Distribution Decisions: Drop-Shipping vs. Inventory vs. Fulfillment House

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.

“Internet product sales are easy,” said Bob Simple, when he first set up Bob Simple’s Online Shoes. Now he’s not so sure. He had found three quality shoe manufacturers who agreed to ship shoes to his customers as soon as he faxed them the order. What’s more, the manufacturers used Bob’s labels and included his completed order form in the box as a packing slip. “Slam dunk,” said Bob Simple. “I don’t have to invest in any inventory, the manufacturers have hundreds of hard-to-find sizes that I can advertise. My costs are minimal.”

Drop-Shipping Model

Bob Simple had bought into the drop-shipping model, as have tens of thousands of online stores. And they have found thousands of willing manufacturers and distributors who are glad for the opportunity to sell more of their products.

Drop-shipping has some very strong advantages and a few disadvantages. Let’s look at the advantages first.

No inventory costs. Purchasing product inventory ready to ship to your purchasers is expensive. In addition to the out-of-pocket costs, you need a place to store the inventory. Finally you have to pick, pull, pack, and ship the products once the order is placed. Having the distributor or manufacturer take all these costs and responsibilities lifts a real burden off your shoulders.

Drop-shipper is transparent. With most of your drop-shippers, especially those with whom you do a regular business, you can send them labels and forms so their package looks like it is from you. Your customer probably won’t know that your hands never touched the product.

It almost sounds too good to be true. But there are two major problems:

Lower margins. While the manufacturer may be willing to sell you product for 30% to 40% of suggested retail, if you want drop-shipping services expect to see another 10% or so off your margins. On the Internet, some categories of products are very price-sensitive, and often the “street” price is substantially under the “suggested retail” price. If you’re selling computer hardware, for example, and using the drop-shipping model, you may find it hard to be competitive price-wise and still make a profit. The difference between making money and losing it may be only a few percent. Unless you’re very careful, drop-shipping may put you out of business.

Crippled customer service. Let me tell you a story. For too many years I squinted at a 14-inch monitor. Early this year I decided to get a 19-inch monitor that won PC Magazine Editor’s Choice recognition. I went to Egghead probably because my family says that my head looks much like the old egghead mascot of brick-and-mortar days. I found the monitor, and it indicated the ability to ship soon, so I ordered it. Immediately I got an e-mail that said the monitor was backordered. :-( Why didn’t they tell me that before I ordered? I was ticked off, but decided to give them a while — after all, it could come any time. So I waited, visions of a shiny new 19-inch monitor dancing in my head. After a week with no word, I finally got tired of waiting and called customer service. I was connected to a polite customer service person who listened to my question:

“When will the monitor be available?”

“We don’t know, sir. The manufacturer hasn’t told us.”

I was frustrated. I had looked around and KNEW it was in stock at another company. “Cancel the order, then,” I told the lady, impatiently.

“You have to give 72 hours notice before canceling,” she said.

“That’s just unacceptable,” I retorted. “If you don’t have the monitor ready to ship now, then cancel it.”

“The manufacturer may be ready to ship it.”

Aha! I thought. This is a drop-shipping operation. “Then call the manufacturer and ask please,” I told her.

“I can’t do that, sir.”

“Then cancel the order. Now!” I was disgusted.

She cancelled the order. The next day the monitor arrived by Next Day courier. It had been shipped, but Egghead’s communication with the manufacturer was such that Egghead didn’t know what was going on.

In the meantime, I had ordered the monitor from another dealer, and subsequently returned the monitor from Egghead. I am sure that the return shipping costs ate up whatever profit there was in the sale. And why did the Egghead site show the item in stock when it wasn’t? Probably because the inventory available wasn’t updated in real time, or often enough to be accurate.

Lesson: Drop-shipping may well handicap your ability to provide excellent customer service. And without excellent customer service you’ll lose your best customers to your competitors. If price doesn’t distinguish you from other online businesses, then customer service most certainly must. Though I’ve had one occasion to return a book to Amazon, I go back loyally because when I called about the problem they handled it so very well.

Inventory Model

The tried-and-true retail method is to order an item from the manufacturer or distributor and keep it in stock until you receive an order. This has some advantages:

You can ship immediately. The faster you can turn around the order, the more impressed your customer is, and the better chance you have of getting him back the next time.

You can provide excellent customer service. In case of a problem, you will have all the records at your fingertips to trace the order and make a correction. In the online book wars, has invested a great deal of money building five regional warehouses and buying a share in same-day Manhattan courier firm to enable them to provide excellent customer service. As a result, they will be very hard to beat, though early on, they don’t show a profit because of the huge initial investment.

Inventory, of course, has its disadvantages, too:

Paid for inventory can sit on your shelves, tying up capital. over-estimated the number of orders for Christmas 1999, and had too much inventory at the beginning of January. When you own the inventory, you also own the risk. If a product doesn’t sell, you’re stuck with disposing of it at pennies on the dollar.

You must have an efficient fulfillment system. One of the reasons that brick-and-mortar stores are slow on the uptake when it comes to online business, is that supplying retail stores is done with pallet-size logistical system. But Internet retail requires an entirely different kind of fulfillment system. Internet retail is essentially mail order, with shipments going out in parcel sizes to end users. Few brick-and-mortar retailers have a humming mail order business to draw from, and are starting from scratch with an entirely different kind of fulfillment system. An inefficient fulfillment system can lose for you the advantages in good customer service that holding the inventory gained for you.

Fulfillment House

A third common Internet distribution model is the fulfillment house (actually a subset of the inventory model). A fulfillment house, the offspring of the direct marketing industry, will handle some or all of the aspects of getting the product to your customer. They will maintain inventory, order new product, assemble, pick, pull, pack, and ship, all according to your specifications and with your labels. They will also handle the order taking, the Internet shopping cart, and provide an ordering and customer service call center if you need one. In other words, you can run an entirely virtual business, outsourcing everything
to the fulfillment house, if you like. Of course, they take their pound of flesh. I think this works best for proprietary products, or products with a higher than average margin. But if you have a single product, such as a book or tape series, using a fulfillment house will probably be much preferable to having stacks of products lining the halls of your home. You can find fulfillment houses in the “Source Directory” section of DM News or in Yahoo’s “Fulfillment Services” category. A service that caters to the needs of small Internet start-ups is Paul Purdue’s in Dundee, Michigan.

Which of these three models should you use? No one can make that decision for you. But armed with the pros and cons, you’ll be able to make a thoughtful choice that will leverage the advantages and minimize the disadvantages of one of these models, and include it as part of your Internet Marketing Plan.

Exercise: Describe the fulfillment model you have selected and why, and explain how you will mitigate its disadvantages.

Dr. Ralph F. Wilson
Dr. Ralph F. Wilson
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