“It’s All About The Benjamins - Part 2” - Drop Shipping’s Impact on 5 Additional Retailing Metrics

Back by popular demand, my next blog discusses drop shipping’s impact on 5 additional retailing metrics. As mentioned in “It’s All About the Benjamins – Part 1”, drop shipping accounts for about a quarter of all online ecommerce. That’s a lot of Benjamins. Retailers should continuously evaluate how this fulfillment strategy impacts their customers and their bottom lines. 

My last blog discusses metrics one through five. Now let’s take a look at the next five metrics.

Metric #6 – Shipping Expense

Drop shipping has a negative effect on a retailer’s shipping expense as compared to internal fulfillment. Retailers report shipping is often the largest expense after cost of goods sold (COGS) and can significantly drag down ecommerce profitability as drop shipping grows as a percentage of the business. 

There are three main reasons for this increased cost:

Multiple shipments per order – Shipments per order increases as retailers grow basket size and attract customers with a wider online assortment. In an age where Amazon set the bar high with Prime one-day shipping, retailers are under pressure to absorb additional ship expenses to match customer expectations.  Retailers need to constantly monitor this metric to ensure incremental sales outweigh added shipping expenses as drop shipping and package count grows.

Long-distance deliveries – Retail supply chains in North America are built to support the forward movement of palletized goods from overseas factories through coastal ports and strategically placed warehouses. Often times drop ship delivery networks lack proactive design and rarely reposition inventory using 3PLs as business conditions change. When the customer checks out from the website, the retailer hopes for shipping efficiencies, but more often than not, the supplier’s fulfillment center is far from the delivery destination, leading to longer cycle times and higher expenses.  

Lack of shipment optimization – Retailers generally do not factor location of drop shipped inventory into expected delivery date calculations. This leads to packages shipping at higher expenses than necessary and missed delivery dates. Shipping optimization is easier to control, and customer experiences are often better when the retailer owns the inventory.

Metric #7 – Item Setup Expense

Drop shipping suppliers and their assortments are generally more expensive for retailers to onboard and manage than owned inventory items. 

There are three main reasons for this: 

Missing Institutional Knowledge – Retailers have to make decisions about products they own, market they serve, and stores they operate. In drop shipping, suppliers maintain much of this institutional knowledge about their assortments. They own the products data and have more familiarity with these SKUs. Yet it is the retailer’s responsibility to actually set up the items for sale. Gaps in institutional knowledge between retailers and suppliers lead to longer item setup times.  

Lack of Process Standardization – While retail supply chains have experienced huge improvements, item setup is still not standardized across organizations. Data elements, contractual requirements, and fee models vary from retailer to retailer and therefore front-line teams are left with sub-optimal approaches to this important business process. What worked to launch SKUs live on Amazon or Walmart does not automatically work at other retailers. This lack of standardization creates manual steps, rework, and process friction; all leading to slower and more expensive item setup costs.  

Resource Turnover – Employees working on drop ship teams tend to move to different areas of the business more frequently than other employees because the real activity within the retailer takes place in the bigger segments of the business. There are plenty of high-quality business and technical managers working in the drop ship space that regularly overcome barriers around item setup processes. When these managers and workers transfer to tackle other challenges, drop ship programs tend to experience brain-drain, process delays, and item setup bottlenecks. 

Metric #8 – Returns-related Expenses

The National Retail Federation published data that suggests customer returns represent about 10% of total online sales, dragging down profitability for both retailers and suppliers. Studies also suggest retailers are increasingly encouraging customers to buy-and-return purchases in store to drive higher loyalty. Big retailers are making it even easier for customers by allowing them to return Amazon items in exchange for the potential increase in in-store sales. 

Drop shipped returns add a layer of complexity to the ecommerce returns equation in two key ways:

Lack of Store-level Execution – Returning drop ship items to stores causes friction for associates because they are less familiar with these items than SKUs they work with every day. If the retailer decides to resell the returned item, it’s more time intensive to get the item in the right spot in the planogram. If the retailer decides to return items back to the supplier, shipment costs are higher and take longer to process than owned inventory returns. Often, retailers simply negotiate return allowances with suppliers and then destroy or donate the merchandise. Even when executed efficiently, managing a drop ship returns program is harder to execute than owned inventory and creates in-store friction.  

Lack of Data – Most drop ship SKUs have gaps in their master data that challenge a retailer’s ability to make good decisions after return. Sell through and return rates are difficult to predict on SKUs that are not common to the assortment. Fundamental questions about whether a retailer should resell or consolidate and return to the supplier require data and take time to master. They become more difficult and expensive to execute correctly when the retailer starts with less product data than the drop shipper. 

Metric #9 – Search Engine Optimization

While drop shipping negatively affects the first three metrics above, Google Search Optimization metrics such as ‘cost per click’ or ‘pages per session’ benefit from drop shipping. Retailers have learned that Google’s algorithms look favorably on additional product content. Ranking at the top of search results makes it easier for retailers to find and convert shoppers. 

A good analogy for drop shipping is a game of roulette. The strategy allows a retailer to place more bets on the wheel, distributing risk more easily, and gambling for their customer’s attention. Adding the right mix of less productive SKUs to an assortment leads to GMV growth.  It also attracts new customers and sales through incremental cross-sales and up-sells of more productive products. 

The best way to determine which products to drop ship is to request the “Products Not Found” search report from Marketing. If the missing products complement the merchandise strategy and item setup friction is minimal (see Metric #7 Item Setup Expenses), these extended assortment SKUs become the bets on the roulette wheel. 

Retailers need to act fast. Amazon continues to influence shopping behavior by changing how customers start their buying journeys. A recent study suggests more than half of all buying journeys now start directly at Amazon and bypass Google Search entirely. As this increases, the benefits of extending assortment to drive better Google search results will diminish.

Metric #10 – GMROI

Gross Margin Return on Investment calculates the amount of money a retailer returns from every dollar spent on investment. In terms of gross margin, we have already discussed in the first blog that drop shipping provides sales with slightly less profitability due to the supplier monetizing inventory risk in the form of higher retailer COGS. The flip side of this key retail metric is that average inventory costs – a key component of a retailer’s investment – approaches zero with drop ship fulfillment.

If merchants are doing a good job managing margin, increasing a drop ship assortment can have a favorable impact on the retailer’s GMROI. This is one of the main reasons why drop shipping is so attractive to retailers.

Business Metrics Summary

The following table summarizes the ten metrics discussed in this blog series and identifies drop shipping’s impact on each.  

Conclusion

Drop shipping continues to be an important supply chain strategy that allows retailers to expand online assortment and compete with major ecommerce retailers (aka Amazon) for their customers’ business. Like any strategy, it has tradeoffs. These two blogs identify key metrics that can be used to think strategically about this supply chain approach and briefly discuss the impact on each. The content is intended to inform internal retailer discussions and help shape the digital business agenda moving forward. 

Remember, it’s all about the Benjamins.