Boxing Match

Joe Cataudella packs a lot of boxes. When customers order video games from his New York-based Web store, Tronix.com, Cataudella selects the videos from his inventory, packs them up himself and slaps on a mailing label. That way, he knows each order is correct. What’s more, when customers call to ask when an order was sent, he knows the answer.

Small operations like Tronix, a two-person shop with less than 80 orders a day, aren’t the only Internet retailers packing their own boxes as a way of ensuring that customers not only get what they’re expecting but when they were expecting it. Much bigger retailers like Amazon.com and Pets.com have taken more control of inventory and shipping for the same reasons, opening major warehouses in time for the holidays.

Cataudella and many other Web merchants have tried relying on manufacturers or distributors to ship products directly to customers who order online. That practice, drop shipping, began with catalogers and has been popular with Web startups that either can’t afford or don’t want to carry a lot of inventory. The model especially makes sense for companies dealing with large, bulky items difficult to store in a warehouse, says Maxwell Sroge, who heads a catalog consulting firm in Evanston, Ill.

Retailers who use drop shipping generally aim to increase their profit margins by keeping less inventory on hand and forgoing the need for expensive warehouse space. What they give up in return is control. That’s why Cataudella became a drop-shipping dropout. He not only sweated out deliveries promised to his customers but also lacked important details if customers called about orders. “We were walking on eggshells,” he says.

To hand over order fulfillment completely to outside firms, Sroge says, is to risk disappointing customers with delays and other hassles. If the supplier makes a mistake or can’t follow through fast enough, customers turn to the retailer for answers, not the distributor.

More and more retailers aren’t willing to take those risks. They’re buying or building warehouses, stockpiling inventory and bringing shipping in house.

“Controlling the fulfillment system in-house is key to success in e-commerce,” says Diane Hourany, vice president of operations at Pets.com. “The only way to be 100 percent certain that every customer is going to get the attention and care they deserve is to do it yourself.”

As a Web store’s transactions increase, so can headaches from drop shipping. According to a recent report from Forrester Research, e-retailers should tackle order fulfillment and other back-end logistics with the same zeal that they have front-end sales, especially as traffic speeds up. And if Forrester’s projections come to pass, Internet retailing is headed for warp speed. The Cambridge, Mass., firm foresees online sales increasing 750% across all categories, reaching some 2.1 billion online orders by 2001.

Built for speed

Web retailers already are acting to keep up with higher volumes and deepen their selections this holiday season and beyond. In June, eToys opened a 400,000-square-foot fulfillment center in Danville, Va. Amazon.com plans to have 3.5 million square feet of distribution space ready for throngs of Christmas shoppers. And online grocer Webvan, which filled its first orders only this June in Oakland, Calif., has signed a contract to build a national network of warehouses costing $1 billion overall. “These people are not dummies,” Sroge says. “They are not building warehouses because they want to. They’re building warehouses because they have to.”

Pets.com is gearing up for an influx Christmas shoppers by opening a 140,000-square-foot distribution center in Union City, Calif. Hourany says the facility is a boon to selection: It will allow the company to more than triple its product offerings—from 12,000 to 40,000 items.

Pets.com used to rely on relationships with a network of distributors to ship goods to its customers. Its shift to buying direct from manufacturers allows the company to outpace even bricks-and-mortar pet superstores in product selection, especially when it comes to hard-to-find items made by smaller companies.

But for all these high profile moves away from drop shipping, supporters of the model say the reasons why some retailers use it remain just as strong. Drop shipping is a challenge to manage, but virtual is still the name of the game in e-commerce, says Greg Girard, a retail application strategies analyst with AMR Research in Boston. A hallmark of pure-play Web retailers is lower overhead that results from outsourcing supporting services and concentrating on selling. “E-commerce will actually drive more of these kinds of relationships,” he says.

The mixed model

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As long as retailers and their shipping partners can develop good technology and good processes, Girard contends, drop shipping will remain a Web fixture. “Drop shipping can be a slow, clunky system,” he says. “But when you scale up and go to a high volume of sales, drop shipping can be part of your overall inventory deployment plan.”

Even retailers with warehouses often drop ship certain items. Under this mixed model, retailers arrange with manufacturers to ship specialty or rarely ordered items, while keeping stocks of high-volume items to ensure they can handle the demand. In other cases, a retailer can use drop shipping to test the popularity of new products without the risk of carrying an inventory.

The wisdom of drop shipping also varies from category to category. In the computer business, there’s no compelling need to invest in huge back-end fulfillment systems, says Jeff Sheehan, chief operating officer at Onsale.com in Menlo Park, Calif. The retailer operates two businesses: Onsale atAuction, a large auction site, and Onsale atCost, which sells computer products at low prices.

When Onsale.com launched Onsale atCost earlier this year, managers opted to work with third-party distributors rather than handle inventory internally. “There was no need for us to take on an inventory risk,” says Sheehan.

Through agreements with distributors, Onsale.com offers 35,000 products—everything from desktop units, notebook computers and cables to built-to-order systems. Onsale’s e-commerce system automatically checks inventories before a customer completes an order, and its customer service center can track the status of orders 24 hours a day. Customers can find out when their credit card is charged, when the order is transmitted to the warehouse and when an order ships.

Onsale atCost works primarily with Tech Data Corp. of Clearwater, Fla., the world’s second largest computer products distributor. The aim is to leverage Tech Data’s expertise and skill as a distributor, Sheehan says. “We don’t have back-office costs or inventory risks, and no need for our own warehousing or distribution. Tech Data has the same customer service ethos as we do. If a product’s in stock, it goes out on time.” The arrangement, says Sheehan, “makes a lot of sense for us and our economic model. It’s more in line with our mindset. Our inclination is to focus on the front end, not the back end. EBags, another devotee of drop shipping, sees similar benefits. Thanks to arrangements with about 100 manufacturers, the e-retailer can put most of its capital into marketing and advertising, says Andy Youngs, vice president of merchandising. “If you’re doing drop shipping correctly, it shouldn’t be a problem.”

The company requires its manufacturing partners to set up accounts with United Parcel Service, which handles the logistics and shipping. To check on their orders, customers use the eBags site to tap into the UPS tracking system. Most orders ship within 48 hours, and everything carries an eBags label.

Still Youngs acknowledges the challenge of staying on top of arrangements with so many manufacturers. But the payoffs are big. Youngs estimates that eBags saves at least 20 percent per transaction by using drop shipping over inventory.

All the same, Sroge contends that drop shipping won’t work over the long haul because it simply isn’t fast enough. In the catalog industry, no major retailer uses drop shipping to fill all of its orders, he says. “All of the big catalogers realized that they needed warehouses from the start...It’s the only way. You have to have the merchandise on hand to get it out to the customer.”

Though the Internet is a new sales channel, customers expect a short learning curve from a medium that promises instant response—as well as reliable, speedy delivery. With customer acquisition costs running as high as $100 per, a retailer that constantly churns its customer base will eventually burn out.

“The only way to make money is from repeat customers,” says Sroge. “People have to be satisfied or it is just not going to work. If you went into a retail store and wanted to buy something and it wasn’t there, you’d walk out. This is an instant gratification society.”

And that’s why Tronix’s Cataudella intends to keep his hands on every aspect of his business. Even when he used drop shipping, it was a last resort during holiday crunch times. “It is nerve-wracking, not being able to see the products leave in front of you,” explains Cataudella. “We are a small company, but we are well-known in the gaming industry. Our reputation matters.”