What is dropshipping? Pros, cons, and how to get started
If you have ever wondered why dropshipping gained so much popularity, and where the sudden interest of so many retailers in it comes from, think of the following:
You have a business where product manufacturing, inventory, warehousing, as well as shipping to the customer, is done by a third party. Your only profit-generating task is to offer the consumer a point of sale where they can place their order and pay securely.
Too good to be true?
Unlike popular belief, when the dropshipping model started to gain momentum, it was a consequence of many people discovering it at the same time. Actually, it is a method that multiple companies have had in place for some time.
The complications began when several entrepreneurs ventured into the world of dropshipping and together they began to discover that the complexities of the business are matched by its potential to generate profits.
However, this does not mean that it is fundamentally a poor idea or a scam (which does not exclude the possibility that there are those who take advantage of its growth to profit from dishonest methods).
For all these reasons, we have compiled a guide with the pros and cons, and included some recommendations, if you are interested in getting into the world of dropshipping.
But first, let's make a few things clea
How does dropshipping work?
Let's start with a few concepts: dropshipping is a fulfillment method, i.e. one of the many processes by which a product travels from the point of purchase to its delivery to the consumer.
What makes dropshipping special is the path that the products follow, as shown in this diagram:
The consumer chooses a product in a marketplace or electronic store managed by a seller. Once the consumer chooses and pays for the product, the seller dispatches the purchase order to the supplier, who ships the product directly to the consumer's home.
In this process, the seller does not require inventory or a storage warehouse, but acts as an intermediary between the consumer and the wholesale supplier.
Now that we have a little more clarity on how dropshipping works, we can start analyzing its pros and cons.
Dropshipping pros
First the good news: let's address their pros, because in recent times, they were the most popular.
1. No need to buy inventory or stock it.
This is perhaps dropshipping's calling card: the product never passes through the retailer's hands. This means that, beyond providing the virtual space where the product is displayed and paid for, there is no need for the seller to store, package or ship it.
As such, a retailer could use it to test new products in its catalog and measure the response of its regular consumers. In theory, the experiment does not represent a major risk, because if it does not work, the product does not remain in storage at the vendor's premises.
2. It is "easy" to start it up
Many businesses start with a dropshipping model because it is very well defined and allows you to iterate your target without compromising your operation too much. Therefore, one area where it is worth investing is in the segmentation of your ads.
So, once you define the niche you are going to target, you need to agree with your supplier on a dropshipping service that meets both your customers and your business objectives.
The most common places to start are Alibaba.com, Google, or even a supplier you have worked with before, as this makes it easier to have trust and stability in sourcing and pricing.
Regarding the latter, it is important to consider that your profits may be comparable to those of a retailer, but this will not happen overnight, nor is there a guarantee that it will.
Some suppliers charge a higher price for dropshipping, so your margins may be reduced compared to a traditional retailer. Remember that your business is all about volume.
3. Recurring costs are low
Since you are not buying inventory or operating a warehouse (with all that this implies: rent, salaries, utilities, among others), your recurring costs are quite low.
As your business grows, they will probably increase, but even so, they will still be low, especially compared to physical establishments.
4. Flexibility and a wide variety of products
As dropshipping is a remote business by nature, it allows you to manage it from anywhere in the world, giving you flexibility regarding the location of your team.
This means that you can outsource services –while being aware of regulations, of course– and thus find the right partners for your business.
Also, since you have a virtual worldwide presence, the variety of products you can offer is virtually unlimited.
After all, at the end of the day, you offer a list of products that come from a third party, so you can test which products are in demand with which audiences. In this way, you bring supply and demand together in a safe way.
5. If the business grows, everyone wins
In traditional business, if your sales double, the workload for you and your team also doubles.
With dropshipping, however, this is not the case, because it is actually your suppliers who dispatch the purchase orders. So, if they grow, the burden increases for them.
Not only that: if the number of orders that your suppliers must process grows, it is in their interest to supply products on a larger scale, since the sale of units via dropshipping is more profitable for them.
Thus, the growth of a dropshipping business is favorable for everyone involved: the consumer gets a wide variety of products at a good price; the supplier sees an increase in its sales volume every time it processes a new order, and the seller increases its profit margin.
So far, so good... but let's see what happens once the operation becomes more complex.
Cons of Dropshipping
Like any business, dropshipping is not without its share of challenges and obstacles. Precisely because its strengths have been the subject of debate, here we outline some of the arguments against this business model.
1. Low-profit margin
Yes, your recurring costs are low, but so is your profit margin until you reach a considerable volume of sales (remember: your business is volume).
As your first dropshipping experiments represent a low risk because they require little investment, they also translate into tight margins.
Although it is a proven model, and therefore safe (some would say that it is almost like following a recipe), the truth is that there are many things to manage that will demand a lot of time and all of your negotiating skills with your suppliers.
In the beginning, the margins of your dropshipping sales will hardly add up to enough to cover your expenses in ads, site maintenance, optimization, order management, and working hours in general.
