What Is Dropshipping & How Does It Work?
If you’re thinking of becoming an online retailer and have begun researching your options, there’s a very good chance you’ve already come across the concept of dropshipping. You may have also noticed that the ecommerce corner of the internet is thoroughly overrun with “How I Made a Cool Million in Three Months of Dropshipping While Blindfolded!” articles and videos.
Even worse, an incessant stream of dropshipping YouTube ads have more recently come onto the scene. For some reason, the dropshipping gurus featured in these ads insist upon showing you exactly how to quit your horrible nine-to-five job and make millions from the comfort of your couch instead. I’m assuming these experts’ motives are pure, and they don’t stand to make a dime themselves.
At this point, it’s only natural to wonder exactly how dropshipping works, with the follow-up question: “What’s the catch?”
It turns out the dropshipping model for retail sales has been around a long time and is likely here to stay. Countless retailers — from giant and well-respected, to tiny and scrappy — have used this supply chain model to sell all sorts of products for many years. Dropshipping is nothing new or particularly fancy, but the techniques, channels and various ways to “work the system” do change rapidly over time.
In this article, we’re covering what dropshipping is, as well as how you might use dropshipping for your own online business. Our goal is not to actively steer you toward or away from dropshipping. We simply want you to understand the system well enough to decide for yourself if it’s worth pursuing any further.
Table of Contents
As we define dropshipping, we’re going to refer to “you” as the retail merchant who uses the dropshipping business model.
Dropshipping is a method of order fulfillment in which you, as the retail merchant, do not hold any product inventory. Rather, you set up a system by which a customer places an order with you, and then you place an order for the same item with a dropshipping supplier.
A dropshipping supplier is typically a wholesaler that’s already buying products — often in bulk — from a manufacturer, though sometimes the supplier is the manufacturer itself. Either way, the dropshipping supplier actually stocks the item, and then ships it to the end customer once you have passed along the order.
To sum up, here are the basic steps in the dropshipping process:
- You find a supplier willing to provide a product via dropshipping
- You list the product on your website (or on an online marketplace that permits dropshipping)
- A customer places an order for the product on your website.
- You place an order for the identical product from your supplier (which can be set up to occur automatically).
- The supplier picks and packs the item.
- The supplier ships the product to your customer.
Your margin for the product is the difference between the supplier’s price and the price you set for your customers. Of course, there are other costs involved in dropshipping — and running an ecommerce business in general — that will offset this margin.
Why Do Suppliers Offer Dropshipping?
It’s fairly straightforward why online retailers find this supply chain model appealing (“You mean I can sell stuff without stocking and shipping any inventory? Sign me up!”). But what’s in it for suppliers?
First of all, remember that a dropshipping supplier is any entity that is willing to stock and ship to consumers through the dropshipping system, operating completely behind the scenes and not taking “credit” for the sale. As we’ve mentioned, the dropshipping supplier role is usually fulfilled by a willing wholesaler, but it can sometimes be the manufacturer of the product itself, or even a retailer further down the supply chain.
Simply put, suppliers like dropshipping because they get to turn the sales, marketing and customer service for certain products over to someone else.
Dropshipping can be an effective way to sell non-name-brand products, in particular. Large, brand-name manufacturers often demand that those further down the supply chain purchase in bulk, and the manufacturers can be very prescriptive about pricing. This leads to lean margins for both wholesalers and retailers.
Off-brand and generic products often have better and more flexible margins, and don’t necessarily have a bulk purchase requirement. The one-off purchasing processes of dropshipping is ideal for both suppliers and retailers of these products.
Meanwhile, generic-sounding products take more effort and resources to sell due to the “unknown” factor. If a supplier would like to sell generic products (or accessories to a main name-brand item), they might be better off finding a motivated online retailer like you to market and provide customer service for these items. As the end-retailer, you do the work of making the sale, and there is enough freedom for the supplier to set margins that allow you both to make money on the deal.
Pros & Cons Of Dropshipping
As we outline the advantages and disadvantages of dropshipping, you may notice that we go into further detail on the “con” side. The reason is quite simple: it’s easier for most people to get excited about the benefits of dropshipping than to thoroughly understand the challenges.
