February 16th, 2021
If you are in the e-commerce retail business, you know that drop shipping is a hot topic. Given its increased popularity and the speed at which the drop shipping market is growing in general, we have decided to dive deeper into the topic. Here are the answers to 10 of the most commonly asked questions from both retailers and suppliers, including some useful information on how EDI fits into it all. Here’s an overview:
- What is drop shipping?
- How does it work?
- Why is drop shipping so popular?
- What are the benefits?
- What are the disadvantages?
- How can you best prepare for drop shipping?
- Should you outsource drop shipping to a 3PL or keep it in-house?
- Who should handle customer service and returns?
- Do you need to have a big IT team to handle drop shipping?
- How can you maximize your chances of success?
1. What is drop shipping?
Drop shipping is a fulfillment method in which the supplier, aka manufacturer, ships the order directly to the consumer on behalf of the retailer. It is also called direct-to-consumer fulfillment.
The best part about drop shipping is that end consumers still have the impression that the order came from the retailer. Take Amazon, for example. Would you be able to tell which packages were fulfilled directly by a supplier versus Amazon itself?
2. How does it work?
The drop shipping process typically looks like this:
➜ The customer places an order on the retailer’s website.
➜ The retailer sends the order to the supplier, including the delivery details, such as the customer address and delivery expectations, via purchase order (EDI 850). The purchase order may also be sent via email in the case the supplier is not capable of receiving EDI messages.
➜ The supplier acknowledges the order (EDI 855) and prepares the order with the retailer’s branded packing slip.
➜ The supplier ships the order directly to the customer and sends an advanced shipping notice (EDI 856) with the shipment details, including the tracking number, to the retailer.
➜ The supplier sends an invoice (EDI 810) to the retailer.
➜ The customer receives the package.
To keep the customer experience consistent, all customer-facing communications are handled by the retailer throughout the entire process. Going back to our Amazon example, even though your order is processed and shipped by the manufacturer in a drop-ship scenario, all communications, such as the order confirmation and delivery update, still come from Amazon. It is therefore crucial in the drop shipping process that the supplier communicates back to the retailer in a timely fashion to provide updates on order status, shipment date, or delays.
3. Why is drop shipping so popular?
Drop shipping has been around for quite some time, but it has really only been over the last few years that this model has become the talk of the town. This is due to three factors: the fast growth of e-commerce, a competitive retail landscape, and the COVID-19 pandemic.
1. E-commerce growth: Retail e-commerce is getting bigger and bigger, and there are no signs of this trend slowing down any time soon. By 2022, e-retail revenues are projected to grow to $6.54 trillion US dollars, up from $3.53 trillion in 2019.
2. Competitive retail landscape: In addition to increasing e-commerce order volume, Amazon’s two-day delivery paradigm has set the bar even higher for retailers that are now called to meet more demanding consumer expectations. In this hypercompetitive e-commerce landscape, more and more businesses are relying on the drop ship model to be ahead of the game. While some businesses see drop shipping as an opportunity to grow their business (read: question #4), some others rely on this model as a mere necessity to stay afloat.
3. COVID-19 impact: In 2020, drop shipping became even more popular for one main reason: COVID-19. The pandemic has drastically accelerated the growth of e-commerce. Some of our customers have seen an increase in their e-commerce order volume by 2-3x times their usual numbers. Retailers who didn’t feel a sense of urgency to test the waters with drop shipping before were forced to turn to their suppliers to help them fulfill the unexpected order influx. In fact, some businesses that have been disrupted by lockdowns were able to keep selling online and continue their business through drop shipping.
4. What are the benefits?
Drop shipping offers great advantages for both retailers and suppliers.
Let’s start from the retailer side.
- No investment in physical inventory: The main advantage of drop shipping is that retailers don’t have to keep, manage, or store any inventory. It goes without saying that with little to no inventory, there is no need to heavily invest in real estate, warehouses, and resources.
- Ability to offer an “endless aisle”: Customers have access to a wider selection of items without requiring the retailers to purchase the stock upfront. This a great advantage for retailers that are trying to diversify their product line. They can try out new products and see how their audience responds to them at no cost before putting them on the physical shelf.
- Ability to scale quickly: With drop shipping retailers are able to fulfill e-commerce orders faster while reducing distribution workload, labor, and costs. Drop shipping opens up the opportunity to start a new business for those retailers that don’t have a lot of capital to invest.
On the supplier side, drop shipping requires some more work behind the scenes. However, the results can certainly pay off in the long run.
- Ability to introduce a new product: Drop shipping allows suppliers to sell products that never made it to the retail shelf because of limited inventory or storage. Once a product has proven to be successful through drop shipping, retailers will be motivated to invest and carry the product in store, allowing suppliers to expand into new markets.
- Improved retailer relationships: When done right, drop shipping will help strengthen the relationship between the retailer and the supplier.
- Increased customer loyalty: Happy customers are returning customers.
- Higher profits: More and more retailers are looking to partner with suppliers that are ready to drop ship.
