The benefits of maintaining inventory vs. drop shipping

Leaders in the e-commerce world are praised for their innovative ideas, bold entry into new markets, and sharp vision into the future of their industries. However, just because a business has the foresight to capitalize on trends, doesn’t mean it can predict which ones will translate into sales. The most successful web-based businesses carefully plan their strategies to minimize risk, maximize profits, and protect against pitfalls.

One of the most important decisions online retailers face is whether to maintain inventory onsite, or operate with a drop-shipping model, outsourcing inventory management—and the risks that come with it. In this blog, we’ll compare the benefits and drawbacks of drop shipping vs. maintaining inventory. We will also look at ways to protect against the risks that come with each strategy.

What is drop shipping?

Drop shipping is a method of commerce that allows retailers to sell goods to customers, even if they don’t stock those items themselves. Instead of purchasing products from manufacturers or wholesalers and then selling them to customers, companies that employ drop shipping reverse the process. They market products online under their company’s brand or store name, and take orders from customers first. Then, they buy products from a supplier and arrange to have them shipped directly from the manufacturer to the end-user.

Drop shipping has become a popular business model because it carries less risk than warehousing items, and allows retailers to run on much lower overhead compared to maintaining inventory. Here are some of the benefits and drawbacks of drop shipping.

Benefits of Drop Shipping

Lower Startup Costs & Overhead

Since you don’t have to pay for space to stock the items you sell, you’ll pay less to start and run a drop shipping-based business.

Lower Risk

If you buy hundreds of bikinis and they don’t sell before the end of the summer, you’ll be faced with an expensive problem. But if you only advertised the swimsuits online and never stocked them, it will only cost you a few clicks to remove them from your shelves, and restock for fall.

More Flexibility

If your storefront is only a virtual one, it’s much easier to work from home, set your own hours, and go on a vacation. Drop shipping gives you the flexibility to run your business on your terms.

Cons of Drop Shipping

Slower Order Times

Since you will not ship orders directly, you won’t have as much control over shipping times. This may result in slower arrival of shipments to your customers.

Slower Customer Response

While you do have control over how quickly you respond to customer requests, you may not be able to answer their questions about shipping or manufacturing right away. Customers will have to wait for you to get answers from your supplier, which may take some time.

Lower Customer Satisfaction

If the above factors aren’t carefully managed, you could experience lower customer satisfaction rates. Clear communication and attention to customer concerns can go a long way toward avoiding and resolving satisfaction issues.

Out-of-Stock Items

The only thing more frustrating than stocking an item that does not sell, is not stocking an item that does sell. Companies who drop ship orders to customers may experience problems with supply, such as out-of-stock or backordered items. Traditional retailers know what they have in stock and what they do not, but with the drop-shipping model, there is some risk that a supplier may suddenly run out of an item, after you have already sold it.

Limited Product Selection

Some manufacturers won’t agree to drop ship your product, and will only sell to distributors, limiting your available inventory. However, there are plenty of companies who will be more than willing to accommodate your drop-shipping request.

Higher Prices from Suppliers

Retailers who stock items in their stores and warehouses pay less to acquire them, because they have established relationships with manufacturers. Companies who employ drop shipping won’t have access to the special deals and discounts reserved for distributors.

High Competition

Because of the low cost of entry and overhead, and the other benefits mentioned above, drop shipping has become attractive to retailers, and many individuals and companies are entering the playing field. This means customers can easily shop around online, making the market very competitive.

Lower Margins

Because of high competition, companies that use drop shipping are constantly pressured to lower prices, which can mean very tight margins for profitability.

Lower Confidence from Investors

While drop shipping can result in low startup costs, it may also reduce the amount investors may be willing to pay. If they see that your company is dependent on a third party for stocking and shipping, they may shy away from making large investments.

Drop Shipping vs. Maintaining Inventory

Now that we’ve learned the benefits and drawbacks of drop shipping, let’s compare them to the standard industry model of maintaining inventory.

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Benefits of Maintaining Inventory

Better Inventory Management

Just as drop shipping gives you less control over your inventory, traditional retail models give you more control. When you stock and ship your own items, you can easily control how much inventory you stock. Assuming you use good inventory management methods, you won’t suddenly run out of an item, because you’ll always know exactly what you have in stock.

Faster Customer Service and Shipping

You can also more quickly respond to customers with shipping times and details—and your items will typically ship much faster, since you won’t have to wait on someone else to ship it.

Better Deals

As mentioned earlier, suppliers may offer you better prices when you are a distributor, because you buy in bulk, allowing them to sell in bulk. You may also get access to faster shipping and/or better service from suppliers, because of your relationship as a distributor.

Walk-in Business

For retailers with a brick-and-mortar presence, simply having the item on hand can mean the difference between making a sale, and losing one. Customers can see your inventory, try things on, and purchase the items they want immediately. This is especially important for fit-critical items like jeans and shoes, or for items your customers need right away—such as a new coffee maker to replace the one that quit working before making this morning’s first cup.

Cons:

Higher Costs

The biggest drawback to stocking items may be the cost. In addition to buying the items you plan to sell, you also have to pay for the space to stock the items—and, if applicable, the employees to staff your store or warehouse. This increases overhead costs, and may force you to charge more for an item in your store than it might cost customers to buy the same item online.

Less Available Capital

When you stock inventory, a percentage of your working capital will always be tied up in merchandise. This reduces the amount of money you have available for other business needs.

Risk / Costs of Unsold Items

If you don’t sell an item you stock, you may be stuck with it. Of course, the longer it takes to tell an item, the more it costs you to store and market it—which drives down profitability. You can also risk an item going out of season, or even out of date entirely, before it sells. This is especially true in the areas of fashion and technology—not to mention food items, which are unusable if expired.

Risk of Loss

In addition to the above, you may also risk loss due to theft, natural disasters, or other physical damages to your inventory.

Higher Insurance Costs

To protect against the above, you will need insurance—further adding to the costs of running your business.

Which Shipping Model is Better for Your Business?

After weighing the pros and cons of each business model, it’s easy to see that there is no one solution that will work for all retailers. Different businesses have different needs, and it’s important to choose the method that works best for yours. You may even choose a hybrid, stocking some items and drop-shipping others.

Businesses with a strong physical presence may choose to stock inventory of their top-selling items, and drop-ship items with lower total sales. For items that are very large or expensive to stock, companies may purchase one or two items for display, but have all customer orders shipped directly from the manufacturer.

There is no right or wrong answer—only the answer that makes the most sense for each individual business.

Capitalize on Funding to Fill in Gaps

If you do stock inventory, you may need access to working capital to bridge the gap between purchasing items and making sales, or to fund the purchase of more stock. Companies that use a drop-shipping model may need funds for other business expenses, such as marketing and advertising the items you sell.

Just as you shop for the best products to sell, seeking out the lowest prices and most advantageous shipping deals, you should also shop around for the best business loans.

Fundomate provides a range of financing options by serving as a direct portal to over 20 prominent lenders such as On Deck, Everest and In Advance. In just a few minutes, you can submit one simple application and compare prices from the top lenders. Select the funder that best meets your business needs, and funds could be wired to your account in under 24 hours.

At Fundomate, we make it easy for businesses to succeed—no matter which marketing model you choose.

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