Make Drop-shipping Work for You

CEOs from two leading drop-ship companies talk about changes in the industry and how e-tailers are using virtual inventory to create profits

As Internet retailing was getting started in the mid '90s, online storeowners assumed drop-shipping would be the answer to their every worry. Little did they know it's an issue still being worked out today. Still, progress is being made in the technology, including standardization protocols and remote inventory-watch functions, and vendors can stand to gain from the distribution method if they know what to consider before signing up.

Filling orders through drop-shipping (sometimes called "virtual inventory") meant that site owners could route all their orders to wholesalers, who shipped directly to customers. For e-tailers, this eliminated the expense of carrying inventory - and the risk of being stuck with it if it didn't sell.

At one point in the mid '90s, "everyone was going to be virtual," says Frank Poore, CEO of Commerce Hub, one of today's top drop-ship companies. Online retailers assumed the days of needing a warehouse were coming to a close. And pity those poor brick-and-mortar stores who actually had to stock goods. They would probably be extinct by about 2005 or so.

But, notes Poore, there were service issues — in fact there were all kinds of issues with virtual inventory. Customers placed orders, retailers routed it to the wholesaler, but the product was never sent. Wholesalers shipped the wrong product or couldn't keep up with the pace of retailers' sales. The list goes on.

Many of these snafus were caused by slow, inefficient communication between wholesalers and e-tailers. In many cases they sent orders back and forth via fax or e-mail, or even — gasp — used the phone. Orders had to be keyed in manually and were prone to human error.

Even for those companies that sent information electronically using EDI or XML, obstacles were numerous. Businesses tend to do things their own way, all the way down to the number of digits in a purchase order number. Or how many lines they use in purchase orders, or how many words are allowed in each field of a purchase order. "Every supplier is like a snowflake," Poore says.

Consequently, drop-shipping created as many problems as it solved. "In the first step of drop-shipping, it did kind of fall on its face," says Jeremy Hanks, CEO of Doba, another of today's leading drop-shipping firms.

The problems were generally the suppliers' fault, he says. "Those companies didn't have the knowledge, the processes, the operations and the technology to really excel at that." For suppliers, it was a foreign concept to ship, say, one camera to a buyer's home. They were used to shipping pallets of products to retailers.

Worse still, as Internet commerce rocketed, the demand for drop-shipping companies exploded, leading plenty of shady salesmen to set up drop-ship firms. Sure, they would take a store owner's money, but would they ship the product?

By the early 2000's, drop-shipping was no longer seen as a magic cure-all for every Internet retailing woe. Many retailers who were setting up shop online carried their own inventory, giving them a competitive advantage over virtual inventory sites. Plenty of businesses began viewing drop-shipping with a pronounced disdain.

Data Translation
Fortunately, the technology for carrying virtual inventory has improved significantly. Commerce Hub, a leader in drop-shipping for big retailers, offers what Poore calls a "universal connectivity hub," between suppliers and sellers. This hub is a central clearinghouse for data exchange, with the ability to translate as many communication protocols as the United Nations translates languages.

Retailers, instead of having to wonder about a wholesaler's inventory level, can now view those levels remotely. And store owners have a "dashboard" to monitor whether a supplier is breaking any of their pre-set delivery rules.

Commerce Hub handles order management systems for multi-channel retailers like QVC, Staples, ShopNBC, Target, Sears and thousands of others. The firm's growth has been phenomenal. In 2000, it handled some 50,000 transactions. By 2005, the number had grown to more than 10 million, Poore says.

Although it handles mostly larger players, Hub does work with some smaller retailers. Generally, though, a retailer must be making a minimum of 2,000 transactions per month for it to be cost efficient to work with Commerce Hub. The company's initial implementation fee can vary wildly, ranging from $500 to $150,000, depending on factors like volume, Poore says.

Big Player for Small Sellers
In contrast, Doba handles drop-shipping for small and midsize retailers. It has contracts with some 50 suppliers, offering more than 250,000 products. The company's proprietary platform connects wholesalers and retailers using a variety of uniform protocols."We've standardized what we need from a supplier to make it work," Hanks says. "Each supplier can work with us one of ten different ways."

