What is dropshipping?
In a traditional business model, retail businesses would be responsible for the entire fulfillment process, including shipping, warehousing, inventory management, and other supply chain costs. These expenses can add up quickly, especially for smaller online retailers, so a new model was created to help reduce overhead costs: dropshipping.
Dropshipping is an order fulfillment model where the seller keeps no stock. Instead, they facilitate sales, then purchase inventory as needed from a third-party wholesaler or manufacturer to be shipped to customers. Essentially, retailers become middlemen between suppliers and customers, which can have a number of benefits and drawbacks.
Pros and cons of dropshipping
Because sales are facilitated online and products are shipped directly from the manufacturer to the customer, dropshipping is an attractive business model for many e-commerce companies. But there are advantages and disadvantages to dropshipping.
Pros
Low inventory costs
Inventory is one of the most expensive assets for merchants, but dropshipping allows the seller to only purchase products after the sale is already made.
Reduced business expenses
Dropshipping removes many business expenses that traditional retailers face, such as warehouse space and staff, packing and shipping orders, inventory management, and handling returns.
Increased product selection
Because you don’t need to order inventory ahead of time, you can offer a larger selection of products and change your selection based on trends without worrying about deadstock. If your supplier has it, you list it on your e-commerce site.
Location and staffing flexibility
Using dropshipping, businesses can operate just about anywhere with a computer and minimal staff.
Cons
Low margins
Because it’s so easy and cheap to start a business based on the dropshipping model, the market is crowded with sellers offering the same products at very low prices. In order to compete, profit margins are invariably low.
Supplier problems
As a dropshipper, you are at the mercy of your suppliers’ business practices. If they make mistakes, it will reflect back on you and potentially damage your business’s reputation.
Supply chain issues
With dropshipping, you have no control over the supply chain. Changes in inventory, fluctuating shipping prices, and different charges from different suppliers can be hard to keep track of.
Determining what inventory to bring in-house
While you can expand your catalog with minimal risk by adding dropshipped products, you may reach a point where you want to bring some inventory in-house to maximize profitability and gain more control. There are a few factors to consider when deciding what to bring in.
1. Stockturn
How quickly do you need to turn your stock and break even on your inventory investment? Work through cashflow projections to see what your threshold is. If you need to make back your investment in one week, that will narrow significantly your options compared to a one month return.
2. Forecast Profits
You want to turn a large enough profit. What is that profitability threshold? It may be too low for the investment or opportunity cost.
What is the threshold to make it worth your while? For example, is it worth it to your business to bring inventory in-house for another $5000/year? That profit may not even cover your time to complete the project. Keep reading to learn about other hidden costs to take into consideration.
3. Forecast Units in Demand vs MOQ
Look at the number of units forecast to sell during your cash flow / return on investment window. This can be important because your supplier might have minimum order quantity (MOQ). If the forecast says you are going to sell 50 units, but the MOQ is 500, that poses a problem. This forces you into over-ordering, and you won’t be able to turn around your investment quickly enough.
4. Variant Performance
Look at each individual variant so you can see which size, color, or style is selling. Concentrate on what is working, not what isn’t.
Let’s say you’re selling a dress in three different colors and only the green dress is really performing well. That is the only one you should bring in-house. The others will sit on the shelves too long, stockturn will be low and you won’t see a return on investment quickly enough.
Potential sources of hidden costs:
If you are considering bringing inventory in-house, consider building into your calculations certain amount (ie 10%) for unexpected expenses like time, logistics, and delays. Of course you do your best to think through everything, but build in a buffer against the unknown so that you’re not overly optimistic about what your profit could be, particularly if this is your first time moving from dropshipped products to storing inventory and fulfilling orders yourself.
1. Infrastructure is another consideration. If your company is already handling some fulfillment in-house, this isn’t as much of an issue because software, employees, and workflows will already be in place. It will be lower barrier to bring additional products on board in terms of operations.
If your company is totally new to fulfillment, there is a lot of software, customer support, and moving pieces to make this happen. Think through the infrastructure of handling fulfillment yourself. It’s a huge undertaking. Talk to people who have done it before to figure out what is involved and detail every single cost. Infrastructure costs – including your time to manage and set-up the process – can add up very quickly.
2. Are you staying with the same supplier? If so, it’s really important to spell out the costs, fees, and timelines. Even if you trust your supplier, have everything spelled out in writing. Everyone should be on the same page so there are no surprises down the road. What the costs are going to be? Are there up-front fees? When fees are due? Does everyone agree on the timeline?
3. You may want to go with a different supplier. The big caution here is not to infringe on any intellectual property. You can’t move to a different supplier and blatantly use someone else’s design. You must come up with a unique product that is your own, so think about production time involved.
4. Alternatively, you may consider licensing from another supplier. Be sure to take into consideration the costs and time involved in the licensing process.
5. Think about timeline of testing products and cost of producing samples. You need to physically see the product from your new supplier to make sure it is exactly what you want; just seeing it online isn’t good enough. Plan for production time for a sample, time to ship it to you, there could be (probably will be?) several rounds of changes to make to your product before going into production on a larger order.
6. When bringing inventory in-house, what additional storage fees are incurred? If you turn to FBA, it could be Amazon storage fees. If you are working with a 3PL (third party logistics) company, there are also fees to consider such as receiving, kitting, and storage fees.. Think about the cost of the item sitting on the shelf with the 3PL or with Amazon fulfillment fees. How does that raise the per-unit cost for each item?
Pros and cons of bringing inventory in-house
Just like dropshipping, there are advantages and disadvantages to holding inventory in-house.
Pros
Lower prices
Look at the per-unit cost, and by extension, the landed cost. You may be able to lower costs. You are lowering the risk for your supplier, so they should reduce costs as a benefit of this arrangement.
Quality control
By bringing your inventory in-house, you can handle the packaging and quality control. This has a lot of upsides, especially for brands based on quality. You can really hone in on ensuring that brand value is communicated to the customer. Custom packaging, branded packaging, and fulfillment speed are just a few things you can directly manage when moving product from dropping to in-house fulfillment.
Better Shipping rates
Another potential benefit to your company could be better shipping rates due to increase shipping volume. If you are shipping out a lot more units, that may be something you can work with your shipping provider (FedEx, UPS, etc.) to lower your costs. It could put you into another tier so that you are getting a lower total shipping cost. Think about if that lowers your overall expenses. A dropshipper typically charges a premium for shipping supplies and fulfillment. Talk to your shipping representative frequently to explore better rates.
Cons
Reduced cash flow
As already mentioned, inventory is expensive to purchase, ship, store, and move. By taking on items in-house, you tie up cash flow in stock, so it becomes vital to know how much to order and when and how fast you’re selling each product. To gain insights into complex data, you also need dedicated inventory planning software.
Get automated, reliable recommendations on what to buy and when to order
Potential stockouts and deadstock
If you don’t stay on top of your inventory management, planning, and demand forecasting, you may end up with a surplus of product that isn’t selling, or not enough product on hand to meet customer demand. This can lead to lost or reduced revenue due to stockouts or deadstock.
Staffing and storage costs
Managing inventory and fulfilling orders requires a lot of time and resources. Warehouses need staff, orders must be packaged, and shipping must be arranged to make sure everything is running properly. In order to maximize profitability, businesses must manage both their inventory and their workforce efficiently so they are getting the most out of those overhead costs.
While bringing items in-house isn’t for everyone, it is certainly worth considering if it will increase profitability enough to be worth your time and effort. This can also give you greater control over your final product. Run the numbers to see if having any in-house items is feasible and, if so, which ones you want.