What is dropshipping? How does it work, and why so popular?
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Dropshipping - a term that is becoming increasingly common in the world of e-commerce. For some, it is a new term; for others, it is an opportunity to find out what dropshipping really is, how it works, and how it differs from traditional inventory management.
The goal of this article is to demystify the dropshipping model - to explain why it is such a hot topic, how it works, what its real benefits are, and how it fundamentally differs from warehouse-based retail systems.
Dropshipping is so popular because it solves several of today's largest pain points among retailers. Increased real estate and labor expenses, and ever-growing demand for diverse and speedy delivery have prompted businesses to rethink inventory handling and order fulfillment processes. Dropshipping presents possibilities of minimizing front-end costs and optimizing processes, and enabling businesses to be more responsive and flexible.
The fast growth of online marketplaces and software, such as automatic ordering and real-time inventory tracking, made dropshipping more convenient and hassle-free than ever before. The strategy keeps start-ups as well as mature brands' entry points low and lets them try out new concepts as well as grow with a minimum risk of losing money.
Why has dropshipping become so trending?
At its bare minimum, dropshipping is a retail fulfilment model that involves a retailer not stocking physical products. After a customer's orders are received, the seller requests a product through a third party, who ships it directly to the customer. The seller never touches physical products but is only responsible for managing the operation of the online storefront, customer relations, and ordering coordination, and the supplying firm takes care of storing, packaging, and delivering goods.
It's simple in theory — how does it actually work, and what are its genuine advantages and disadvantages?
Dropshipping definition
Low inventory and start-up capital. No huge inventory or warehouses have to be invested in by vendors, so it is easy to get started and try out new business ventures.
Broad product line. Unfettered by physical stocks, vendors have many products that are available to them to offer and are capable of adapting to changing trends very quickly.
Scalability and adaptability. As orders rise, your supplier takes care of fulfilling the load so that you can ramp up without adding to your facilities.
Quick testing of markets. With dropshipping, businesses are able to test new products or new marketplaces with minimum financial risk.
The benefits of dropshipping
Lack of control. Since you don’t handle the products yourself, you depend on your supplier when it comes to shipping schedules, packaging, and product quality. This means that you have minimal control over how the customer experience unfolds.
Low margins. Suppliers do all the work for you, so they tend to be more expensive per unit, and there’s so much competition in the market, it’s hard to keep prices low and still make a profit.
Branding and quality challenges. Without direct control over your merchandise, it’s almost impossible to ensure consistent quality or build a solid, well-known brand.
Major drawbacks and risks of dropshipping
It is important to understand that dropshipping is a selling strategy, rather than a way to eliminate inventory management. The responsibility for inventory management shifts upstream to the supplier. The supplier must:
Keep accurate inventory records
Manage stock levels effectively
Ensure timely picking, packing, and shipping
Manage returns and restocking effectively
If the supplier is lacking in any of these, the reputation of the seller and customers will be impacted. Simply put, dropshipping can only be successful if the supplier's inventory management is reliable and effective.
Dropshipping driven by supplier inventory management
Dropshipping compared to traditional inventory management
So traditional inventory management offers control and better margins but requires significant capital and operational resources. Dropshipping, on the other hand, emphasizes flexibility and capital efficiency, but demands careful supplier management to avoid quality and fulfillment issues.
Under the dropshipping business model, no inventory management software is required because there is simply no stock on hand and no warehouses to manage. A dropshipping business owner just forwards orders, which are received on e-commerce, to the supplier, who ships directly to the customer.
When dropshipping is compared to traditional inventory systems, several important contrasts become clear.
In traditional inventory systems, there is a large initial capital requirement because businesses have to purchase and retain stock in advance. With dropshipping, however, the sellers do not pay the suppliers until after a sale is made, significantly diminishing financial entry costs. In traditional models, unsold or outdated merchandise risk rests on the seller, whereas with dropshipping, it rests on the supplier.
Controlwise, the conventional seller has full discretion over product quality, packaging, and brand. Dropshipping, on the other hand, limits such control because the sellers must rely on third-party suppliers almost exclusively.
Conventional inventory usually has higher margins of profit owing to economies of scale, whereas dropshipping usually has thinner margins as a result of higher per-unit costs.
Operational overhead is higher on the traditional models due to the warehousing, staffing, and logistics infrastructure. Dropshipping has lower overhead with the utilization of digital tools and coordination of suppliers.
Lastly, speed to market is generally slower with the traditional inventory due to the stock planning, while dropshipping allows faster adaptation to trends by the quick addition or removal of products.
Testing new products or markets with minimal risk
Operating side businesses, promotional periods of time, or test product lines
Expanding into new regions without having to invest in in-house warehouses or complex logistics
Limited capital or space for inventory
When dropshipping is worthwhile
Personalized packaging or special unboxing experiences in brands
Businesses that must have high control over shipping rates and order accuracy, and fulfillment
Large volume products where bulk pricing will be more profitable than dropshipping.
When dropshipping is not an option
Dropshipping can be considered a strategic extension of inventory management in today's supply chain. It's an electronic conduit to enable businesses to expand their sales channels through seamless connections and APIs. While inventory management mechanics remain of utmost importance, the burden now lies with the supplier. With businesses expanding sales channels, smooth inventory flow and assured fulfillment become even more important to enable customer satisfaction and healthy cash flow.
For small businesses and startups, dropshipping is an actual reality. It minimizes the entry barrier, and hence, entrepreneurs can begin businesses with minimal capital and without warehousing requirements. This practice permits quick product testing, quick adaptation to trends, and new market access, without tied-up capital in inventory. Increased cash flow, since payments arrive before supplier payment, gives small businesses the agility they need to grow.
For larger businesses, dropshipping is a good force multiplier for diversification. Established businesses can use dropshipping to push product extension or enter new geography without the risks and costs of traditional inventory extension. It allows rapid experimentation with new categories and geographies on the back of the supplier's logistics and fulfillment capability. By adding dropshipping to their overall inventory management, big companies can stay agile, respond to market trends, and take advantage of fresh opportunities without inordinate disruption.
If you are thinking of starting a dropshipping business or already have a business up and running, inventory management is not your concern. Since there is no inventory stored on hand, inventory tracking and fulfillment are entirely the problem of the supplier. On the dropshipping model, entrepreneurs rely on their suppliers to do all the inventory work so that they can focus on sales, marketing, and customer support.
Thinking about using a traditional inventory model? Get in touch with us for expert advice.
