This article was written by Michael Capsuto; Certified Public Accountant, Doctor of Business Administration, SCORE Orange County Management Counselor
Businesses are always afraid of losing a sale. Certain products are kept readily available in their inventory even though there is not much demand for it. There are many costs incurred - the costs of purchasing it, warehousing it, and maintaining it, all in hopes of a sale. If the product does not sell you risk not recouping your cost but also negatively impacting your cash flow. One possible method of reducing this risk while not losing sales is through drop shipping.
What is drop shipping? Drop shipping is an inventory reduction technique where a seller does not keep a product in stock for immediate delivery to a customer. The seller routes the order directly to a supplier who in turn ships the product directly to the customer. The seller makes a profit on the difference between the selling price and the supplier's price. The supplier can be the manufacturer or distributor of the product.
Who uses drop shipping? Businesses large and small use drop shipping. Examples are:
• The television home shopping programs. Orders are received from viewers. The order is then forwarded to the supplier who ships the merchandise to the customer.
• Retailers that sell large ticket items such as carpeting, appliances or furniture. They keep sample items or a similar items in the store so that the buyer can inspect it prior to purchase. The seller takes a deposit or full purchase price and has the desired item drop shipped from the manufacturer or distributor.
• Customized products such as coffee mugs or t-shirts with the buyer's logo. A manufacturer produces the product to the buyer's specifications and ships it directly to the customer.
• Others use drop shipping when selling through online auctions, catalogs or websites. This method of customer buying is becoming more popular each year.
What are the benefits of drop shipping?
Drop Shipping has several benefits.
• There is a positive cash flow. The seller is usually paid in full or receives a deposit which can cover the seller's cost, at the time the purchase is made. The seller does not pay the supplier until the merchandise is shipped. There is this period of time in which the seller has the customer’s money until the payment is made to the supplier. This is called float.
• There is a facility savings. By not stocking a slow selling item, warehouse space is reduced. This results in savings in rent, insurance and maintenance. Alternatively, the space can be used for stocking more popular items or to expand your product line.
• Become a full service seller. Most businesses stock items that are fast selling and ignore other slow selling complimentary items. By having access to catalogs or websites to show customers these products you can increase sales.
What are the drawbacks of drop shipping? Drop shipping is not without its difficulties.
• Drop shipping is not an across the board method for reducing or eliminating inventory. The products must be carefully selected. Drop shipping works best in cases where the customer has an expectation of waiting a reasonable period of time for delivery such as products that are customized, large ticket items, difficult to find, or normally ordered from a catalog or websites. If the product can be found readily on hand elsewhere, you will not only lose the sale but also the customer.
• The ability of the supplier is critical. The supplier must be reliable, have the item in stock, ship on time, and in the quantities and quality the customer expects. The shipper is invisible to your customer, therefore any problems that arise are a reflection on you.
• The customer may find out who are your suppliers and go directly to them for future sales. This can be overcome by “blind shipping” (shipping merchandise without a return label or with just a return street address). Other methods include customized shipping labels with the return address of the seller, customized packing slips with the seller's name, logo, and contact information.
• Increased costs. Unit costs may be increased when purchasing small quantities to meet a specific customer order rather than purchasing larger quantities for your inventory. There also will be added packaging and shipping costs imposed by the supplier. These must be considered in determining your selling price and profit margin.
What is the difference between drop shipping and a fulfillment house? Using drop shipping you do not purchase the inventory until an order is received or shipped to a customer. When using a fulfillment house you are out sourcing your warehouse operations. You purchase the products prior to sale in the quantities that are anticipated to be sold and park them at the fulfillment house. The fulfillment house stores receive your orders, packages, and ships the ordered items to your customer. The fee that is charged you is generally less than maintaining your own warehouse operations. For small businesses or start-up companies that may not have adequate storage facilities or the funds to build them, a fulfillment house can satisfy their warehouse needs.
What are the steps necessary for successful drop shipping? There are several important procedural steps in using drop shipping. These are detailed below.
• Verify that the customer is an approved buyer. Other than a cash buyer, it is possible that the person who signed the purchase order is not authorized to do so by the company.
• Verify that the supplier has the stock on hand. The customer expects a reasonable shipping time. If the items are not in stock notify the customer of the additional time needed to receive the order.
• Confirm prices. If the supplier’s current prices are significantly different than what was included in determining your selling price, discuss the situation with the customer.
• Substantiate that the customer's has sufficient credit before forwarding the order to the supplier. Once the customer receives the items, it becomes difficult to obtain payment.
• Verify that the order was received and processed by the supplier. This is the highest risk in the drop shipping process. Verification can be done simply by fax, email or phone.
• Match the bill of lading to the customer’s order. Request that a copy of the bill of lading be sent to you at the time of shipment. A bill of lading is a document issued by the supplier to the shipper itemizing the items shipped and delivery point. Match the shipped items with the customer 's order. This information is needed to invoice the customer. An invoice should be sent to the customer even if they paid you in full at the time of purchase. This keeps the line of communication open and also provides an additional opportunity to sell other products by including brochures and marketing information with the invoice..
• Investigate all open orders. Open orders are old orders that have not been shipped or shipped orders with a small number of items in backlog. Follow up on these open orders to determine if the supplier is able to ship them or if the customer still wants them.
• Maintain good customer service. Follow up on all customers periodically. Do not assume that once the merchandise is received by the customer that all is well. Resolve all issues to the customer's satisfaction. Benefits of maintaining open communication are customer loyalty, customer referrals, increased customer satisfaction and increased revenue. Good customer service is so important that it often is the difference between businesses that survive and those that fail. There is an old business expression: “No customers, no paycheck”.