What is DropShipping?
DropShiping is a retail model that appeals to many because it does not involve any significant initial financial outlays. There are plenty of YouTube videos and similar adverts filled in exotic locations by young entrepreneurs telling you just how easy it all is. I am not making any judgements about the viability of DropShipping as a business model, it quite clearly works for lots of people so there is no reason why it wouldn’t work for you … but that doesn’t mean that it will.
A DropShipping store sells goods directly to its customers but it doesn’t hold any stock and for this reason, the DropShipping business model is best suited to virtual stores where the customer is never in close physical proximity to the products on sale. However, DropShipping isn’t restricted to online stores; the principles of DropShipping can also be applied to catalogue shopping and some door-to-door selling operations.
DropShipping doesn’t work particularly well with High Street retailers. People going shopping in the High Street expect to be able to engage with their purchases before handing over the cash and taking them home.
Traditional Retail Model
The traditional retail model involves a progressive value chain with goods moving along it, step by step, from the originating manufacturer, through a series of distributors and wholesalers to the end-user customer. At each link in the chain, the goods are moved one step closer to the end-user whilst the equivalent cash moves in the opposite direction. So … whenever goods change hands, the receiving party is buying them from the “supplier” and therefore must be able to pay for them. Having paid, the receiver then holds them in stock until selling them on, up the chain … the end-user, or customer, completes the process.
From this, one thing is clear: if you want to become a retailer, you will need to carry stock and that stock will need to have been paid for, although I have to say that this isn’t always the case. If you can negotiate favourable credit terms … like a big supermarket, for example, it is possible to order and receive goods, put them on sale and then sell them BEFORE you have to pay your supplier. The next time you are in Tesco, have a look around and consider the value of the stock sitting on the shelves … then consider how much of it is paid for!
Not all retailers can negotiate such favourable terms, which means the majority of retailers are carrying stock they have had to pay for – tying up their capital. Then they also have to manage their inventory and pay to move stock from warehouse to shelf, absorbing any losses incurred on the way. And then after all of this, they must still sell enough of the product to earn a return on the investment.
This is not how DropShipping works.
How does DropShipping Work?
DropShipping retailers do not carry stock, and they only pay for the goods they are selling after their end-user customer has completed the purchase and paid. Once a product has been sold, the DropShip Retailer takes the customer’s money and passes the order on to a DropShipping fulfilment centre.
Once the purchase has been completed, the DropShipping retailer initiates the fulfilment process.
In some cases, this function will fall to the manufacturer, if the manufacturer offers a DropShipping service. In some respects, this arrangement is to be preferred as shipping directly from the manufacturer to the end-user customer cuts out the middle-men … except for you, that is!
But … if you are going to adopt this approach, you are probably going to need to develop relationships with a lot of manufacturers, depending on the breadth of your proposed product range.
The more common arrangement, especially for beginners, is for the fulfilment to be completed by a DropShipping wholesale partner. Whilst this may not prove to be as cost-effective, it reduces the number of relationships and integrations you will need to be responsible for.
Your customer has been looking at the products you have on sale and has decided to make a purchase.
The product is on sale for £500, which is paid at the checkout and the funds are transferred to your bank account.
Depending on the nature of the Merchant Service Provider, you may have to wait a day or so for the payment to land in your account but you will receive £500, minus any Merchant Service Fees that have been applied to the transaction.
Once the sale has been completed by the customer, the next step is to initiate the delivery of the product.
You are going to need to place an order for the product with the Supplier.
In this example, the wholesale price of the product is £300, which will need to be paid at the time of the order.
This may be difficult if the cash isn’t available, but in the early days, a credit card may be the answer to filling the financial gap.
You have provided the order and shipping details to the DropShipping Supplier and they do the rest.
The Supplier ships the order to your Customer on your behalf.
Assuming that the process works and the customer receives the goods they ordered – there is no reason why it shouldn’t – you will have made a profit of £200.
Clearly, there are more things to consider but this is the general DropShipping business model.
DropShipping considerations you should be thinking about
Now that we understand retail and we have grasped the principle of the DropShipping business model, some things to think about.
- DropShipping requires less start-up Capital
- You don’t need to develop a supply chain infrastructure to get started
- Running costs can be minimal
- You don’t need a permanent base
- The list of potential products is broad
- Easier to scale
On the one hand, adopting a DropShipping business model will allow you to become an internet retailer without tying up capital on inventory. This isn’t cheating … don’t forget that the management at Tesco ensures that Tesco doesn’t have capital tied up in stock.
