Why you should hate dropship ecommerce like I do.

For the last few years, buyers have been purchasing a type of website that, left unchanged, is almost always doomed to fail. The worst part is, it’s probably one of the most popular types of site being sold.

This is part of a series of guest posts by Justin Gilchrist the cofounder of Centurica, a company that provides due diligence and website assessments to people who buy web based businesses.

I’d like to show you how you can avoid the same fate. More importantly, I’ll take you through a strategy that’s been working for over 8 years now, turning these problem sites in huge profits for buyers.

A few months before writing this I sat opposite a lady on a flight and we had one those really awkward cross-aisle conversations. The type that happens when the other person sees Google Analytics on your screen and realizes you also have an internet business, but neither of you know if the other person really wants to talk.

Originally, she said she ran an ‘ecommerce company’. Five minutes in, it was actually a farming supplies store in the British countryside that happened to have a website … where about 5% of all their transactions happened, compared to the other 95% that happened in store. Her website was three months old and she was very proud of it. I didn’t have the heart to tell her otherwise.

I guess running an ecommerce company sounds so much cooler than “I run a small shop” but that wouldn’t be the first time I’ve heard ‘ecommerce’ used for all the wrong reasons. People’s definition of ecommerce varies depending on who you speak to.

We frequently work with buyers at Centurica where someone wants to purchase an ‘ecommerce business’. Sometimes, they want an online store. Sometimes, they’re just referring to any business that transacts on the internet – like a content site.

Both are technically ecommerce, but not the online store we usually mean.

Ecommerce can be split up into

Physical Ecommerce (PSE) – an online store selling a physical product that is either warehoused and dispatched by the owner, or warehoused by a third party fulfillment center such as Amazon FBA or ShipWire.

Drop-ship Ecommerce (DSE) – an online store that also sells physical products, but these are dispatched directly from the manufacturer or wholesaler.

Digital Ecommerce –  is a website that sells one or more digital information products where the transaction happens on the site. If this were an Affiliate site, the user would be sent elsewhere to make their purchase. If the user is taken to a third party hosted page to make payment (like many shopping carts do) then it still counts as Digital Commerce, providing the site owner also owns that cart transaction.

Knowing the difference is pretty important.

One of those three models comes almost doomed to failure unless you’re able to do something about it. Can you guess which one? Pretend for a minute that you didn’t already read the title.

Here’s the problem with drop-ship

In my opinion, drop-ship ecommerce (DSE) holds the least value out of all three of those types of business.

And to clarify, the ‘bad’ kind of drop-ship are those stores that sell generic products that are easy to source. The kind where you type ‘drop-ship directory’ into Google and your supplier pops up. If you have a site with a distribution agreement, or products that are difficult for competitors to find elsewhere, then the rules change.

New buyers tend to see DSE as being extremely low maintenance. After all, you’re just sitting watching the orders come in while someone else does all the hard work right? If you’ve been around for a few years you’ll probably know anything that seems like easy money on the internet is a problem waiting to happen! Less work means far less reward and whole host of other issues, but we’ll get to those soon.

In reality, Digital Product Ecommerce tends to be the lowest maintenance of the three different types. Outside of customers being unable to open a zip file (yes … it happens), and people asking for a refund, there’s very little maintenance that you need to do providing the product itself is evergreen.

Meanwhile, drop-shipping (which everyone assumes is the easy option), is probably tied second with Physical Ecommerce (PSE), often to people’s surprise. This is providing you have a PSE store where you:

1) Use a fulfillment center to warehouse and dispatch your goods, and a shopping cart that automates most tasks for you, like sending the orders to that fulfillment center when they come in.

2) Outsource or hire someone for basic customer support and

3) Set up triggers with your suppliers for automatic reordering whenever stock runs low. Again, this is something most modern shopping carts will automate.

You’re likely to spend about the same amount of time maintaining a physical ecommerce store (with fulfillment) as you would with a drop-ship one, so the argument about maintenance becomes redundant.

But you promised ‘hate’ in the title …

Being ‘comparatively not as low maintenance as everyone thinks it is’ is hardly a crime or a reason to loathe drop-ship ecommerce. The maintenance issue was merely making a point that DSE’s biggest perceived benefit actually isn’t that much of a game changer.

My personal vendetta against drop-ship ecommerce is that the business model is seriously flawed. When you sell goods on a drop-ship basis, you will always have the smallest margins in the supply chain. UPS will often make more than you do on a typical transaction.

DSE margins are usually so slim there’s not enough left to run paid traffic campaigns. And love or hate paid traffic, most new buyers soon learn this is the ONLY reliable and consistent way to grow an ecommerce business.

Look at it this way – organic traffic is nice, but difficult when you sell a generic product with the same description as everyone else and very few genuine product reviews. You could start a blog and you will get traffic, but most of that traffic will read the article and bounce. Ecommerce blogs typically have low conversion to sales, even with remarketing. Social marketing works well in niches where people care enough to share their love for the products you sell, but what if that product is a lawnmower … or worse still a pubic hair trimmer? Suddenly, your only source for new customers are those where you have to pay to reach them.

Based on the average conversion in your niche, and the cost to buy one click (which is dictated by the other advertisers who all have bigger margins if they’re supplying direct), the amount you would spend to get a sale usually doesn’t generate enough gross profit to make buying clicks sustainable. I’m sure there are exceptions or sites that convert so well, they buck the trend but you’ll find this isn’t the case for the majority of drop-ship sites that you look at.

This why most drop-ship stores rely on Organic Search traffic.

The owners try paid traffic and quickly give up. But we all know that an ecommerce store without paid traffic is like a goldfish in a shark tank right? Besides never being able to hit scale that matters, you’re stuck in a market dominated by competitors who can and will spend whatever it takes to steal your market share, and you’ll be defenseless to do anything about it.

