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Thinking about starting a dropshipping business? You might want more details on what the dropshipping business model really is, how it works, how it makes money, and how you can make this business idea work for you.
Before you start dropshipping, it’s vital to invest some time and effort in researching your options and understanding how to start a dropshipping business. Read on for more details about what you need to know to become a successful dropshipping entrepreneur.
What is dropshipping?
Dropshipping is a way of selling products where the business owner doesn’t own or manage the inventory. With a dropshipping business, you as the business owner run the ecommerce website where the customers buy products, and then the fulfillment (packing and shipping of products) is handled by third-party suppliers. Your customers receive the products from your business’s suppliers, even though they purchased the items from your business.
Think of dropshipping as a way of running a retail business, without the traditional costs and complexities of running a brick-and-mortar retail business.
How does the dropshipping business model work?
Running a dropshipping business can be a great business model, because it lets you sell products to customers at retail prices without the overhead costs of keeping inventory on your shelves. With dropshipping, there are no shelves—your inventory is held and managed by your dropshipping suppliers, and your business only has to pay for inventory right when you make a sale.
Selling at retail price, buying at wholesale price
When you go into a store and buy products off the shelf, you are paying “retail price” for that item. But the store initially purchases that product for a cheaper price, called the “wholesale price.”
As a dropshipping business owner, you sell products to customers at retail price, and then you pay your suppliers the wholesale price for the actual product that gets shipped to your customer. Dropshippers don’t have to spend money on inventory until the product is purchased by the customer. Your customer pays you, you pay your supplier, and your supplier ships the product.
Customers, dropshippers, and suppliers
Within the dropshipping business model, there are three players involved:
- Customers. These are the people who buy from your ecommerce website. They will place orders online and pay you directly for products.
- Dropshippers (you!). These are the ecommerce entrepreneurs that run dropshipping websites. As a dropshipper, you connect your customers to high-quality products, offer a fresh selection of products to meet the needs of your target market, and provide customer service, targeted marketing, and a great customer experience.
- Suppliers. As a dropshipping entrepreneur, your dropshipping suppliers are essential to your success. They are your business partners who actually pick, pack, and ship the products that your customers purchase from you. Great dropshipping suppliers can provide you with constant opportunities for new inventory, give you helpful customer support, and act as a reliable link in your supply chain to pick, package, and deliver products to your customers on time and on budget.
How do dropshipping businesses make money?
Dropshipping businesses make money by selling products at retail price, and then paying (lower) wholesale price to the supplier who ships the product. The difference between retail and wholesale, also called the “markup,” represents your profit per item sold.
Dropshipping businesses tend to be a low-cost business model, since the inventory is held by the suppliers, and the dropshipper doesn’t have to pay the overhead costs of maintaining inventory or storing products onsite.
But your business will still have some costs to cover, such as the cost of building and maintaining your business website, paying for advertising and marketing, issuing refunds to customers, and paying any other costs of doing business.
Real-life example: Dropshipping in action
Let’s say you have a dropshipping business that sells gardening supplies. Your ecommerce site offers a set of shovels for $100 (retail price), and your supplier agrees to ship this product to your customer for a wholesale price of $50.
Here’s a step-by-step example of how dropshipping works:
- Your customer puts the shovel set in their shopping cart and clicks “Buy” on your website. They give you their home shipping address and payment information. Congratulations! You have officially made a sale for $100.
- You contact your dropshipping supplier, forward them the customer’s shipping information, and place an order for the shovel set at the wholesale price of $50.
- Your supplier receives the customer’s mailing address and receives your $50 payment.
- Your supplier handles the fulfillment (picking, packaging, and shipping) to send the shovel set to the customer.
- Your customer receives their product. You have earned a profit of $50 ($100 retail from the customer - $50 wholesale to the supplier = $50 profit for your business).
Is the dropshipping model difficult to implement?
The dropshipping business model is generally considered to be one of the easiest ways to get started in ecommerce. You only need a few things to start your dropshipping business.
Before you get started in dropshipping, you need to choose a dropshipping niche. This is your special target market, your unique little corner of the world where you want to help customers and offer products.
Your niche could be a certain hobby, industry, type of product, or category of customers. For example, maybe you want to sell photography equipment, fitness and nutrition supplements, cosmetics, personal care products, or pet supplies. Think carefully and be strategic about your niche.
This is your online store where customers buy from you. You can set up an ecommerce website on your own or by using an ecommerce platform like Wix Ecommerce or Squarespace.
If you're ready to set up an e-commerce site, review our list of best e-commerce website builders for small businesses.
You need suppliers to actually provide you with the products that you will sell to your customers. Fortunately, it’s relatively easy to get access to worldwide networks of dropshipping suppliers, especially if you’re willing to pay a modest subscription fee.
Legal business entity
Before you start a dropshipping business, you should make your business legal in the eyes of tax authorities and government regulators by forming an LLC (Limited Liability Company) or other business entity. Setting up an LLC will make your business official for tax purposes and help separate your business finances from your personal finances.
Creating a legal business entity will also help you get a business bank account and solid access to other financial tools to make your life easier during tax season and throughout the year.
As you can see, your dropshipping business model doesn’t have to include a lot of complexity. But if you are serious about earning income from dropshipping, be sure to make it official by forming an LLC and dealing with the other strategic aspects of setting up your business.
