose from. This is because you don’t have to pre-purchase the products and you therefore can offer an array of products to your potential customers.
- It is easy to scale you inventories. By leveraging drop shipping suppliers, most of the work to process additional orders will be borne by the suppliers, allowing you to expand with fewer growing pains and less incremental work. Sales growth will always bring additional work – especially related to customer service – but business that utilizes drop shipping scale particularly well relative to traditional ecommerce businesses.
Drawbacks to drop shipping
- Low profitability margins- A low profit margin is one of the biggest challenge while operating in a highly competitive drop shipping market segment. While this kind of business is easy to start and the overheads incurred are relatively low as compared to other kind of businesses, many merchants in this business will set their selling prices very low. Even though your completion may have low-quality websites or even poor customer service, this will not stop your customers from comparing their prices to yours. This will deplete your profit margins. You can however mitigate this problem by selecting niche from your market segment.
- Another challenge faced in drop shipping is back ordering. This occurs when a seller places a shipment request with a wholesaler, but the product is sold out. This may further lead may be accompanied by a long wait for a shipment while the wholesaler waits for new products, which may reflect badly on the retailer. A good wholesaler will keep retailers updated, but it is the business owner’s job to be aware of the quantities that the wholesaler has available.
- Shipping complexities- This happens when you work with different suppliers to ship the products to different customers. When working with different suppliers and let’s say a customer places an order for four different items, all of which are available only from separate suppliers. You will incur four separate shipping charges for sending each item to the customer
- Errors made by suppliers – Suppliers may make mistakes during shipment and at the end of the day this will reflect badly on you with your customer and can damage your business’s reputation.
As we initially warned, drop shipping isn’t a perfect, stress-free way to build a successful business. The model has some definite advantages but comes with a number of built-in complexities and problems you’ll need to be able to address.