What Is Dropshipping and How Does It Work?

What Is Dropshipping and How Does It Work?

You just heard about dropshipping and you would like to try it? See what dropshipping is and how it works. Consider also the initial investment needed to start with dropshipping.

What is Dropshipping?

What is dropshipping and how is it defined? Dropshipping is a new retail business model where the store does not keep products in stock. Instead when the store sells a product, the store owner or employee purchases the product from a third-party supplier, and the supplier sends the purchased product directly to the customer. The beauty of the dropshipping model is that the store does not have to handle the logistics: fulfillment and shipping.

Visually, it looks like this:

In a nutshell, dropshipping boils down to these four steps:

Step 1: The customer places an order with the store, usually an e-commerce website.

Step 2: The store sends the order to the third-party partner for fulfillment and shipping.

Step 3: The dropshipping partner prepares the order.

Step 4: The dropshipping partner ships the product directly to the customer.

In this business model the store does not have any products in stock. The inventory is purchased from the partner or manufacturer once it is sold.

This is the adoption of the Just-in-time manufacturing used by car makers. A new car would be assembled once there has been a sale at a dealership.

Benefits of Dropshipping

Dropshipping is a go-to business model for new entrepreneurs. Why so? It is accessible and it is flexible. Your initial investment will be relatively low. You will also be able to test different products out before you get the magic product-market fit. Let us go over the benefits of dropshipping.

Low Initial Investment

Starting your dropshipping business will require a couple of thousand dollars and a good amount of hours to start with. But you do not need to spend your capital money on any inventory upfront.

You will not need to buy inventory and store it. Keeping inventory and not moving it fast is costly. Just think about the storage fees, in the least.

Quick Start

Dealing with physical products is not easy. If you can avoid that, it will save you tons of time. You can use this time to focus on developing your e-commerce site or exploring other business opportunities.

Dropshipping removes this burden. You don’t need to manage a warehouse, pack and track, monitor the inventory, deal with shipments and returns.

Flexible Management

You can manage your dropshipping business from any physical location. At the time of writing, travel is limited due to the coronavirus pandemic. But in better times you can be in an exotic destination and still manage your dropshipping business all right.

Easy Testing

You are not married to the first product you’ve tried with dropshipping. You can try more as the choice is wide with a lot of national and international suppliers out there.

Potential Scaling

If your dropshipping business takes off well, which means you have a good product and good suppliers, you might be scale up easily. Your suppliers take care of the fulfillment, thus, allowing you to focus on sales.

The only caveat with scaling up is that you will need to spend more time doing customer service. With more orders, expect to get more customer inquiries. Well, this is normal for any business.

Inconveniences of Dropshipping

Unfortunately, there are also inconveniences to dropshipping. We’d like to talk about the shortcomings too.

Issues with Inventory

Sourcing products from multiple suppliers or warehouses may be a nightmare. You want to make sure you have tools that communicate with your suppliers. You want to be able to track their inventory – whether the products are in stock or not. You’d also want to track shipments.

Shipping Fees

There are cases when you might be selling different products sourced from different partners. If transactions include products from different suppliers, you might need to pay multiple shipping fees. Hopefully, you are a good negotiator to bring these fees down.

Errors

Err is human. But you don’t want to lose customers because of your supplier’s errors. And errors can be as simple as missing items in the shipment or bad packaging. Finger pointing will not help in such situations. But frequent errors from your supplier may damage your site’s reputation.

Low Margins

Good-quality products don’t cost cheap. At the same time, your final price should be competitive. This may drive your margins down.

What gives? The low upfront investment is already a fact. Now put more effort into making users’ experience on your e-commerce site more pleasant and more intuitive than competitors. Differentiate your e-commerce business from competitors. But don’t start a price war. Price dumping will erode all margins on your products.

How to Start a Dropshipping Business?

To try dropshipping, you might want to move fast. You need an e-commerce website, which is easy to set up. You need to find reliable partners. You want to test the partners out. You need to promote your e-store. Let’s talk about each of these above separately.

