Last week, we talked about the advantages of drop shipping, especially for new online sellers. I promised that we’d get to the limitations of drop shipping, and some techniques for overcoming them. The primary disadvantage associated with drop shipping is the slim profit margins. One of the biggest complaints I hear from new e-tailers is that their wholesale drop ship prices are as high as their competitors’ retail prices, so they don’t have any room to make a profit.
Let’s start by understanding WHY drop shipping profit margins tend to be thin. The explanation is simple: your wholesale prices on drop shipped products are always going to be higher than your wholesale prices on products that you buy in bulk. There are a couple of good reasons for this:
- First of all, as we touched on in last week’s post, wholesalers’ margins on individual products are very, very thin. They make their money by selling in large quantities. When you buy items one-at-a-time, the wholesalers can’t afford to give you the same price breaks and rebates that they can give to the big chain stores that buy those products in massive quantities on a regular basis. A drop ship price is a real wholesale price, but it’s a wholesale price on a single product.
- Secondly, on top of higher wholesale costs, you’re also going to encounter a drop ship fee. This is basically your wholesaler’s handling charge.�When you purchase products in volume, you are responsible for storing those products and shipping them out to your customers in a timely manner. That involves a LOT of extra time and expense on your end.�When your wholesaler drop ships those products for you, they take over those aspects of your business. They set aside valuable space in their warehouses to store the drop ship products. They invest in special tracking software and shipping packaging, and they set up corporate accounts with shipping couriers. Then they pay workers to go in and break each case open, repackage the products, label the packages, and ship them out to the end consumers.�The drop ship fee is how your supplier recovers the additional expenses that they incur by offering drop shipping. It is a legitimate charge and a very standard industry practice.
My point here is, don’t be surprised if your drop ship prices on some products are higher than some of your bigger competitors’ prices. Finding products with good profit margins is the number one challenge faced by retailers who use drop shipping.
So then, the obvious question is, HOW do we overcome those slim profit margins and make money with drop shipping? It is doable (or else no one would be doing it), and we have a two-step plan to make it happen:
Step 1: Market Research.
Doing your online market research is the key to discovering which products you can do well with. It’s also how you’re going to determine what to charge for a product, how best to list it, and which keywords to advertise it with. There are many excellent tools that can help you get a good idea of the online product market.
You need to look at the supply (how much competition you have), the demand (how many people are looking for your product), and the pricing (how much your product is going for). When doing your research, make sure you look at the specific pricing on the ecommerce platform you plan to sell on. For instance, if you plan to sell on Amazon, check out the other sellers’ prices on Amazon. If you plan to sell on your own website, check out other independent websites’ prices. What an item sells for in one venue may not be what it goes for somewhere else.
It’s also important, when doing market research, to make sure that you are looking at the right set of numbers. In other words, if you’re going to list new sterling silver bracelets on eBay, look at eBay’s completed items listings for NEW sterling silver bracelets. If you just look at the results for ‘sterling silver bracelets’, you’re going to pull up prices for both new and used jewelry alike. This is going to lead you to wrong conclusions about what price you should be charging.
You need to understand that, when you are selling online, your profit is not your retail price minus your drop ship wholesale cost. Your profit is your retail price minus the total cost of purchasing, listing, marketing, selling, and drop shipping that product to your customer. Any costs you forget to include will eat into your profit margin, so make sure you figure in ALL your selling expenses, from drop ship fees to listing fees. If you find the current retail market for a product will support a price that covers your total cost of goods sold and leaves you room to make a decent profit, then you’re looking at a product you can profitably drop ship.
When it comes to figuring out what a good profit margin is, the numbers will vary greatly, depending on the product category and many other factors. There’s no average number you should expect to see every time, but a good rule of thumb for home-based online sellers is that you want to make at least a 20% profit margin on an item. With drop shipping, margins typically range anywhere from 20% to 60%. Again, these are not hard-and-fast rules, but rather good general guidelines.
So step 1 is doing your market research to determine what products you can drop ship profitably. Let me add a word of caution here: Even though it takes patience and persistence, you have to do the market research if you want to pick products you can drop ship profitably. If you just pick products on a whim, you’re going to waste a lot of time and you’re not going to pick a lot of winners.
Step 2: Move Beyond Drop Shipping.
The next step is actually less of a ‘step’ and more of a mindset shift. Step 2 is simply to realize that drop shipping is only one part of your overall product sourcing solution. It is a great entry point, but it is not an end in itself. As your sales pick up and you begin to see profits coming in, you can start to reinvest them into purchasing inventory. That way, you are able to take advantage of the better pricing and higher margins that come with buying wholesale in bulk. Your drop shipping will identify the products that sell well for you, so you don’t have to invest any money into untried inventory that might not sell.
The point is that, while you’ll find many situations in which drop shipping is the best fit for your e-business’ sourcing needs (we discussed many of these situations in last week’s post), it’s not a good idea to limit yourself to using only drop shipping. No one method of sourcing products is the most effective solution for every situation. That’s why, as your e-business grows, you need to branch out into other methods of product sourcing and experience the benefits they offer.
In conclusion, the biggest drawback to drop shipping is thin profit margins, but that doesn’t mean you can’t make money with it. By doing your market research, you can find products that will sell very well and give you room to make a profit. And when you find those consistent sellers, you can buy them using other sourcing methods for even better pricing and profits.
Check back next week when we cover the OTHER big drawback to drop shipping: limited control over customer service. We’ll also cover some best practices to help you make sure you choose reliable drop ship suppliers and guarantee that your customers are happy and will come back again.