What is Drop Shipping and How Does it Work?

This article is for informational purposes only and does not constitute legal, accounting, or tax advice. The information contained herein is subject to change and may vary from time to time in your region. For specific advice applicable to your business, please contact a professional.

If you want to start a business, launch an online store or shift your business model, you may be curious about drop shipping. But what is drop shipping and how does it work? Here’s what you need to know about this fulfillment model.

What is drop shipping?

Drop shipping is a retail fulfillment method where a business doesn’t keep the products it sells in stock. When a drop shipping retailer sells a product, it purchases the item directly from a third party (a manufacturer, wholesaler, or another retailer) that ships the product to a customer.

If your business adopts this drop shipping model, you act as a storefront that customers visit to place their orders. Once they place an order, your business charges the consumer, and the drop shipper charges you. You never handle the shipping and handling of the actual products. As a drop shipper, this allows you to focus on expanding your customer base and growing your brand — without the headaches and costs associated with stocking and shipping inventory.

How does drop shipping work?

Drop shipping is a supply chain management method. (If you recently opened a retail business or an online store, a supply chain is a network of suppliers, materials, manufacturers and retailers involved in the creation and distribution of a product, from production to customer delivery.)

These are the parties involved in drop shipping:

• Manufacturers create the products. They usually don’t sell to the public; they sell in bulk to wholesalers and retailers instead.
• Wholesalers buy products from manufacturers and mark them up before selling them to retailers. Wholesalers typically stock products from a variety of manufacturers.
• Retailers sell products directly to the public, at a markup.

And here’s how drop shipping it works:

• The customer places an order with your business (the retailer).
• You alert the drop shipping partner — either the manufacturer or the wholesaler — who packages and ships the product directly to the customer.
• The drop shipping partner charges you (the retailer), for the service, and you charge the customer.

Generally, the shorter the supply chain, the greater your profits will be because fewer parties are taking a cut. A short supply chain is one where you deal directly with the manufacturer.

Leveraging technology in drop shipping

In the fast-paced world of eCommerce, leveraging technology is essential – and technology is the backbone of a successful drop shipping business.

You need an online store that customers can trust. Platforms like Amazon are invaluable for hosting your online store. For example, Amazon helps attract a global audience to your online store.

Having a strong brand is also crucial if you want to rise above the competition in the drop shipping market. Branding goes beyond just selling products; it’s about creating a unique brand identity and customer experience. Make sure that your brand communicates trust, quality and reliability, which involves consistent branding across all platforms and outstanding customer service.

With Square Online, you can launch a personalized, mobile-friendly online store in minutes Choose among a wide selection of themes to customize your branding.To reach new and existing customers where they are, you can take orders on social media by linking your site to Shopping on Instagram or Facebook.

The benefits of a drop shipping business

Drop shipping is a retail inventory management method that can help your business decrease risk, but there are other benefits as well. The drop shipping business model offers flexibility and efficiency for eCommerce businesses looking to mitigate inventory risk and increase cost-effectiveness.

• It lowers the costs of starting and maintaining a business: Drop shipping drastically reduces the initial costs of starting an online business, since you don’t have to invest in building inventory upfront, which can be cost-prohibitive for new and small businesses. And because you don’t have to deal with purchasing inventory (or managing storage for that inventory), your overhead remains relatively low. It also means you aren’t stuck with products that won’t sell, and you won’t have to mark down those items and take a loss.

• Your location can be flexible: Drop shipping businesses can also be more nimble than businesses with more traditional structures. As you don’t have physical inventory, you can run your store from anywhere you find an internet connection.

• You can offer customers a wider selection of products: Since you don’t have to invest in building your own inventory, you can stay on top of trends and quickly add new products to your site. You can also quickly switch up your offerings without having to order new items or clear out any backstock.

• You don’t have to manage inventory: A lack of inventory also means that you won’t have to manage it. Managing inventory can be complicated and time-consuming (although inventory management software can make the job much easier). Not having to watch stock, reorder it, and process it means that you and your employees have more bandwidth to work on other aspects of your business to help it grow. Keep in mind that selecting the right drop shipping supplier is crucial to reduce the complexity of managing stock.

Essential metrics for a successful dropshipping business

Drop shipping is a competitive marketplace. To stand out, monitoring key performance indicators (KPIs) is necessary.

Keeping track of sales data and customer feedback will provide insights into which products are high in demand. Additionally, assessing the efficiency of your supply chain, from packaging to shipping times, will help you identify bottlenecks and areas for improvement.

Using these platforms also helps track sales performance and manage customer data, ensuring you provide high-quality service that meets customer demands.
Understanding these metrics not only aids in maintaining high-quality standards, but also allows you to make informed decisions about your products and adjust your pricing strategy based on the market.

Expanding your product assortment with drop shipping

One of the distinct advantages of a drop shipping model is the ability to diversify your product range without the need to invest heavily in inventory. By responding quickly to market trends and consumer demands, you can update your product offerings regularly.

A close partnership with your drop shipping supplier can make this process easier. It allows you to constantly have access to a wide array of products to meet the ever-changing preferences of your target customers. This flexibility can have a powerful impact on your growth. It helps attract new and repeat customers and increase sales.

The challenges of drop shipping

Drop shipping offers several upsides to business owners, but it also comes with challenges. Being aware of potential drawbacks is important to make sure a drop shipping model aligns with your business strategy. Here are a few examples of why some businesses decide against drop shipping:

• Reduced profit margin: As discussed above, the longer your supply chain, the lower your profits.

• Inventory issues: When you own inventory, it’s easy to check stock levels. But when you get products from multiple suppliers — who in turn are working with other retailers — it’s more difficult to make sure that the products you need are readily available.