We will also provide cost estimates, which are minimalistic, the famous “starting at…”.

Setting up an Online Store

You will probably start with a Shopify site, which will be from $29/month to host your store. Shopify offers turnkey sites with short setup times.

You can also go with WordPress. Hosting WordPress sites may be free for the first year when you buy a domain name with them.

Buying a domain name is your next step. See our guide about choosing a perfect domain name for your e-store. This will be between $7-$15 per year.

Both Shopify and WordPress accept custom themes for your site. Shopify-compatible themes are available at their Theme store. Envato has tons of quality themes for WordPress.

Here the range can be between from $29 to over $150 per theme. This is usually a one-time fee. There might be a hidden cost when you purchase a theme for your e-commerce site. If the theme looks great as a demo, but is poorly coded, you will need to pay the theme’s developer to set it up for you. Read the reviews before committing to a theme. Usually, additional support for the initial setup of the theme goes between $150-$300.

Your initial investment into your e-commerce website will be between $50 and $500. This does not include your time.

Finding Reliable Partners

This is where a lot of legwork happens. You can start with Shopify’s Oberlo. You can also start your search on AliExpress.

Testing Purchases

Set some money aside to test your suppliers. If you set up shop in the US or Canada, make several test purchases from your suppliers and check the shipping speed, the packaging, the documentation. Put yourself in your perspective clients’ shoes.

Online Advertising

With your site up and running, suppliers vetted and tested, payment processing in place, it’s now time to promote your brand and products.

Remember you would like to move fast and test fast? Paid advertising will be your first stop.

You will set up a Facebook page and an Instagram account for your business. Once done, your will have a Facebook ad manager to start running campaigns on Facebook and Instagram.

You will also want to run Google and Bing ads.

Most e-commerce platforms, like Shopify, create product feeds that can be connected to Facebook (Product Catalog) or Google (Merchant Center). This will allow to run shopping ads on Facebook, Instagram, and Google (Bing can use Google’s product feed for its shopping ads).

How much to invest in online advertising? It will all depend on how well your product sells and what margin you get on each sale.

Say, your average order amount is $100. You pay your supplier $50 to fulfill and ship. Your other expenses may be $10 on each sale (earlier investment, maintenance costs). You get $40 in profit on each sale.

Your paid marketing should bring in sales at a target cost of under $40. To factor in labor, you might need to lower it to $30 or under as a target.

In other words, if your paid marketing brings in sales at under $30 per sale, your return is positive.

Need more insight about paid marketing for your new e-commerce site? Send us a note and request a free site audit. We will be happy to help.

Is Dropshipping a Legit Business Model?

Dropshipping is a legal business model. As a process, it’s a legit method of order fulfillment. Relationships with suppliers may sometimes run into legal issues, which depends on who your supplier is and how you set up your contract with them.

Protect yourself with a Dropshipping Agreement, where you will have it all clear about:

  • Content and image infringement. Make your supplier stipulate clearly what you can and cannot use in your communication and marketing.
  • Fake products. Check on the products you are about to start selling. Selling fake and counterfeited products is a crime.
  • Shipping costs. Working with overseas suppliers means shipping costs and duties may be high. Talk through these and include them in the agreement.
  • Shipping time. Make provisions and insurances against delays.
  • After-sales support. Make the supplier be clear about what support is given.

Is Is Worth Starting a Dropshipping Business?

Finally, what’s the verdict about dropshipping. Is it worth as a business enterprise? Our position is that it’s a viable business model for aspiring entrepreneurs. The setup investment is low, and the startup time is relatively quick. Dropshipping allows more flexibility with no need to keep inventory than traditional retail business models. It also sets a precedent about constant product testing.

The obstacles and difficulties one can incur with this business model are all surmountable.

By Nick

Nick is a seasoned search specialist with 10+ years of hands-on experience in both paid and organic search campaigns. Nick has managed both multi-million ad budgets and small-budget SEO campaigns.

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