Increase Margins by Carrying Inventory in Your Dropship Business

In my consulting practice, I often work with entrepreneurs who own dropship e-commerce stores and are struggling to expand. Dropshipping as a business model is getting harder and harder – margins are compressing, niches are getting crowded, and everyone is in a brutal price war with Amazon. As a result, many dropshippers are finding it increasingly difficult to grow top-line revenue, and are looking for ways to grow the bottom-line instead by expanding margins.

One of the best ways for a dropshipping business to expand margins is to do the one thing they’re all scared to do – take on inventory. Although it seems scary, taking on inventory is actually one of the easiest and lowest risk ways to make more profit quickly. In this post, I’ll break down some of the reasons why carrying inventory is a no-brainer home run for most established dropshippers:

• You already know which products move. You have months or years of sales data gleaned from dropshipping these products from your store. You can say with nearly 100% confidence that if you buy X units of your top 10 bestsellers, they will sell in Y months – because they’ve been moving at that rate historically.
• Your margins will double overnight. Standard dropship margins are 20% and sliding toward 15%. And that’s before you pay credit card fees and all your other fixed costs. When you buy a product wholesale, you’ll typically get 40-50% off retail price – on the exact same products you’re already selling.
• You already know all the vendors. You don’t need to spend days researching to find a good and trustworthy vendor, because you’re buying from them already – they’re your existing dropship partners. Simply call them up and say “we are interested in buying wholesale in addition to the existing dropship business we do together.”
• Outsourced fulfillment is easier than ever. It used to be that carrying inventory required a warehouse, staff, and losing several fingers to a tape gun. In today’s world, you can outsource all of that to a 3rd party fulfillment provider like Shipwire. That means your suppliers will ship inventory directly to your outsourced warehouse, and as the orders come in you simply tell the warehouse to ship them out. And that’s the beauty of it – with outsourced fulfillment, carrying inventory feels like dropshipping (with better margins).

Put all of the above together, and you’ll realize that your life and business don’t actually change that much – you’re still selling the same products from the same vendors, except now you’re “dropshipping” from your own warehouse instead of someone else’s.

Once you make the decision to start carrying inventory, there are a few questions you’ll probably end up asking yourself:

• Which products should you carry? It’s easy to think of carrying inventory as an all-or-nothing proposition, but in reality, beginning to carry inventory does not mean abandoning the dropshipping model entirely. My rule of thumb is that you should start by carrying the products that make up the top 10-20% of your revenue, but cap it at 5 items to start. Continue dropshipping the rest as you do today. That lets you capture the largest opportunity for margin improvement, with the least complexity as you get used to carrying inventory. The easiest way to manage this is to simply set yourself up as a dropshipper in whichever software you’re currently using to manage your orders.
• How much inventory should you buy? This will depend on several factors, mostly each item’s velocity (how fast it sells) and the minimum wholesale order required by your vendor. Most vendors require that you purchase at least a certain amount of product to get wholesale pricing – so try to balance that against each item’s velocity and take no more than 6 months of inventory into stock if possible.
• How much will it cost? The biggest drawback to carrying inventory is that you have to “tie up” money in the inventory on your shelves. That’s typically money you will never get back, because you’ll have to buy the next round of inventory while your current inventory is still selling so you don’t run out of stock – there will always be inventory on your shelves. You can estimate how much cash your inventory will tie up by calculating your average inventory value. If an item costs you $100 at wholesale and you must buy 100 pieces – that’s $10,000 total of total upfront investment to buy the inventory. That means your average inventory value will be $5,000 for that item (because you’ll be at an average of 50% in-stock all the time). So you’ll have to pony up $10,000 upfront, and $5,000 of that will be sitting on your shelves for as long as you carry that product. Note also that if your sales volume increases and you start buying 200 units at a time (a $20,000 order), you will require an additional $5,000 of capital because your average inventory value has increased to $10,000.

The last point is the most common reason dropshippers shy away from carrying inventory – it requires capital upfront. Still, it’s an investment that pays back very quickly, because your margins instantly more than double from 15-20% to 40-50%. Almost all of that drops straight to your bottom line. If you’re having trouble coming up with the money for inventory, call your local bank and ask their business banker about an inventory loan. You’ll be surprised at the generous terms they’ll offer, and the interest will be more than covered by your increased margin.

Obviously there are a ton of strategies for expanding your dropship business, but it’s my opinion that adding inventory is one of the highest leverage and lowest risk strategies you can implement. If you own a dropship store, give yourself a Christmas present this year and ask your suppliers about buying wholesale.

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