What Is Dropshipping and How Does It Work?

Posted 24.02.2022

You want to get into ecommerce. But the barriers for entry are punishingly high. You need to load up on inventory. You need to manage (and pay for) the logistics of order fulfilment. And that’s before you even get into warehousing and storage. These substantial overheads require a hefty business loan. And even if you’re lucky enough to secure funding, repaying that loan is likely to put a significant squeeze on your nascent company’s profits.

Looks like your entrepreneurial ambitions are over before they’ve begun. Or are they?

Dropshipping is a business model that eschews costly overheads and lowers the barriers to entry for ecommerce start-ups. It can simplify your supply chain, drastically reduce start-up costs, and enable newcomers to find their niche in the ecommerce market.

Here, we’ll look at everything prospective online merchants need to know about dropshipping and how it works. So you can find out whether it’s the best option for them, and how to maximise their chances of turning a profit quickly.

What Exactly Is Dropshipping?

Dropshipping is a form of ecommerce where the retailer never actually holds the products they sell. Typically, an online retailer buys products from a wholesaler, holds onto them in their own warehouse or storage facility, and ships those products out to the consumer.

Dropshippers, on the other hand, act as an intermediary between a third-party supplier and the customer. Unlike conventional online retailers, it is the dropshipping supplier rather than the retailer that fulfils the order.

This means that new companies can enter the ecommerce space without having to front the cost of manufacturing products or fulfilling orders. So newcomers can enter the ecommerce space with very little startup capital. And because much of the process is automated, this is the kind of business that can be run alongside a day job.

While this may seem like a licence to print money, it also comes with its fair share of caveats. Before we take a look at the pros and cons of dropshipping, let’s take a closer look at the process.

How Does Dropshipping Work?

When you start a dropshipping business, you’re effectively advertising the supplier’s goods on their behalf and facilitating sales in exchange for a cut of the profits. In a sense, the money you earn is a commission rather than a markup. And as such, your margins will be much slimmer than if you were manufacturing the products or fulfilling the orders yourself. But this is balanced out by the lack of overhead costs and the inevitable borrowing and interest that your business would encounter in order to cover them.

What’s more, the process of dropshipping makes the business of ecommerce easy. So even newcomers can navigate it with relative ease.

The dropshipping process is as follows:

  • The retailer displays the supplier’s products on their website or online marketplace
  • The retailer supplier or wholesaler stocks these products, and can supply from anywhere in the world. These suppliers will charge a fixed cost per unit onto which the retailer will build their margin. For instance, a retailer may charge £4 per unit for a mobile phone cover, while the dropshipper lists the same phone cover £10 each, making a £6 from the sale of each unit
  • The retailer receives a notification when a customer places an order. They then forward that order to their supplier for fulfilment. They can do this manually or automate the process with the right software
  • The order is then fulfilled by the supplier, who ships it directly to the customer. However, they do this under the retailer’s company name rather than their own
  • The retailer takes responsibility for returns. If a product needs to be returned, the retailer requests an authorisation number from the supplier. The customer then returns the product to the supplier, who refunds the retailer the wholesale cost of the item

Advantages of Dropshipping

It’s likely that the potential advantages of dropshipping are already clear to you. The dropshipping model enables your company to enter the ecommerce space with very little logistical or financial obligation.

Of course, that’s not to say that there isn’t plenty of work to be done. While this business model simplifies the supply chain there’s still a lot of work you’ll need to do to make your dropshipping business profitable. Still, you’ll be starting up with a host of advantages:

Lower startup costs

It’s cheap and easy to get started in dropshipping. A conventional online store can expect to spend a great deal of money establishing its online presence, building an inventory and finding somewhere with enough space to keep it all. Even super-small, ultra-niche ecommerce retailers can find themselves burdened with garages and spare bedrooms packed with stock.

Dropshipping businesses don’t have to worry about the costs associated with securing or storing an inventory. They don’t have to worry about the cost of logistics or fulfilment. All they need to do is decide on their niche, choose a product range and start selling.

Flexible location

Because you don’t have to worry about the cost and logistics of storing your products, you can run a successful ecommerce business from anywhere. You don’t need to max out on office space that will further erode your profit margins. In fact, you can run a successful ecommerce business from your kitchen table, your hotel room, or virtually anywhere else with an internet connection.

And because it’s flexible to operate alongside your existing job, you can mitigate your financial risk, only using it as your primary source of income when your business has grown enough to allow you to do so.

Just remember that all income from your dropshipping business needs to be declared to HMRC.

No inventory management

Inventory management can get enormously complicated. Especially when selling in the quantities of units that will make for a profitable business. Indeed, many retailers invest significantly in digital inventory management solutions to grease the wheels of order fulfilment and ensure that their stock is up to date.

When you’re a dropshipper, you don’t need to worry about any of that. The supplier will manage inventory on your behalf. Leaving you with more time and attention to spend on growing your online reach, engaging your target audience and building your brand.

Stay relevant and on-trend

Every retailer dreads finding themselves with aisles full of inventory that nobody wants to buy. In order to liquidate such stock, they usually have to sell it off at a discount, inevitably taking a huge hit on their profit margins.

The great thing about dropshipping is that it enables you to be agile, switching up your offering in order to stay relevant and on-trend. So you can bring your target audience the products they want, even as their tastes and needs change.

Scalability

In business, scalability usually comes with massive overheads. In order to make more sales, they need to invest significantly in building an infrastructure to facilitate more sales while still maintaining their quality of service.

When you’re a dropshipper, you have no such obligations. Your operational expenses and logistical efforts remain the same whether you’re making 50 or 50,000 sales a day.

