At EcomCrew we've had quite a few interesting discussions about Drop Shipping in the past several weeks. The basic discussion revolved around the question of whether drop shipping is a dead business model or not. Our feelings aside, drop shipping as a business model is still heavily promoted as a reliable ecommerce business model and continues to surge in popularity.
So this leaves us the question – is drop shipping a dead business model? If not, how can one succeed with drop shipping?
Related Podcast: Drop Shipping vs Private Labeling: A Friendly Debate
- Drop Shipping Demand – From Sellers
- First-Hand Experiences with Drop Shipping
- What Still Works in Drop Shipping & Opportunities
- What Types of Products Are Successful in Drop Shipping?
- What Doesn’t Work Anymore in Drop Shipping
- How to Find Companies to Drop Ship for You
- Drop Shipping is a Volume and Cost Cutting Game
- Drop Shipping Is Suited to Small Companies
- What are the Pitfalls of Drop Shipping?
- Drop Shipping from China
Drop Shipping Demand – From Sellers
Drop shipping is a business model that a lot of bloggers have been writing about for years. I first found out about drop shipping not long after starting my first ecommerce business in 2008. While we can subjectively debate the merits of drop shipping, there's no denying that there is an increasing appetite from entrepreneurs regarding drop shipping businesses.
If you follow tech stocks at all, you may recall when short seller Andrew Left lamented about Shopify: “Shopify [is] a company that has mastered the good ol' get-rich-quick scheme”. Shopify often exudes the drop shipping business model. Aside from a momentary blip, shareholders don't seem to buy into Shopify selling snake oil as the stock price has gone from $42.87 at the end of 2016 to over $145 as of this writing.
I have a confession: I'm a recovering drop shipper. My previous company did about $2million in revenue and of this, just under 10% came from drop shipping. Our margins were razor thin on these products. While we aimed for 20-30% gross margins on our branded products, our drop shipped products we're closer to 10% or less. We sold these products largely to fill out our own store. However, at the end of the day, 10% of roughly $200,000 in revenue is still a lot of money.
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I also have many friends running very nice businesses doing Drop Shipping. Check out our interviews with David Couillard and Kevin Stecko for examples of people running high 6 and 7 figure businesses exclusively drop shipping.
Michael Jackness (of this blog) is also a recovering drop shipper as well – he previously owned Treadmill.com and sold it in 2014 for, among other reasons, the troubles that come with running a drop shipping business.
What Still Works in Drop Shipping & Opportunities
In my experience, people who are successful in drop shipping are successful for a couple of different reasons.
The first way to be successful with drop shipping is to simply sell products online from a brand who doesn't have a significant online presence. In today's world, often this means being the first to put a company's products on Amazon. This happens often with a lot of very old school manufacturers who still aren't ecommerce savvy. These are often smaller companies and they have long-standing distributor agreements that they're worried to disrupt. The problem with this model is that it is nowadays much harder to find such brands with not significant online presences. Brands were previously in the dark about the power of ecommerce but the lights are slowly being turned on.
The second way is to take a brand's products and add additional value, even if they already are selling online. Often people can do this simply by offering better photography of products. Our good friend David Couillard from HardCases.ca takes this one step further and does Hollywood-quality videography of all of his drop shipped products. We used to bundle one of our drop shipped products with another product (it was actually two parts from the very same brand!). We basically gave the bundled product for free with the product. It worked great for about 4 months until the brand owner saw what we were doing and actually came out with an exact same bundle but for 10% less money.
Ways to be successful in drop shipping:
- Target unsophisticated manufacturers and avoid distributors and middlemen
- Target manufactures with sales tax phobia
- Target foreign companies and/or foreign marketplaces (i.e. Amazon Canada/Europe)
There are still a ton of very old school manufacturers out there with little or no online presence, although the number of these brands is dwindling quickly. The fact that these companies have poor online presence makes finding them difficult. One of the best ways I've had luck with is to visit industry trade shows and simply ask brands if they drop ship in person.
Many companies also have sales tax phobia. Companies that are afraid of creating sales tax nexus in other states will not use Amazon FBA. This leaves a big opening for sellers who, rightly or wrongly, do not have such concerns.
Finally, drop shipping is a saturated business model in the U.S. but not nearly as much in other countries like Canada and Europe. The problem though is that these overseas markets don't have the plethora of manufacturers as the U.S.
What Types of Products Are Successful in Drop Shipping?
