Online retail is currently valued at over $3.5 billion worldwide and trends higher year after year. Within e-commerce, several business models have emerged to take advantage of the growing opportunities in the industry - dropshipping, in particular, has been gaining traction amongst online businesses over the past number of years.
In this article dropshipping for dummies article, we’ll be going through the basics of this business model and sharing information about its advantages, disadvantages, and whether this type of business is right for you. Dropshipping for amateurs is nothing complicated.
What is Dropshipping
Dropshipping is an online retail fulfillment system whereby a business connects consumers and suppliers directly for the purchase of goods.
It has become a popular business model among entrepreneurs as it offers many benefits - both in the start-up as well as operation - over traditional businesses. Approximately 33% of online retail is done using this model.
A business operating with this model does not hold any of the products it sells. Instead, when customers place orders, they purchase directly from third-party suppliers and have them ship the products directly to the customer - therefore never having to touch the product.
Compared to the traditional retail model, dropshipping offers huge advantages for entrepreneurs. The biggest one is the cost savings as you don’t incur the expense of managing a brick-and-mortar store, managing inventory, and paying recurring overhead costs. It leverages the inventory and shipping channels of third-party suppliers to fulfill orders to customers.
As a dropshipper, you serve as the middleman between customers and suppliers, processing orders of products, and facilitating the transactions between them. This may sound overly simple and too good to be true. But don’t be fooled. This advantageous position in the supply chain yields tremendous profits.
How does dropshipping work?
Traditional businesses that sell products typically work like this:
A manufacturer produces a product or widget. They make their money by selling in volume with contracts that have minimum order amounts. Normal customers like you and I don’t usually buy from manufacturers because our order amounts are small. So they sell to wholesalers or big-box retailers.
A wholesaler will purchase goods directly from the manufacturer. Wholesalers will have the resources and space to order and store large quantities of products. They then go on to sell these products to their retail clients at a higher price than what they purchased them for from the manufacturer.
A retailer will buy from a wholesaler at a marked up price than what the wholesaler purchased from the manufacturer. Retailers also make volume purchases so they can still command better prices than you and I. The retailer then goes on to sell those same products to customers in the public for a marked up price.
As you can see, in the traditional model, every time the products enter a new stage in the supply chain, it gets more and more expensive. Those markups eventually get passed on to the end consumer.
With dropshipping, the supply chain is significantly reduced.
As a dropshipper, you set up an online store and advertise specific products. Customers interested in your products can use your site to place orders and make inquiries. When your store receives customer orders, it routes the same order details to your supplier.
There are millions of third-party suppliers who work with dropshippers - most located in China. The manufacturing efficiencies, shipping subsidies, and lower quality control requirements has created a valuable market in the region for dropshipping suppliers.
When your supplier receives the customer order, they will process, package with your company logo and branding, and ship the product directly to the customer.
Advantages of dropshipping
- Low startup costs
- The capital expenditure required to set up a business under a traditional business model is expensive.
- You need money for a store-front.
- You need money to buy inventory.
- You need money to employ staff.
- And the list goes on.
Even if your business operates primarily online, the cost of purchasing and storing inventory could deter you from making that initial investment.
But with dropshipping, this capital expenditure is so much less. Most dropship businesses have been able to start up with less than $500 - which may seem unrealistic but makes a lot of sense when you break it down.
These are the most common expenses for starting up this type of business:
- Purchase of a domain name for your online store
- Getting web hosting service for your website.
- Purchase of a few product samples from suppliers
- Operation fees like accounting (and taxes)
- Purchase of design services for branding, logos, website, etc.
- Low overhead
- Customer acquisition (via ads and promotional campaigns)
- Risk of lawsuit
- Aftersales service like product returns, defects and warranties
Operating your dropshipping business is significantly lower than any other type of business:
- No rent for a storefront
- No warehouse costs
- No utilities
- No payroll
The lack of recurring expenses means that it costs way less to operate a dropshipping business compared to traditional brick-and-mortar. These savings not only protect your bottom line and reduce the risk of insolvency, but they also maximize the profits you earn which you can easily reinvest into your business.
As a dropshipper, you operate an online store that connects customers directly with suppliers, handling the communication between the two parties. Because of the lack of in-person communication required, you can operate your business from anywhere in the world - with nothing more than a laptop and an internet connection.
An added bonus to this is that once your online store is up and running, your involvement in the day-to-day operations of the business is minimal, especially if your store has automated order processing with suppliers.
Low cost to pivot
Oftentimes in business, decisions or opportunities do not work out. Consumer interests and tastes may change or new opportunities to present themselves.
Businesses often wrestle with the decision of whether to pivot their offering or stay the course, typically due to the high investment required to change.
With dropshipping, the decision is less difficult to make. Because of the low investment costs, it is easy to switch courses when you like.
If a particular product you’re selling doesn’t take off, it’s easy to switch to selling a different one.
