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

Drop Shipping Guide: What is Drop Shipping and How Does it Work?
Drop shipping is a popular inventory method for online businesses. Learn everything about how drop shipping works and decide if it’s right for your business.
by Square Mar 03, 2024 — 7 min read
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:

And here’s how it works:

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.

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:

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:

Tips for a drop-shipping business

There are a few best practices to implement to assure success for your drop-shipping business.

Drop-shipping FAQ

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.

The Bottom Line is brought to you by a global team of collaborators who believe that anyone should be able to participate and thrive in the economy.


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