Pros of Dropshipping
1) Low Barrier To Entry
To start a dropshipping business, all you really “need” is a place to sell (i.e., website or online marketplace) and a way to access dropshipping suppliers. The time, capital, and effort to get started with dropshipping is minimal compared to other methods of selling.
2) Low Overhead:
No renting warehouses or hiring warehouse staff is necessary. Your primary fixed cost is maintaining your website. You also don’t need to purchase any products until they are ordered by a customer, eliminating the expense of dealing with unused inventory.
3) Wide Product Selection
Almost any product from any part of the world you can think of can be drop shipped, provided you find a supplier.
4) Location Independent
Not only can you work from home, but the physical stocking and shipping of inventory are unrelated to your location. You could manage a dropshipping business from the moon, provided the moon has good wifi.
5) Very Scalable
As your orders increase, all you must do is increase your orders to suppliers and ensure your customer service can keep pace with your growth. Stocking, picking, packing, and shipping is all scaled by your suppliers.
Cons of Dropshipping
1) Low Margins
Reported averages for dropshipping margins are all over the place. Some sources claim 5-15% on average for the end-retailer, while others put the range closer to 20-40%. Obviously, lots of variables are at play. The important point is that profit margins are most definitely lower than if you buy inventory in bulk directly from a manufacturer. Plus, your marketing and other expenses will further offset your final profit margin.
2) Highly Competitive
While large retailers have used this supply chain strategy for many years, the dropshipping model saw a boom among budding online retailers more recently. This was propelled by increased accessibility to user-friendly, inexpensive software to facilitate the process, along with the propagation of dropshipping success stories across the internet. With increased exposure to the model came increased competition. You’ll likely be using the same apps, supplier lists, and tactics as everyone else in the game, so it’s extremely difficult to find a competitive edge. Also, your more established competitors can afford to take slimmer margins per item.
3) Limited Control
You’re at the mercy of your suppliers in many ways. For one thing, it’s hard to control product quality when you never deal with the actual product itself. And, when something goes wrong — an item shows up broken or defective, cheaply-made (or even counterfeit), or takes longer than expected to arrive through no fault of your own — you are still responsible to the customer.
4) Management Complexities
Keeping on top of inventory from multiple suppliers and shipping from multiple locations — often within a single order — is no simple task. You need well-integrated systems and software, along with a clear strategy.
5) Difficult To Brand
The products you sell are not “yours,” and may not be a recognizable brand name either. At the same time, you must find ways to stand out amongst your competitors, with your options for personalizing packaging and adding your own special touches limited by your suppliers. Some suppliers may offer more customization options than others, but these perks can come at a premium.
6) Harder Than It Looks
With such a low barrier to entry for dropshipping, this point cannot be overemphasized. Successful dropshippers are a particular breed, possessing a generous helping of general business-savvy, along with strong marketing, customer service, SEO, and website development skills. They are creative, tenacious, and patient. They thoroughly understand the challenges of the model, and how these can be overcome or avoided.
For a closer look at these cons and other potential dropshipping pitfalls, check out: 7 Reasons To Rethink Dropshipping
This point deserves special attention, unfortunately. The highly scam-prone nature of the dropshipping business model is not an inherent flaw of the model itself, but is due to the particular way the dropshipping landscape has evolved over time.
By nature, the dropshipping model attracts entrepreneurs who are driven to make money in ecommerce by “working the system.” While there’s nothing wrong with this approach, the problem in recent years is that some of these savvy entrepreneurs have begun working the system inward, directly targeting other dropshipping hopefuls. In other words, dropshipping has gone a bit meta.
What we’ve seen emerging is not always a multilevel marketing or pyramid scheme, but it sure can stink of one nonetheless. Predatory dropshipping empires work in several different ways. A dropshipping guru might offer a free initial course, but then sell an expensive mentorship program with hefty fees. Not to mention, positive reviews of these courses are often paid.
In other cases, the guru might sell special access to supplier lists that include extra middlemen, thus skimming profit from the unsuspecting dropshipper’s already-slim margins.
These are just two examples, and new ways of working the system will undoubtedly develop over time. Granted, some training courses and dropshipping programs may not be total scams, but you need to do your research. More importantly, you need to decide if spending a lot of money (often in the thousands of dollars) on the exact same training many of your competitors are getting is worth it, when you could be using that investment elsewhere.
