Dropshipping is method whereby retailers don't keep physical inventory on hand, but rather fulfill orders via a third-party who sends the item(s) directly to the buyer.
The biggest difference between this business model and a more traditional retail arrangement is that the store or the seller doesn't own any inventory. The third-party used by the retailer is usually a wholesaler or manufacture of the product.
Dropshipping is most commonly associated with e-commerce.
What Is Dropshipping?
A dropshipping arrangement might work like this:
A customer makes an online purchase from a store or other online seller of a particular product. Once the order is received, the seller contacts the third-party supplier via whatever means they've arranged and transmits the details of the order. The third-party fills the order and then ships the item to the end customer.
There typically is sort of online means for the seller to communicate the details of the transaction to the third-party fulfillment house. Payment arrangements for the item, for shipping and any other charges would be in place as well.
What Are the Pros of Dropshipping?
Dropshipping can offer a number of pros for sellers and retailers, including:
- There is no need for a warehouse or storage facility for the inventory.
- There is no investment in inventory.
- There is no need to employ workers to pack and ship orders.
- Somebody else is responsible for handling returns and any inventory-related inbound shipments.
Overall, not holding inventory or dealing with shipping will lower a company's overhead, all else being equal.
The use of dropshipping also offers flexibility in where the store or the seller is located, especially for online businesses, which can be location-independent.
Not having to invest in inventory allows the seller to offer a wide array of products for sale and this type of business can be easy to scale as well.
What Are the Cons of Dropshipping?
While dropshipping offers a number of advantages, there are some potential disadvantages as well, including:
- You have no control over the supply chain. Sellers using dropshipping are at the mercy of their third-party suppliers. If they go out of business, have problems procuring the inventory needed, etc., the seller is out of luck and perhaps out of business.
- The seller has no control if the suppler engages in shady or illegal business practices, but you could be held liable, or at least suffer reputational damage through no fault of your own.
- As a dropshipper of someone else's product it can be tough to build your own brand. As a reseller of other company's products, you are susceptible to customers seeking out other sellers if your prices aren't the lowest. This can both cost you business or hurt your bottom line if you are forced to lower prices to be competitive.
Is Dropshipping Profitable?
While every dropshipper's situation is different, there are some factors that can be a drag on profitability, including:
- You have no control over the costs that the third-party supplier will charge you for the item and for other services like shipping and handling returns.
- If you are selling competitive products you are always at the whim of the prices set by larger sellers and retailers. They may be able to undercut your pricing, causing you to match or beat their price, sacrificing your profit margins.
- Using a third-party to fulfill orders will likely increase your cost of goods sold versus stocking the items yourself.
- Using an outside fulfillment service can result in customer service problems that might not be there if you were handling that aspect yourself. You have no control over their processes and procedures.
Is Dropshipping Legal?
Dropshipping is legal, but there are some potential legal issues to consider:
- Proper licensing to engage in selling online as applicable. These might include a business license in the location in which you are physically located.
- Taxes can be a thorny issue. Beyond the normal business tax issues, you may be liable for sales taxes in the locations where your customers are located, either directly or via your third-party fulfillment service.
- You will want to ensure the products actually shipped are legitimate and not counterfeit goods.
Working with a high-quality supplier can go a long way to preventing these types of issues.
Is Dropshipping a Good Idea?
A dropshipping business model can be a good idea. There are low costs of entry and few barriers to entry.
That said, it is still a business and you need to treat it as such. Go in with a business plan and take the time, perform the due diligence needed to strike a relationship with a solid, reputable supplier. This relationship can make or break your business.
Introducing TheStreet Courses:Financial titans Jim Cramer and Robert Powell are bringing their market savvy and investing strategies to you. Learn how to create tax-efficient income, avoid mistakes, reduce risk and more. With our courses, you will have the tools and knowledge needed to achieve your financial goals. Learn more about TheStreet Courses on investing and personal finance here.