This article was co-authored with Kyle Tymoszewicz.
Is it possible to generate billions of dollars in revenue from inventory that you don’t own yourself?
For example, an innovative dropship order fulfillment model involves vendors directly fulfilling orders to end customers. End customers interface with the retailer while the third-party vendors receive orders from the marketplace and ship the purchased products directly to the end consumer.
This model has proven to generate billions of dollars in revenue for leading retail giants like Walmart, Target, and Staples. However, a dropship order fulfillment model can look incredibly risky for retailers who are used to buying wholesale, holding inventory, and selling retail.
This is because a dropship model means decentralizing your supply chain. Having your vendor ship straight to your customer means one point of failure for your business. And of course, becoming a retailer who doesn’t hold inventory deviates from the proven wholesale business model that has served most retail organizations for years.
However, because of the accelerating relevance of digital commerce, consumer expectations have shifted. Especially in the competitive retail environment that we are in today, a traditional wholesale “business-as-usual” model might be riskier than a modern dropship retail model.
Digital retail leaders need to surface these risks, in order for their executive teams to objectively weigh the costs and benefits of shifting to a streamlined supply chain and order fulfillment model, a model that could potentially close the gap between their physical business and digital ecosystems.
In this article, we’ll examine how enabling dropshipping within a thriving wholesale business could be the differentiator between resilience and irrelevance. Next, we’ll cover the pros and cons of the 4 most popular dropship arrangements, along with industry examples that you can model for your particular business. Finally, we’ll briefly cover what a well-executed dropship program could mean for a retail organization moving forward.
Implementing dropshipping separates the retail leaders from the laggards
McKinsey expects that there will be 3 defining characteristics between retailers who thrive post-COVID and ones who don’t:
- A healthy balance sheet
- A resilient operating model
- A COVID-19 response that highlights the brand’s core business values
The dropship model addresses one or all 3 of these fundamental points of polarization. It liberates retailers from their dependency on wholesale, builds supply chain flexibility, and strengthens their digital channels. This is why retailers with successful online marketplaces such as Walmart and Target have adopted dropshipping as an integral part of their business model.
Lack of dependency on wholesale
Dropship retailers do not hold title to the inventory and associated fulfillment costs. Instead, their dropship marketplace consists of third-party vendors who both list products and fulfill orders on the retailer’s behalf.
While this might mean deviating from the tried-and-tested wholesale model, as business expert Marshall Goldsmith teaches, “What got you here won’t get you there.”
The dropship model changes how retailers view their supply chain. Instead of profiting from volume discounts and retail margins, retail leaders of the future will win the market with inventory they don’t own themselves.
Supply chain flexibility
The idea of shipping product directly to the customer terrifies retailers because they no longer control what happens after an order is placed. There’s a fear that a lack of control means that more processes will go awry or dilute the customer experience.
However the opposite is true. Less mistakes and problems happen, not because the retailer has less control over the system, but because they have less things to do.
Using a dropship order fulfillment model builds resilience and agility into a vertical marketplace. Dropshipping allows retailers to delegate the responsibilities for inventory management, warehousing, and shipment out to their vendors. And because there’s less steps and points of failure in the system, this minimizes the overall risk of a debilitating system failure.
Strong digital channels
Dropship offers a virtual supply chain and a streamlined online fulfillment process. Dropship retailers benefit from decreased inventory risk and improved cash flow. By eliminating the capital requirements of inventory and warehousing, retailers can then reinvest profits into high ROI avenues such as customer acquisition.
Model a proven dropship arrangement for your business goals
Regardless of the particular dropship model that works for you, here’s what the model looks like in action:
A recent Forrester report outlined four derivative models of the template above:
- Dropshipping via third-party logistics (3PL)
- Dropshipping via a retailer
- Dropshipping via a third-party marketplace
- Dropshipping via flash sale sites
There are subtle differences between each arrangement and we’ll define and detail examples for each one.
Dropshipping via third-party logistics (3PL)
This is the boilerplate dropship template with which most retail executives are familiar. This is also the underlying supply chain model that supports most modern direct-to-consumer (DTC) brands.
In a 3PL dropship model, a brand or vendor pays a 3PL provider to receive, warehouse, and ship their products. Once the vendor receives an order from their website, the order gets routed to the 3PL who takes care of shipping and delivering the product to the end customer.
Working with a 3PL means less moving parts and points of failure for a vendor at scale. This streamlines day-to-day processes and makes troubleshooting any hiccups easy. However, the trade-off of having a specialized, 3PL-based supply chain means having a single point of failure -- fulfillment could just as easily be brought out of your control.
For example, in April 2020, all non-essential businesses in Canada, including 3PLs, were instructed to shut down operations and go into lockdown. This meant that if a business worked with a 3PL to store and deliver its goods -- even if the business itself produced essential goods and could thus stay operational -- most if not all, of its inventory was immovably embargoed in the 3PL’s warehouse.
By outsourcing warehousing and inventory management, this model eliminates the requirement to maintain a retailer’s own facilities, frees up cash flow, and thereby, accelerates a brand’s growth rate. At the same time, this model requires a retailer or vendor to have enough scale and critical mass to justify the additional expense of hiring a 3PL over having its own team do everything in-house.
