Drop Shipping and Marketplace Selling: Strategic Choices and Trade-Offs
By Logicbroker | June 7, 2021
eCommerce sales in the United States grew 44% in 2020 and 27.6% worldwide (DigitalCommerce360.com). Businesses with a developed online presence pre-pandemic saw significant revenue increases through their online channels while businesses with underdeveloped online channels were able to expand their online footprint and generate higher margins. Not surprisingly, more retailers, suppliers, and brands are looking increase their revenue by entering the online market as a complement to their brick-and-mortar operations. To succeed, companies need to understand the differences and cost benefits of the two main types of business models for eCommerce: drop ship and marketplaces.
D2C Drop ship and Marketplace: What’s the Difference?
D2C (Direct to Consumer) Drop ship is a fulfillment method where suppliers ship orders on behalf of the retailer. A customer places an order from a retailer’s site, then the retailer places the same order at a from a supplier or brand and has it shipped directly to the customer with their own branding applied. Retailers do not need to hold their own inventory, reducing the risk of holding on to excess, unsold goods. This model also allows retailers to quickly source goods from new suppliers as consumer demand changes.
Marketplaces are eCommerce platforms that facilitate transactions between customers and third-party suppliers. A customer places an order, the marketplace operator collects commission, and the third-party supplier receives payment and ships the order.
Both models have their advantages, but different businesses may benefit more from one or the other depending on their strategy, business model and various cost factors. Below is an overview of the key cost considerations for each model, and how they affect both retailers and suppliers.
Reduce inventory risk and costs
Keeping inventory in house is one of the main differences between the two business models when it comes to cost. With drop ship, retailers never hold or handle inventory, so they avoid inventory risk. Not holding the inventory also reduces or avoids some operating costs. In addition, with applications that automatically sync quantities from retailers’ sites to suppliers’ inventory, the risk of overselling and going out of stock is essentially non-existent. On the other hand, marketplace sellers are often suppliers themselves. They carry inventory and are therefore susceptible to inventory risk. They must account for the cost of goods sold plus
holding, handling, and shipping expenses. This provides a lower cost of inventory for the retailer and reduces their risk of unsold inventory.
Expand and manage product offerings
The time saved from drop ship on handling inventory can be allocated to sourcing a larger pool of suppliers to offer a wider array of products. In a drop ship model, the retailer has more control over the products being offered and how they are described and priced on their own site. As consumer demands and trends changes with the ebb and flow of seasons, styles, and TikTok trends, the D2C drop ship model also allows retailers to quickly source new SKUs from new suppliers in response.
Both drop ship and marketplace retailers need a technology platform and business processes to build a strong online presence and manage supplier relationships. Drop ship retailers normally build an eCommerce site or app using site builders like BigCommerce or Shopify. They maintain their site and assume all associated costs. For marketplace retailers, on the other hand, the price of entry is a much lower, with many marketplaces, such as Amazon, Wayfair, eBay, and Etsy, offering free retailer registration.
The main difference between the two models when it comes to marketing is which party assumes marketing expenses. With drop ship, the retailer is responsible for marketing products and engaging customers with their brand. They have more control over the end-customer experience, with suppliers typically using retailer packing slips and branding. Well-executed shipping leads to customer satisfaction and repeat business, so it’s important for retailers to maintain strong seller-supplier relationships.
With marketplaces, the marketplace operator assumes marketing expenses and the retailer, in turn, complies with marketplace promotions and events such as Amazon Prime Day and Black Friday. Retailers who hold products in marketplaces sacrifice their branding, since customers know orders are being outsourced and suppliers ship on their own behalf. Suppliers can expect high traffic through marketplaces but may also experience the downsides of selling in an environment saturated with similar products. Through SEO tactics and product differentiation, however, marketplace retailers can set themselves apart from the competition. In terms of customer behavior, drop ship marketing encourages customers to buy products directly from retailers’ sites, strongly tying those products to the retailer’s brand. Marketplace marketing, meanwhile, directs customers to bestselling items and high-volume ordering practices through promotions and subscription deals like Amazon Prime. This trains customers not to buy products directly on retailer sites and encourages loyalty to the marketplace instead of to individual brands.
Investment, profit and revenue
The up-front investment required to start selling online is relatively lower for marketplaces than for drop shipping. But where businesses see larger revenue differences between the two models has to do with how each model is used and who is implementing. For drop shipping retailers, shipping costs increase if customers place orders containing items from more than one supplier. Retailers also see lower margins due to high product costs, since they are required to pay a premium for each individual order outsourced. Meanwhile, the competition is stiffer, so retailers need to allocate more funds toward marketing. Another consideration is when each party involved sees their revenue. Retailers often hold funds in escrow, and suppliers do not see revenue until after 7-14 days (sometimes longer), giving the customer enough time to report any dissatisfaction.
Through marketplaces, sellers may face lower sales volume due to competition with similar products, thus impacting revenue. Commissions and listing fees also eat away at profit margins.
Sales tax must be collected on most online transactions. But it’s not always clear whose responsibility this is. It is important to consider economic nexus laws by state, as each state has different thresholds for when sales and orders must be taxed. Drop shipping requires two transactions to be made: the first between the retailer and the customer and the second between the retailer and the supplier. Normally, the retailer charges sales tax to the customer, depending on the state the order will be shipped to. But depending on the state where the transaction is made and where the three parties are located, the retailer may be charged sales tax by the supplier. Through marketplaces, the distinction is clearer, since only one transaction is being made and the marketplace operator charges sales tax to the customer.
Drop shipping and marketplace selling both offer advantages, depending on a retailer’s or supplier’s goals. Overall, drop shipping is ideal for retailers and brands who want to offer a broad selection of products but have control over curation and presentation with a smaller pool of core products, while connecting to a new marketplace can offer accelerated growth, new customer reach, and the opportunity to offer competitive pricing. Leveraging both models together can be a strategy as well: by diverting marketplace traffic back to their drop ship platforms, brands and retailers can drive customer loyalty and hedge against marketplace cannibalization. For this hybrid approach to succeed, retailers will need a robust yet agile eCommerce fulfillment platform that can handle both drop ship and marketplace connections.
Regardless of which eCommerce model retailers adopt, building and maintaining strong relationships with suppliers is crucial for fostering customer loyalty and driving business success. Through Logicbroker’s eCommerce fulfillment platform and Connected Commerce NetworkTM, retailers, brands and suppliers can connect with each other and with Logicbroker’s cutting-edge drop ship and marketplace solutions to open new roads to eCommerce growth. For more information, visit the www.logicbroker.com.
Ready to take the next step towards Supply Chain Excellence?
Fill out the form below to get in touch with our team: