Dropshipping modernizes supply chain management. Already, we are witnessing the massive transformative impacts of the Internet as it globalizes and integrates economies; Capital One reports that the e-commerce industry is set to grow by 17% and currently exists as a $220 billion industry in the U.S. alone. The report further notes that an expanding mobile market and along with B2B e-commerce provides fresh opportunities for new market entrants.
However, like most emerging technologies and trends, the impact of replacement is not immediate. This means that while the popularity of dropshipping may be increasing as a result of growth in the e-commerce space, traditional supply chain methods involving intermediaries and holding stock still represent a significant logistical aspect of the market. The intersection, cooperation, and competition between dropshipping and traditional supply chain management methods is something businesses should not gloss over.
In reality, running a successful dropshipping business will be like walking a tightrope in the beginning. Furthermore, it’s important to not only operate through dropshipping but also have a few different, interconnected areas or forms of business that you interact with so that your business is not isolated and has social exposure and connections with the relevant firms in your industry. Oftentimes, dropshipping doesn’t make the supply process more convenient but may complicate it if business owners take too lax of a stance towards their suppliers.
This playbook will guide you through the premise of dropshipping, the motivation and planning needed to start a dropship business up, and the things you’ll need to do to hedge and adapt to when your business first starts to take off. We’ll walk through a history of where dropshipping fits into supply chain management models, its merits and its demerits, and how you can structure a dropshipping business that takes advantage of the dropshipping model while reducing your exposure to the risk associated with that same model.
Dropshipping and The History of Supply Chain Management Paradigms
Most people are familiar with the traditional supply chain model. This is the one that involves multiple intermediaries between businesses dealing with the extraction of raw materials, the production of the product, its transportation, and its storage. Arguably, this more archaic model consists of businesses finding the most conveniently located suppliers and then figuring out a deal with them for the materials that they want – it is a hit or miss process with very little information exchanged and potential for optimization.
Now, this may seem a ways off from dropshipping, but these traditional models of supply chain management actually are the basis for solutions such as dropshipping. It’s impossible to understand dropshipping without first having a good grasp on supply chain management since the whole premise of dropshipping is predicated on using technology to create shortcuts and to make the traditional chain more efficient. But that doesn’t mean that dropshipping cleanly averts all supply chain issues.
As an example of how the fundamental problems of supply chain management (SCM) still impact dropshipping, consider the classic issue of the bullwhip effect. The bullwhip effect is an inefficiency that arises from the fact that demand signals become weaker and vaguer as you go up the in the supply chain. MIT’s Sloan Management Review characterizes the primary consequences of the bullwhip effect: “Distorted information from one end of a supply chain to the other can lead to tremendous inefficiencies: excessive inventory investment, poor customer service, lost revenues, misguided capacity plans, ineffective transportation, and missed production schedules.”
You might better intuitively understand the bullwhip effect if you’ve ever played a game of telephone. The original message that that first person in the cycle is often distorted into something completely different and unrecognizable at the end. The person relaying the first message in a game of telephone is comparable to the end customer who sends signals through their demand to the rest of the supply chain.
To better understand the revolutionary notion of dropshipping, we should first think about how pre-Internet SCM operated and changed over time. At the turn of the century, the prevalence and applicability of information technology were already redefining the way suppliers, intermediaries, distributors, retailers, and all other agents along a supply chain were acting.
A 2000 study published in Management Science documents the impact of technology on the supply chain: “In traditional supply chain inventory management, orders are the only information firms exchange, but information technology now allows firms to share demand and inventory data quickly and inexpensively.” It was like a bright light illuminating a cave, firms could now evaluate their respective numbers and make more appropriate stocking and manufacturing decisions since demand signals were more precise.
What was happening in the 2000s was that more reliable information sharing infrastructures were developing across the industries as part of an era of technological advances. This meant that the agents along a supply chain could now share demand and inventory data with a number of firms and optimize their choice of firm instead of relying on more haphazard manual methods of searching. These technologies created a marketplace for suppliers, retailers, and their intermediaries.
Dropshipping is the next step in the evolution of SCM mediated by more reliable and commonplace online payment platforms and the ubiquity of communications systems. But you shouldn’t treat traditional SCM strategies like chopped liver just yet.
Globalization Fuels Dropshipping’s Viability
The reason anything becomes popular is that it produces some sort of benefit to the market. Dropshipping is no exception to this rule, as dropshipping is part of a larger strategy by various companies who are attempting to ride on the trend of globalization and technological advances to shorten and quicken the distance between the supplier and consumer.
In fact, globalization itself exists as a trend because it seems to bring greater prosperity in general. According to a report by the International Monetary Fund (IMF), globalization is a predictor for enhanced economic growth: “Furthermore, a common denominator which appears to link nearly all high-growth countries together is their participation in, and integration with, the global economy.”
