Great question and glad you asked!
It is best to think about all the different ways that you have purchased a product before. For example, when you buy from Amazon, you usually are buying from a supplier who has directly sold to Amazon or from a third-party partner of Amazon who serves as the distributor. If you buy from a retail channel, chances are there are quite a few people involved in sourcing the product and moving it from the place of manufacture to the end retail store. Whether it is from a store or online, there are many links in the distribution chain. Some items are bought directly from the manufacturer. Yet other items bought from a retail store may have three or four steps in the process. So where does Drop Shipping fit?
Drop Shipping usually involves a Drop Shipper (of course), a Customer, and a Supplier. The Customer navigates to the website (or visits the physical store) and purchases the item. From there, the Drop Shipper gathers the necessary information to get the shipment to the customer and collects payment information to process the transaction. Once this has been confirmed and received, the Drop Shipper will send the details over the Supplier to create and send the shipment directly to the customer (no shipping to the Drop Shipper!). This means usually at least one less chain in the process, which may provide some cost savings for the end customer.
Which brings us to our next question…
What are the Advantages of Drop Shipping?
Let’s break this down into the three parties.
First, the Supplier wins because they do not have to maintain a selling network and deal with inventory flow problems. If their retail channel is 100% Drop Shipping, they know that if something gets purchased, they will not have to deal with overstock or restock issues at the end of the retail chain. They also do not have to worry about retailers discounting product because they have too much.
Second, the Drop Shipper’s biggest advantage is that no stock is required to be on hand for the drop shipper. The inventory is purchased as the orders are placed. It is also low overhead and easy to get setup because of the lessened need to watch inventory and capital requirements associated with that. Additionally, other overhead such as space, inventory carrying costs, and overhead to maintain a physical location are minimized.
Lastly, for the End Customer there is likely no large difference in the final price of the good. However, due to the competitive nature of the Drop Shipping service, it is likely that it will be lower due to the collapse of the distribution channel into smaller components.
But what about the downsides?
The Disadvantages of Drop Shipping?
For the Drop Shipper, it does not make a ton of money and is highly competitive. If the product is widely available to many other Drop Shippers, price competition can be rough and can erode most of the margin gained from collapsing the distribution channel.
Additionally, even when the orders are placed, there is a risk that the orders will not be able to be sent to the end customer due to low inventory levels at the Supplier. It is important to have an up to date, real-time inventory account to process drop ship orders correctly.
One of the advantages of using a distributor is that multi-item fulfillment may be cheaper due to more items per box to the same address. When Drop Shipping, it is rare for more than one item to come from a supplier, so the Drop Shipper may incur multiple shipping charges.
Additionally, on the Logistics side, anything that goes wrong with the shipment from the Supplier to the end customer is on your time and effort to resolve. With all the things that can possibly go wrong in the world of Logistics, this can be a significant time commitment.
For the end customer, it can also be more of a rough experience than the traditional model through a distributor as they really do not own the relationship directly with the customer. They are just fulfilling the need.
- Drop shipping is shipping directly from a Supplier to a Customer
- Drop shippers do not have to keep inventory on hand. This is good because less capital is required. This is bad because the Supplier may stock out of the inventory needed.
- Drop shippers have lower overhead costs due to not having large warehouses or large amounts of inventory. They need it too because the margins generated are not as high as other business models.