A fairly recent development in retail fulfilment, dropshipping sounds like a godsend for small operators. In this article, Renae Smith puts dropshipping under the microscope so you understand exactly what it is, and how to get the most value from it.
In the past few years, the dropshipping business model has seen a huge rise in popularity. But despite what you might read online, dropshipping is not a quick money-making-scheme that comes without hard work or risk.
While the concept itself might sound simple enough, few people get all the processes and potential pitfalls involved in dropshipping.
How then, can you work out if dropshipping is right for you?
Dropshipping is a retail business fulfilment method that doesn’t require a company to keep stock on hand. Instead, when a retailer or merchant sells a product, they simply pass the purchase details on to a third party, who ships the product directly to the customer.
This means that the seller never sees, stores or handles the product, they merely act as an agent between the product’s manufacturer or supplier and the buyer. Shipping = dropped.
This delivery model is undoubtedly a low cost/high return type of business, as it doesn’t take a lot of investment (either financially or time-wise) to set up a store that uses dropshipping to deliver products to customers.
After a relatively small investment of setting up your website, you could theoretically offer an unlimited selection of products that will appeal to a huge pool of potential customers.
Adding new products to the store is instantaneous and requires no up-front purchases. As it’s only once a customer purchases and pays for an item that any physical action needs to take place.
In addition, because there are no warehouses to run, orders to pack or stores to supervise, many dropshipping retailers are run by a single business owner, from a laptop, anywhere with a WiFi connection. This keeps overheads costs low and offers complete flexibility when it comes to the businesses location and the option of scaling the business up or down.
These low cost, high convenience benefits make the dropshipping model incredibly attractive, but it’s important to understand the disadvantages before deciding to create a business with this structure.
While the dropshipping model has some definite advantages, it’s those widely appealing advantages that have raised industry competition in popular markets and which feed the built-in complexities of dropshipping.
Oversaturation in this field means any number of competitors could be selling the exact same products as you do, no doubt at very similar prices. In addition, larger, more established companies will have more buying power, meaning that they can reduce their prices to a level that may not allow smaller operators to compete.
It’s essential to understand that dropshipping models work on very low profit margins and when working on your business plan, a realistic approach should be taken when calculating whether you believe it can work for you.
According to Fit Small Business, you can predict your potential income by using the formula of 20 percent margin with a two percent conversion rate (the reported averages across the e-commerce industry).
Their website offers a real-life scenario: ‘If I sell SuperDuperFuture TVs for $1000 I would expect to make $200 on each sale. And if I have 1,000 people visit my site per month, then I would estimate that 20 of those people will buy my product. If I made $200 per sale and had 20 sales, I have made $4,000’.
While this formula is a good place to start, Big Commerce recommends considering an additional three factors. They note that in most instances, your discount on buying from manufacturers and wholesalers will be less than 20 percent. In addition, this 20 percent margin doesn’t account for any of the additional expenses that you have to pay from your end, meaning it’s not the final profit.
Also consider you’ll likely have to cut into your profits to keep your sales prices competitive. If you stubbornly hold on to your 20 percent margin, other companies will easily undercut you.
A further risk involves the fact that you do not have access to products you sell before they reach your customer, so there’s no possibility of conducting regular quality control.
If there’s an issue with a product or a delay in delivery, this can not only result in bad reviews and customer complaints, which can be expensive to handle, but may also raise legal liability issues.
So it’s important to remember that, while dropshipping seems like a ‘low maintenance’ business model, when it comes to customer service issues relating to complaints, returns or damaged goods, these must all be managed by you.
As the person speaking with both the customer and supplier, your workload is essentially doubled and problems can take a lot longer to fix.
Thankfully, it’s not all doom and gloom for those still hoping to get into the dropshipping industry.
Like in most areas of business, with careful research, strategic planning and a bit of creative thinking, there’s still room for new entrepreneurs looking to enter the retail space.