The competitiveness of modern markets requires firms to function on an international level, meaning that they must consider how to deal on a global basis if they are to remain relevant. An abstract published by the Journal of Global Business Management observes this macroeconomic shift as part of a comparison between traditional SCM and e-SCM methods like dropshipping: “In today’s business environment, enterprises have to consider their global reach as it is important to a firm’s survival, especially for multinational firms that are more profitable and grow faster.”
So, the prominence and increased feasibility of dropshipping ventures may reasonably attribute to trends pertaining to globalization. This will be a key point to remember as we go forward in describing the key reasons for why dropshipping businesses either fail or succeed.
Now, we’ve been using this word dropshipping a lot but we haven’t exactly settled on a definition – let’s clear up this ambiguity. Shopify, a leader in e-commerce, gives a very concise and lucid definition in their article describing the new SCM strategy: “Dropshipping is a retail fulfillment method where a store doesn’t keep the products it sells in stock. Instead, when a store sells a product, it purchases the item from a third party and has it shipped directly to the customer.
The model of dropshipping puts a big red cross right through the idea of intermediaries. The e-commerce site running a dropshipping strategy usually has a number of contracts with various suppliers to sell their products and customers who browse that e-commerce site put in orders for those listed products. As the customer pays for the product, the e-commerce site relays the order information to the supplier, who is then responsible for producing and shipping the product to the customer directly themselves.
Furthermore, e-commerce sites that practice dropshipping can focus more attention on optimizing the ranking of their site and other marketing techniques after handing off the responsibilities of manufacturing and shipping to a supplier. In this way, dropshipping creates a bit of a feedback effect since it encourages e-commerce companies and similar retailers to invest more into their online presence and the mediums of communication.
The numbers look promising for this nascent SCM model as well, as Smart Insights notes that online shopping has experienced a sharp increase of 45% in 2016. Furthermore, 40% of the world’s population has purchased products online and the countries that spend the most online are China, the United States, the UK, Japan, and Germany, highlighting its increasing popularity worldwide. Of course, dropshipping is quickly becoming a preferred method for some of the online retailers responsible for these increases as it stands as the primary SCM strategy for 22-33% of companies.
Charting The Beginnings of a Business Plan Around Dropshipping
Here, we’ll develop a rough sketch of the things you’ll want to do when researching and creating a business plan, including how your dropshipping business might start off and how you will want to grow it. Afterwards, we review some of the liabilities associated with dropshipping and how to overcome them by accounting for the risk of loss associated with each type of liability in your business plan. First, dropshipping best applies to e-commerce ventures, the two are inextricable.
Dropshipping simply doesn’t make sense if the store employs the strategy in a physical location. To be clear, dropshipping as an SCM strategy is only viable online – no one will be going into a physical location to select from a catalog of items and then have the supplier ship it to them. Therefore, all of your efforts should be invested into researching a niche, creating a presentable e-commerce website, increasing its online presence, quickly servicing customers, and finding a reliable group of suppliers.
Let’s start with the first point of finding a niche. When it comes to dropshipping, you’ll be in competition with a number of other sites that already have a set of products and a lot more experience on you in specific fields. You want to enter the e-commerce market in a space where there are fewer competitors, and you do so by researching a niche that appears lucrative but has not been capitalized on just yet.
Naturally, all of the broad categories that you can think of are gone – courtesy of huge corporations like Amazon. You’ll want to look for products that are esoteric and just out of sight of the mainstream but have a sufficiently large following. Ironically, you can do just that by performing some market research by using Amazon; a profitable niche selection determines the amount of success your ecommerce and dropshipping business can achieve from the get-go.
Subsequently, you need to create a presentable e-commerce website and invest resources into increasing its online presence. Existing e-commerce outlets like Shopify actually offer their own website and features like product organization, staff login, and built-in customer service panels that may help you expedite this creation process. Apart from the aesthetic of your site and ensuring that it has a degree of consistency with the niche you trying to appeal to, you’ll want to make an active effort towards improving the presence of your website online.
Creating a blog to cast a wider net for visitors on search engines, paying for positive reviews on your service, and allowing for a community to form around the niche that your marketplace serves are all viable strategies to increase your website’s online presence. Being creative with these strategies may pay off. For instance, you may opt to combine content marketing and usability strategies to give your website the greatest boost in online reputation.
Customer service and finding consistent and trustworthy suppliers are the last piece of the equation for a dropshipping business that attracts business. The disconnect between the actual item ordered by a customer and the dropshipper is a huge plus for the case of dropshipping because it eliminates the need for inventory expenses, but the complexity it brings to customer service is also one of its greatest demerits. An article from WorldWideBrands expounds on some of the issues that come with implementing dropshipping as an SCM strategy: “…when you use a drop shipping wholesaler, you are giving up control over the logistical aspects of your customer service. If your drop shipper doesn’t send an order out on time, your customer is going to be upset with you.”