On the other hand, you and your team must be equipped to withstand some doses of frustration, because at the end of the day what you are building is a customer base, and that doesn't happen overnight.
Some experiments will be successful and may leave some money in the cash box. Others may involve a monetary loss, but they may leave valuable learnings. And of course, inevitably, there will be some that will simply be failures that you will have to shake off quickly because your competitors are not going to wait for you.
Speaking of which...
2. Competitive and poorly regulated market
One of the aspects that got many entrepreneurs excited about dropshipping is that its barriers to entry are minimal (compared to other businesses). But, that's precisely where the key is: many.
Due to the fact that it doesn't require a significant amount of capital to get started, a large number of people jumped on board the trend. In addition, of course, to the companies that already applied this method to manage their business.
This basically translates into a saturated, highly competitive market, with players that have significant competitive advantages.
In addition, this climate has favored players with vast experience in the market to take drastic measures, such as significantly cutting their prices compared to "newcomers".
In that sense, you should also consider that exclusivity contracts with suppliers in the dropshipping world are not a common practice –quite the contrary.
And if some of these practices are probably starting to sound like unfair competition, we regret to inform you that at the moment there are few indicators that this market will be subject to robust regulation in the short and medium term.
3. No control over supply chain and quality
If you receive a complaint or query from a customer regarding product quality, delivery of their order, or shipping speed, in conventional e-commerce you can take care of these problems because you have control over your supply chain and the quality of your products.
In dropshipping, on the other hand, you are at the expense of your supplier... but you are still the one who has to face your customer.
This is because the model allows little agility when a complication occurs because inevitably the complaints of your customers go through a triangulation that in other types of business has no place.
The advantage of being an intermediary between the supplier and the final consumer is also a disadvantage if you think about it from the point of view of customer service since it will always be more complicated to resolve any type of dispute as neither the chain nor the quality depends directly on you.
Many dropshipping entrepreneurs find that it is easier to send a new product to the customer than to validate a warranty or reship the order. This, of course, directly undermines your already low-profit margin.
Also, inadequate management with one of your customers can lead them to point you out on social networks or leave a review of your services that damages your business reputation.
4. Legal issues
Although this is not a recurring problem in dropshipping, it is important to mention it.
Unfortunately, some suppliers are not as legitimate as they claim, so there is a risk that the origin of the products is uncertain. Or they may use another company's intellectual property without your consent.
Just as the dropshipping boom directly impacted the growth of entrepreneurs interested in trying it, the same happened among suppliers. Some of them engaged in unethical and even illegal practices.
This potential problem can be prevented with a dropshipping contract that will formalize your business relationship with your supplier.
Note: this is not an exclusivity contract, but a manifesto in which your supplier guarantees the legitimacy of its products.
5. It is complicated to build a brand
A dropshipping entrepreneur is similar to a music composer or a ghostwriter: the recognition of your work is not directed to you, but to third parties. You'll still get paid, but don't expect your picture on the cover of Forbes any time soon.
A dropshipping company hardly has the elements to build a brand or a portfolio of intangible assets like a traditional company.
If the product satisfies them, your customers will focus on the brand of the product and forget all about their shopping experience (unless, of course, something goes wrong, in which case your company name will not be forgotten anytime soon).
Good dropshipping is like good design: if your customer doesn't notice, you're doing it right.
In short
How can I start?
Specialists suggest that the model is a better fit for established brands than for newcomers looking to build a company with dropshipping as the cornerstone of their business.
For those e-commerce companies looking to grow their business and improve their fulfillment processes, we spotted four useful approaches for this business model:
- Market research: use dropshipping if you are looking to validate new products. Instead of increasing warehousing, inventory, packaging, or shipping costs, you're better off leveraging dropshipping for market testing. If the experiment doesn't have the results you're looking for, you won't face a loss that could jeopardize your business.
- Protection from overselling: Experienced e-retailers know that market fluctuations are unpredictable. In such scenarios, having a good dropshipping provider as a backup inventory is more effective: not only does it cover the risk of increasing inventory during turbulence, but it also facilitates access to products in times of shortage.
- Strategic shipping systems: one consequence of expanding your business is shipping to new areas. The further away your delivery point is from your fulfillment center, the more complicated it becomes. Dropshipping is a good way to test the scope of your business: if your supplier's service satisfies your customers and your business expectations, then you have found a strategic alliance to accompany your expansion.
- Avoid high-maintenance products: Complicated products will make your business more complicated, it's as simple as that. Large, heavy, fragile, fragile, valuable, cold chain, photosensitive products, or any other product that requires special storage to be kept in good conditions will cause you headaches.
Decided to try?
The lesson we can take away from these tips, as well as the pros and cons, is that dropshipping is more a means than an end. Building a business from scratch with this business model involves efforts that, in the long run, may not pay off what you are expecting. On the other hand, as a complementary tool, it has many benefits.
If you consider that your company is at a stage where testing dropshipping is favorable, Tribal can help you with the financial part.
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