304: Dropshipping – Everything You Need To Know With Steve Chou

Podcast: Download (Duration: 28:19 — 32.7MB)

Dropshipping trades near-zero startup cost for margins of 10% to 30% instead of the 50% a traditional store earns, plus customer service headaches you cannot control. It works as a stepping stone for validating products on a tight budget, and it works poorly for anyone trying to build a brand.

I get 30 to 35 emails a week asking how to start dropshipping, and I am not a fan of the model. This episode gives the balanced picture rather than the pitch.

Below is everything: how dropshipping actually works, how to find and vet real suppliers, the pros, the cons that surprise people, the variants you should avoid entirely, and the specific situations where it is the right call.

Key takeaways

• Dropship margins run 10% to 30% versus roughly 50% for a store carrying inventory.
• A real wholesaler never charges a monthly fee for catalog access and never sells to consumers at wholesale.
• You are the face of the business. Customers do not know your supplier exists, so returns and support are yours.
• Multiple suppliers means multiple shipments and multiple shipping charges on a single order.
• Ask about EDI upfront. Without it your inventory counts will never stay accurate.
• Negotiate quantity discounts before you grow, because leverage disappears once the supplier knows you need them.
• Amazon-to-eBay and AliExpress-to-Amazon dropshipping are against platform policy. Do not do either.
• Use dropshipping for product validation, then buy inventory for whatever sells.

What dropshipping is and how it works

Dropshipping is an ecommerce model where you sell physical products without holding inventory, owning a warehouse, or handling shipping.

Your supplier handles fulfillment. An order comes in, you notify your dropshipper, and they ship directly to your customer on your behalf.

The mechanics run in four steps. The customer orders on your store and you collect the money, you forward the order and shipping details to your supplier and pay the wholesale price, the supplier packs and ships it as though it came from you, and you keep the difference.

Startup cost is effectively nothing. An open source shopping cart runs under three dollars, and you need only a website and credit card processing to start taking orders.

My nine and eleven year old kids launched a dropshipped store selling entrepreneurship t-shirts for $2.95 a month, which you can see at kidincharge.com.

How much money you can make dropshipping

Typical dropship margins land between 10% and 30%, well below the roughly 50% gross margin of a store carrying its own inventory.

The range depends heavily on how crowded your market is and how price sensitive your buyers are.

Higher outcomes exist in the right niches. I have friends hitting 50% to 60% margins dropshipping perfume, jewelry, and oversized items like stoves and outdoor grills.

One colleague dropships personalized funeral urns and caskets at high margins, specifically because that niche is not price sensitive.

The upside is scalability. Without inventory or fulfillment to manage, all your effort goes into marketing and sales, and overhead does not grow linearly with revenue.

How to spot a fake dropship wholesaler

Two rules separate real distributors from the scammers who crowd this space.

A real dropship wholesaler never charges a monthly fee just for access to their catalog. Distributors exist to sell product in bulk rather than to run a membership site.

A real dropship supplier never sells its own products to consumers at wholesale prices. Their primary customer is a retail shop, and undercutting their own customers works against them.

Where to find real dropship suppliers

The most reliable method is calling the manufacturer directly and asking for a list of their wholesale distributors.

Then contact those distributors and ask whether they will dropship. Most carry products from many manufacturers, so landing one large distributor often gives you access to a wide catalog.

Come prepared, because legitimate suppliers only want legitimate retailers. We get asked to dropship Bumblebee Linens products constantly, and what a distributor needs to see is that you are serious and can actually move product, starting with a real website.

The competitor method works when you know a rival dropships. Place an order on their site, then check the return address on the shipping label when it arrives, and Google the address to identify the distributor.

Trade shows concentrate vendors in one place, let you handle the entire product catalog, and make relationship building far easier. Most US trade shows are free with a business license, and major cities host them across many niches throughout the year.

Directories like Worldwide Brands pre-vet their listings, which is convenient for brainstorming. The tradeoff is that every other member has the same access, so those products are more competitive. I held a Worldwide Brands membership for ten years and no longer use it.

How to vet a dropship supplier before committing

Your business hinges on supplier quality, so place a test order before relying on anyone.

