Dropshipping and How It Works
If you’re planning to start an e-commerce business, you might be weighing your options for managing inventory and delivering products to customers. One popular method to consider is dropshipping, as it gives entrepreneurs a fast way to build a catalog of products and sell products online without inventory. In this guide, we’ll cover all of the basics of dropshipping, including:
- What dropshipping is—and how it differs from traditional retail
- The benefits of dropshipping
- The disadvantages of dropshipping
- The answers to FAQs about dropshipping
So, what is dropshipping?
Quite simply, dropshipping is a way to sell stuff online without keeping products in stock or manually handling any of the shipping responsibilities.
In a traditional retail setting—whether brick-and-mortar or online—the business owner must maintain a warehouse full of inventory. When someone buys an item, the store itself handles the transaction and then ships that item directly to the consumer.
With dropshipping, however, there’s no physical inventory to manage. When a customer makes a purchase, the store processes the order and transfers it to a third-party supplier, who then prepares the order and ships it out to the customer. The store owner only pays the supplier for an item when someone buys it; they’re not responsible for producing it, storing it, or shipping it themselves.
What are the benefits of dropshipping?
For many entrepreneurs, the most significant benefit of dropshipping is that it allows you to start an online store quickly without owning any inventory. Since you don’t buy the product until after it’s sold (and after you’ve been paid), dropshipping can provide a healthy cash flow for minimal investment.
Here are some other key benefits of dropshipping.
Sell anything you want
There are thousands of dropshipping suppliers selling just about any product you could imagine. You can add as many dropship products to your online store as you want, and it’s easy to add more product listings to your e-commerce sales catalog.
Test the market
Dropshipping gives you an opportunity to see which items resonate with your customers without having to invest in physical inventory. If the products sell well and provide you with your desired profit margin, great! If not, you can choose to keep them in your online store anyway (just in case) or drop them altogether—there’s no cost to you either way.
More options for customers
Dropshipping provides business owners with an easy way to expand product offerings and give customers more options. If folks are browsing your site for a product and don’t find exactly what they want, they may leave and shop elsewhere. With dropshipping, you can add more of the products that customers are searching for and entice them to spend with you.
Reduced operating costs
Every time you have to touch a product in the supply chain, there’s a cost. Freight, warehousing, inventory management, labor costs, picking, packing, and shipping all add up. Holding costs, dead stock, and damaged or misplaced items also add to the expense. You can only pass on so much of your operating costs to customers without alienating them. In many cases, it may be cheaper to sell a dropship product than stock it yourself.
The internet opens the door to international selling since nearly anyone with an internet connection can access your online store and make a purchase. By using dropshippers, you may be able to partner with companies that offer products locally or regionally in countries where it would otherwise be cost-prohibitive for shipping across international borders.
As long as you can communicate with customers and suppliers, you can run your business from nearly anywhere—including your home. Since there’s no brick-and-mortar storefront and no inventory to manage, you don’t need a dedicated physical space for operating your business.
In a traditional retail or e-commerce store, increased sales also mean increased costs. There are more products to buy, manage, and fulfill. You may need expanded warehouse space and more employees to handle all of the tasks necessary to run the business. And if your volume grows quickly, you risk struggling with order fulfillment. In a dropship business model, much of the work is done by your supplier, allowing you to scale with less additional overhead.
What are the disadvantages of dropshipping?
Because you don’t have to store or manage inventory yourself, dropshipping can save you quite a bit of money on overhead. There are a few catches, however.
Since you’re not purchasing inventory in bulk—and you’re paying someone else for storage and order fulfillment—your profit margins from dropshipping are typically lower than they would be if you managed the whole process in-house.
Online sellers often use dropship products to augment their other physical inventory. You tie up less capital with dropshipping, but you’re only getting a small percentage on the sale; most of the earnings go to the dropship provider.
Dropshippers will typically offer you a discount on products because they don’t have to handle the marketing and sales. Your profit comes from the markup. While you’re saving on warehouse space, you’re also unable to take full advantage of wholesale pricing. Plus, you’ll still have to pay for order fulfillment, processing, returns, customer service, marketing, and other business overhead. That means you’ll need to sell a lot of dropship products to build a profitable business.
