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What is Dropshipping? Benefits, Challenges, and Getting Started

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Dropshipping can be a great approach for eCommerce merchants who want to keep their overhead low. But with the dropshipping market growing steadily in recent years, there are more competitors than ever. Additionally, eCommerce merchants who adopt a dropshipping approach must contend with lower profit margins while choosing the right eCommerce platform to support their dropshipping strategy.

What is Dropshipping?

Dropshipping is a retail strategy where brands don’t directly manage and distribute their product inventories. Instead, when an order is received, information such as product number, delivery address, and order date are sent by the company to a third party to fulfill the order on its behalf.

The dropshipping process follows five main steps:

  • A shopper places an order with a dropshipping retailer.
  • The retailer processes the order and forwards it to the wholesaler.
  • The wholesaler receives the order from the retailer.
  • The wholesaler ships the order.
  • The shopper receives the order.

The main difference between dropshipping and traditional retail fulfillment is that the retailer neither maintains the inventory or the associated physical infrastructure. Additionally, dropshipping fundamentally changes the dynamic between suppliers and retailers. Instead of buying items from suppliers and reselling them, retailers forward orders to suppliers who fulfill them on their behalf. Because of the lack of physical inventory, dropshipping works only for eCommerce retailers, rather than traditional brick-and-mortar operations.

Find out the sales tax implications of dropshipping

Benefits To Dropshipping

Dropshipping offers some significant advantages to eCommerce merchants:

  • Lower startup costs
    Businesses that adopt a dropshipping strategy don’t have to invest capital in acquiring inventory or establishing a location to store it. They also don’t have to spend time organizing their inventory or hiring a staff to fulfill orders. This means that dropshipping has a very low barrier to entry, as you can start a dropshipping business when you don’t have the funds necessary to run a traditional retailing operation.
  • Scalability
    A dropshipping retailer can scale quickly because order fulfillment is not dependent on the size of a physical location or the number of workers needed to ship out an order. For this reason, dropshipping can greatly benefit retailers that experience fluctuating sales due to seasonal factors or other reasons.
  • Lower inventory management
    By eliminating the need to maintain physical inventory, dropshipping reduces the management overhead retailers that face. They do not need to spend time tracking inventory, managing the infrastructure that houses it, or managing shipping, which is outsourced to suppliers.
  • Broad product offerings
    Dropshipping opens up more product opportunities. Retailers can offer a wide range of products with dropshipping, meaning a small business, which would otherwise not be able to offer so many options without storage, can sell a broad selection.
  • Flexibility
    Dropshipping brings flexibility to many facets of a retail business. A brand can operate from anywhere, offer different types of products, and change its offerings easily if market preferences change.

Dropshipping Challenges

Though it is a popular retail strategy, there are specific challenges associated with dropshipping. Successful dropshipping requires the particulars of its workflow align with your business goals. You must also work with the negative impacts associated with dropshipping, such as lower profit margins or potential legal issues.

Reliance on Third-Party Suppliers

Retailers are typically reliant to some extent on their suppliers, but this is especially true for those who use dropshipping services. If a third-party supplier fails to execute an order as promised, the retailer pays the price when the customer complains. Similarly, if a supplier suddenly goes out of business, the retailer faces massive disruption to its own business operations. 

These types of issues would be less of a blow if a retailer has physical inventory on hand, allowing operations to continue during the search for a new supplier. It’s important for new brands to have a working contingency plan in place in the event of such a disruption.

Dropshipping puts control over areas such as product availability and quality control in the hands of third parties as well. It deprives retailers of the ability to inspect items before they ship to customers or offer value-added services, such as pre-installing software on a phone or inscribing a custom message on jewelry.

High Level of Competition

The ease with which a retailer can take advantage of dropshipping means you’re likely to face substantial competition. Unless your business has an exclusive agreement with a supplier to dropship certain products, there is nothing stopping competitors from selling the same products you offer.

This means that retailers who rely on dropshipping may have a harder time standing out from the crowd because they won’t be able to offer products or services unique to their brands. Retailers will need to compete in other ways, such as providing an exceptional customer experience or providing a memorable, user-friendly eCommerce experience.

Tight Profit Margins

Because dropshipping involves outsourcing part of the order fulfillment process to a third party, it lowers your revenue. This means you will usually need to increase sales volume in order to turn the same profit as a traditional retailer.

Difficult Customer Support

When something goes wrong with an order, providing customer support to sort out the issue is more difficult for retailers who don’t control their inventory. If the customer has a question about the product, claims it was defective, or never received it, the retailer may need to work with the third-party seller to resolve the issue. This creates more work and management overhead than if no supplier was involved in the order fulfillment process.

Learn the 5 W's of Dropshipping Tax Rules

How to Get Started with Dropshipping

Before kicking off a dropshipping business, you need to develop a strategy to set you apart from the competition.

Finding Your Niche and Planning for Growth

The first step is to identify the right market opportunity. As noted above, it’s easy for retailers to begin dropshipping, so you need to find a consumer audience that is not already saturated by other sellers dropshipping the same items you are planning to offer. A good approach is to focus on identifying products that are typically difficult for buyers to obtain without engaging a supplier directly, but also hard for retailers to maintain within their own physical inventory. 

