In my previous post I spent a lot of time discussing the benefits that drop shipping can provide for brands and suppliers. These included increased selling channels, expanded assortment, development of direct to consumer capabilities, rebalancing of trade relationships, alleviation of inventory distortion, and product testing.
In order to successfully launch and operate an enterprise drop shipping program, however, supply side companies also need to have a good understanding of the complex problems, costs, and risks they will have to tackle with pick, pack, and ship.
In this second post I will provide a quick overview of some of the major challenges that suppliers and brands face with drop shipping. In later posts I’ll dive deeper into each of these challenges as well as discuss best practices for handling them.
Top Ten Drop Shipping Challenges
Increased inventory risk is the most obvious challenge suppliers face when running a drop shipping operation. Unlike with wholesale, if the retailer doesn’t sell a product, the inventory of a supplier or brand stays in its warehouse.
Less Upfront Financial Security
As a corollary to increased inventory risk, suppliers who drop ship also have less upfront financial security than wholesalers. Instead of receiving payment for a bulk wholesale order, supply side drop shippers only get paid after the retailer makes a sale. In essence, it’s the end customer paying for the product not the retailer.
Developing pick, pack, and ship capabilities requires significant investments in manpower, logistics, warehouse space, technology, and accounting. Additionally, the process required for drop shipping is a lot more costly and time consuming per individual item than for large bulk orders. Your overall margins per item will therefore be lower than with wholesale, with the hopes of moving more product in aggregate.
Increased B2B Data Exchange Volume
Ecommerce retailers can only sell products based on the inventory data on individual SKUs they receive from their suppliers. All inventory data is therefore atomized and updated in as close to real time as possible in order to sell more products, avoid cancellations, and keep end customers happy. Additionally, supplier catalogues are much larger and more detailed than with traditional wholesale and invoicing is done for every drop shipped order. All of this means high volumes of data exchange.
This can end up costing a lot of money for suppliers that use VANs and pay kilo-character and other data fees. It can also require a lot of overhead to setup and maintain a complex tech stack capable of exchanging data based on the individual requirements of every retail trading partner.
Suppliers and brands therefore need to be careful to choose a robust B2B data sharing solution capable of receiving and transmitting any amount of data, in any format, using any protocol required by retail trading partners. We think such per connection data-agnostic platforms are the future of B2B communication solutions and this is the way we’ve built our own data exchange technology at Dsco.
Hundreds and thousands of orders are fulfilled every day by a supply side drop shipper. This means that inventory is in a constant state of flux with items going in and out of stock throughout the day. In order to avoid opportunity costs and cancellations, retail partners need accurate inventory data to be sent to them in as close to real time as possible.
Suppliers therefore need to send out inventory updates at least four times day, if not every hour. The technology, manpower, and processes needed to provide this higher level of inventory visibility to retail partners can be complex, expensive, and time consuming if the wrong tech solutions and processes are used.
Fulfillment and Shipping Compliance Complexity
Most retailers expect their supply partners to do “blind drop shipping” meaning that end customers will not know that the purchases they receive have been fulfilled by someone other than the retailer.
This typically involves including a retailer-branded packing slip inside the order. Each retailer will also have its own shipping rules that include guidelines on when items must be shipped, which carrier to use, and rules for upgrading shipping class.
Additionally, carriers such as UPS and FedEx all have regulations that must be followed as to size, weight, girth, and pickup and drop off times that are important for calculating when and how a package must be shipped in order to make the promised delivery window.
Finally, modern customers expect to be able to track a package from its fulfillment to delivery, meaning they need shipping codes and continual package updates until their purchase arrives.
All of this makes accurately fulfilling and shipping the orders sent in by hundreds or thousands of different retailers an extremely challenging operation.
Many suppliers underestimate the costs and complexity involved with drop shipping and ecommerce fulfillment. Pick, pack, and ship, however, is a unique skill set. It requires the capacity to retrieve individual items in a warehouse or fulfillment center, correctly ship them to customers (who need the ability to track the product they’ve purchased), and then handle post-fulfillment problems such as taxes, invoicing, fraud, and returns.
This means that warehouse space and workflows need to be rearranged to accommodate the new processes, and crews will need to be retrained or built from scratch in order to fulfill drop ship orders. To avoid these logistical complications, some suppliers might opt to use a 3PL partner that specializes in their industry. Either way it will take a good amount of effort and overhead to make sure the logistics are set up correctly.
In drop shipping suppliers are paid for each individual order that is fulfilled and shipped. This means that invoices created for each retail partner can contain thousands of items, leading to an increase in the complexity of accounts receivable. As the number of a brand’s retail partners increases, navigating their various accounting systems and processes can be a huge challenge.
Add to this the complications involved in dealing with returns, cancellations, and damaged orders and it’s clear that suppliers must have robust processes in place to handle the increased volume and complexity of atomized drop ship invoicing.
Taxes are much more complex in drop shipping due to the fact that three different entities are involved: the customer, the retailer, and the supplier. Each of these entities might be in different states with different tax laws and liabilities that must be taken into account when figuring out who owes what tax to which state.
Most of this tax liability is based upon whether or not a company has sales tax nexus (i.e. a presence such as an office, warehouse, or employees) in the state in which a sale occurs. Unfortunately, the definition of and regulations surrounding tax nexus differ from state to state and are constantly being changed and updated. It can therefore be extremely complicated to untangle all of the tax liabilities for each party of the transaction and any mistakes can lead to hefty fines.
Drop shipping adds an entire layer of complexity to returns because there must be coordination between suppliers, retailers, and customers to make sure that items are returned correctly. Additionally, suppliers often have various return agreements/arrangements with each of their retail partners. Each of these arrangements will follow different procedures for where returns should be sent, how invoices and taxes are processed, and whether or not there will be restocking fees. Juggling all of these requirements can be extremely challenging.
For some ecommerce product categories such as apparel, however, return rates can approach 25%. It is therefore imperative that procedures and policies be put in place by suppliers, and negotiated ahead of time with retail partners.
A Different Way of Harnessing the Supply Chain
Drop shipping is not just another distribution method but an entirely different way of doing business that involves the integration of suppliers and retailers into many of the supply chain roles that are typically kept separate in wholesale. Despite its many advantages, therefore, drop shipping also has a lot of unique and complex challenges that must be navigated correctly in order to function at peak efficiency.
In later posts I will look at each of these challenges in turn and show how the right combination of technology solutions and cooperative integration with retail partners can resolve or mitigate many of the issues described above.
For now, let’s hear your thoughts!
What do you think are the most important challenges faced by suppliers and brands in drop shipping today? And what have you found to be the best ways of dealing with them.
Share your comments or vote in the poll below!
Azad Sadr is Dsco’s head of industry research and content development.