One of the advantages of running a business on the Internet is that everyone starts with a URL and builds out from there. A startup retailer with the right skills can design a site that’s just as sleek as one operated by an online merchant 10 times its size, which can enable it to compete with larger rivals—provided it can operate efficiently.
Smaller e-retailers especially have to use their limited capital efficiently, and that leads many to minimize the inventory they own by relying on suppliers to drop-ship products after consumers place orders. After the consumer makes an online purchase, the merchant sends the order information to the product’s distributor or manufacturer and the supplier ships the product directly to the customer. E-retailers say drop-shipping makes it possible for them to market many products—and make themselves seem larger than they may actually be—without investing heavily in inventory or warehousing.
Eddie Lichstein, co-founder of car parts e-retailer Autoplicity.com, which drop-ships all of its more than 5,000 SKUs, says the fulfillment method enabled him to start his company a dozen years ago with two people and no warehouse. Autoplicity now counts more than 100,000 consumers as customers and in 2013 generated $12 million in sales, up 50% from $8 million in 2012, according to Internet Retailer’s Top500Guide.com, where it ranks No. 655 among the 1,000 largest e-retailers based on North American online sales.
“If I had to have products in a warehouse, I would have to have hundreds and thousands of dollars of product on hand at any time, and some of it might not sell for a long time,” he says. “With drop-shipping, I have just a small retail space so I reduce my risk significantly.”
Beyond not having to rent and manage a warehouse and the staff it would need to employ to run it, e-retailers say they save money by not having to pay to have the product shipped to them and then pay again to box and ship it to the customer. Many e-retailers say they channel the money they otherwise would have tied up in inventory and warehousing into more web orders.
Michael Epstein, co-founder of eDimensional Inc., which sells computer components and gaming accessories, says he put some of the money he saved drop-shipping into building a better web site. EDimensional, which generated up to $10 million in annual sales online, drop-shipped about 20% of its SKUs when Epstein sold the company last year.
“These were large, heavy items that did not make sense to ship twice—from the manufacturer to us, then to the customer,” he says. Epstein’s larger items included big shells for the components for do-it-yourself computer builders. He also didn’t like keeping high-tech items worth more than $1,000 in his warehouse, as there was a chance they wouldn’t sell and he would be stuck with the inventory.
Rather than spend the money on inventory, he invested in merchandising and site improvements. “We created thought-leadership content to build industry authority and other conversion rate enhancements,” Epstein says. For example, staffers wrote tips and guides on how to get the most out of the products and also produced video tutorials.
While drop-shipping enables smaller retailers to reduce some operational expenses, some online merchants say it can also create other tasks. For example, e-retailers typically take a slimmer margin on drop-shipped orders than when they own the merchandise. “On average, it costs us about 15% more to have something drop-shipped,” says Andrew Mabrey, owner of Cressio LLC which sells e-cigarettes, vaporizers and other smoking products at GreenSuppliesOnline.com.
What’s more, e-retailers have to ensure that the firms drop-shipping the products satisfy their customers. After all, if a product arrives damaged, late or wrong, it’s the e-retailer’s reputation that’s on the line. Small online merchants that use drop-shipping say they try to manage it to their advantage, although some have run into a new problem spawned by the growth of online shopping: Some manufacturers are getting out of the drop-ship business and focusing on selling directly to consumers themselves.
Retailers interviewed for this story say drop-shipping’s biggest advantage is that they can sell a wide variety of products without assuming warehousing costs. With the average U.S. warehouse renting for about $4.75 per square foot per month, according to real estate tracking company CoStar Group, retailers can save thousands of dollars per month by not housing their own products. And instead of offering a limited selection that they can warehouse cost effectively, they can display nearly every variety without worrying whether one customer or thousands will buy each item.
Adam Berkowitz, chief operations officer of Pharmapacks, an e-retailer that sells pharmaceutical and personal hygiene products with more than $20 million in annual sales, says consumers often arrive at the site seeking to buy one of the best-selling items, which Pharmapacks holds inventory of and prices competitively. But many then browse and add to their cart other less-popular items, sometimes from the same brand, which Pharmapacks may not stock directly. “We make money on people buying other items that we don’t always keep in stock, items that are on the long tail,” he says, using a term for items purchased infrequently. Berkowitz estimates that Pharmapacks drop-ships about 20% of its orders.
Having a greater selection is also an advantage for Toner Emporium, a startup that sells toner for printers and drop-ships all its orders. Owner Brandon Howard says having the selection consumers want is critical, and drop-shipping allows Toner Emporium to market virtually every type there is. “The only thing that holds us back is how much the supplier can manufacture,” he says.
The benefits of drop-shipping goes both ways for Daltech Enterprises, which manufactures leather goods and apparel and is both a direct-to-consumer e-retailer and a drop-shipper for its wholesale retail clients.