Dropshipping doesn’t require a significant investment to get started, but the low barrier of entry can cause market saturation in the dropship business model. The most popular products can be found at thousands of online sellers; some may even come from the same dropshipping suppliers.
Selling dropship items can quickly be reduced to commodity sales, where you will be competing with other e-commerce sites on price and reputation. Larger, more established retailers may reduce their markup to offer lower prices, which can force you out of the market. Even if you can match their pricing, consumers may feel more comfortable buying from an established vendor.
Lack of inventory control
In a traditional retail model, you’re in control of every aspect of the process—from marketing and sales to shipping and customer service—so you always know exactly how much product you have in stock. With dropshipping, you rely on your supplier to handle a significant part of your business, so your reputation hinges on their job performance.
If there’s an issue with an order, the customer will contact you, and you’ll have to reach out to the dropshipping supplier to find a solution. This back and forth makes it tougher to resolve problems quickly and efficiently.
While plenty of dropshipping partners are top-quality suppliers, you should be aware there are some bad actors, too. You might encounter some suppliers that have a professional presence but deliver in a less-than-professional manner.
For example, there are scammers who claim to sell brand-name products but ship knock-offs. When customers receive low-quality products, it reflects poorly on you, so if you find a dropshipper that claims to provide designer products at dollar store prices, be very cautious. Like anything else, if it sounds too good to be true, it probably is.
Less repeat business
Since you’re selling other people’s products, it may be difficult to set yourself apart. Consumers shopping for discount items tend to buy from places where they can find low prices with minimal risk, so many folks will be comparison shopping rather than returning to your store regularly.
You may miss out on one of the most profitable things a business can do: earn repeat customers.
One of your biggest e-commerce expenses will be your customer acquisition cost (CAC). For many online sellers, CAC represents as much as 80% of your expenses. Repeat customers lower your CAC dramatically—by as much as 5 to 25 times. A 5% increase in customer retention produces more than a 25% increase in profitability because loyal customers shop more frequently—and spend more when they do.
Managing multiple dropshippers
Many dropshippers opt to use several different suppliers at once to increase the diversity of their products. This strategy can be beneficial, but shipping multiple products from separate locations can cause your fulfillment costs to rise, too.
Common dropshipping FAQs
Do I have to pay for products before selling them?
No. The biggest advantage of dropshipping is that you don’t pay for products up front. You only buy the product after you make a sale on your online store and receive payment for it.
How much money do I need to start dropshipping?
Creating a dropshipping store is significantly less expensive than opening a traditional retail shop or buying inventory. But there are costs involved, including:
Online store: You’ll need to create an online store. Most people use an e-commerce platform with tools to help build and maintain your product catalog. Costs can run from as little as $30 a month up to $300 a month (or more), depending on the size of your business. And if you choose to sell on Amazon, it can cost you $40-$60 per month plus a 15% commission on sales.
Domain name: Your domain name is the online identity of your business—and a powerful brand-building tool, too. Fortunately, domain names are customizable and affordable, with many costing as little as $20 or less per year. If you’re using an e-commerce platform to sell stuff, you can even redirect the URL so customers go directly to your store when they type in your web address.
Website and hosting: Most of the major e-commerce platforms allow you to build your e-commerce website on their platform; they’ll even host it for you, too. If, however, you’d rather go the DIY route, you can expect to encounter additional fees along the way. You’d need to factor in the costs of designing a website (or hiring a pro to help)—including any paid plug-ins, extensions, or add-ons that might be required to get the site up and running. And if you want to choose your own web hosting provider, it can cost you anywhere from $50 to $1,000 per month, depending on volume, features, and services.
Payment processing: Another thing to keep in mind is that there will be a fee every time someone uses a credit card or electronic payment service to buy products from your store. Besides any bank fees, you can expect to pay slightly less than 3% (plus a small transaction fee) for PayPal, Stripe, or Authorize.net. Visa, Mastercard, American Express, and Discover typically charge between 1.3% and 3.4%.