Check how fast the order ships, since one to two business days is the standard an ecommerce store needs.

Check how it arrives. Whether it is shoved in a poor box with packing peanuts, and whether the box is unmarked rather than carrying the supplier’s business name.

Check their customer service. Response times, tracking information and invoices, and whether they refund defective merchandise and returns.

What to ask a dropship supplier upfront

Ask whether they can customize orders, including inserting your own marketing materials into the box.

Ask about pricing terms and quantity discounts, and negotiate those price breaks before you grow. Waiting until you have hit a milestone means the vendor knows you need them and has less reason to move.

Ask what their per-order dropship fee is, since most charge one for packing each shipment.

Ask about the return policy, because returns come back to you rather than to them, and you need to understand how to get your money back.

Ask whether you can buy items wholesale at lower prices, since carrying inventory on your best sellers earns a higher margin. Wholesale pricing should sit below your dropship pricing.

Ask whether they use EDI, electronic data interchange, which transmits their stock levels to your site in real time and keeps your inventory in sync.

Finally, ask for a single point of contact for support issues. Products go out of stock, products get discontinued, and shipments miss deadlines, and you need a person to call.

How returns work on a dropshipped order

You accept returns and provide support for defective merchandise even though you never touch the product.

The reason is that your customer has no idea your supplier exists. As far as they are concerned, you are the supplier, which means you cannot lean on your vendor for customer support.

The sequence runs through five steps. The customer contacts your support asking for a refund, you contact your supplier for an RMA number, the customer ships the product back to your supplier with the RMA clearly marked, the supplier refunds the wholesale cost to your account on receipt, and you refund your customer.

Restocking fees complicate it further. Your supplier may charge one, and you either pass it to the customer or absorb it.

What happens when a dropshipped product is out of stock

Communicating the stockout is your responsibility, not your supplier’s.

Give the customer three options: wait for restock with an estimated arrival date, exchange for something else, or take a refund.

This is also where the lack of EDI hurts most. Most vendors do not use it, so you will be interfacing with customers manually about availability, and keeping accurate inventory counts is difficult unless your cart is tied into your supplier’s database.

Why multiple dropship suppliers create problems

A customer ordering across three distributors receives three separate packages at three different times from three different locations.

You get charged separate shipping by each supplier, so you either raise shipping prices to break even or absorb the difference.

Either way you have to warn the customer, so they are not confused when packages arrive piecemeal.

Time-sensitive orders make it worse, since every distributor in the chain has to hit the deadline.

The structural problem is that you have linked your store’s reputation to every distributor you use. One unreliable supplier reflects on you.

The real advantages of dropshipping

Startup costs are effectively zero. No upfront inventory, no warehouse, no overhead, and I cannot name a less expensive business model to start.

Risk scales with that. Investing almost nothing means there is almost nothing to lose, and no inventory means no pressure from carrying costs.

Product variety is unlimited. Browse a directory or walk a trade show and you will find suppliers in nearly every niche, and you can carry one product or thousands without storing any of it.

It is entirely location independent. No office, no warehouse, no employees, so your effort goes to growth rather than logistics.

That combination makes it one of the most scalable ecommerce models available, and I know several people running good-sized dropship businesses with a handful of employees.

Why dropship margins hurt more than the number suggests

Most people expect the same wholesale pricing everyone else gets, and distributors tack extra fees onto the quoted wholesale price.

Put yourself in the distributor’s position. Selling a bulk quantity once is materially different from picking, packing, and shipping onesie-twosie orders individually, and that labor shows up in your price.

The margin gap is the consequence. Ten to 30% for dropshipping against roughly 50% for a store carrying inventory.

That gap does more than reduce profit. It limits your ability to advertise on Facebook and Google, where you are bidding against competitors with twice your room.

It also degrades your customer service. Our store runs 70% to 90% margins, so an angry customer gets a refund and keeps the product. At dropship margins, that generosity is unaffordable.

Why customer service is the biggest dropshipping risk

Your online reputation can make or break the business, and dropshipping puts most of it outside your control.

News of a botched transaction spreads fast through social media, so maintaining a good image matters enormously.

Referrals are what this protects. Whenever a call comes into our wedding linen store I ask how they found us, and most people were referred by a friend.