If that wasn’t bad enough, you might also be competing against your own suppliers, who can offer lower prices if need be and spend more to advertise than you ever could.

In short, DSE is a flawed model that SHOULD never scale. It sometimes does, but it’s usually short-lived. Buy at the wrong time and you’ll be left paying for the seller’s mistakes.

So wait, I should never purchase a drop-ship Store?

Not quite.  Drop-ship purchases have been some of the most profitable ones I’ve ever made. The problem comes from purchasing a drop-ship store and leaving it that way, expecting untold riches and a place on the Inc 500.

If you buy DSE, do so with a healthy dose of reality. You could keep it as is, but chances are you’ll find it difficult to grow and scale, and often struggle to just maintain your current position.

A more effective strategy for renovating drop-ship sites is to see it for what it really is – an opportunity to acquire customers cheaply and build a more sustainable system around what is already there.

Take this example

You purchase a store that sells stationery and office supplies to businesses that order online. Currently, they drop-ship directly from the manufacturer and have an average of 100 orders each month. The site generates a profit of $10 on a $100 average order size.

Most of the traffic comes from organic search and the seller has told you PPC is too expensive and doesn’t work. When he tried it, he experienced a conversion rate of 2% and an average cost per click of $0.80

Your first step would be to look at the most popular 20% of products that account for the majority of revenue. In this case, it’s pens, staples and paper. You can order these products directly from the manufacturer in bulk and pay a wholesale rate. On stationery, the margins are significantly higher when you buy wholesale as it’s a commodity item dominated by low cost Turkish and Chinese imports.

Next, you setup an account with a fulfillment provider like Shipwire. They handle all of your warehousing and shipping just for these new products. After Shipwire’s costs have been considered, let’s assume you’re now making an average profit of $70 on each $100 order that you dispatch from the fulfillment centre. All the other long-tail products like lamination machines or laser toners are still drop-shipped as it makes no sense to keep inventory just for the occasional purchase.

Your profit on a sale now averages $60 on a $100 order. This is an average of the majority of products where you earn $70 and few drop shipped items where you still earn $10.

With increased profit per transaction, paid marketing is now back on the table.

Based on the figures above, 100 clicks would cost $80 and generate 2 sales. Previously, this equaled $20 profit (a $60 loss after marketing costs are removed) whereas now, it’s $120 (i.e. a $40 profit after marketing costs). If a campaign works on Google Adwords, then it’s highly likely it will work well with retargeting platforms and paid social too (e.g. Facebook or Twitter Ads), often at a fraction of the acquisition cost of Google.

You now have a system that’s scalable and gives you far more defense against new competitors. You’ve also increased the value of what you purchased several times over before even thinking about recruiting an extra visitor. Any kind of strategy that doesn’t involve the ever-vague “doing SEO” instantly gets my vote.

Conclusion

So on reflection, hate was a little strong.

If you own or you’re thinking of buying an ecommerce store, then you should think twice before diving head first into drop-shipping as a model.

That said, you can turn a negative to your advantage and acquire drop-ship ecommerce sites, providing you intend to change the model, and you’re able to do so quickly.

In Digitally Wed, I go into some depth about how to avoid the type of purchases that appear great on the surface, but deliver mediocre results because of a flawed business model. You can download or order a copy really soon from Flippa – with a special price just for Flippa members. Stay tuned for my next post to get this deal.

Happy Hunting!

  • ROb

    Well what about the 800lb question. If Amazon sells your products then you are in a class of competition that needs to be re-evaluated. Not that they are infallible, you can compete with them but it is hard. I would look at them as your fulfillment option too.

  • Noel Tabb

    Dude you know nothing about dropshipping. People who really make money use a method that is superior to what you have spoken of. Drop shipping is very profitable. Those who avoid middle men and do use model correctly can earn 20%-35% on items. Those who use their brain and not sell staples, and pens can earn commissions off the low end items of $1,000 and if only 20% can earn $200 per sale AT LEAST. Think of $5,000 or better at 35%. Their are people making millions. I know a guy with a course that is so in depth that I earn big money.

    I will not tell the secrets but those of us who know this business model know we have thousands of products from which to choose, and none cost us anything. We win all the way around. You do not know very much about drop shipping and I am glad because we guard our secrets to earning big time money or else everyone would do it. This is better than digital products which need squeeze pages and sales funnels and convincing people how your product is better.

    This model is simple physical goods, plus great products and using the proper ads and organic traffic equal big earnings. I use paid methods and really avoid Google adwords.There are much better and MUCH LEAST EXPENSIVE ways to generate cash. Many people do not even know what it is. Many people do not realize that many items they buy are paying some guy in flip flops laying on the beach big time doe, and he is simply drop shipping.

  • I liked how you subtly implemented Pareto’s Law into the article. The 80/20 rule is something I came across recently, but it seems you are familiar with it already. 20% of the effort should equal to 80% of the results, so if it is the other way around (as you mentioned) then it is a waste of time. I’ve had a lot of clients with dropshipping companies that do very well, but most of them flop after a year or two because they don’t put the effort in.

  • Custom Parcel Solutions is 40-60% cheaper than Amazon FBA and been in business for over 25 years, people think FBA is the only way but for small companies selling 1-100 products a day the saving you can have through CPS is amazing- Find out why our rates are cheaper than smart post and usps Visit our website here

  • Andres

    this is by far the most realistic article ive read, im in my 4 month of dropshipping with local suppliers and I could relate to everything you said. Im losing money and i still got 4 employees to pay, CPA is freaking high for office supplies which kills our margins, problem is I cant find a proper fullfilment center in my country, if you are available for mentorship please contact me. Thanks

  • Josh

    It’s all true! It’s all true!
    Very well done, thank you.