It may sound like things are starting to get expensive, but many entrepreneurs are able to get into the e-commerce business for $500 to $1,000, all while keeping their monthly fees under $100. Compare that to the cost of starting a retail store—you’d pay more than that just for a month’s rent on your brick-and-mortar space.
What are the best-selling dropship products?
There are millions of products that can be sourced through dropshippers. According to Grand View Research, the dropship products that bring in the most sales are fashion items (30%), food and personal care products (30%), and electronics and media (22%). Other significant categories include toys, hobbies, DIY, furniture, and appliances.
Who will handle customer service?
People sometimes make the mistake of thinking that dropshipping is a completely automated business, and all they have to do is set it up, turn it on, and let the profits roll in. Unfortunately, that’s not the case. You’ll still need to manage the business, including handling customer support, sales, and marketing. Your dropshipping supplier will sell you the product and ship it out for you, but everything else is up to you.
How do I submit orders to suppliers?
Most dropshipping suppliers accept orders online through a portal or spreadsheets, and some will even allow you to place orders by email or over the phone. If you’re using an e-commerce shopping platform that works with dropshippers, there’s a good chance that you’ll be able to submit orders directly from the platform.
How big is the dropshipping market?
Global retail e-commerce sales are expected to reach $4.9 trillion in 2021 and grow to $6.4 trillion by 2024. Dropshipping in North America alone now exceeds $36 billion and is estimated to continue to grow at a rate of more than 17% a year. By 2027, researchers expect dropshipping to be a $125 billion market in North America.
Where can I find dropship suppliers?
If you’re working with an e-commerce shopping platform, look to them for recommendations on suppliers. They want to keep you as a customer, so they’re only going to recommend suppliers they trust. If you’d prefer to find a supplier yourself, performing a quick online search for dropshippers will bring up plenty of results, including a lot of suppliers who specialize in niche products.
Remember: partnering with a reputable, reliable dropshipping supplier is one of the most important things you can do. Poorly manufactured products or low shipping standards will only lead to dissatisfied customers, so choose carefully.
If you’re sourcing products internationally, there will be a longer delivery time. Will people be patient when they’re used to getting 2-day shipping from other online sellers?
Some shoppers will understand the longer delivery times, especially if you’re selling a unique product. Other folks might not be as willing to accept a longer turnaround time on their order. It’s important to make sure that you’re very clear with customers about delivery timetables and any associated costs. A lack of transparency can lead to complaints and refunds, which add to your expenses.
Many dropshippers include the cost of shipping to their product price. This allows them to offer free shipping for items, which helps mitigate concerns over longer shipping windows.
Is dropshipping a legitimate way to run a business?
Dropshipping is completely legal. In fact, many of the online stores you visit regularly take advantage of dropshipping to supplement their product lines. Walmart, Sears, Rakuten, Staples, Target, Overstock, and plenty of others are in the dropshipping business.
You can even use dropshipping for order fulfillment at Amazon, but keep in mind that there are some specific rules you’ll need to follow, and you’ll have to pay Amazon a percentage of the sale. It’s also OK to dropship on an eBay store as long as you’re fulfilling orders from a wholesale supplier and not buying it from another retailer or marketplace.
It’s not that different than buying from any other e-commerce store. Most online sellers don’t make the products they’re selling; they buy them from manufacturers or wholesalers. With dropshipping, you’re doing the same thing without having to buy the inventory ahead of time. You will, however, have to pay a higher price to have a dropshipping supplier handle the order fulfillment for you.
Do I need a business plan?
You don’t necessarily need a full business plan to get started with dropshipping—unless you want to pursue business loans, financing, or investors, of course—but you should take some time to think about your marketing strategy. You’ll need to consider how you’re going to get the word out about your business, grow your audience, and keep customers coming back.
Think dropshipping might be for you?
Dropshipping can be a profitable business if you pick the right suppliers, the right products, and then market your business properly. You’ll find stories online about people who made their fortunes dropshipping, but you’ll also find plenty of stories about people who didn’t have such positive experiences.
Go into it with your eyes open, do your research, keep your expectations realistic, and you just might find dropshipping success.