What is dropshipping

Dropshipping in 2021: What is dropshipping and how does it work?

This guide covers the definition of dropshipping, pros and cons, and alternatives to consider for ecommerce businesses
illustration of packages with Amazon Smile on pallets

Introduction to dropshipping

Dropshipping is an order fulfillment option that allows ecommerce businesses to outsource procuring, storing, and shipping products to a third party. This order fulfillment method appeals to entrepreneurs seeking low overhead and low capital investments, but it can come at a cost.

Ecommerce is competitive. Dropshipping may appeal to entrepreneurs looking to sell generic products, but it can limit opportunities to build a brand or differentiate products. Thus, businesses that use dropshipping may wind up competing on price, leading to low margins.

If you are considering dropshipping for your ecommerce business, there are several factors you should review—including some variations and alternatives that offer similar benefits.

What is dropshipping?

Dropshipping allows you, the seller, to outsource the fulfillment process to a third party, typically a supplier. The manufacturer or third-party supplier handles the production, storage, shipping, and delivery of products to the customer.

This business model appeals to some ecommerce sellers because it can decrease overhead and operating costs. In some dropshipping agreements, you handle marketing and customer service, while the dropshipping service manages the physical goods and fulfillment.
a man and a woman looking at a clipboard while standing in a warehouse

How does dropshipping work?

When you work with a dropshipping supplier, you pay them to fulfill products when a customer places an order. The exact logistics of dropshipping depend on your arrangement, but typically the dropshipping process follows this general sequence:
  1. Your dropshipping supplier sources or produces the product.
  2. You make an agreement with the dropshipping supplier.
  3. Your dropshipping supplier stores the inventory.
  4. You host the ecommerce storefront or webstore.
  5. A customer places an order.
  6. You process the payment.
  7. You forward the order to the dropshipping service.
  8. The dropshipping service prepares the order.
  9. The dropshipping service ships the product(s).
Usually, you send customer orders to the dropshipper, then you inform customers the products are on the way, and the rest of the physical fulfillment process is out of your hands.

Key players in the dropshipping model

Let’s unpack some of the key players and their roles in detail, starting with the seller of record—in other words, your ecommerce business.

Seller of record

The dropshipping process starts with you. As the seller of record (SoR), you’re the individual identified as selling the product to the end consumer. You set the price, record the purchase as revenue, and assume responsibility for the sales tax on a particular sale. Even when a third party stocks and ships the items, you’re the seller of record because you own the products before they ship to the customer.

For Amazon sellers, using a dropshipping service is generally allowed by Amazon dropshipping policy, as long as you’re the seller of record and identify yourself as such.

Manufacturers

Manufacturers make products to sell to wholesalers and retailers. You can purchase goods from manufacturers, but the bulk purchase amounts they may require can potentially be a barrier to starting or scaling your business. Some manufacturers may offer dropshipping services.

Wholesalers

In a typical product supply chain, wholesalers buy from manufacturers and sell to retailers at a slight markup. They function as middlemen; generally, they do not sell to the end consumers but may provide dropshipping services to retailers.

Determine which dropshipping providers could be right for you based on your business model and fulfillment requirements, among other factors.

Potential pros and cons of dropshipping

In ecommerce, as in life, there are advantages and disadvantages to any fulfillment approach. Whether the gains are worth the pain largely depends on your goals and business situation. Here are potential pros and cons to consider when weighing whether dropshipping is right for your ecommerce business.

