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Dropshipping

What is dropshipping? How does it work?

Drop shipping is a form of retail business where the seller accepts customer orders without keeping stock on hand.

Dropshipping is an order fulfillment option that allows e-commerce businesses to outsource procuring, storing, and shipping products to a third party—typically a supplier.

The dropshipping model commonly appeals to entrepreneurs seeking efficiency and low overhead, but it can come at a cost. This guide will cover what drop shipping is and explore how this fulfillment method can work. We’ll also look at a few alternative fulfillment models.

What is a dropshipping business model?

In a dropshipping business model, you promote products and provide an online storefront. When a customer places an order, you send the order to the drop shipper and inform customers the products are on the way. The rest of the physical fulfillment process is out of your hands. In some dropshipping agreements, you may also handle customer service, while the dropshipping service manages the physical goods and fulfillment.

How does dropshipping work?

The exact logistics of dropshipping depend on your arrangement, but typically the dropshipping process follows this general sequence:

  1. Seller signs an agreement with the drop shipper.
  2. Customer orders online.
  3. Seller receives the order.
  4. Customer receives an order confirmation.
  5. Seller forwards the order to the drop shipper.
  6. Dropshipper ships the order.
  7. Customer receives their product.

Key players in the dropshipping model

Let’s unpack some of the key players and their roles in detail, starting with the seller of record—in other words, your e-commerce business.

Seller of Record

The dropshipping process starts with you. As the seller of record (SoR), you’re the individual identified as selling the product to the end consumer. You set the price, record the purchase as revenue, and assume responsibility for the sales tax on a particular sale. Even when a third party stocks and ships the items, you’re the seller of record because you own the products before they ship to the customer.

For Amazon sellers, using a dropshipping service is generally allowed by Amazon dropshipping policy, as long as you’re the seller of record and identify yourself as such.

Manufacturers

Manufacturers make products to sell to wholesalers and retailers. You can purchase goods from manufacturers, but the bulk purchase amounts they may require can potentially be a barrier to starting or scaling your business. Some manufacturers may offer dropshipping services.

Wholesalers

In a typical product supply chain, wholesalers buy from manufacturers and sell to retailers at a slight markup. They function as middlemen; generally, they do not sell to the end consumers but may provide dropshipping services to retailers.

Determine which dropshipping providers could be right for you based on your business model and fulfillment requirements, among other factors.

Potential pros and cons of dropshipping

In e-commerce, as in life, there are advantages and disadvantages to any fulfillment approach. Whether the gains are worth the pain largely depends on your goals and business situation. Here are potential pros and cons to consider when weighing whether dropshipping is right for your e-commerce business.

Possible benefits of dropshipping include:

  • Overhead costs: Since you don’t store or ship the products, dropshipping has the potential to lower overhead costs, such as maintaining a storage facility or sending products to customers.
  • Starting costs: Entrepreneurs looking to start a business with minimal investment may turn to dropshipping as they don’t need to invest in facilities or resources to process orders.
  • Multi-channel selling: You can use dropshipping for your business while selling on your own domain, through a store like Amazon, or social media channels —or all of the above.
  • Operating location: Dropshipping allows you to fulfill orders regardless of your operating location, opening up a possibility to work from anywhere.
  • Scalability: Leveraging suppliers can make it feasible to accept more orders without increasing the inventory you store, package, and ship.

Potential limitations for dropshipping include:

  • Competition: Given the low cost and investment to get started, dropshipping is a highly competitive field.
  • Product quality: Dropshipping reduces your involvement in the order fulfillment process, curtailing your ability to monitor and guarantee product quality.
  • Branding: Because the products you sell may not be unique or distinguishable from similar offerings by other sellers, you could have trouble differentiating your offering.
  • Profit margins: Little to no product differentiators means your business may end up competing more aggressively on price. Selling at low prices can eat up your profit margin.
  • Fulfillment timeline: When a dropshipping service handles the fulfillment process, you do not have control over order selection, packaging, and shipment.
  • Inventory management: Up-to-the-minute updates on what is available in stock may not be possible. If a customer places an order only to find the product is out of stock, this poor experience can discourage future orders and damage your brand.
  • Range of offers: Because you don’t handle order fulfillment, you may be limited in the special offers and promotions you can run, such as bundling or free shipping.

For some businesses, dropshipping limitations do not outweigh the potential benefits. Luckily, if you want to lower your inventory management and order fulfillment costs, a service like Fulfillment by Amazon may be an option. For some sellers, FBA provides a happy medium, offering many of the benefits of dropshipping without the downsides

Fulfillment by Amazon: A dropshipping alternative with added perks

Fulfillment by Amazon (FBA) offers similar benefits to dropshipping while giving you more control over your brand experience. You don’t need to sell products in Amazon stores to use FBA—although with an audience of 200 million unique visitors each month, Amazon is a selling channel worth considering.

With FBA, you store products in an Amazon fulfillment center, and we:

  • Offer quick delivery with Prime Shipping
  • Manage customer service
  • Take care of returns
  • Notify you when you need to restock products

How FBA works

  • You decide the products and quantities you’d like to fulfill and send them our way.
  • We receive products into our network and store them in Amazon fulfillment centers.
  • As orders arrive, we pick, pack, and ship the products on your behalf.
  • Amazon manages customer service and returns on these orders.

Is dropshipping right for you?

It depends on your business. Here are a few questions to ask yourself if you’re considering dropshipping.

How do you want to build your brand?

Your brand is the look and feel of customer-facing aspects of your business. Building a memorable brand impression can help grow customer loyalty.

