The Pros and Cons of Drop Shipping

Editor’s Note: This article was originally published by Web Marketing Today. Practical Ecommerce acquired Web Marketing Today in 2012. In 2016, we merged the two sites, leaving Practical Ecommerce as the successor.

“Drop shipping is a supply chain management technique in which the retailer does not keep goods in stock, but instead transfers customer orders and shipment details to either the manufacturer or a wholesaler, who then ships the goods directly to the customer.” — Wikipedia

When I spoke at a conference a couple of years ago, and I made the mistake of referring to two types of online retailers: “real retailers” (like me) who stock what they sell and then those other folks that drop ship. Whoops! I have never gotten so much hate mail. It was a very educational faux pas which made me stop and reconsider the use of drop shipping.

Drop shipping has as many upsides as downsides. In this article I’ll address the strategic benefits and liabilities of drop shipping,  then give examples of different types of retailers who use drop-shipping as a profitable business strategy.

Advantages of Drop Shipping

First, let’s look at the advantages of drop shipping.

1. Upfront Costs. As an online retailer you have a virtual store, so why not have a virtual inventory as well? Drop shipping can reduce your upfront costs and commitments. You have no inventory-carrying costs. You don’t have to buy products in case lots or meet minimum purchase requirements to order or restock. You have no warehouse to maintain with no pick-pack-ship staff that you have to pay regardless of whether or not they’re working.

2. Bulky Items. Certain product types lend themselves to drop shipping, especially big and bulky items. These items are expensive to receive, store, and ship back out, so it makes a lot of sense to drop ship them from the manufacturer.

3. Location. The location of certain suppliers can also provide a geographic shipping advantage. For example, while our company is centrally located in the US, we have a very reliable West Coast company who is an excellent shipper. Since they are a lot closer to our customers than we are, drop shipping makes a lot of sense.

Problems with Drop Shipping

But there can be problems associated with drop shipping.

1. Drop shipping can increase your COGS (cost of goods sold). Usually a stocking retailer is paying less — and sometimes much less — than a drop-shipping retailer selling the exact same SKU. Stocking retailers typically get better pricing, additional bonuses, marketing incentives (such as co-op advertising), insider knowledge about the product line, access to deals, and many other advantages of having a direct relationship with the manufacturer of what they sell.

2. Drop shipping can limit product selection. When you limit your store’s merchandise to drop-ship only manufacturers and distributors, you limit your customers’ options. For example, with Gun Dog Supply we have over 100 vendors,  most of whom don’t drop ship. Thus most of those products aren’t available from secondary distributors or drop shipping companies.

3. Drop shipping can have higher fulfillment costs. When you drop ship, you not only pay the real cost of stocking, picking, packing, and shipping, you also pay a hefty mark-up which means drop shipping costs scale as your sales grow.

When you stock merchandise yourself, you have a lot more control over these costs. For example, my warehouse rent has been the same for the past three years. My cost to ship a  box goes down each month as our sales grow and as we get more and more efficient at shipping packages.

4. Drop shipping can increase customer service headaches. Drop shipping entails at least twice as much customer service work on every order, and problems with orders are more difficult to sort out.

For our company, dropping shipping adds two extra steps: placing the order with the drop shipper and posting the shipped order within our Order Management System. Many times this can be automated, but for smaller retailers it’s problematic. Some manufacturers’ and wholesalers’ internal systems are horrible.

Also, several of our suppliers use shippers that we don’t use. When UPS gives us trouble about a box, because we have a shipping account and ship a lot of volume, we have a pretty good idea about their policies, delivery times, and have someone on speed dial to call when there’s a problem — even when it’s not our account shipping the box. But our customer service representatives don’t know the ins and outs of FEDEX or DHL.

Different Types of Drop Shipping for Different Types of Retailers

Though drop shipping has its downsides, there are situations where drop shipping can be a real advantage.

Drop Shipping as Business Model. One of my former clients has an eight-figure a year business and all he does is drop ship. He consolidates the catalogs of 50 to 75 different manufacturers on his Yahoo! Store and literally has no inventory. The industry he is in typically has longer delivery cycles than most online retailers, so he’s at no disadvantage with an extra day or two of order processing.

Drop Shipping as a Research Tool

I once had a small business client who ordered $25,000 worth of inventory and had it stored in his basement before he even built his Yahoo! Store. He ordered one of each SKU made by several companies because that’s what he thought he needed to do to get started selling online. He would have been better off spending that money on creating content and marketing his new business, to get some cash flow going through his business before committing to a large inventory of products. Even with 20 years of experience, this happens to us as we get into new product lines. “Uh, why do we have $10,000 of white dog collars?”

Drop Shipping as a Secondary Source of Supply. Some retailers use drop-shipping as a back-up source for when snafus happen with traditional sources. For example, the manufacturer of one of our most popular dog training collars changed the box design, so shipments were delayed for several weeks. This is a product that we should never sell out of, but we did, and fortunately the two or three days we were sold out, we had multiple other drop-shippers to use to make up for our mistake. We made less money, and did more work, but our customers were happy.

Drop Shipping for Bulky Items. We also use drop shipping for specific items when it makes more business sense than stocking the item. For example, some of our dog houses are big and bulky. It makes no sense to ship them more than once.

I hope I don’t sound too biased against drop-shipping. My direct experience from 20 years of retailing is that drop shipping is great when everything goes right, but when things go wrong, they get ugly and fast! Drop shipping is great when you can find the products you want to sell, and have a reliable partner to drop ship for you. Once a drop-shipped product line gets traction, however, I try to buy direct as soon as it makes business sense to do so.