In my experience, products that can be successfully drop shipped share a few commonalities:
- Niche items with relatively low demand
- Heavier items, especially those requiring LTL (truckload) shipping
- High priced items
The reason these items tend to be a success is that they are exactly the items that Amazon hasn't heavily penetrated. Amazon is still largely a small and light marketplace (relatively speaking). Pool tables and hot tubs aren't huge sellers on Amazon, although they likely will be at some point in the future.
Heavier items also tend to have higher price points. With higher price points generally, you have more room for marketing and advertising budgets.
What Doesn't Work Anymore in Drop Shipping
Selling major brands online through drop shipping rarely works for the fact that they either have online presence themselves or they have hordes of other drop shippers already selling for them. Andrew Youderian publicly documented the sale of his site TrollingMotors.net in 2013, which sells almost exclusively large consumer brands, in part because of the downward pressure on price: and that was five years ago!
The good rule of thumb is that if Amazon is buying an item itself (opposed to being sold through a third party seller) then you have almost no hope of ever succeeding in drop shipping that item. Just look for where it says “Ships from and sold by Amazon” in the listing. Among other reasons, Amazon has price match algorithms that will often lower their price to the point of break even or worse. You can't compete profitably with that.
What that means is that you're often left dealing with the far fringes of niches. Being in the fringes isn't bad and in fact I highly recommend doing that, but with drop shipping, you have to be deep in the fringes. I have one friend running a fairly successful drop shipping business selling wallpaper borders. When was the last time you bought wallpaper?
How to Find Companies to Drop Ship for You
Here's the bad news – being successful in drop shipping requires you to employ some guerilla tactics to find companies to drop ship for you. If you plan on buying a directory of drop shippers then this means that all of these companies have almost certainly been penetrated by the ecommerce marketers. You should also try and stay clear of distributors/wholesalers. Distributors are companies who buy in bulk from manufacturers and sell in smaller quantities to retailers. Distributors are attractive because they often have lots of different items and reliable inventory. However, these distributors normally take a minimum of a 50% markup which will make it difficult to be profitable.
Ultimately, the biggest key to success is finding brands that are not aggressively advertising online and that do not have a lot of other ecommerce brands working with them. How do you find these companies?
- Walk trade shows and ask manufacturers face to face if they drop ship
- Browse print catalogs of major retailers, find the contact information for the brands, and contact them directly
- Browsing major brick and mortar retailers and contacting the brands that they sell
Like anything in ecommerce, the more focused your strategy is on a particular niche, the more successful you will be. When you have a narrow focus of a niche it is easier to narrow down your selection and really get to know what the brands are in your space.
Drop Shipping is a Volume and Cost Cutting Game
The big reason I personally am not fond of drop shipping is that it is a margin and volume game. He who sells the most products at the lowest prices and lowest costs wins. Drop Shipping businesses tend to have around 1/2 to 1/3 the margins of a private label business. This means in order to have the same profit with a drop shipping business, you need to have 2-3x higher revenue. This means you need to have 2-3x more orders which means 2-3x more customer support emails, 2-3x more returns, and ultimately 2-3x more headaches.
Drop shippers also tend to have catalogs of thousands of products, opposed to private labelers who have a fraction of this. To be successful you have to be an expert at managing a very deep catalog of products. Some skills you need to be good at to manage a catalog of thousands of products:
- Using file feed uploads (csvs) to upload products instead of manually entering them
- Systems for getting product descriptions, media, pricing, etc. from multiple manufacturers
- Managing pricing, stock, descriptions, updates etc. from manufacturers (you will almost certainly need some type of inventory management system)
You also have to avoid, by all means possible, being tricked into a false sense of profitability. Almost all ecommerce business owners underestimate costs, and the newer they are to ecommerce, the more they tend to underestimate. Costs you have to consider are:
- Inbound freight costs (i.e. from the manufacturer to FBA)
- Outbound freight costs (i.e. from FBA to the customer)
- Referral fees from Amazon, eBay, etc.
- Other advertising costs
- Returns, damages, and other shrinkages
It's actually easier to track costs with a drop shipping business as there are fewer costs than in a private labeling business, but it is still easy to underestimate them.
Drop Shipping Is Suited to Small (Very Small) Companies
Drop shipping is such a low margin business model that in my experience it is very difficult to profitably pay other employees to help you manage the business. In other words, drop shipping is very well suited for solo-preneurs. This may, in fact, actually sound very attractive to you.
Most drop shippers are succeeding by doing things like having successful SEO, offering exceptional customer service, and doing amazing marketing. All of these jobs are very expensive to hire for. An argument could be made that entrepreneurs with successful drop shipping businesses are simply making their market salary. You also see a plethora of entrepreneurs running drop shipping businesses from abroad. A big part of this is that they're taking advantage of the luxury of being able to work abroad but another part is that drop shippers don't make enough money to be able to afford to live in an expensive Western country.
