The Hand-Off

Drop shipping expands a merchant’s offerings, but not without a lot of homework

Drop shipping is akin to the superstar job applicant with the killer resume, tons of experience and multiple degrees.

It looks great on paper.

The benefits of drop shipping—a program in which a third party, often the manufacturer of a product, owns the goods that a company sells and ships them to the consumer on behalf of the e-retailer—are enticing indeed. There are the obvious: the ability to offer more inventory without additional financial risk, zero warehouse costs and less staff to pay as the drop shipper takes care of running and staffing the shipment and fulfillment center.

And, there are the not-so-obvious: the ability to constantly test or gauge interest in different products and the capacity to offer niche goods and truly become a one-stop-shop retailer.

Elbow grease

But merchants who dig a little deeper and evaluate what it takes to launch a successful drop shipping program will learn that the rewards don’t come without a bit of elbow grease. Drop shipping, retailers and consultants say, requires a lot. A lot of time. A lot of preparation. And, in many cases, a lot of money.

Just ask Don Cohen, president and founder of ToolKing.com, a hardware and tool e-retailer with about $30 million in annual sales. ToolKing began its drop shipping program about four years ago and today works with 30 manufacturers who drop ship about 25% of its orders accounting for 30% of sales. Cohen says drop shipping helped triple its SKUs from about 6,000 to 18,000.

“It allowed us to expand our product offering with little inventory risk. We now pride ourselves on having the most comprehensive tool selection online,” Cohen says. “And we are offering items that we didn’t have the space to stock or the desire to put up the money to buy before, like more obscure goods.”

But such rewards didn’t come without a price. Cohen estimates ToolKing’s drop ship program cost about $100,000 and took about six months to implement.

Most of that time and money was spent building the technology that allowed it to communicate back and forth with vendors. ToolKing brought on a freelance programmer and used its own team to build the technology in house. But even with careful planning and patience it wasn’t a glitch-free launch.

“At first it was tedious, there were a lot of e-mails and going back and forth,” Cohen says. “There were times when customers would order three tools and get them in three separate packages on three different days from three different vendors.”

ToolKing now tracks orders online and works with each vendor differently, setting up programs for sending and receiving data.

‘What we have here…’

If there is one resounding message among consultants, merchants and vendors involved in drop shipping it is that communication is key.

Lack of communication is a gaping hole in drop shipping programs, says Mark Clendenin director of consulting for Fry Consulting Services, a unit of e-commerce technology firm Fry Inc. Fry has helped such major retailers as The Home Depot Inc., Meijer Inc. and Kohl’s Corp. launch drop shipping programs.

“Retailers tend to oversimplify. It’s a problem a lot of companies run into, you need the technology to manage inventory and fulfillment and communicate with your drop shippers,” says Clendenin, who recently wrote the white paper “Supplier Direct Fulfillment: Strategic Enabler to Accelerating E-Commerce Growth and Profitability.” Drop shipping is often referred to as supplier direct fulfillment.

If an order is out of stock, for instance, the e-retailer needs to know—fast—so that it can take the product off the web site or inform the customer that it is on back order. The same goes for a product that arrives damaged or late. Other cases, such as a product returned to the drop shipper’s warehouse, require communication lines with the shipper so that the retailer can credit the account quickly. Or, if a drop shipper is discontinuing an item, or running low on a particular product, the e-retailer needs to know so it can work with another manufacturer to acquire more or inform customers.

Bill Pryor, chief operations officer of footwear and accessories retailer Shoebuy.com, a subsidiary of IAC InterActive Corp., which owns such other retailers as HSN and the former Cornerstone Brands online and catalog merchants, says data sharing is top priority when his company sets up a drop shipping program with a new manufacturer.

“First we look to understand the drop shipper’s company,” Pryor says. “Is it one person or a multi-billion dollar corporation, and what kind of systems do they use? How can we get our data out of their system and into ours?”

Shoebuy, launched in 1999, has drop shipped all orders since its inception. Beginning with about 50 drop shipping partners the e-commerce site now offers over 550 brands from more than 500 drop shippers. About 4.5 million shoppers visit the Shoebuy site each month to purchase the more than 700,000 goods it offers.

It’s a lot to keep track of, Pryor says.

Outside help

While Shoebuy built its data-exchange technology in house using a variety of systems such as EDI, XML, FTP and SOAP, or simple object access protocol, to share data with drop shippers, many vendors will help manage that communication process for a fee.

CommerceHub, a division of Commerce Technologies Inc., for example, offers a hosted software system that integrates retailers’ systems with more than 4,200 drop shippers, manufacturers and carriers. CommerceHub charges a variable percentage of each transaction for its service, depending on volume, says Steve Hamlin, CEO. Sears Holdings Corp., Circuit City Stores Inc. and The Home Depot all use CommerceHub to help manage their drop ship programs.