Disadvantages of Dropshipping

As we can see, dropshipping has some distinct advantages. Especially for those whose entrepreneurial ambitions have been curtailed by a lack of startup capital.

But there are also certain disadvantages that you should seriously consider before you commit to starting a dropshipping business.

Lack of quality control

You’re building a brand on the quality of your products. And that requires a huge leap of faith when you have no control whatsoever over their quality. If a product does not arrive as described, it arrives broken or faulty or simply arrives late, the customer will blame you. Even though nothing that has taken place is technically your fault.

This is why you should never choose your dropshipping supplier arbitrarily. Take the time to get to know their products. Order some for yourself. Request samples. If possible, go to trade shows.

Your brand’s reputation can be made or unmade by your choice of supplier

Low margins

Whatever you’re selling online, the dropshipping business model has very low margins. The model lends itself best to items that are small and inexpensive. As such, you may find that your competitors are all selling the same products for the same price as you (or maybe even cheaper). So you probably won’t be able to give yourself an insider track by undercutting your competitors on price.

You’ll need to dedicate time and effort to growing your customer base, establishing your brand, and gradually increasing your number of units sold to make your business profitable.

Inventory can be complicated

On one hand, it’s great that your dropshipping supplier deals with the logistics of inventory management on your behalf. On the other hand, however, the lack of transparency can be a problem that creates complications for your business. Suppliers work with a number of retailers, and most dropshippers use more than one supplier. This can make it extremely difficult to know which products are readily available and which are delayed.

What’s more, because dropshippers use suppliers all over the world, international shipping can add cost and complications that can impact your profit margins and your customer experience.

Competition and customer experience

Dropshipping removes barriers for your business. However, it also removes those same barriers to entry for your competitors. They have the same opportunities to capitalise upon that you do. And the nature of dropshipping affords relatively few opportunities to stand out from the competition. You and your competitors are selling the exact same products to the exact same consumers. As such, you need to work harder to ensure that customers choose your products at the expense of your competitors.

This can be frustrating when, to a large extent, customer experience is out of your hands. You’re effectively making promises that you must trust your supplier to keep on your behalf.

Is Dropshipping Profitable?

It certainly can be. But in order to turn a meaningful profit, your business needs to be able to shift large volumes of stock in a short timeframe. And that can be tricky given the density of competition in your field.

The key to success in dropshipping is finding the golden ratio of high demand, and low competition. Which is why it’s so important to ensure that you’re offering the right products to the right people at the right time.

Here are some tips to ensure that you escape the common pitfalls associated with dropshipping, and pave the way for a profitable ecommerce business.

Know your niche

Finding the sweet spot between demand and competition is much easier when you target a specific niche. Try to be all things to all consumers, and you’ll likely over-stretch yourself and find it difficult to define your brand.

Providing niche products to a niche market affords you an opportunity to build a tangible relationship with your customers, catering to their needs, desires and anxieties. Since your products and prices can’t provide a point of differentiation, you’ll need to rely on your customer service and understanding of your target market’s needs.

Not sure which niche to target?

Use Google Trends to identify niches that are ripe with potential. Of course, it’s a good idea to start with something you’re knowledgeable and passionate about. This may be a hobby, a pop culture phenomenon, or even a favourite accessory.  Once you’ve identified your niche, you can start to identify gaps in the market where other retailers are not adequately responding to demand.

You’ll also need to decide whether you want to operate within the B2C space (where you supply products directly to the customer) or B2B space (where you supply products to other businesses). B2B and dropshipping can make for a profitable combination, since business buyers tend to purchase in bulk. It’s just a case of choosing the right product.

Build your brand

Because your margins are low, you won’t have the capital to invest in costly paid advertising campaigns, so you’ll need to build your brand the hard way.

Take the time to get to know your target market, carry out competitor analysis, and decide how you will cater to the needs of your target audience better than other dropshippers. Develop a website that offers an easy and intuitive user experience (UX) across a range of desktop and mobile devices. Build SEO content like blog posts, how-to guides and infographics that will get your brand noticed when customers carry out online searches. This content marketing can also help you to position yourself as a useful and authoritative resource for customers. Keeping your brand at the forefront of their mind when they next want to make a purchase.

Some dropshipping suppliers also offer white-labelling solutions. This enables you to use your own custom branding and packaging to add a greater sense of brand identity to the product.

Choose the right product

You can come up with a perfect name for your company, design a beautiful logo and develop a website with great UX. But ultimately, your products will have the final say in defining your customers’ perception of your business. So it’s important to choose the right products for their needs. If products are relevant to their needs, offer good value for money, and provide the level of quality they expect, you have a strong foundation on which to build.

The beauty of dropshipping is that you can add to, subtract from or completely overhaul your product range, without needing to worry about inventory gathering dust on the warehouse shelf.

Popular product ranges for dropshippers include;

  • Office supplies
  • Phone cases and accessories
  • Pet supplies
  • Novelty jewellery
  • Fashion accessories such as bags, hats, wallets etc.
  • Sunglasses and other eyewear
  • Toys and games

The importance of choosing the right platform

If you’re new to ecommerce, you may underestimate the importance of choosing the right ecommerce platform. With so many to choose from, you may be unsure which is best equipped to accommodate the emerging needs of your growing dropshipping business.

Choose a platform that offers complete customisation and scalability. One that can help you to automate key processes, and that fits seamlessly into your existing digital infrastructure. With the right platform, you can build a dropshipping company with a strong brand, frictionless operational processes and a customer experience that encourages loyalty and repeat business.

Image credit: RODNAE Productions from Pexels

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