If a new product becomes the new trend amongst consumers, it’s easy to switch to selling that one or to add it to your store (next one).
Easy to scale
Expanding a business typically takes a great deal of planning, research, and investment - and it carries significant risk. With dropshipping, scaling out your business can be done quickly, cost-effectively, and with minimal risk.
Since you are not handling inventory, restricted by regions, and have low supply chain costs, expanding your dropshipping business can be done very efficiently. A lot of times it comes down to just following the same steps that you took to get your business started.
One store can be created to sell multiple products fulfilled by multiple suppliers.
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Disadvantages of dropshipping
Over a third of online e-commerce is done through dropshipping. That means that you will often be competing with a lot of companies selling the same or similar products to yours.
A huge disadvantage that new entrants will encounter because of competition is low margins. Most of the items being sold through dropshipping businesses are sourced from China - many times from the same suppliers too.
The result is that in order to stand out companies continuously compete on who can sell their items the cheapest. The more generic your product is the more competition, and the lower the margins.
One of the best ways to account for this is by sourcing high-quality products with excellent branding and packaging. Invest a lot of time and energy into customer service to make your business stand out and justify the higher price.
Inventory management complexities
Businesses that hold their own inventory face a number of challenges that dropshipping companies do not share. But one advantage they will always have is more streamlined inventory management.
With these types of businesses, when a customer places an order, you’ll know right away if this item is in stock by looking at your warehouse inventory. And when the order is placed it’s very simple to just go to the warehouse, pick out the items and send them to the customer.
With dropshipping, it’s a little more complicated. Because you don’t hold any inventory and work directly with suppliers to fulfill orders with customers, there’s less you have control over.
These suppliers are typically working with other companies doing the same thing so inventory is constantly changing. And because you’re not managing the inventory you get no visibility into what the stock levels are like or when inventory will be replenished.
No business is immune to angry customers. There will be times when customers are not satisfied with your products - sometimes it won’t even be your fault.
- Packages may arrive damaged.
- The wrong products may be sent.
- Products may arrive late.
- Beware of lawsuits of angry customers (and local laws regarding after-sales service)
With traditional businesses, it’s easy to implement processes to improve the customer experience and minimize angry customers. But the reality with dropshipping is that you let go of a lot of this control when you work directly with suppliers.
These suppliers field orders from a variety of customers in addition to yours. So the likelihood that one of your customers gets sent the wrong item or a defective unit is high.
You can offer top notch customer support as the customer facing online business to manage complaints and answer questions. But when it comes to implementing actual changes to improve the fulfillment of products to customers, there is not much you can control.
Limited branding and personalization
Custom branding and packaging is a great way to differentiate your products from your competitors and communicate value to your customers. Sadly, the level of branding and personalization you can do for your products is limited.
Many suppliers will allow for the printing of your company logo and some generic options for packaging. But anything more would either require you to pay a higher price or deal in a higher minimum order size.
Who is dropshipping for?
At the beginning of the 2020 decade, the global market share of dropshipping was valued at over $100 billion. This number is expected to grow to over $500 billion by the year 2025. This presents a very lucrative opportunity for those looking to earn money online either as a side gig or even as a full-fledged business.
Dropshipping as a full-time business
Anyone can run a full-time business as a dropshipper.
There are low barriers to entry, low startup costs, and low operation costs. You can get your online store up and running very quickly and once you’ve found the right products, you can start selling products to customers right away.
Expanding your business can also be done very quickly and easily so it is very easy to increase your revenue in a short period of time - especially if you’ve attracted a good group of customers.
The path is not easy, though. Navigating the waters as a new retailer can be challenging at first as you work to understand all the nuances of this model. But once you’ve settled into your niche and have been successful selling products, it is easy for you to expand and sell more.
A fine-tuned dropshipping business is like a locomotive. Once it gets going it can just keep going - and generate some good passive income.
Dropshipping as a side project
Dropshipping is a great way to earn money online because it’s easy to start and takes little time and energy to operate. Some of the disadvantages related to low margins and dealing with suppliers may deter some people from doing this full-time - but it doesn’t have to deter them from running this type of business.
The flexibility of this business model is a great option for those who want to maintain the stability of a traditional job but also be able to earn some extra income in their spare time.
In most cases balancing a full-time job and your dropshipping company takes just a bit of time management and discipline. Once you’re able to build some good routines for managing both areas, you’ll be able to run your business smoothly while still performing well at your job.
Dropshipping retailers make up a huge portion of the current e-commerce space, with a good overall outlook for many years to come. This business model offers entrepreneurs low barriers to entry, low overall investment, and a great deal of flexibility - and can be done either part time or full time.
Those who decide to enter this industry will likely face challenges with competitors, low margins, and issues with suppliers. But with good product and supplier research, quality customer support, and an optimized online store, dropshipping can be a viable opportunity for anyone looking to make money online.