Q: HOW DOES DROP SHIPPING WORK?
A: An e-commerce business decides to offer a new product to customers. Instead of buying mass quantities of that product and storing it and shipping it out themselves, the company researches until they find a manufacturer interested in working with a retailer to distribute their products. The retailer contacts the manufacturer and reaches an agreement: the retailer will host the product listing on their website and make the sale, and the manufacturer will ship it out. The manufacturer is the entity that both produces, stores, and ships the product.
The retailer may agree to pay the manufacturer $25 for a product, so they might choose to list the product for $100 on their website, leaving them with a profit of $75.
Q: WHY DO COMPANIES CHOOSE DROP SHIPPING?
A: Many online stores will use drop shipping to expand their product offering to customers. It’s a low-risk way to test potential merchandise without having to pay for inventory up front. A home goods retailer, for example, might be considering offering a line of outdoor supplies. Instead of purchasing the inventory, finding a place to store it, and risking taking a loss if products don’t sell, they can work directly with a drop-ship supplier of outdoor goods. They can promote the items on their own site to gauge the interest level of the consumer base without spending money on the inventory in advance.
It’s also a helpful option for new startups, as these companies don’t usually have a ton of cash on hand. The manufacturer takes care of the storage and shipping, so there’s a low barrier to entry on the part of the retailer.
Q: ARE DROP SHIPPING BUSINESSES LEGAL?
A: The concept of drop shipping is 100 percent legal. It's not necessarily a business strategy — it’s a fulfillment method. A manufacturer has 1,000 units of product, but it’s generic, so drop-ship suppliers provide the product to these retailers to apply their own brand to it. And each supplier agreement has different terms, which is where the legal aspect comes in. There's always an agreement between the retailer and the drop-ship supplier that have specific terms that will be legally binding.
Q: WHO IS LIABLE IN THE CASE OF A PRODUCT DEFECT?
A: The liability will be laid out in the agreement between the retailer and supplier. It often depends on who has more leverage — a drop-ship supplier for a large corporation will likely have the upper hand when it comes to determining which side takes responsibility.
Q: SHOULD COMPANIES EVENTUALLY BRING DROP-SHIP INVENTORY IN HOUSE?
A: It depends on the strategic goals of the company. Profit margins tend to be low with drop shipping. The drop-ship supplier is the one who has all the fulfillment costs, but usually the retailer has all the costs of acquiring the customer, running the advertising and promotions, and driving demand. Retailers often aren’t able to generate a lot of new cash.
The choice to bring drop shipping in house depends on how well the drop ship inventory is moving and if retailers prefer to use drop shipping for a few products or as a way to retain customers, rather than expand the customer base.
Q: DOES DROP SHIPPING BENEFIT CUSTOMERS?
A: Many of the benefits of drop shipping are on the merchant side — low overhead, low risk — but customers do benefit as well. The flexibility that drop shipping provides to merchants as a way to quickly begin offering new products to customers makes it easier for a retailer to start providing a wider variety of products to their customers and to consider what product their customers might need. If a customer is a fan of a product or brand, and they want the retailer to offer more options, instead of spending months designing and developing a new product, the retailer can turn to a drop-shipping supplier and start offering the product the next week.
Q: IS THERE A DIFFERENCE BETWEEN ADVERTISING IN-HOUSE INVENTORY AND DROP SHIPPING PRODUCTS?
A: To a customer it should be relatively incognito because the retailer has branded the drop-shipped products as their own product. But there are differences. Since drop-shipped products have lower margins, and a retailer might make more of a profit on a product they produce and store in house, they have to be careful when evaluating how to spend their marketing budget.
Q: HOW DO STORE-WIDE PROMOTIONS AFFECT DROP-SHIPPED PRODUCTS?
A: Every discount or promotion includes fine print and exclusions. There are rules the retailer can apply to certain SKUs so the coupon doesn’t work for a drop-ship item, because the low profit margins mean a discount might cause the company to lose money.
However, in certain cases a retailer might include the drop-shipped products in a promotion. They may lose money on that specific sale, but it could lead to customer retention or customer acquisition, which will be more profitable in the long run.