Of course, I'm sure a lot of people wouldn't mind earning $30,000 and essentially living for free in Chiang Mai. However, if you have dreams of having a huge company with a bunch of employees, drop shipping is a business model that is very difficult to accomplish this with.
What are the Pitfalls of Drop Shipping?
- Stock outages
- Pricing changes
- Manufacturers learning from you and undercutting you
- Sales Tax
One of the biggest pains of running a drop shipping business is managing inventory stock levels. Often to be a successful drop shipper you're working with relatively unsophisticated suppliers who will not be able to give you access to real time inventory levels. Normally you find out that a product is out of stock after you have sold it. This is a very good way to get yourself suspended on Amazon.
Equally as scary as inventory outages is price changes that you don't accurately update either through an error on your part or through your supplier failing to notify you. Especially as you're working on razor thin margins in a drop shipping business, a small change in the cost of goods sold can make you unprofitable.
As you begin to be successful with your drop shipping business, manufacturers will start to learn from you. In my previous business, we had a product from a manufacturer that we simply bundled with another product from that same manufacturer. The manufacturer quickly caught on to what we were doing and recreated the same bundle, killing that product. I've even heard stories about manufacturers stealing a drop shipper's photography (the very thing that gives them a competitive advantage). Your supplier can quickly turn from friend to foe in drop shipping.
Finally, be aware of returns and taxes. Often a market place like Amazon will have return policies that don't jibe with the return policies of your supplier. This will normally mean you're stuck with eating the costs of that return (either destroying it or trying to resell it). Sales tax is another grey area for drop shipping. In many states, having a drop shipping agreement with a supplier gives you sales tax nexus in that state. I'm not even going to begin to touch on the nuances of this!
Drop Shipping from China
There is one relatively new opportunity for drop shipping and that is drop shipping from China. Sounds crazy doesn't it?
Mike talks about drop shipping from China briefly in his Amazon Product Launch and Validation Strategy. This strategy works well because there's still a lot of manufacturers in China not selling direct in the U.S. and shipping from China to the U.S. is often cheaper than directly from within America for products under 2 lbs or so (that's not a misprint – it's seriously cheaper to ship a small box to the U.S. from China rather than from within America itself). Moreover, because of America's $800 de minimis threshold, almost all products drop shipped from China incur no additional duties or brokerage.
There's two ways you can drop ship from China:
- From Aliexpress resellers
- Directly from the manufacturer
With Aliexpress you simply buy products from sellers on there and ship them to customers. Most sellers on Aliexpress are resellers, not the actual manufacturer. Shopify covers this extensively in a drop shipping from Aliexpress article on their website. You can automate everything using software like Oberlo or you simply buy a product on Aliexpress and enter the customer's shipping information instead of yours. The big downside revolves around logistics.
The second way is to ship direct from manufacturers in China. This works well for small products and high ticket items (where the shipping price is small relative to the product price). When shipping direct from suppliers in China, it is often difficult to get them to agree to this unless they have an existing relationship with you and even then many factories in China aren't set up to ship directly to customers in America. In cases where I've seen drop shipping from Chinese suppliers, the seller normally has a traditional relationship with the factory (i.e. buying in bulk from them) and asks the Chinese supplier to drop ship for them after they have sufficient trust.
The biggest problem with drop shipping from China is logistics. Shipments from China take around 20 days if shipping via China Post and this is an absolute nightmare in terms of customer service. For larger items that are shipped via FedEx/UPS/DHL/etc. shipment times are often around a week but the costs are very high, normally $100+, and there is still all of the unpredictability that goes with international shipping. If you're considering drop shipping from China, I strongly caution against doing this with Amazon (especially an Amazon account with good account history) as it can very quickly get your account suspended due to negative customer satisfaction rates.
When drop shipping from China you must also be aware that shipping to any country besides America will almost certainly mean significant duties and taxes to the customer (most countries only have around a $20 duty free de minimis exemption).
Is drop shipping dead? Probably not. I personally know enough people with nice drop shipping businesses to believe drop shipping still has a place in the world of ecommerce. However, I do think if there was a business model lifecycle curve, drop shipping would probably have already crested and be on the downward slope. Margins will continue to get pushed down, more brands will start to sell direct, and the ultimate result will be drop shippers having a more challenging time being successful.
Are you running a drop shipping business? Do you think drop shippers can still be successful? If so, share your thoughts and comments below.