Since your DropShipping supplier is taking on the responsibility for shipping – that’s what DropShipping is all about – you do not need a supply chain infrastructure. Piggy-backing on your supplier reduces the cost and time to market considerably.
You are not shelling out on inventory and you are not building and managing a logistical supply chain. Running costs are therefore limited to paying for you and your team … and your team will scale with your business, providing you are able to manage the customer service elements.
Whilst there is obviously a need for delivering physical goods to customers, DropShipping is essentally a digital or virtual business. What else could it be?
If you are DropShipping, then your suppliers are fulfilling your orders on your behalf. It doesn’t particularly matter where they are, they could be located anywhere … and so could you! As long as you have access to the internet, you can be located anywhere, hence the DropShipping entrepreneur videos filmed by the pool.
The function of wholesalers in the real-world is to bring a variety of related, or unrelated, goods together in one place. DropShipping suppliers are essentially performing the same function … but in a slightly different space. Like traditional wholesalers, DropShipping suppliers can offer you, the retailer, a broad range of potential products for your store, sourced from many different suppliers.
Now, once you are successful and you have gained sufficient traction, you will naturally be looking to expand. If your base is a physical location, expansion may mean moving to bigger premises with the associated step increase in operational costs and overheads. Scaling up a DropShipping operation amounts to little more than increasing the number of bums on seats, assuming that your suppliers have the capacity. And since the relationship between business growth and bums on seats is linear, you will only ever need to spend the extra money when you need the extra capacity.
DropShipping considerations you’d rather not be thinking about
… but you must!
There are a couple of things that you should be aware of. Most of them are obvioius and I am sure you know about them already, but …
- Pressurised Margins
- Timely Stock Control
- Delivery times
- Multiple DropShipping relationships
- Fielding errors made by suppliers
DropShipping margins are generally under pressure for one of two reasons: your DropShipping supplier needs to take a cut, but you need to factor in the cost of inventory storage and delivery services that you would otherwise be in the frame for; the fact that the DropShipping business model presents with a low entry cost means there is inevitably going to be a lot of competition. Your success in this environment is going to depend on your ability to differentiate. This is no bad thing … a good relationship with customers is important as is the development of a brand and a niche market.
You are in the business of DropShipping and so you are relying on your business partners. You are at least one step removed from effective stock management because you are not going to be able to count the widgets on the shelves for yourself. The need to and the complexity of keeping track of stock levels at suppliers will increase as you engage with more suppliers, and whilst there are apps and service interfaces that can help, be prepared for some stock-level trauma.
Delivery times are going to depend on the location of the supplier in relation to the customer and this is something that you should consider carefully. There is a big difference between next day delivery and one that might take several weeks. Some customers might be prepared to wait, but it’s another potential impact on your Customer Services.
Multiple DropShipping relationships are complex and the potential impact of the complexity can never be understated. The more organisations you are going to be interacting with, the more difficult things are going to be.
There is another point to consider: multiple suppliers are, without doubt, going to cause problems with shipping rates. Customer service is going to suffer if two products are ordered from different suppliers and two shipping charges appear! It doesn’t matter how legitimate this might be, it just looks wrong! Something to think about.
Finally, you are not going to be in control of the purchase process from the initial website order through to product delivery to the customer. Even the best suppliers will make mistakes and when they do, you are going to be making excuses for their error. Good suppliers won’t make that many errors, but the ones that are not so good …
To a degree, customer service delivery is a little bit out of your hands, but you will still ultimately be responsible for it. It’s your responsibility to make sure that your DropShipping suppliers are up to the task.
We know what retail is and now we know what DropShipping is. We have a grasp of the principles of the DropShipping business model and we know what we should be looking out for.
Before you decide to go ahead and kick something off, you probably should have a look at what’s out there for the beginner. Whatever you do, you should know that it’s going to take an investment in time and money; it could be a big investment and you really don’t want to be wasting any of it.
You don’t want to be forking out tons of cash for DropShipping suppliers before you have your basic infrastructure sorted, so let’s have a look at some of the few DropShipping suppliers that don’t charge you for looking!!
Click Next Steps for … the next steps!