With dropshipping you cannot control when a customer receives their product, and returns are a genuine pain because you have to recover your money before refunding theirs.

Mitigations exist, and all of them involve either raising prices or accepting a profit hit.

How Amazon made dropshipping less attractive

Before Amazon, distributors needed traditional retailers and dropshippers to reach the mass market.

Amazon now controls enough of ecommerce that most companies can sell directly as third party sellers, with Amazon handling sales, fulfillment, and customer service.

The distributor keeps the extra margin that used to flow to retailers like you.

If you dropship products also available on Amazon, competing on price is impossible and your leverage is minimal. Given the choice between Amazon at a lower price and an unknown shop at a higher one, most consumers pick Amazon.

Dropshipping models to avoid entirely

Amazon-to-eBay dropshipping means listing an Amazon product on eBay at a markup, then buying it on Amazon and shipping to your eBay customer.

That is no longer allowed. eBay permits dropshipping only when orders are fulfilled by a wholesale supplier, and fulfilling from Amazon, Walmart, or any other marketplace can get your account banned.

AliExpress-to-Amazon dropshipping works the same way in reverse, listing an AliExpress product on Amazon and fulfilling from AliExpress when it sells.

Amazon’s policy mirrors eBay’s, requiring fulfillment from a legitimate wholesale supplier. It also relies on an ePacket shipping loophole that will not last.

When dropshipping actually makes sense

The strongest use is product validation.

Without inventory to buy, you can stand up a store with hundreds of products quickly, see which ones sell, and then buy inventory for the winners at proper margins.

The other good use is filling out an existing store with sparse categories, adding breadth without tying up capital.

Beyond that, it fits new entrepreneurs on a genuinely small budget who want a stepping stone into ecommerce before moving to a more profitable model.

When to avoid dropshipping

Avoid it if you are building a brand, because you are selling other people’s products and cannot differentiate.

Too much of the experience sits outside your control. The unboxing experience is not yours, late or missing shipments are blamed on you, and a hot product with an out-of-stock supplier earns you nothing.

Your dropship business lives and dies by your suppliers, and unreliable ones end it.

The three conditions that rule it out are wanting to build a brand, wanting high margins, and wanting exclusivity. Dropshipping offers none of them.

Is dropshipping actually less work?

The time you save on inventory and fulfillment gets spent on customer service, unless your distributors are unusually reliable.

Without EDI you are manually handling stockout communication, and accurate inventory counts stay difficult.

So the real trade is fulfillment logistics for customer service headaches, and whether that is a good deal depends on your temperament.

Plenty of people succeed with it, and it works particularly well for small niche stores. My own recommendation is to avoid it where you can.

Frequently asked questions

What margins can you expect from dropshipping?

Typically 10% to 30%, against roughly 50% for a store carrying inventory. Non-price-sensitive niches like perfume, jewelry, oversized goods, and funeral urns can reach 50% to 60%.

How much does it cost to start a dropshipping store?

Practically nothing. An open source shopping cart costs under three dollars, with no inventory, warehouse, or overhead required to start taking orders.

How do you tell a real dropship wholesaler from a fake one?

A real wholesaler never charges a monthly fee for catalog access and never sells its own products to consumers at wholesale prices, since that would undercut its retail customers.

Who handles returns in a dropshipping business?

You do. The customer does not know your supplier exists, so you take the return request, get an RMA from your supplier, and refund the customer after the supplier refunds you.

Is dropshipping from AliExpress to Amazon allowed?

No. Amazon requires fulfillment from a legitimate wholesale supplier and can ban accounts that fulfill from third party marketplaces. eBay has the same rule about fulfilling from Amazon.

What is EDI and why does it matter for dropshipping?

Electronic data interchange transmits your supplier’s stock levels to your website in real time. Without it, keeping accurate inventory counts is difficult and stockouts become manual customer service work.

Can you build a brand with dropshipping?

Not really. You are selling other people’s products with no control over the unboxing experience, shipping speed, or stock availability, which are the things a brand is built from.

When is dropshipping a good idea?

For product validation, for filling sparse categories in an existing store, and as a low-budget entry into ecommerce before transitioning to a model with better margins.