The Supply Side: Drop shipping an ‘interesting option’ for online retailers

Wal-Mart Stores and many of its online competitors are requiring suppliers to shoulder more of the outbound supply chain risks with drop shipping direct to customer. Forrester Research recently noted about 23% of online sales ($85.1 billion) this year will be delivered to customers via drop shipping models.

Drop shipment models involve a customer ordering a product online from the retailer’s website, but since the retailer doesn’t take inventory of it, the supplier fulfills the order from the manufacturer directly to the consumer. While there are risks to retailers, there are also benefits, according to Annibal Sodero, assistant professor of supply chain at the University of Arkansas.

Sodero told Talk Business & Politics that retailers like Wal-Mart trying to grow online inventory simply can’t take receipt of all the products which is a primary reason for the growth in drop shipping. Walmart U.S. eCommerce has more than 65 million items available on its site, and that has grown exponentially over the past two years and so has the retailer’s use of drop shipments. Amazon, with more than 300 million items sold online, has required drop shipments for several years.

Sodero said it’s too early to know if drop shipment models can be profitable, and retailers are using it because they have no choice.

RETAILER RISKS
“Drop shipping is an interesting option for online retailers because they can focus their efforts on acquiring and retaining customers through the provision of price statements and customer service promises, without having to perform any inventory carrying and delivery functions,” Sodero said. “However, in doing so, these firms relinquish the ownership and management of the inventory of products they sell to customers, so they risk the loss of control over warehousing and inventory costs.

“They also give up the power of choosing the inventory locations to use, limiting the ability to decrease delivery distances, associated transit times, and costs incurred in transporting products to customers.”

Sodero also said retailers obsessed with improving customer experiences give up the ability to control much of what constitutes that pleasing experience. Customers want lots of choices which drop shipments help retailers provide. Getting the right price can be a challenge given the supplier may not be able to leverage logistic costs the way Wal-Mart can. That could take the price higher than if Wal-Mart were handling the logistics.

Sodero said retailers may also face operational challenges ranging from being unable to fulfill a customer’s order because a vendor is out of stock, or perhaps losing money on expedited delivery while drop shipping from a vendor’s facility located too far away from the customer.

SUPPLIER RISKS
Sodero said risk for suppliers that sell in stores and online for omnichannel retailers like Wal-Mart are in the trickiest position given they use traditional supply chain for stores but then have to drop ship direct to customers for the items that are sold only online.

“Think of an athletic wear supplier that may sell some items to brick and mortar — those popular sizes like medium, large and extra-large. But maybe they have new products and more specialty sizes which are only sold online and can make it harder for them to manage their inventory. Many suppliers I have spoken with are still trying to figure how to do it,” Sodero said.

He said suppliers could put the inventory into specific buckets allocated to certain retailers, but if one bucket empties faster than others, there are missed sales opportunities. Sodero also said products that include drop shipping also cost more to handle and that must be part of the contract price with the retailer. That could lead to a vendor having multiple contracts with the same retailer, depending on where the item is sold.

Sodero said some suppliers are trying to manage inventory out of a single bucket. But depending on how the online inventory reaches the customer, it could be costly for them to ship in the two-day table stakes threshold. Not only that, but the supplier is building pallets for brick and mortar and now they must also pick a single item and ship it separately, which can increase labor costs. He said Amazon has put some of its own employees inside its supplier warehouses to manage the online drop shipments, and that is how that e-commerce giant is pulling it off.

“Amazon has been selling online for 20 years without physical stores, and have figured out where to place the inventory,” Sodero said. “Drop shipments have been one way they can add more inventory to the online offerings without having to take physical receipt of the physical inventory.”

Suppliers also have to be careful to build in enough margin to handle the drop shipments when negotiating with retailers. In the case with Wal-Mart, it may be hard for suppliers to get enough margin given that retailer demands the absolute lowest costs. The drop shipping allowance of the retailer might not be enough to cover all the costs.

THIRD-PARTY OPPORTUNITIES
Sodero said retailers and suppliers have more third-party solution providers to help them manage their drop shipping operations. FedEx has a Vendor Enablement Program retailers can use to gain more insights into drop shipments as well as help supplier lower the average shipping costs.

An online sporting good retailer uses the FedEx program and over the course of a year 97% of its 1,700 vendors joined the program and saved a combined $2.093 million annually on reduced transportation and related costs, according to a case study completed by Sodero.

Apps like Oberlo help online retailers improve drop shipping operations by saving time and giving retailers transparency into the supply chain. ShipMonk is a boutique e-commerce fulfillment option that takes shopping cart information overlays with its proprietary software, then allocates for order picking, packing and shipping.
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Editor’s note: The Supply Side section of Talk Business & Politics focuses on the companies, organizations, issues and individuals engaged in providing products and services to retailers. The Supply Side is managed by Talk Business & Politics and sponsored by Propak Logistics.