How the dropshipping ecommerce business model compares to a traditional business model
It’s vital to know the differences between a dropshipping ecommerce business model and traditional retail. Here’s a breakdown of the key differences.
Traditional retail business model
- Retail business buys inventory upfront.
- Retail business stores inventory onsite on store shelves, and/or at warehouse.
- Retail business covers the overhead costs of inventory management, retail storefront rent, utilities, lights, etc.
- Retailer handles the fulfillment (picking, packing, and shipping) of online orders.
Dropshipping ecommerce business model
- Dropshipper buys inventory only after a sale is made.
- Dropshipper does not have to store inventory onsite; inventory is handled by dropshipping suppliers.
- Dropshipper does not have to pay for overhead costs of managing inventory, retail space, etc.
- Fulfillment is managed by dropshipping suppliers.
As you can see, dropshipping provides a simpler, lower-cost business model compared to traditional retail.
Pros and cons of dropshipping
Let’s take a look at some pros and cons of the dropshipping ecommerce business model.
Pros of the dropshipping business model
There are a lot of reasons why dropshipping is an appealing, low-cost, high-upside business model:
Low costs to get started. As a dropshipper, you do not have to invest a lot of money to get your business started. Set up an ecommerce website, get connected to suppliers via wholesale directories, and start selling.
Limited overhead costs. Traditional retailers have to deal with ongoing costs like utilities, lights, and rent. As a dropshipper, you can offload a lot of those costs onto your dropshipping suppliers, who cover the costs of inventory management and fulfillment.
Sell via multiple channels. Dropshippers can sell products via any channel, whether it’s Amazon or eBay, social media, your own website, or any other online space. You have the flexibility to create a true omnichannel sales strategy for your dropshipping business.
Work from anywhere. If you dream of having a globetrotting lifestyle, dropshipping can enable you to be location independent and work from anywhere with WiFi. With a 100% online business and suppliers that can be managed remotely, it doesn’t matter where you live or work, which means dropshipping can help you have a flexible schedule and an independent life.
Unlimited growth potential. Your dropshipping business can grow as fast as you can find customers. The only limit is how many sales you can make and how much traffic your ecommerce website can handle. Your dropshipping suppliers are accustomed to handling large volumes of orders, so the more you can scale up your business, the more money you can make.
Cons of the dropshipping business model
Along with the advantages of dropshipping, there are some potential risks and challenges that go with this business model.
Lots of competition. Because dropshipping is so low-cost and relatively easy to enter, you can expect to see a lot of other businesses competing for your same customer base. Be prepared to adapt and hustle to stay ahead of the competitors who are fighting to poach your customers and shrink your profit margins.
Lack of QA (quality assurance). Dropshippers have to trust their suppliers to manage the fulfillment process. This means you won’t have full visibility or control over QA as your products get shipped. And if there are errors, shipping delays, or damaged items, your customers will hold you accountable for mistakes that might be beyond your control.
Lower profit margins. Because there is such stiff competition, dropshipping companies might struggle to create a memorable brand that commands a premium price. Your customers might prefer to buy from lower-priced competitors. This can reduce your profits and make it harder to have a higher-income lifestyle.
Limited visibility and flexibility on special offers. As a dropshipper, you usually don’t have any visibility into the inventory management of your suppliers. If a product is out of stock, your customer might not know until they click “Buy.” Dropshipping also gives you limited flexibility to provide special offers, discounts, and promotions, such as packaging multiple products into a specially priced bundle.
Although dropshipping has some potential drawbacks, hopefully the low-cost model and flexibility of how to build your business can make up for the possible challenges.
Dropshipping lets you start an ecommerce business without the costs and financial risks of a traditional retail business model. Working with dropshipping suppliers, you can provide customers with great products while managing your costs. If you’re willing to work hard, keep learning, try new things, and adapt to customer demand, you can be successful as a dropshipping entrepreneur.
Ready to start a dropshipping business? We’ll walk you through the process in our guide to starting a dropshipping site.
Is dropshipping a good business model?
Dropshipping can be a good business model if you want to get started in ecommerce while managing costs and reducing your financial risks. There are a few challenges and disadvantages to being a dropshipper, but hopefully you can manage these downsides with adaptability and hard work.
How do I start a dropshipping business?
Start by setting up an ecommerce website and connecting with suppliers. Before you get started, you will also want to choose a profitable dropshipping niche. And make sure to set up an LLC (Limited Liability Company) or other legal entity for your business that makes your business official in the eyes of the law.
What does dropshipping mean in business?
Dropshipping is a way of selling products to customers where the retailer’s inventory is held and managed by third-party dropshipping suppliers. As a dropshipper, you run a retail business, but you don’t actually have inventory on hand. Instead, you buy inventory from your suppliers after your customer buys from you. Product fulfillment (picking, packing, and shipping) is also managed by your suppliers.
Dropshipping is a way of being in business as a retailer, but without some of the usual overhead costs and complexities of running a retail business.
Can you lose money with dropshipping?
There are no guarantees of success with any business model. As with any business, it’s possible to lose money with your dropshipping business. For example, if you spend $1,000 setting up your ecommerce website but never make any sales, you’ll have lost that money.
However, dropshipping is generally considered to be a low-risk business model because you don’t have to pay for inventory until a product is purchased by your customer. If you can identify a profitable niche, build a user-friendly ecommerce website, offer helpful products, and provide a great customer experience, you’ll likely generate enough sales to build a profitable business.
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