Drop Shipping Guide: What is Drop Shipping and How Does it Work?

What is drop shipping?

Drop shipping is a retail fulfillment method in which 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 directly 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.

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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 then mark them up before selling them to retailers. Wholesalers usually 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 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 there are fewer parties taking a cut. A short supply chain is one where you deal directly with the manufacturer.

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 or 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. Because you don’t have physical inventory, you can basically 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 first having to order new items or clear out 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 there are drawbacks that might not bode well with your overall business strategy. Here are a few examples of why some businesses decide against drop shipping for their business:

• 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 a number of suppliers, your shipping costs become quite complicated. Let’s say that a customer orders two items, each from different suppliers, with different shipping costs. You’ll need to determine what to charge the customer for shipping in a way that the customer won’t feel overcharged.
• Lack of control over the customer experience: By relying 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 that 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, it’s important that you learn how to manage your suppliers effectively in order 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.
• Is there a handling fee? If so, assess how it may affect 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 come returns. Find out the return and warranty policies. If returns aren’t accepted or are products 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

There 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 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, you should also work to boost your online credibility to ensure customer trust. 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

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 a number of 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. In addition to the amount of shipping fees that your company decides to absorb for the customer, you will need to pay the drop shippers. The average hourly pay for professional drop shipping in the U.S. is $19.70 an hour, according to a ZipRecruiters report.

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.

How is drop shipping different than affiliate marketing?

While both drop shipping and affiliate marketing seem like similar options for eCommerce businesses, they’re actually very different. When a business uses drop shipping as a fulfillment option, they act as the middleman between the customer and the supplier. The business handles marketing, sales, and customer service, but not the fulfillment of the product. The supplier, on the other hand, handles the fulfillment of goods for the customer after the order is placed. Retailers typically set their prices higher than the wholesale price, and they earn a profit on the difference.

On the other hand, affiliate marketing is a marketing tactic that any type of retailer can adopt, agnostic to their fulfillment model. When a business engages in affiliate marketing, the affiliate marketer or affiliate agency promotes the products or services of the company and earns a commission for each sale or lead generated through their marketing efforts. The affiliate marketer does not handle product fulfillment, customer service, or any type of inventory management.   

Running a business isn’t an easy feat, but Square is another resource you can turn to. We have all the tools you need to start, run, and grow your business, whether you’re selling in person, online, or both. And we’ve made all our tools work together as one system, saving you time, money, and effort. So you can get back to doing the work you love and focusing on whatever’s next. See how Square works.