What is dropshipping and what's the catch?

Dropshipping is a retail business model in which a retailer does not buy and hold stock of the products it sells, rather it pays a supplier to ship a product directly to a customer in response to an order that a customer places.

Dropshipping - the benefits

Dropshipping has several benefits for a retailer:

  • Working capital is not required to purchase stock upfront
  • Do not need to forecast demand for the product, fulfilment operations can scale with the success of your marketing and sales
  • There is no stock risk - the risk that stock will remain unsold after the season or the useful life of that inventory, or in the case of low demand

You can treat dropshipping as an addition to your established traditional ecommerce business, or as a lower risk model with which to start your business.

Dropshipping - the catch

There is no one specific drawback to dropshipping, but there are several disadvantages:

  • It can be difficult to find a supplier willing to provide a dropshipping service at an attractive price, especially if you are not willing to commit to a specific volume of units sold
  • You have no exclusivity over the product - other retailers can sell the same products from the same manufacturer and there will always be other businesses that see your success and replicate it but at a lower margin. Your success, if you achieve it, will therefore be short-lived
  • The price you pay your supplier for each individual unit of a product ordered via dropshipping will be higher than if you can commit to buying wholesale (in bulk) and having them all shipped in one consignment to your warehouse.
  • In common with other forms of B2C ecommerce, it takes money to run marketing to attract people to your dropshipping store with no guarantee they will buy your product. In fact you should assume the "conversion rate" of your website will be less than 2% and in many cases much much lower than that. The risk associated with this marketing spend is therefore a catch.
  • Since you never see the product beyond the initial samples, it can be difficult to assure ongoing quality of the product and its packaging. You might only start to hear of problems once many customers have already received their products and become dissatisfied. 
  • Shipping can take much longer, as the product is often supplied from the Far East to a customer in your local market in the US.
  • There may be customs duties to be paid by the customer when they receive the shipment and duties not paid by consumers may fall on you as the retailer to pay on their behalf, ruining your margin.
  • Returns can be more difficult and expensive to handle, especially if you expect a consumer to ship a parcel internationally.

Adding value through dropshipping

To make a margin on the products you sell, you must add value to either the product itself, or to the consumer's transaction with you as a business. A product you source from China at $20 is only worth $20. To sell this at a solid margin and make a good profit overall (after shipping, marketing, payment fees, returns, etc.) you might need to sell this for $50. To do this, you need to add value in the eyes of the customer. This can be:

  • Product value for example by providing complete product descriptions, images, videos showing the product in use, detailed specifications, high quality packaging, making the product available at short lead time
  • Transaction value - appearing (and being) a trustworthy business with which to do business, authority in the product category you are selling, customer reviews, returns policy, payment methods and terms with which the customer is comfortable

In dropshipping you must be willing to accept a relatively hands-off approach to the physical product and play a very active role in marketing, branding and finding customers. If your skills are in digital marketing, data analytics and building buzz around a product or brand, this can work well.

How to start dropshipping

To start dropshipping you must find a niche product or product range for which you believe you can successfully attract customers at an acceptable cost. You need to find a supplier willing to work on a drop shipping arrangement and then contract with them to cover packaging and carrier requirements, unit or tiered price, minimum order commitment per month, service levels, support, returns handling. Following this, you need to set up your B2C ecommerce store and create your marketing campaign to attract customers and implement strong order management processes to control the processing of each order.

Secondly, you need to think hard about establishing a brand rather than be a simple seller of individual products. Acquiring customers for an unknown merchant is expensive - advertising and other methods of attracting new customers, costs money. A brand which establishes authority and trust with customers from their first purchase has permission to continue to talk to customers and promote other products from their range. Every customer who purchases a second time is many times more valuable than a customer that must be attracted for the first time through costly marketing.

Finally you must work hard to ensure excellent customer experience - from the purchasing, through fulfillment and into after sales customer service. 

This article was updated on January 28, 2021

M Ryan

M Ryan is an ecommerce consultant with twenty years experience working with retailers, consumer brand manufacturers and other consumer-facing businesses helping them to develop their ecommerce strategy, implement ecommerce technology and improve their ecommerce operations. He works extensively throughout US and Europe, with clients including global brands, large retailers and household names in consumer goods.