• Shipping complexities: If you’re working with several suppliers, your shipping costs can become quite complicated. Let’s say that a customer orders two items, from different suppliers, each with different shipping costs. You’ll need to determine how to charge the customer for shipping in a way that the customer won’t feel overcharged.

• Lack of control over customer experience: By putting reliance on a drop shipping partner to get products to your customer, you’re acting in good faith that they will deliver the orders on time and intact. If they don’t come through on their end of the deal, or deliver items late, broken, or not at all, it can result in bad reviews and a loss of consumer trust, which can negatively impact your company’s customer service reputation.

• Issues with suppliers: It’s imperative to have solid relationships based on trust and mutual respect with your suppliers. Consider their history and reliability. Suppliers are at the core of your business, so be selective about who you partner with, and never take those relationships for granted by paying them late or being difficult to work with. To build strong partnerships, you must learn how to manage your suppliers effectively to maximize drop-shipping efficiency.

• Tax considerations: The tax obligations associated with drop shipping in Canada can get complicated, especially if you deal with international suppliers and customers. Navigating Canadian tax considerations such as when to charge the HST/GST or PST can get tricky when you’re importing or exporting goods and dealing with multiple currencies. Educating yourself on tax compliance and maintaining rigorous accounting practices is essential.

How to select a drop shipping supplier

The third party you choose as a drop ship supplier will determine your supply chain’s success, so you need to do your due diligence during the selection process.

Generally speaking, you want to set up drop shipping arrangements directly with the manufacturers of the products you want to sell. The fewer middlemen you have to go through, the bigger your profits will be. Each additional fee charged by your supply chain partners affects your bottom line, so whenever possible, it’s best to work directly with a manufacturer.

Here are some questions to ask potential suppliers:

• How much do you charge?: Crunch the numbers before selecting a drop shipping partner. If the wholesale price isn’t enough for you to make a decent profit off of the products, look elsewhere.

• Also, is there a handling fee?: If so, assess how it may impact your profit margin. Again, every fee and each middleman affects your bottom line, so you want to streamline the process as much as possible.

• How are products shipped?: You want a partner who ships items via a service that provides tracking numbers (which they should send to you). That way, if your customers inquire about the status of their orders, you can provide them with accurate, up-to-the-minute information. And, with shipping comes returns. Find out the return and warranty policies. If returns aren’t accepted or products are not guaranteed, steer clear.

• What is the billing process?: Do drop shipping partners charge your credit card as soon as you submit an order? Or do they send you a monthly bill? Make sure to choose a partner whose billing process is a good fit for your cash flow.

Maximizing profits with efficient drop shipping

Ready to get started with drop shipping? Selecting the right drop shipping supplier can make or break the success of your business. The right partner will not only help facilitate order fulfillment, but will also ensure that your customers consistently receive high-quality products in a timely manner. -there are more niche suppliers available depending on product types.

A close partnership with your drop shipping supplier can make this process easier. It allows you to constantly have access to a wide array of products to meet the ever-changing preferences of your target customers. This flexibility can have a powerful impact on your growth. It helps attract new and repeat customers and increase sales.

Choosing a supplier with competitive pricing is also important to maximize your profit margins. Suppliers that handle both packaging and shipping efficiently can streamline your operations, providing a quicker and more reliable service to the end consumer. That said, not all

Remember that a trustworthy supplier is integral in maintaining low operational costs, allowing you to focus on marketing and customer acquisition for your drop shipping store.

Tips for a drop shipping business

Here are a few best practices to implement to ensure success for your drop shipping business.

• Make online shopping a pleasure: From ordering to delivery, you want to make the experience as seamless as possible. That starts with a user-friendly eCommerce experience. You want to invest in building an elegant site that is easy to use (on all devices) and simple to understand.

• Be particular about products: While drop shipping allows you to sell a wide variety of products, that doesn’t mean you should sell everything. Do market research and analyze trends to determine what you should be selling in your store. Think carefully about what is marketable, what is easy to ship, and what is hard for people to find locally.

• Focus on quality: Even if you thoroughly vet a supplier, you should remain vigilant about the service once you’re working together. For example, if there are several incidents of damaged products, lost packages, or late deliveries, cut ties with the supplier or risk losing the confidence of your customers.

• Build a trusted business: Your reputation is everything, so not only do you need to follow through on your promises with reliable drop shipping partners and a great website, but you should also work to boost your online credibility to build customer rapport. This will guarantee long-term success. From building a robust social media presence to creating successful email marketing campaigns, forming strong relationships with your customers will help ensure the success of your drop shipping business.

Drop shipping FAQ

1. Is drop shipping legal?

Yes, drop shipping is legal. Business owners who get into drop shipping should be mindful of the suppliers they work with — and especially pay attention to trademarks and intellectual property — but the process itself is legal.

2. Is drop shipping profitable?

Drop shipping can be profitable, though it depends on several factors. When you consider the costs of handling fees and percentages taken out by various middlemen, it might not be worth it to pursue a drop shipping operation. There’s also a lot of competition in the drop shipping niche. Because it takes so little investment to get started, drop shipping businesses often provide products at very low prices. To compete, you often have to drop prices, too – or tap into a unique niche. According to Shopify, the average profit margins of a drop shipping business are between 15% and 20%.

3. How do I create a drop shipping website?

A drop shipping website will work similarly to an online store on an eCommerce platform. The primary difference will be managing inventory with your third-party supplier. Square has partnered with Spocket to help make this integration possible for your business.

4. What is the difference between drop shipping and affiliate marketing?

Both drop shipping and affiliate marketing involve selling and marketing third-party products. But they are different business models. With drop shipping, you sell products under your own brand. You control the price, and you earn money based on the profit left after the order is fulfilled. With affiliate marketing, you promote another brand’s products. The price is usually fixed, and you make money based on a percentage of each sale that you drive.