The lesson here is to be very, very careful when turning to any kind of dropshipping expert to start your business. Ask yourself why these gurus are so eager to share their best dropshipping secrets. Be particularly wary of any YouTube ads from so-called dropshipping “experts.” I definitely lied earlier when I said I was sure their motives are purely altruistic. It’s always a business, and often a sketchy one.
Finally, I personally recommend that every aspiring dropshipper listen to episode #117 of the “Reply All” podcast, entitled “The World’s Most Expensive Free Watch,” which takes a look at the darker side of this business model.
Common Dropshipping Platforms
Building A Dropshipping Website
As mentioned, most sellers using the dropshipping model start with an ecommerce website. Beginners typically set up a fully-hosted online store with an SaaS (Software-as-a-Service) ecommerce platform. These platforms are quite easy to use with little technical background.
You’ve probably heard of Shopify as the leader of the pack for dropshipping businesses, but other similar platforms options include BigCommerce, 3dcart, and many more. You’ll purchase a domain name for your site and pay a monthly subscription fee to use the platform. Hosted ecommerce platforms typically offer a selection of free and paid templates for your store that you can subsequently customize to varying degrees. You must also link a payment processor so you can accept credit cards and other forms of payment at your store. Credit card processors then charge a fee per sale.
Many ecommerce platforms also offer built-in integrations with your other sales channels, such as social media profiles and online marketplaces, so that all your sales are managed and tracked together in one place.
Once you’ve decided on a platform for building your site, the next step is to integrate with one or more dropshipping apps that help you connect supplier lists, load products to your site, and automate your ordering process. Oberlo is the most popular dropshipping app for Shopify users, but there are countless other options.
An ecommerce site of your own provides the most flexibility to really brand your business and develop your own customer base. The tricky part is driving traffic to your store, and this is where your marketing and SEO skills come into play.
Check out our ecommerce platform comparison chart and accompanying guide to learn more about this type of software.
Dropshipping With Marketplaces
Some sellers prefer the established traffic base of online marketplaces like Amazon over launching and managing their own sites from scratch. The downside, of course, is that you share this wonderful web traffic with some of your closest competitors, each featuring similar products directly alongside yours. On top of this, your options for branding and marketing to help set yourself apart are limited.
Amazon, eBay, and other popular marketplaces do allow dropshipping, as long as you stick to their published rules. Keep in mind that dropshipping with Amazon is not the same as Fulfillment By Amazon (FBA). With traditional FBA, you own your own inventory, and you pay Amazon to both warehouse and ship your products.
Lastly, remember that marketplaces have their own listing fees and pricing structures to factor into your budget.
Is Dropshipping A Viable Business Model?
Successful dropshipping is not about deciding what products you are passionate about and trying to sell them. It’s about figuring out what other people are passionate about, and ensuring this niche isn’t already completely saturated with options for these consumers. It’s about using the right techniques, but also relying on a good deal of luck and being in the right place at the right time. It’s about a lot of trial, and a whole lot of error. It’s about working the system, but not getting “worked” by a dropshipping scam in the process.
This is all to say that dropshipping is absolutely still a viable business model, but a lot of things have to line up just right to make it a good fit for your own situation and temperament. Dropshipping is more competitive than ever, so it takes a lot of work, ingenuity, and adaptation to be successful. Not to mention, you need actual skills and resources in the areas of research, marketing, SEO, website development, and customer service — or else end up dead in the water.
Historically, the dropshipping model has been most viable when smaller businesses could accomplish one or more of the following:
- Offer or add extra value (often informational value) along with their products.
- Offer products within a highly specific, unsaturated niche.
- Sell a lot of high-margin accessories. All the better if the accessories are consumable, requiring frequent repurchase.
- Source directly from the manufacturer to eliminate extra middlemen and dropshipping aggregators.
- Use dropshipping to supplement their own proprietary product(s). This may include conducting market research for new products, providing protection against unpredictable events and seasons, or selling difficult-to-ship products.
Of course, there are no guarantees you’ll be successful with dropshipping if you follow the historical trends. This has been the general pattern up to this point, but we’ll just have to see what the future holds for dropshipping!
If you’ve made it this far and you’re ready to continue your research, you may want to take a look at How To Start A Dropshipping Business next. We’ll keep an eye out on YouTube for your dropshipping success story.