Dropshipping - What Is It and How Does It Work?

Dropshipping is a type of ecommerce business model in which the customer receives their order straight from the supplier, with no third party ever holding the product in stock. Instead, the dropshipper orders the goods from the supplier and ships them directly to the consumer when a customer buys the product in the dropshipper's online store.

So, the selling merchant is simply the middleman in this scenario, having never stocked or owned the inventory, which is the main distinction between dropshipping and a conventional retail business.

From the perspective of the customer, there isn’t much difference between buying goods from a traditional merchant versus a dropshipper. Customers simply place an order and wait for it to be delivered to their home, just like they would for any online order. The only distinction is that the products arrive directly from the manufacturer.

For dropshippers, the dropshipping model has become a quick and convenient way to grow a sales business and generate revenue. It allows them to purchase inventory and fulfillment services from an intermediary rather than storing and distributing the goods themselves.

How does dropshipping work?

First, the customer places their order and makes their payment on the retailer’s ecommerce website. The retailer then purchases from the dropshipping supplier the goods the customer ordered. The dropshipping supplier ships the goods directly to the customer after receiving the original order. The customer's buying experience is the same as with any other e-commerce transaction even though the merchant never handles the products.

So, the retailer markets, sells, and provides customer service for the dropshipper’s products, but otherwise remains a middleman. They do, however, control the selling price of the goods, as well as the final margins.

How to start dropshipping

Anyone looking to launch a successful dropshipping business will first need to find a reliable supplier. There are countless dropshipping suppliers to choose from, but picking the wrong one can result in errors or delays, which could be damaging to a new business. For this reason, it’s important to do extensive research before committing to any one supplier.

Many opt to collaborate with large, tried-and-tested dropshipping suppliers, like dropshippingXL, BigBuy, Spocket, and SaleHoo, but no matter the supplier, it’s important they’re a good match for your business and its needs.

Once you’ve decided which dropshipping supplier to partner with, an ecommerce platform like Shopify will help you get your online store set up and ready for customers (if you don’t already have one).

Is dropshipping worth it?

Dropshipping pros

Minimal startup investment

Unlike most business models, dropshipping doesn’t require a large capital investment upfront. It’s possible to get started as a dropshipper with just your computer and an internet connection, along with money for the platform fees and some marketing.

Less risk

Because they don’t own the inventory or the storage facilities, dropshipping business owners incur fewer financial risks.

Less responsibility

When you receive an order from a customer, you just need to place that order with your dropshipping supplier. Along with fulfilling the order, they will also ship it to your customer and take care of any returns on your behalf.

Flexibility

Dropshipping's fulfillment model means you can make changes to your store whenever you want. If a strategy doesn’t succeed or certain products don’t sell, you can try something different with no loss to you. It gives you the freedom to test out what works and what doesn’t.

Location independence

Owners of dropshipping stores can operate from anywhere, without having to be tied to a storage warehouse or fulfillment center. You can be in contact with your customers and suppliers from anywhere.

Dropshipping cons

Reduced profit margins

Dropshipping generates significantly lower product margins than a typical e-commerce business. The reason for this is that you’re paying for the order fulfillment with the supplier as well as the wholesale price of the product.

Intense competition

You’ll be doing business alongside many other dropshippers selling the same products, making competition fierce. That means that to stay competitive you’ll have to market aggressively, lower your prices, and offer frequent promotions.

Not much quality control

You won’t be able to inspect your products since they’re shipped directly from the supplier to the customer. While some dropshippers will order a ‘sample’ of an item before they list it, the majority rely on the sales history of the product and its reviews.

Fulfillment errors

Dropshipping business owners aren’t responsible for the packing or shipping of their orders, but if mistakes happen they will be held accountable by their customers. When things go wrong, it reflects badly on your brand.

Dropshipping and VAT law

Dropshipping is considered a ‘chain transaction’ for VAT purposes. Chain transactions are any transaction involving a VAT-eligible product in which there are at least three parties and the product is shipped from the first business to the last customer.

The VAT due when selling via the dropshipping method will depend on a number of factors, including the type of products sold, the annual turnover of the company, and also the customers and their location.

It can be a complicated process trying to figure out your VAT liabilities when you start a dropshipping business, but Taxually can help.

To find bespoke solutions for your business, optimize your VAT costs, and reach millions of new potential customers, email us at mycompliance@taxually.com and we’ll arrange a free call with one of our VAT experts.