“Our [e-retail] site, DaltechForce.com, mostly sells gun belts and gun holsters, but we drop-ship for other companies reselling our belts and leather holsters for pliers, which we don’t get a lot of customers for through our web site,” says Alex Dallas, Daltech’s president. “Also, many of the smaller customers we drop-ship to don’t have a big enough business to have their own shipping departments. By picking up their orders, we keep our shipping department busy all the time.” Daltech’s drop-shipping division generates more than $1 million in sales each year.
Ensuring quality product and service standards are met is a critical part of being successful with drop-shipping, e-retailers say. Many e-retailers create links to suppliers’ computer systems to automatically communicate order data from their own order management software to the drop-shipper’s system. The messages often include fulfillment instructions, such as the order data and required shipping speed, the consumer’s shipping address and any packing slips or extras that should be included. The links created by these application programming interfaces, or APIs, also often feed live inventory data from the drop-shipper to the e-retailer so the merchant knows what’s available to sell.
Occasionally, problems arise. “You are relying on drop-shippers to fulfill your orders in a timely manner. You are also relying on their inventory feeds to tell you if a part is in stock,” says Michael Dash, president of CarPartKings.com. “When you are doing hundreds or thousands of orders a day with a drop-shipper there will be some orders that fall through the cracks and it is your job to clean up the mess with your customers and retain good relationships.” CarPartKings.com drop-ships all of its SKUs and the e-retailer’s annual sales fall in the $7 million to $10 million range.
Dash says about 0.05% of all CarPartKings.com orders are not delivered in a timely manner. The problems can arise because of computer or human errors, such as an order picker selecting the wrong item or not being able to find an item that’s listed in the inventory. Dash says he solves these problems on a case-by-case basis, working with both the drop-shipper and the customer to ensure better service in the future.
Bob Shirilla, co-founder of Custom Bags, which operates SimplyBags.com, is more concerned about making sure the quality of the product SimplyBags sells—but that it doesn’t actually see or handle itself—meets expectations. Many of the products SimplyBags sells are customized by the customer and sold in bulk, such as tote bags imprinted with logos of marketing messages for an event. While Shirilla says drop-shipped products account for just 3% of the SKUs he offers, the quality of those products is crucial because those SKUs account for about 64% of his revenue, which is less than $2 million annually.
“We have increased our revenue tremendously by drop-shipping our custom tote bags. Last year we took a large custom online order from the Boston Red Sox and drop-shipped the entire order,” Shirilla says. To ensure the quality of the product, Custom Bags worked with the Red Sox to refine its design requirements and worked just as closely with a supplier in India to make sure the totes were made to those specifications. Shirilla says the process worked.
The lack of direct control over how a consumer’s order is handled also troubles Pharmapack’s Berkowitz. He says while he likes being able to market more products at his online store, he doesn’t like that he can’t oversee the entire process from start to finish.
“No one cares more about your company than you do,” he says. “We have spent a lot of time building up a culture where everyone is passionate about what they do and making sure the product gets out quickly and correctly. When someone else controls part of the process, they might not care as much as you do.”
To address this, Berkowitz negotiates clauses in his drop-shippers’ contracts requiring that they ship in the same amount of time he would ship the item from his company’s own warehouse.
Berkowitz says that not all drop-shippers are set up to accommodate these needs. The larger an e-retailer gets, the more negotiating power it has to require a drop-shipper to ship orders quickly.
There’s also the issue of margin. E-retailers, especially when they are starting out, have less leverage to negotiate the best price with the distributors and manufacturers that they want to use for drop-shipping. E-retailers say they usually pay more per unit for a product they want drop-shipped than if they bought it wholesale, but save on the warehousing and fulfillment costs they’d otherwise incur.
While Mabrey, the owner of GreenSuppliesOnline.com, says he pays about 15% more to drop-ship orders, he says it’s worth it because of the policies of the suppliers of e-cigarettes and vaporizers. “Most of the factories have a MOQ [minimum order quantity] of 100 units. We have no MOQ agreement with our drop-ship supplier.” That means Cressio can offer a wide variety of products for sale and take orders for even a single item, without tying money up in inventory. The e-retailer charges a flat rate of $4.99 for shipping on orders of less than $50, which Mabrey says is most orders. That fee helps cover the shipping costs, which Cressio pays for.
There are some signs that manufacturers may be becoming more reluctant to drop-ship on e-retailers’ behalf as they work to increase their own direct-to-consumer sales online.
That’s the situation Shirilla, from Custom Bags, is contending with in the gift bag industry. Several of the manufacturers he’s worked with successfully for the past 15 years to drop-ship orders now operate their own e-commerce sites and are refusing to drop-ship for Custom Bags anymore, he says.
While drop-shipping can bring a lot of upside for small and medium-sized e-retailers, it also presents challenges with working with suppliers and ensuring that customer service meets the standards set by these retailers. As customers continue to expect to be able to buy nearly anything online, retailers will have to keep up by continuing to find ways to supply a wide variety of products. Working with suppliers can provide this advantage at a low cost if retailers can find suppliers they can work with profitably.
Maureen Wilkey is a freelance reporter based in Chicago.