In this case, the disconnect between the supplier and the dropshipper and the customer’s attribution of responsibility is what complicates the customer service relationship. If your customer receives a faulty or subpar product, they’ll complain to your firm. Then, you would have to launch an investigation into what’s going on with the supplier.
In the traditional model of SCM, your business is the one that is receiving and stocking items for customers, so you have more control over the oversight process than when you are dropshipping. Your company would notice an issue or defect in supplied products before the customer because your company handles the product before distributing it to them in this SCM scheme.
So the issues of customer service and finding reliable suppliers are actually interrelated because reliable suppliers will tend to produce less customer service issues for your dropshipping venture. However, you will want to dedicate separate efforts targeted at confirming the consistency of your supplier and the staff that runs your customer service operations.
The Inherent Liabilities of Dropshipping
We’ve discussed the exciting prospect of dropshipping as part of a series of trends emerging from a globalizing market. Also, we’ve seen how dropshipping fits into a larger scheme of SCM models resulting from recent technological advances and the attempts of various firms to enter and adapt to this sweeping globalization. However, there are a number of big liabilities that you want to watch out for when you’re trying to drive business to your e-commerce site through dropshipping.
According to the Wall Street Journal, a large swath of retailers such as Macy’s and Home Depot are getting the jump on dropshipping as part of their strategy to make their supply chains more efficient and as part of a wider strategy to better serve a global marketplace. Yet, the same article underscores that dropshipping strategies actually introduce a number of big liabilities for even the biggest companies. Among them is the fact that dropshipping shifts the control of who supplies the end consumer: “Retailers must hand control over key parts of their supply chains to third parties, including inventory management and shipping.”
If you think about it, you’re cutting out a significant portion of the supply chain in order to save costs and reduce the amount of management required as well as lessen the impact of the bullwhip effect (there are fewer intermediaries between the demand signals). But you’re also giving a big part of your business’ autonomy and ability to manage responsibility by handing the task of production and shipping to a supplier.
In this manner, dropshipping actually introduces a greater element of risk because of its inherent requirement that the e-commerce site or retailer place its trust in the supplier to be able to meet the demands of its customers. Some of the most frequent reasons for why dropshipping companies fail stem from shipping issues, a lack of discipline, and insufficient customer service provision. Quora reveals a number of conceptual reasons for why dropshipping businesses often fail as well, including:
- Lack of a proper business plan
- Identifying the wrong niche
- Lack of a marketing policy
- Poor website
- Unreliable supplier
- Quality competitors
Note how each of these reasons relates to some of the steps to planning a business plan for a dropshipping company we’ve discussed in the previous section. To get the most out of a dropshipping business you’ll need to control for all of these factors. But, the most deadly threat to your business is buying too much into the dropshipping hype by only relying on dropshipping to drive business and sales.
Accounting for Supplier Liability While Growing Business
You should aim to take a rational perspective when it comes to matters such as transitioning to a new SCM strategy like dropshipping. That perspective usually involves a cost-benefit analysis. To use dropshipping as your sole SCM strategy will expose your fledgling e-commerce business to an unprecedented amount of risk despite what you may save.
Dropshipping is a strategy that looks great in theory but has a number of complications associated with its practice that need to be accounted for if you want to drive business. Let’s say you’re setting up your dropshipping business and following through with all of the basic steps like researching a niche, building a website, and the whole nine yards. Your site is now established and running with a healthy amount of customers.
Over time, your suppliers are not able to match your demand and they fail to deliver the proper quality and quantity of products on schedule. Now what? Your business is now left high and dry for the customers it needs to serve. Orders will be placed and relayed to the relevant suppliers, but those suppliers simply will not be able to produce and ship the product – it’s a logistical nightmare.
The key flaw underlying the entire premise of dropshipping is that it puts too much trust into suppliers. The solution to this issue is straightforward. Rely on a business model that incorporates both features of dropshipping and traditional SCM. This way, you will be able to accrue the benefits of efficiency from dropshipping while mitigating the risk of supply-side shortages or stoppages.
Moreover, a research article published in Computers & Industrial Engineering provides the empirical grounds for the greater success of e-commerce businesses that utilize a marketing mix of holding inventory along with dropshipping: “A mix of holding inventory and drop shipping is frequently optimal for e-retailers.”
The key takeaways for driving business through dropshipping are to start out with the right business plan. Target a profitable niche and center your online marketing efforts towards capturing that market. Mitigate the risks of fragmented order deliveries and other supply-side liabilities by utilizing a market mix that includes a strategy that holds inventory but also dropships to maximize the growth potential of your venture.