5. What are the disadvantages?
Just like advantages, disadvantages can vary between retailers and suppliers.
Once again, let’s start from the retail side.
The biggest disadvantage for retailers is having less control over the customer experience. Retailers build their business on their brand name and with drop shipping they are taking up a big risk in putting their reputation in the hands of the supplier. If the quality of the product is misrepresented on the retailer’s website, or if the supplier is not able to deliver the product on time, the retailer is held responsible. As suppliers are invisible to the end consumer when drop shipping is used, a bad customer experience ultimately reflects negatively on the retailer’s reputation.
Another big risk for retailers is not having enough visibility on orders or inventory. Remember, the retailer is the one responsible to communicate the status of the order to the end consumer. If the retailer doesn’t know where a package is, they are unable to provide status updates to their customers. That’s why more and more retailers are choosing to partner with drop shipping vendors that are able to automate the exchange of real-time inventory and order status updates.
Now let’s move on to the supplier side.
On the suppler side, the biggest struggle is to transition from bulk to direct-to-consumer fulfillment. Let’s take an apparel manufacturer, for example. They would typically ship one single order of a hundred sweaters to Macy’s. When it comes to drop shipping, the supplier needs to ship a hundred orders not to any single location, but to a hundred individual customers scattered throughout the country. If not handled strategically, drop shipping can easily get very expensive.
6. How can you best prepare for drop shipping?
To be successful, drop shipping requires flawless collaboration between the retailer, the supplier, and any other third party involved in the process. There are four necessary steps for achieving this:
- Perform a technology check
- Choose your partners wisely
- Set the right expectations
- Prepare for orders
1. Perform a technology check: Make sure you have the right technology and infrastructure in place to handle drop shipping. It only takes one bad experience for the customer to never come back. In order to provide a good customer experience, both the retailer and the supplier need to be able to share critical information timely at every step of the process. Let’s take inventory for example. With no real-time visibility into the supplier’s inventory levels, the retailer might misrepresent the stock available online and end up sending an order to the supplier that can’t be fulfilled.
Investing in the right EDI solution will help streamline the exchange of order, inventory, and shipping data from end to end. If you already have a solution in place, make sure your ERP and EDI providers are capable of handling drop shipping and that the solution you are using is scalable. Fully integrating your EDI and drop shipping systems with your ERP will help to make your drop shipping process more efficient, all while reducing processing costs.
2. Choose your partners wisely: Do your research and choose your partners wisely. There are plenty of suppliers and retailers out there that are drop-ship ready. Chances are, companies that have been doing this for quite some time have a well-oiled process in place—they will be easier to partner with.
3. Set the right expectations: Setting up service level agreements (SLA) with your trading partners will help to clarify the process and set the right expectations for everyone involved. It’s important to define how orders, inventory, and returns will be managed, as well as what packing slips will be required for each retailer, for example.
4. Prepare for orders: Be prepared to receive drop ship orders quickly after signing with a partner. Don’t waste any time, and make sure you have everything ready to go for when the first order comes in.
7. Should you outsource drop shipping to a 3PL or keep it in-house?
There are some pros and cons in keeping drop shipping in-house versus outsourcing it to a third-party logistics company, but the short answer is this: If you want to scale quickly, consider outsourcing to a 3PL.
A common belief is that if you keep drop shipping in-house, you can keep costs down. However, it all depends on order volume and your ability to handle single-customer fulfillment versus bulk-order fulfillment. A 3PL will typically have the resources and expertise to quickly handle direct-to-customer orders around the country, offering delivery standards competitive with Amazon’s two-day shipping model.
If you decide that outsourcing to a 3PL is the best option for you, there is one thing to keep in mind: Not all 3PLs are created equal. You might assume that all 3PLs can be used for drop shipping, or that they at least have the right technology in place to support you with order fulfillment, inventory management, and shipping services—but that’s not true. Be sure to choose a 3PL that has automated drop shipping capabilities, because that is what will ultimately help you to scale up.
8. Who should handle customer service and returns?
To keep things consistent with the entire shopping experience, it is recommended that the retailer communicates directly with the customer. Returns can be a complicated process, especially when drop shipping is involved, and Amazon has set the bar high with its free return model. EDI automation can help accelerate the process by streamlining important return information between partners.
But it’s really up to you and your partner to agree on the best process to ensure that you meet consumer expectations. Ultimately, however you decide to handle customer service and returns, it is crucial that you clearly define the process in advance in the service agreement.
9. Do you need to have a big IT team to handle drop shipping?
Not necessarily. Automation can help lessen the burden on your IT team. Drop shipping is a lot to handle manually, especially if order volume is high. Consider partnering with an expert drop shipping EDI provider to automate your processes, reduce data entry errors, and keep your IT team small and focused on your core business.
10. How can you maximize your chances of success?
Our secret sauce for a successful drop shipping program has 3 key elements:
- The right partner
- The right infrastructure
- Collaboration and transparency among partners