This guide covers the advantages and disadvantages of drop-shipping, one of the four methods for getting stock from the factory to the customer.
Drop-shipping is a form of e-commerce in that you still need to set up your store, upload your product listings, and start driving traffic to those product listings to get leads and sales for your business. But, rather than sourcing all the products yourself, you work with a middleman that has a catalog of products they can ship out as you sell those products.
- No upfront inventory costs. One of the big things that hold people back from starting an e-commerce store is paying for the inventory upfront. Drop-shipping solves this problem by drastically lowering the barrier to entry. You’re only ever paying for the inventory that you’ve actually sold.
- Quick product testing. When you’re sourcing inventory for a traditional e-commerce business, you should carefully research (refer to our Product Research guide) to make sure there is a real market demand for those products. In drop-shipping, you can upload hundreds of products all at once and test numerous marketing funnels on each product to see which products are winners. This way, you can quickly populate your store with products that people actually want.
- Quick test results. With drop-shipping, you’re paying higher costs for each unit sold. However, once you have found out what sells best, you can source your own (and hopefully better) versions of those products.
- Uncompetitive pricing and low profit margins. Higher costs mean your profit margins may be significantly lower with this model. The higher cost also gives you less flexibility for setting price points to attract sales. You can’t benefit from bulk ordering discount since you’re not paying any upfront inventory fees in the first place.
But, if you achieve good sales, your supplier is likely to be open to exclusive supplier relationships, special marketing privileges, special terms like an increased margin, and permitting you to discount prices.
- Competition from the copycats. Most of the time you won’t have an exclusive agreement with your drop-shipping supplier. Other drop-shippers will find your supplier, use their catalog, and start testing their own marketing funnels on the same products you’re selling.
Ask yourself how easy is it for others to copy your business. If your answer is “too easy,” then it is time to “dig a deeper moat.” Good marketing like an email list of raving fans, fostering active online communities for your customers to discuss your company and products and creating industry-related podcasts and webinars. Tactics like these help build a quality brand that copycats can’t compete with.
- Lack of Control. Whereas traditional e-commerce businesses own every step of the process, with drop-shipping a lot of the process is out of your hands. There are more critical points of failure, such as a Facebook ad suspension or losing your supplier.
If your supplier does a poor job with your shipping, it’s your store, not them, that will get the bad review. And, it will be up to you to do the customer service/remediation. You can mitigate these risks by making sure your drop-shipping supplier is verified and has good reviews.
Despite the drawbacks, there are still plenty of hungry investors that see acquiring a good drop-shipping store as an excellent investment. Building with the mindset that you will sell the business will often lead to a more efficient and profitable business, even if you never sell it.
These two tips will make your business attractive to investors:
Transferable Exclusivity. If you do secure special terms with your supplier, make sure they are transferable to the new owner so it becomes a unique part of your store.
Standard Operating Procedures (SOPs). As for any other business model, a good set of SOPs can make your business much more attractive to buyers. Develop good SOPs for product selection, marketing campaigns, uploading new products to your store, and any other routine tasks. An effective SOP is when someone else can be about 80 percent as effective as when you’re doing the task.
Contributed by Greg Elfrink, Empire Flippers