While you may be able to create a branded online experience, dropshipping gives you less control over product quality, delivery experience, and the aesthetics of the final package. If the products and packaging fall short of expectations, a customer may choose not to purchase from your brand again.

Dropshipping suppliers often offer little room for product customization. This limitation may make it difficult to set your brand apart from the competition.

How much control do you want over product quality?

Product quality can have a big impact on other aspects of your business such as customer acquisition, brand loyalty, and returns. While you may be able to inspect the quality of products at the start of your dropshipping relationship, you will likely have limited control over the quality of the items you sell on an ongoing basis.

If the products fail to meet customer expectations, your business could receive negative customer reviews.

How quickly do you want to ship products?

Ecommerce customers tend to expect quick shipping. In a recent survey, nearly 84% of people surveyed regarded delivery as an essential part of their online shopping experience.

Long shipping times can negatively impact your business. When working with a dropshipping supplier, review its standard shipping costs and delivery timeframes.

For sellers looking for fast order fulfillment services, a service like FBA can be valuable…

How much capital do you have access to?

In some cases, the dropshipping business model allows you to hold off on product procurement until customers actually place orders. This can make dropshipping attractive to entrepreneurs who want to get a business up and running with limited inventory investment. Some alternatives like third-party fulfillment also allow you to launch and run your business with less capital compared to sourcing, storing, and shipping products on your own.

What is your target profit margin?

Compared to other business models, such as owning a retail store or building your own order fulfillment center, dropshipping has a lower barrier to entry. Unfortunately, this can mean more competition for your business.

The playing field can be highly competitive for businesses that use dropshipping. Dropshipping sellers are commonly able to offer products at low prices because they’ve invested so little. If you use dropshipping for your business, you may earn low profit margins.

You might be able to overcome some of these issues if you position your business within a niche outside of any hyper-competitive field. Find potentially profitable or less competitive niches through market research, networking, and sales. Or invest in differentiating your brand.

Are you ready to handle supply and inventory issues?

If you choose to use dropshipping, you may have little to no control over the supply chain. Delays in production might determine how many orders your dropshipper is able to fulfill. Having to disappoint your customers by informing them an item is out-of-stock is hopefully the exception and not the rule. Sourcing products through multiple dropshipping services is one way to avoid running low on product inventory. When one supplier is out of a needed product, you can rely on another. However, working with multiple suppliers adds complexity to logistics and fulfillment, which may defeat the purpose of a dropshipping strategy.

How will you handle refunds, returns, and replacements?

Returns are an inevitable part of ecommerce business. Sometimes the return process can be as simple as a customer contacting you regarding an item they would like to return. The customer sends back the product, then you refund the customer and contact the dropshipping supplier to credit or reimburse you. But this is not always the case.

Be prepared for more complex return and replacement processes. Take the time to understand how a dropshipping service handles returns before creating your refund and return policy.

Think through the steps of the ecommerce transaction. Here are some examples of questions to ask before signing on with a dropshipping supplier:

  • Who is responsible for defects?
  • Who covers return shipping fees for defective items?
  • What are the supplier’s restocking fees?
  • What is the return window for customers?

Questions like these can help you understand a dropshipping agreement and help paint a clearer picture of the potential costs involved before you make changes to your business model.

 
 

Yes, dropshipping is a legal method of order fulfillment.

Do your homework on possible dropshipping suppliers and thoroughly review any dropshipping contracts in an effort to avoid surprises and bad actors down the line.

Not necessarily. Businesses that use dropshipping services commonly operate on slim profit margins due to competition. Dropshipping may be a viable possibility for your business, but you could find yourself confronted with a tradeoff between low overhead and upfront costs versus lower profit margins.

Yes, as long as your business follows Amazon’s dropshipping policy, you can use drop shipping for your business on Amazon.

To use dropshipping services for your business on Amazon, you must:

  • Be the seller of record of your products
  • Identify yourself as the seller of your products on all packing slips, invoices, and external packaging
  • Be responsible for accepting and processing customer returns of your products

Fulfillment by Amazon (FBA) is an alternative to using a dropshipping supplier. You procure products from your supplier of choice while Amazon handles the shipping, customer service, and returns on your behalf.

Multi-channel fulfillment allows you to use FBA even when you sell your products through your own domain or other e-commerce channels.

With drop shipping, the seller of record does not handle the product directly but instead uses a third party to source and store products, and ship orders directly to customers. Any party in the supply chain can dropship, including manufacturers, wholesalers, and retailers. A manufacturer, wholesaler, or retailer’s role doesn’t change based on the seller’s fulfillment method. For more details on how manufacturers, wholesalers, and retailers fit into the dropshipping process, see key players in the dropshipping model.

Retail arbitrage is the process of sourcing products from a retailer and selling the items at a higher price. Essentially, a seller re-sells products already available to the public to make a profit.

Retail arbitrage can be a labor-intensive venture as it requires you to consistently discover discounted items you can “flip” to make a profit. Sellers might find it challenging to rely on retail arbitrage when combined with a dropshipping method of order fulfillment, especially if the business model already operates on slim

While it is possible to operate your online store without a business license, you may be leaving yourself open to issues down the line. Registering as a Limited Liability Company (LLC) or another formal entity can reduce your liability and show potential suppliers you’re a legitimate business.

Yes, some do. Shipping rates, timeframes, and fees will vary between companies. If you want to reach customers worldwide, be sure to investigate the details of international order fulfillment as you research different dropshipping options.

Amazon operates fulfillment centers around the world and FBA international programs can help you reach customers in other countries.

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