Yet whether a retailer manages its own communication technology or uses a third-party, figuring out how to share information is just the beginning. Once the data-sharing system is set up, other issues arise: How often will shippers and retailers communicate? What information will they share? And, when will they share it?

Hamlin, along with many other retailers that drop ship, recommends merchants set up a list of business rules that a vendor must meet and a system to notify the retailer if a benchmark is missed.

“It allows customer service to handle a lot more orders, because you don’t have to have staff checking and tracking every order,” Hamlin says. “If there is a problem, your business rule is there and you are informed. That way you’re only dealing with orders that are problematic.”

Shoebuy, for example has created such business rules as an average ship time of 1.4 days, and at least a 99.6% fill rate, meaning that when a customer orders a product, the inventory must be in stock and filled at least 99.6% of the time. If a partner fails to meet a business rule, which Shoebuy refers to as a key performance indicator, Shoebuy receives an automatic notification, as does the shipper

“They should beat these averages,” Pryor says. “If you are not meeting our KPIs we will be having a conversation with you.”

Need-to-know

Online business supply retailer Shoplet.com, which drop ships all its 200,000 products, has a similar alert system, says Tony Ellison CEO and founder. Ellison’s team receives messages on a need-to-know basis, as well. Staff receives a notification if a customer receives damaged goods or if an item is “shadow stocked,” meaning a warehouse incorrectly reported it had an item when it did not.

Fry’s Clendenin, who helps draw up drop shipping contracts for retailers, says retailers must see the drop shipper as a partner and establish business rules and standards that are feasible for the warehouse staff to meet. For example, Clendenin says something that seems like a simple request to a retailer, such as a two-sided packing slip with special logos, advertisements and line itemizations, can be time-consuming and tedious for a drop shipper.

“It may be something that seems very logical to do from the retailer’s warehouse, but is very onerous from the drop shipper’s,” Clendenin says. And although a drop shipper may be willing to customize a packing slip or receipt, or modify its warehouse to meet other demands, such changes can be pricey. “You have to gauge what’s important,” he says.

Accountability matters

Once standards are in place, Clendenin says it’s important to hold shippers accountable. In addition to a notification system tied to business rules, Clendenin recommends having mystery shoppers randomly place orders to ensure packages arrive on time, in the correct box and with the proper documents.

When retailers take the time to work with staff and outside vendors to develop a solid, efficient drop ship program, Clendenin says many start reaping benefits beyond the obvious.

For example, the consultant says many merchants he’s worked with use drop shipping to try out new products.

Department store chain Kohl’s used drop shipping to test the sales of high-end jewelry on its e-commerce site and found a customer base it never knew existed.“They were able to bring in a lot of jewelry online that they never would have brought to their site without drop shipping,” Clendenin says.“They are now selling jewelry that costs as much as $8,000.”

Home improvement retailer The Home Depot tested several styles and colors of area rugs through drop shipping and response to some of the rugs was so positive that it began offering them in stores. Clendenin says drop shipping can be a great way for multi-channel retailers to select new products to bring into bricks-and-mortar locations, which unlike a web site, have limited space.

“If a retailer has to buy it, they a lot of times won’t expand their product line,” Clendenin says. “Drop shipping lets them do it without risk.”

However, Cohen of ToolKing found offering more products can present another hurdle—figuring out where to put them on the site so that a customer can find them. “You have to list all the products, add categories to your site and incorporate them into your search,” Cohen says. “Having more products touches every part of your business.”

Another potential drawback retailers point to is margin. With drop shipping, merchants pay for items on an as-ordered basis and therefore may miss out on discounts offered with buying in bulk, Shoebuy’s Pryor says.

And then there is the issue of trust.

Drop shipping requires a merchant to hand over one of the most important aspects of its business to a third party—order fulfillment. Moreover, as most e-retailers “blind drop ship,” meaning the vendor ships items with boxes and packing slips bearing the merchant’s name and logo so that the consumer is unaware another party is involved, an e-retailer is literally putting its good name in another company’s hands.

Fear not

For some merchants that can be downright scary. “Many retailers, especially smaller retailers, don’t understand the benefits and are afraid of losing control,” Clendenin says.

While drop shipping can take time and resources, Clendenin says the benefits typically outweigh the drawbacks.

Several merchants the consultant has worked with to launch drop shipping programs have experienced a 200%-300% return on investment within two years when taking into account sales of items they may not have offered previously.

“It mitigates the risk of inventory, the risk of having additional employees, the risk of owning and operating warehouses and the risk that you will have to reduce your margin to get a product out the door,” Clendenin says.

That is, of course, if the retailer gets it right.