Enterprise Drop Shipping, Part 2: The Basics

Last week I discussed how important drop shipping is for brick and mortar stores to be able to compete with online retailers. If you need a refresher, you can read it again here.

My basic point is that drop shipping gives physical retailers access to inventory at levels comparable to online retailers. This in turn allows omnichannel strategies such as SFS and BOPIS to have more items in stock more of the time and provides more opportunities to save the sale both online and in store.

In this post, I’ll provide a definition of drop shipping, explore some of the hype surrounding it, and define its major challenges.

What Is Drop Shipping?

Here’s my definition:

Drop shipping is a supply chain management technique in which the retailer does not keep goods in stock, but instead offers a third-party source of inventory — from a manufacturer, distributor, wholesaler, or other retailer — for sale. Upon customer order, the retailer transfers the order and shipment details back to the product supplier, who then ships the goods directly to the customer on behalf of the retailer.

And here’s how it looks drawn out.

Drop shipping originates with a consumer, who places an order with a retailer, which sends it to a supplier, which ships it to the consumer.

Drop Shipping: Is It All Hype?

In today’s market, drop shipping is sometimes a polarizing concept for enterprise retailers. It’s often associated with mom and pop shops looking to make an easy buck. Additionally, retail executives such Tony Hsieh, the CEO of Zappos, have had negative experiences with drop shipping. In his book Delivering Happiness, he writes, “We all knew deep down inside that we would have to give up the drop ship business sooner or later if we were serious about building the Zappos brand to be about the very best customer service.”

He then explains that in March 2003, Zappos removed all the drop-shipped products from its website and that removal was one of the main reasons Zappos turned the corner and was ultimately successful.

Despite Hsieh’s experiences, however, there are massive ecommerce companies like Wayfair that have used drop shipping to reach $4.72B in sales while still maintaining high customer satisfaction ratings. As for brick and mortar retailers, research companies such as IHL have found that those with 5% growth or more are 80% more likely to drop ship.

So which is it? Massive customer service headache or growth engine?

The truth is in between.

Drop shipping is easy to oversell. It sort of oversells itself, in fact. Think of the other terms that are used to describe it: “inventory free retail”, “endless aisle.” As I mentioned last week, drop shipping strikes to the foundational challenge of a retailer: more accessible inventory. So it’s hard to cut through the drop shipping hype.

But, it’s also not new. Retailers and catalogers have been drop shipping for over a century. As far back as the 1870s Montgomery Ward used a form of drop shipping to ship catalogue products straight from suppliers to distant rural consumers. And in the 15 years since Zappos discontinued drop shipping, a lot of the underlying dynamics in the supply chain have changed such that in today’s ecommerce market, drop shipping is not only fairly common but is becoming one of the key strategies for competitive brick and mortar retailers.

How Common Is Drop Shipping?

It is difficult to determine how many merchants utilize drop shipping. The answer is elusive. Here is some information that can help.

• In 2017, CommerceHub, a software company that facilitates drop shipping for enterprise retailers, processed millions transactions that represented $16 billion in retail sales. That’s more than 3.5 % of all of ecommerce ($16 billion out of $453 billion of total ecommerce sales) in the U.S. drop shipped and facilitated from just one technology company. There are many other technology companies that facilitate drop shipping, and even many more companies who have built their own technology directly.
• Billion dollar plus etailers such as Hayneedle, Wayfair, and Overstock each work with thousands of supply sources and drop ship the majority of all of their consumer sales. Many other top etailers also follow these leaders by drop shipping a substantial piece of their sales.
• 40% of Amazon product sales come from third party sellers on their marketplace, which is similar in concept to drop shipping. So estimates are that even from just Amazon, you’re looking at another $23 billion in drop shipping (marketplace) sales. Many other companies (such as Walmart, Staples, Buy.com) also operate marketplaces.

The best guess I’ve been able to get to, after being involved with drop shipping for over 15 years, is that around 33% of all ecommerce transactions in the United States could be classified as a drop shipped transaction. In emerging markets such as China, where Alibaba runs marketplaces like Taobao, the lion’s share of ecommerce could be characterized as drop shipping.

Routinely Complicated

Drop shipping is routine, but it’s not simple. It sounds simple, looks simple; but it’s far from so. It’s a significant departure from the typical flow of how product gets to the consumer. The systems and relationships have to be thought through differently compared to a traditional supply chain. The root challenge is that by attempting a virtual supply chain, retailers and suppliers face system-to-system integrations and automation to share product catalog data, real-time inventory feeds, and a coordinated consumer order lifecycle so that consumer expectations can be met.

Some specific challenges include the following.

• Catalog & Item Setup – The need to capture, create and share product information (descriptive text, images, taxonomy, physical characteristics) that is as close to a perfect virtual representation of a physical product as possible.
• Inventory Available to Promise…by location – Each supplier will be a source of inventory, so you will need up-to-date visibility of potential inventory pools, versus integrating and having visibility with a single repository of inventory.
• Consumer Experience – The loss of control as retailers must now rely on their suppliers to ship orders in a timely and expert manner. To ensure good customer service, the suppliers will need to be able to accept electronic orders and provide timely status updates directly to your systems, as well as support specific fulfillment and packaging requirements.
• Distributed Order Management – Your ecommerce platform will need to coordinate products from multiple suppliers and locations, to start with a consumer order and break it up into multiple supplier orders and, in turn, consolidate order status updates back into a single consumer view.
• Supplier Fulfillment – The need for suppliers to pick, pack, and ship consumer orders in a much different process than shipping pallets or case packs to a retailer or distribution center.
• Technical Integration – The disparate tech stacks within a retailer’s ecosystem means there is a high likelihood that drop shipping can require (continual) updates to a supplier’s warehousing, fulfillment, and invoicing systems, as well as changes to processes and channel policies.
• Inventory Risk – The transfer of inventory risk back to the supplier.
• Data sharing costs – Increased data sharing costs as inventory, shipping, and invoicing data is atomized to a per-consumer-order as opposed to a per-pallet level.
• Tax Complexity – More complicated tax liability as three entities–the consumer, the retailer, and the supplier–must navigate the tax codes of the various states and local districts within which each is located.

Drop Shipping: Worth It

Despite the challenges, one of the most significant trends in the ecommerce supply chain over the last decade has been the shift toward drop shipping and third party distributed inventory. A lot has changed since 2003. With such clear advantages, retailers and suppliers are being compelled to adopt drop shipping to be competitive with product selection, product penetration, and omnichannel. As we saw in last week’s post, those who fail to overcome the challenges associated with drop shipping and a more virtual supply chain will face far more severe disadvantages as ecommerce and omnichannel inevitably take up a larger percentage of retail.

Next week I’ll discuss the importance of a partnership orientation–as well as several other success factors–for running an enterprise level drop shipping operation.