Drop Shipping Explained
Drop Shipping, which is often used by online stores and catalogue companies, is a means by which the retailer offers certain products for sale but doesn’t actually carry the inventory for those products. Instead, the retailer passes the order along to the producer/manufacturer (aka – you!) and you fulfill and ship the order. You then charge the retailer your wholesale price and the retailer makes their money on the margin between the wholesale price and the retail price they charged the consumer.
So let’s take this as an example:
Company X is an online and catalogue company and they approach you about being a drop ship partner with them. They put pictures and descriptions of your Hot Mama’s Salsa on their website and in their catalogue. Customer Y in New Hampshire gets her catalogue and thinks Hot Mama’s Salsa would be the perfect gift for her sister so she calls Company X (or goes online) and places an order. Customer Y is charged $32.99 which includes all shipping and taxes.
Company X now takes that order and sends it to you (most larger online and catalogue companies work through an automated drop ship software program so that the order, shipping information, and packing label are emailed directly to you). You box up one jar of Hot Mama’s Salsa and send it on its way to New Hampshire. Then you invoice Company X (again, this can typically be done through the drop ship software with larger companies) your wholesale price of $12.00 for the order which Company X pays when they receive it.
Pros of Drop Shipping:
- By partnering with another company – especially a larger more established company – you open your products and your brand to a wider audience;
- Strategic partnerships can help elevate your own brand. For example, if you partner with a company like Williams-Sonoma or Neiman Marcus that helps reassure customers that your products meet a high level of quality;
- Potential for increased sales;
Cons of Drop Shipping:
- You have to make sure you have enough product inventory, or can make enough product fast enough, to fill orders that may come in at anytime. The risk here of course is that if you do have a lot of inventory and the sales don’t happen then you’re the one who is carrying that inventory cost not Company X;
- You need to have shipping boxes and packing material on hand so that you can fulfill orders. In order to get the best rates you will have to buy in upwards of 100 or more boxes of specific shapes which is a cost that you don’t recoup until all those boxes have been used for orders;
- You have to pack the box inline with that company’s specifications. For instance, some companies will let you pack a complete order into one box whereas other companies want each item packed and shipped in its own separate box. You also can’t add any marketing material or other means by which to try to turn these customers into direct customers for you.
- You will typically be on NET terms with the retailer so that means that even if you ship the box out today you may not be paid for 30, 45, or even 60 days. Again, that is a cost to you because that is cash you don’t have access to.
Things To Consider Before Signing Drop Shipping Agreements:
- Does the company you’re talking to have the cache to be worthy of drop shipping? By that I mean, it may make sense to agree to drop ship for a big name like Dean & Deluca where you know your product will be exposed to hundreds of thousands of people. Does it make the same sense to drop ship for “new internet startup company” that has a very limited customer database? Part of that decision is based on how shelf stable your product is and whether or not it needs to be shipped fresh and part of that decision should be based on how much business you think this partner will bring in for you. Don’t underestimate the time, cost, and stress involved with keeping a substantial drop ship inventory ready to go – especially around the holidays! – so you want to make sure you align yourself with strong drop ship partners who will help enhance your business.
- How will the drop ship partner communicate orders to you? As mentioned, larger companies typically have seamless automated systems which, one you get the hang of them, are fairly straightforward to you. I’ve talked to other smaller partners though who have different means for getting orders out – some of which are seamless and some of which seem to entail jumping through 4 hoops and doing a jig before the order is processed. Make sure that whatever process you’re considering makes sense for your business and won’t add significant more work to your plate.
- See if you can find one or two box sizes that will work for the packaging of all of your products so that you don’t have to carry 20 different sizes of packaging. Maybe a small package for just a single product and a medium or large box size for when people want to purchase multiple items.
- Since you do have to pay for the boxes and the packing material (not to mention the time to pack up orders individually), make sure that is reflected in the wholesale price you present to drop ship partners. You need to take into account the fact these items (and time!) cost above and beyond your typical wholesale price so make sure you’re going to be reimbursed for it.
- Without a doubt I would make sure that all products are shipped on the Company’s account number and not something you have to pay for in advance. No matter how big or small the drop ship partner is, if they are not willing to provide you with a shipping account number then you might want to seriously consider walking away. Not only are account numbers beneficial to the Company’s because, if they are doing a lot of shipping (as you would assume a catalogue or online store is) then they will likely be able to command a better shipping rate than you can. From your standpoint though, if you’re not being paid on the order for 30 – 60 days you don’t want an addition $15-$30-$+++ added onto that invoice in shipping charge that you’re waiting to be reimbursed for. That’s money you can use today to help grow your business. It may not sound like much now but when you have 100 of those orders that you’re waiting to be paid on and $15 added to each order in shipping then that’s a lot of money you have tied up that you can’t use elsewhere!