Like Commerce Hub, Doba acts as a data translator. "So the retailer doesn't need to know that supplier A is sending data in XML and supplier B is sending flat files that go to an FTP site, and supplier C just hired three people to manually do all the work."

The company enables retailers to monitor suppliers' inventory levels, allowing sellers' sites to accurately (and quickly) reflect remote product offerings. Doba's user interface for merchants is Web-based, so it's easily accessed.

"With a few clicks of a button they can fire [a product] off to eBay or eBay Stores, and take the pictures and the descriptions from the supplier and leverage that to make it easier to list the product for sale to the consumer." (Doba is an eBay Certified Service Provider.) Retailers, of course, don't have to purchase the products before they post them - they owe nothing until a shopper actually buys them.

Tight Margins
It's inexpensive to get started with drop-shipping. Doba charges its retailers a monthly subscription fee, ranging from $30 to about $70, depending on the services required. But working with a drop-shipper is not a path to easy riches. For a retailer, drop-shipping typically provides smaller profit margins than if they carried actual inventory, Hanks notes.

Given the nature of drop-shipping, these tight margins are to be expected. The supplier is taking all the risk and covering the expense of holding inventory, plus handling fulfillment and shipping. All the retailer does is post a photo and description of the item on their site.

Hanks claims his company can offer a better wholesale price for retailers because it aggregates the purchasing power of its many retailers to negotiate a competitive rate. In particular, Doba has been successful in getting lower shipping and handling fees from wholesalers, he says.

There is no single margin percentage that retailers can expect from Doba's wholesalers. Margins differ greatly among the many product categories, from consumer electronics to home and garden to camping equipment, and may even vary from product to product within a category. One notoriously slim-margined category is electronics, Hanks says. Overall, the margins vary from "10 percent to 90 percent," he says. But it's reasonable to assume the majority of products offer margins near the smaller end of that scale.

Detecting Fraud
It's not often talked about in e-commerce but it's a huge problem: fraud. Unlike the face-to-face transactions in commercial storefronts (which also deal with credit card fraud), online transactions take place between two parties who don't know each other.

Some big e-tailers budget 2 to 3 percent for losses to fraud, Hanks says. But for small sellers working on razor-thin margins, that's not realistic.

Furthermore, drop-shipping adds a third party into the transaction. "It's a little bit easier for people who are looking to be bad people to use the disadvantages of drop-shipping to defraud individuals," Hawks says.

With this in mind, Doba launched a fraud protection program to protect retailers. "If their consumer defrauds them, and [the seller] followed best practices…then we'll cover it," Hanks says. This means his company is accepting responsibility for a transaction between two unknown parties. However, "we're able to do that because we've built a lot of proprietary systems so that we're really good at seeing when fraud is going to happen."

The "Secret" of Drop-Shipping Success
Launching an online store that uses drop-shipping to fulfill orders is comparatively easy. Hire a Web designer to build a site, post some photos and product descriptions from wholesalers, and — like magic — you're running an e-commerce site.

But building that store and making it a real success are two different things. To attract actual paying customers, that store must offer far more than a selection of goods that shoppers can find elsewhere.

The biggest mistake that Hanks sees small online sellers make is that, "they forget the fact that they're a retailer and they need to add value, they need to market the product." As easy as it is to carry virtual inventory, "it hasn't made it any easier to be a retailer in the sense that your job is to have a unique value proposition, a reason for somebody to buy from you," he says.

Anyone can post a photo of a glitzy new digital camera. But "the best retailers in the world, they take that and say, 'I used this camera in my backpacking trip to Glacier National Forest and it changed my life,'" Hanks says.

Other techniques that retailers use to establish a brand identity include offering a library of articles about their products, and hosting the opinions of industry experts. Customers respect retailers who have a deep understanding of the products they sell.

Regardless of how you build your brand, leveraging the technology of drop-shipping can help you operate your business more efficiently. Just be sure to consider how inventory controlled, be sure the firm you hire has a proven track record of delivering goods and be sure it can accept your order protocol.

James Maguire is a regular contributor to ECommerce-Guide.com.

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