Possible benefits of dropshipping include:
  • Overhead costs: Since you don’t store or ship the products, dropshipping has the potential to lower overhead costs, such as maintaining a storage facility or sending products to customers.
  • Starting costs: Entrepreneurs looking to start a business with minimal investment may turn to dropshipping as they don’t need to invest in facilities or resources to process orders.
  • Multi-channel selling: You can use dropshipping for your business while selling on your own domain, through a store like Amazon, or social media channels —or all of the above.
  • Operating location: Dropshipping allows you to fulfill orders regardless of your operating location, opening up a possibility to work from anywhere.
  • Scalability: Leveraging suppliers can make it feasible to accept more orders without increasing the inventory you store, package, and ship.
Potential limitations for dropshipping include:
  • Competition: Given the low cost and investment to get started, dropshipping is a highly competitive field.
  • Product quality: Dropshipping reduces your involvement in the order fulfillment process, curtailing your ability to monitor and guarantee product quality.
  • Branding: Because the products you sell may not be unique or distinguishable from similar offerings by other sellers, you could have trouble differentiating your offering.
  • Profit margins: Little to no product differentiators means your business may end up competing more aggressively on price. Selling at low prices can eat up your profit margin.
  • Fulfillment timeline: When a dropshipping service handles the fulfillment process, you do not have control over order selection, packaging, and shipment.
  • Inventory management: Up-to-the-minute updates on what is available in stock may not be possible. If a customer places an order only to find the product is out of stock, this poor experience can discourage future orders and damage your brand.
  • Range of offers: Because you don’t handle order fulfillment, you may be limited in the special offers and promotions you can run, such as bundling or free shipping.
For some businesses, dropshipping limitations do not outweigh the potential benefits. Luckily, if you want to lower your inventory and order fulfillment costs, a service like Fulfillment by Amazon may be an option. For some sellers, FBA provides a happy medium, offering many of the benefits of dropshipping without the downsides.

How Hope & Henry used FBA to grow their brand quickly

man pointing at a computer screen with children's clothes from Amazon seller Hope and Henry
We were able to launch without having a distribution center. We were able to launch without having people dedicated to fulfilling inventory. That’s a big deal.
Matt McCauleyCEO/Founder, Hope & Henry

Fulfillment by Amazon: A dropshipping alternative with added perks

Fulfillment by Amazon (FBA) offers similar benefits to dropshipping while giving you more control over your brand experience. You don’t need to sell products in Amazon stores to use FBA—although with an audience of hundreds of millions of unique visitors each month, Amazon is a selling channel worth considering.

With FBA, you store products in an Amazon fulfillment center, and we:
  • Offer quick delivery with Prime Shipping
  • Manage customer service
  • Take care of returns
  • Notify you when you need to restock products
How FBA works
  • You decide the products and quantities you’d like to fulfill and send them our way.
  • We receive products into our network and store them in Amazon fulfillment centers.
  • As orders arrive, we pick, pack, and ship the products on your behalf.
  • Amazon manages customer service and returns on these orders.

Watch:

How FBA works

illustration of an Amazon fulfillment center

Is dropshipping right for you?

It depends on your business. Here are a few questions to ask yourself if you’re considering dropshipping.

How do you want to build your brand?

Your brand is the look and feel of customer-facing aspects of your business. Building a memorable brand impression can help grow customer loyalty.

While you may be able to create a branded online experience, dropshipping gives you less control over product quality, delivery experience, and the aesthetics of the final package. If the products and packaging fall short of expectations, a customer may choose not to purchase from your brand again.

Dropshipping suppliers often offer little room for product customization. This limitation may make it difficult to set your brand apart from the competition.

How much control do you want over product quality?

Product quality can have a big impact on other aspects of your business such as customer acquisition, brand loyalty, and returns. While you may be able to inspect the quality of products at the start of your dropshipping relationship, you will likely have limited control over the quality of the items you sell on an ongoing basis.

If the products fail to meet customer expectations, your business could receive negative customer reviews.
illustration of man looking at customer reviews on mobile device

How quickly do you want to ship products?

Ecommerce customers tend to expect quick shipping. In a recent survey, nearly 84% of people surveyed regarded delivery as an essential part of their online shopping experience.

Long shipping times can negatively impact your business. When working with a dropshipping supplier, review its standard shipping costs and delivery timeframes.

For sellers looking for fast order fulfillment services, a service like FBA can be valuable.

Did you know?

During the 2019 U.S. holiday season, independent third-party sellers—mostly small and medium-sized businesses—sold and shipped over 100 million items with Prime Free One-Day Delivery.

How much capital do you have access to?

In some cases, the dropshipping business model allows you to hold off on product procurement until customers actually place orders. This can make dropshipping attractive to entrepreneurs who want to get a business up and running with limited inventory investment. Some alternatives like third-party fulfillment also allow you to launch and run your business with less capital compared to sourcing, storing, and shipping products on your own.

What is your target profit margin?

Compared to other business models, such as owning a retail store or building your own order fulfillment center, dropshipping has a lower barrier to entry. Unfortunately, this can mean more competition for your business.