Take specialized automotive parts, for example. They are not typically offered off the shelf in most retail stores. At the same time, they would be difficult for all but the largest of retailers to keep in stock, because each specialized part is likely to see a low sales volume. Therefore, each would be costly to keep in inventory, relative to the revenue it generates over a given period of time. By dropshipping these items, a smaller retailer can offer them profitably.

If you can enter into an agreement with a supplier to fulfill orders, you can effectively sell within a particular market space in a way that gives you an advantage over traditional retailers who may seek to sell the same types of products.

It’s also important to think about which market space is best for the long-term growth of your business. Focusing on a line of products you have some expertise in will be an advantage over the competition even if other retailers begin dropshipping the same types of products. Likewise, do your research to determine how much the category of items you sell is expected to grow in coming years.

Creating Your Own Dropshipping Site

Once you’ve determined your product focus, you are ready to create dropshipping website. There are a variety of eCommerce platforms available to help with this task, and it’s important to choose one that aligns with your business goals.

One factor to consider is how comprehensive the platform’s capabilities are. To keep things simple, you may want to choose a single solution that provides everything you need to build a dropshipping site rather than relying on multiple options.

Another factor is how much visibility your dropshipping site and associated tools will give you into the order management process. To help run customer support operations and gain insight into any issues with suppliers, you should be able to collect as much information as possible about what happens after forwarding each order to the supplier.

The online user experience is an important factor to consider as well, as providing a seamless digital commerce environment can help you stand out in competitive markets. Make sure your site is configured for users to conveniently access, browse, and purchase through their preferred devices.

Handling Finances

While dropshipping requires relatively little initial investment, it’s critical to manage finances properly in order to generate a profit over the long term. Stay on top of the profit generated by each sale and don’t be afraid to explore other product offerings if your current line isn’t generating the expected amount of revenue. 

You should also reevaluate your dropshipping partnerships on an ongoing basis. You may be able to find a new supplier who offers lower costs for the same products. This type of adaptability is critical for maximizing dropshipping’s revenue potential.

Finally, factor taxation into your financial equation. Dropshipping makes taxation somewhat more complex because sales tax calculations depend in part on where the supplier is located. Check out this tax rules guide for details on how to approach taxation for a dropshipping business.

Working with Suppliers and Fulfilling Orders

Because dropshipping suppliers play a central role in the fulfillment process, it’s important to choose one that is reliable and offers rapid order processing. Do your research and look for established suppliers with a demonstrated track record of successful retailer partnerships.

Form relationships with multiple suppliers so if one runs out of an item – or goes out of business – you have a backup ready to pick up the slack. Order and test out a few products from each to see if they can deliver quality goods in a timely fashion. This has the added bonus of giving you first-hand experience with the products you’re selling so you can better market them to customers.

Pay attention to agreements regarding what happens if a supplier runs out of stock, known as a “backorder” situation. Find out if it cancels an order entirely or if it will be fulfilled when said item is back in stock. Likewise, if a customer reports a problem with an order caused by the supplier and you determine a refund to the customer is warranted, find out if the dropshipper refunds your costs associated with the item or if you have to absorb the expense. You should also look for a supplier who offers contractual guarantees items will ship within a certain timeframe.

Remember, good communication with suppliers is critical to working through the problems that will inevitably arise. When you first approach a dropshipper, pay close attention to how easy the company is to work with and how accessible it is. This is especially important given many suppliers are based overseas, which creates additional communication challenges related to time zones and language differences.

Addressing Legal Issues

Dropshipping itself is completely legal, but it can create legal issues if the process isn’t handled correctly.

As noted above, you have to pay attention to jurisdictions where your inventory is stored when calculating sales tax to avoid tax underpayment. Counterfeit items can also create some legal risks for dropshipping retailers as you may be held liable if suppliers ship counterfeit products. You could also be liable for trademark or licensing violations on products your shippers distribute.

Choosing reliable, reputable suppliers can help reduce these risks. So can reviewing the items you sell for signs of potential issues. For example, if your dropshipper claims to be able to supply designer handbags for a fraction of what they cost elsewhere, get proof the items are genuine and all necessary licenses are in place.

Make Dropshipping Easy with the Right Platform

Launching a successful dropshipping site hinges on choosing the right platform. Magento Commerce offers a variety of features, such as catalog management tools, which make it easy to keep track of extensive inventories, even if you don’t stock the products yourself. Magento Commerce also provides a powerful system for tax calculation, allowing retailers to factor in all variables when working with dropshipping suppliers. Additionally, analytics and reporting features help retailers track orders and maintain profitability at any scale. This is a particularly important consideration for businesses which relies on the dropshipping model in order to achieve a high sales volume while maintaining a small staff.

Learn more about how Magento Commerce makes it easy to build an eCommerce site for dropshipping and any other kind of retail strategy by requesting a free demo.

What is Dropshipping? Benefits, Challenges, and Getting Started