Business Model Cuts Your Inventory — and Control

Eli Williams’ path to his current business started with a closet full of sunglasses.

Actually, two hallway closets in his 700-square-foot New York apartment. In a previous e-commerce venture, Williams and his then-roommate sold sunglasses online, and they stored their product in the cheapest place available.

“I saw that inventorying thousands of products … can be both risky and expensive,” Williams, 28, writes in an email. The difference with Foundry35, his current business: the online retailer of hunting, fishing and outdoors supplies actually never owns any of the products it sells. Rather, it fulfills its orders via dropshipping.

» MORE:How to start a business: A step-by-step guide for entrepreneurs

Dropshipping 101

Business that use dropshipping don’t carry their inventory, meaning they don’t burn through cash buying and warehousing what they sell. Instead, after orders come in, they buy products from a supplier – a wholesaler, a manufacturer, even another retailer – who ships directly to their customers.

This business model removes one of the more time-consuming and potentially fraught aspects of running a product-based operation: managing inventory. When you carry inventory, you’re under the gun to sell it. If you can’t, it may be impossible to recoup the money you spent purchasing it.

Dropshipping requires little initial investment, has low operating expenses and offers flexibility. At its most basic, you can start a store with your computer and a credit card. But there are challenges as well, such as intense competition and limited control over your product. And you probably shouldn’t expect to get rich quick, or even rich at all.

There’s still a lot of work to do

The main attraction of dropshipping is the low cost to get started. Set up an online storefront on Shopify or Amazon , pick products, then get them from your supplier when the orders come in. Dropshipping can be used with an array of mass-produced consumer products. Toys, shoes and watches are popular examples.

But once you’ve hung your virtual shingle, what’s next? Running a dropshipping business is a lot like running any other kind of business. You still have to build a brand, get customers and handle customer service. The list goes on, and it all takes attention to detail and effort.

“It’s not a set-it-and-let-it-go business,” says Brian Brewer, an entrepreneur in Plano, Texas, who offers e-commerce training.

Here are a few tips on running a dropshipping business.

Find a product niche

Brewer recommends picking a category of products that satisfies a passion in your customers for which they’ll pay higher prices. Golf, yoga and jewelry are good examples.

To get customers, you should be a savvy digital marketer, adept at search engine optimization and social-media advertising, Facebook in particular. There’s also that durable mainstay, email.

Whatever the method, hawk your site to potential customers repeatedly to build a core customer base, Brewer says. “You can make a very good living advertising to the same 1,000 people.”

Get ready to rumble

Because it’s so easy to start a dropshipping business, competition is fierce, Williams says.

In such a crowded market, you must price your product to compete with others selling similar items, including big online retailers like Amazon. To be profitable, you also must also predict and manage your own expenses. Shipping costs and the price you get from your suppliers could be the difference between making and losing money.

“If you underestimate the costs and fees of selling your products, you can quickly dig yourself into a hole, and for a young business, that can be tough to recover from,” Williams says.

Get Your Free Personal Credit Score Every Week from NerdWallet

• Open more doors for financing your business.
• Set your goals and track your progress.
• Signing up won’t affect your score.

Get your credit score

Be a coldblooded data expert

Because it’s so competitive and the margin for error is so small, dropshipping is “all numbers, all the time,” says Williams, who majored in math at the Massachusetts Institute of Technology and later traded derivatives on Wall Street.

To get your revenues and costs straight, you need be comfortable with using spreadsheets to crunch the data and decipher it. Then you have to determine what action to take, if any.

You should “be completely objective about the profitability and viability of selling certain types of products” and not hesitate to move to a different niche if the first isn’t working, says Williams, whose business originally sold products for drones and 3D-printing.

Know the tradeoffs

In addition to low startup investment and lack of inventory costs, dropshipping is a flexible business, particularly if you’re a one-person shop and you work out of your home. If you want to go on vacation or shut down during slow months, you can, Brewer says.

There are, of course, tradeoffs. Not carrying inventory means you don’t have much control over the supply or quality of your product, or shipping times. That’s up to your supplier, who for many dropshippers is a Chinese manufacturer on the other end of an AliExpress transaction.

Dropshipping is also “fundamentally a low-margin business,” Williams notes. Revenue can sink when you have to compete on price, and product costs can balloon because you’re at the mercy of suppliers.

“Ultimately, dropshipping was a good way to quickly enter into a different market,” he says, “but in the long run I think it may play a diminishing role due to extremely high competition and lower margins.”

More on small businesses

Andrew L. Wang is a writer at NerdWallet. Email: [email protected]. Twitter: @andrew_L_wang.

The article Business Model Cuts Your Inventory – and Control originally appeared on NerdWallet.