The playing field can be highly competitive for businesses that use dropshipping. Dropshipping sellers are commonly able to offer products at low prices because they’ve invested so little. If you use dropshipping for your business, you may earn low profit margins.

You might be able to overcome some of these issues if you position your business within a niche outside of any hyper-competitive field. Find potentially profitable or less competitive niches through market research, networking, and sales. Or invest in differentiating your brand.

Are you ready to handle supply and inventory issues?

If you choose to use dropshipping, you may have little to no control over the supply chain. Delays in production might determine how many orders your dropshipper is able to fulfill. Having to disappoint your customers by informing them an item is out-of-stock is hopefully the exception and not the rule. Sourcing products through multiple dropshipping services is one way to avoid running low on product inventory. When one supplier is out of a needed product, you can rely on another. However, working with multiple suppliers adds complexity to logistics and fulfillment, which may defeat the purpose of a dropshipping strategy.

How will you handle refunds, returns, and replacements?

Returns are an inevitable part of ecommerce business. Sometimes the return process can be as simple as a customer contacting you regarding an item they would like to return. The customer sends back the product, then you refund the customer and contact the dropshipping supplier to credit or reimburse you. But this is not always the case.

Be prepared for more complex return and replacement processes. Take the time to understand how a dropshipping service handles returns before creating your refund and return policy.

Think through the steps of the ecommerce transaction. Here are some examples of questions to ask before signing on with a dropshipping supplier:
  • Who is responsible for defects?
  • Who covers return shipping fees for defective items?
  • What are the supplier’s restocking fees?
  • What is the return window for customers?
Questions like these can help you understand a dropshipping agreement and help paint a clearer picture of the potential costs involved before you make changes to your business model.
illustration of seller answering customer questions via online chat

How will you manage customer fulfillment questions and concerns?

Even though you may not physically handle the products, you may still need to respond to customer questions and concerns about a shipment, delivery, or product quality.

A seemingly small miscommunication with your dropshipping supplier can result in negative reviews and poor customer experience. To avoid this, consider the entire purchasing process from the customer’s vantage point. Pay special attention to the following aspects of the customer experience:
  • After ordering, do customers get a shipping notification on when to expect their orders?
  • Do packages arrive in the expected time frame?
  • Do products arrive in proper condition?
  • Is the packaging a good reflection of your brand?
Optimize each of these touchpoints to create a positive customer experience, which can help you earn positive reviews and build brand loyalty.

Alternatives to dropshipping

If dropshipping is not right for your ecommerce business, there are alternatives. Here are a few options if your goal is to outsource fulfillment.
illustration of a fulfillment center, a support representative, and a package with return label

Outsource storing and shipping products with third-party fulfillment

As an alternative to dropshipping, some sellers purchase products in bulk, then enlist the help of a third-party fulfillment service to store items, pick and pack orders, and handle the shipping to customers.

This approach allows you to procure products upfront, potentially at lower costs. You can also:
  • Assess the quality of items before they ship to the fulfillment center
  • Offer promotions and special offers on products
  • Offer product bundling or subscription services through some providers
If you would like to outsource fulfillment while maintaining control over product quality, learn about FBA.

Create your own branded products

At some point in the life of your business, you may require specialty products featuring your own branding. Selling branded products can help your business grow by helping you:
  • Differentiate your business from other ecommerce brands
  • Earn customer loyalty by building a unique online experience
  • Building a memorable ecommerce brand identity
  • Building brand recognition to help you launch future products
  • Build an asset, your brand identity
Some sellers find a dropshipping supplier to add individualized touches like special packaging and branding and create branded products or white label products.

Another option is to have a manufacturer produce branded products in bulk, then use FBA for distribution. This method lets you take advantage of Amazon’s fast Prime Shipping, helping you stand out in the crowded ecommerce market.

Focus on promotion and earn a commission through affiliate marketing

Affiliate marketing is a different business model altogether, but it’s worth considering if you’d prefer to avoid managing customers, orders, and returns entirely.

Affiliate marketers don’t sell any products at all. Instead, they promote products for an ecommerce retailer and collect a commission when a customer purchases through a unique referral link.