For example Ingram Micro, a Fortune 100 electronics distributor, offers a 3PL service for its marketplace vendors. To maintain service quality, however, Ingram prequalifies vendors: only those who can fulfill 1,000 orders/month are allowed to take advantage of their 3PL service. Additionally, to maintain marketplace customer service standards, Ingram insists on vendor insurance, assumes no responsibility for product loss, and states that vendors are required to take any and all returns in its service level agreements (SLAs) with vendors.
Dropshipping via a retailer
This is the most dominant kind of dropshipping and is adopted by many vertical marketplaces.
In this model, a marketplace retailer curates the brand and product assortment for their marketplace. When shoppers put in an order, the order is sent directly to the brand who fulfills the order on the retailer’s behalf.
The brands have little-to-no control over which products appear on the marketplace. On the other hand, this model works well for the marketplace retailers who want to expand their catalog or category.
McKinsey found that more than 50% of companies whose revenue growth was at the top 10% of their respective industries were more effective than their peers at rapid experimentation, measurement, and implementation. Dropshipping gives marketplace retailers this ability to experiment with new brands and objectively measure which products sell fastest. They can quickly iterate on and implement their findings as they discover winners to optimize their merchandising mix. This serves a downstream effect: it allows a retailer to know how to move into a new vertical or speak to a new customer persona without months of research.
The downside of this model is the operational risk of a decentralized supply chain. For example, COVID-19 dramatically impacted the shipping times for the retail industry. The typical average ship time for vendors in our network is 31 hours. The pandemic disrupted multiple pieces of the supply chain, driving average ship time up to at least 4-5 days.
To insure themselves against the risk of decentralization, many marketplace retailers like Ingram Micro set and enforce SLAs. The two key measurements they look at are average ship time and return rate.
Marketplace retailers maintain a 2-day turnaround or time to fulfillment, or shipment within 24 hours of receiving an order to ensure the customer receives the product in a reasonable time frame.
Fashion retailer Harry Rosen, for example, has exceptional customer service. They average a 2-day turnaround per product, due to their 2-3 day product delivery SLA with vendors.
Many of our retailers also enforce a 10% return rate for their vendors to ensure product quality. A higher than average return rate might indicate that the customer is unhappy with the end purchase or quality of the product.
Learn More: Retailer's Guide to Dropship
Dropshipping via a third-party marketplace
Enabling dropshipping through a third-party marketplace entails listing products in a marketplace aggregator like Amazon, Alibaba, or Rakuten. The third-party marketplace might have a 3PL function that houses vendor products or, as is the case with a dropshipping model, simply sends orders to the brand or vendor to fulfill.
For vendors, dropshipping with a third-party marketplace is one of the best places to test and see if a specific product has product-market fit. The barrier for brands to enter and sell on these marketplaces are low because the marketplace is incentivized to have as much assortment as possible (think Amazon).
In return for the guarantee of sales and product turnover, marketplace vendors relinquish brand differentiation and premium pricing. Vendors and retailers in third-party marketplaces suffer from commoditization, product mimicry, and little-to-no control over how their brand is presented to the end customer.
In a survey Etail conducted with 100 retail leaders, they found that 46% of retail professionals avoided selling on Amazon for these very reasons. In contrast to a brand-conscious shopper in a standalone marketplace or specialty store, customers browsing third-party marketplaces are simply looking for the fastest way to purchase at the lowest price.
Retailers who win on third-party marketplaces do not rely on them as their main source of revenue, but only as a way to test new products. These vendors list on third-party marketplaces to optimize and experiment with their digital merchandising mix, balanced with full ownership of their catalogues and curation on their own websites.
Dropshipping via flash sale sites
Liquidation marketplaces, like Canadian flash sale site Style Democracy, help retailers with slow inventory turnover offload their products. Retailers with this model capitalize on the traditional volume discounted buying model, while reaping the benefits of retail sales, albeit with slimmer margins.
Unlike listing on a third-party marketplace, retailers with a flash sale dropship model retain control over their customer service, customer data, and product offering. Flash sale sites work particularly well for retailers who have an endless aisle retail model in place.
As we mentioned earlier, while doing flash sales helps stabilize cash flow, retailers pay for that stability with lower margins and lower average order value. Flash sale sites also attract a different customer demographic and reinforce bargain shopping behaviour -- variables to which a higher end retailer may not be accustomed. Finally, flash sale sites run the risk of cannibalization and a race to the bottom, especially if they trade in commoditized items.
For example, one San Francisco retailer in the baby/toddler vertical has a main marketplace with premium products. However, they also manage a blowout inventory site that runs weekly promotions to liquidate their main site’s stock. Both sites essentially sell the same products, but do so for a vastly different customer base and cultivate diametrically opposed customer behaviour.
Dropship enables core business growth amidst change & competition
Much like the effects of a pandemic or a global recession, difficult times weed out to the good companies from the great. And these are arguably some of the most difficult times that retailers have had to deal with.
Retailers who overproduce and as a result, overstock, will be overtaken by environmentally-conscious, streamlined, and community-focused incumbents -- many of which adopt a dropship order fulfillment model so they can focus on their brand values and core business. Moving to dropship or putting more manpower into a digital strategy requires streamlining the business and changing other parts of the business.
Zooming out beyond the bottom line, using this volatility in the retail industry to enact positive change in your business model allows you to cut back on the fat and the noise and to go back to the basics of what makes retail so great -- valuable human connection, tangible experience, and trusted product curation.