What is Drop Shipping and How Does it Work?

drop shipping

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.

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.

So, if your business adopts drop shipping, you act as a storefront that customers visit and order products from. Once they place an order, you charge the consumer, and the drop shipper charges you. You never handle the actual products.

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 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.

Get Started With Square Invoices

Get paid faster with online invoices.

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. This order fulfillment method is popular for ecommerce businesses and other companies looking to mitigate inventory risk and increase business flexibility.

  • 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.

The challenges of drop shipping

Drop shipping can be beneficial for business owners, but some drawbacks might not bode well with your overall 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. Suppliers are at the core of your business, so be selective about whom 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.

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.

Tips for a drop shipping business

Here are a few best practices to implement to assure 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 e-commerce 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, 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.

H2: Drop shipping FAQ

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.

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.

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.