While affiliate marketing is an advertising business model as opposed to a retail solution, it can provide benefits such as minimizing startup or overhead costs while allowing you to build an audience and earn money when products you promote to your audience result in sales.

How affiliate marketing works

With affiliate marketing, you market a product online and include a link for customers to buy the item. The link takes customers to a website where they can place an order directly. You get paid when the customer uses your referral link and makes a purchase. The supplier handles the order confirmation, fulfillment, and shipping.

Affiliate marketing can be a way to jumpstart your ecommerce business or monetize an existing asset such as a blog or email list. Since you don’t stock, process, or ship the products, you may be able to operate with relatively low overhead costs. You can also:
  • Start an affiliate marketing business using your own website or social media accounts
  • Outsource customer management to your supplier, which then acts as the seller of record and handles customer communication
  • Outsource returns or order management to your supplier
Unlike dropshipping, if you use affiliate marketing, your supplier handles returns for products. Thus, there may be a set window in which the supplier holds your commission payment, after which you get paid.

Did you know:

Amazon has an affiliate marketing program?

You can earn a commission on orders customers make from referral links on your website, email, or social media channels.

Conclusion

At the end of the day, only you can decide whether dropshipping is right for your business or not.

While it may be appealing not to handle physical products, pay for warehouse space, ship orders, or manage stock levels, there are drawbacks as well. Weigh your options and goals in order to find the right online selling and fulfillment strategy to help you grow your ecommerce business.

Working toward the launch of your online store?

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Dropshipping FAQ

Is dropshipping legal?
Yes, dropshipping is a legal method of order fulfillment.

Do your homework on possible dropshipping suppliers and thoroughly review any dropshipping contracts in an effort to avoid surprises and bad actors down the line.
Will dropshipping help make my business profitable?
Not necessarily. Businesses that use dropshipping services commonly operate on slim profit margins due to competition. Dropshipping may be a viable possibility for your business, but you could find yourself confronted with a tradeoff between low overhead and upfront costs versus lower profit margins.
Is dropshipping allowed on Amazon?
Yes, as long as your business follows Amazon's dropshipping policy, you can use dropshipping for your business on Amazon.

To use dropshipping services for your business on Amazon, you must:
  • Be the seller of record of your products
  • Identify yourself as the seller of your products on all packing slips, invoices, and external packaging
  • Be responsible for accepting and processing customer returns of your products
Does Amazon offer dropshipping services?
Fulfillment by Amazon (FBA) is an alternative to using a dropshipping supplier. You procure products from your supplier of choice while Amazon handles the shipping, customer service, and returns on your behalf.

Multi-channel fulfillment allows you to use FBA even when you sell your products through your own domain or other ecommerce channels.
What’s the difference between dropship manufacturers, wholesalers, and retailers?
With dropshipping, the seller of record does not handle the product directly but instead uses a third party to source and store products, and ship orders directly to customers. Any party in the supply chain can dropship, including manufacturers, wholesalers, and retailers. A manufacturer, wholesaler, or retailer’s role doesn’t change based on the seller’s fulfillment method. For more details on how manufacturers, wholesalers, and retailers fit into the dropshipping process, see key players in the dropshipping model.
What’s the difference between dropshipping and retail arbitrage?
Retail arbitrage is the process of sourcing products from a retailer and selling the items at a higher price. Essentially, a seller re-sells products already available to the public to make a profit.

Retail arbitrage can be a labor-intensive venture as it requires you to consistently discover discounted items you can “flip” to make a profit. Sellers might find it challenging to rely on retail arbitrage when combined with a dropshipping method of order fulfillment, especially if the business model already operates on slim margins.
Do I need to register my business to use a dropshipping supplier?
While it is possible to operate your online store without a business license, you may be leaving yourself open to issues down the line. Registering as a Limited Liability Company (LLC) or another formal entity can reduce your liability and show potential suppliers you’re a legitimate business.
Do dropshipping companies ship internationally?
Yes, some do. Shipping rates, timeframes, and fees will vary between companies. If you want to reach customers worldwide, be sure to investigate the details of international order fulfillment as you research different dropshipping options.

Amazon operates fulfillment centers around the world and FBA international programs can help you reach customers in other countries.

Looking to simplify your inventory management and order fulfillment?