Dropshipping: To Own a Facility or to Contract Out?
Updated: Aug 24, 2022
You've made the decision to launch a dropshipping segment of your business. Now, you need to decide whether to invest the capital to launch your own facility or initiate a relationship with a 3PL partner. There are pros and cons to each, so it's important to understand all facets before determining which direction you go with your business. I will cover all of them throughout this multiple blog series.
Today I'm focusing on what I deem to be the most important; the financials. There are two sides to the financials that are key to your decision-making. The first is understanding your product financials. More specifically, the gross margin you realize on each unit sold. When considering this, the gross margin percentage isn't as important as the absolute dollar margin, commonly referred to in retail as "Penny Profit." The second aspect is the cost to dropship that unit to the customer.
The difference between these two amounts provides you with the ceiling of how much you can spend to process and ship a unit to a customer and still break even. Once you understand this, you can now evaluate the cost structures of operating your own drop shipping fulfillment center versus contracting with a 3PL.
Building Your Own Facility
If you set up an internal dropship operation, you'll need to factor in a full range of start-up costs. These include:
securing a lease and the associated security deposits
setting up utilities
purchasing equipment, racking, hardware, and software.
The list can go on almost indefinitely before you are ready to process and ship your first unit.
Then you've got to understand your ongoing monthly costs. These are fixed costs and include everything you will incur regardless of how many orders and units you process that month.
Then there are your variable expenses. These include everything from labor to shipping supplies, everything you will incur with each unit you process.
When you are just starting up your operation, this processing cost will be astronomical due to lack of volume. One facility I opened had an initial cost per unit the first month of $37. However, the benefit of running your own operation is that as order volume grows, you start to leverage those costs. After just nine months and scaling to process more than 5,000 orders per month, we had reduced that $37 processing cost down to just $3.75 per unit, a range that made our clients profitable after just six months.
Working With a 3PL
The benefit of this cost structure is that there is no large initial upfront capital investment. You provide the inventory, set up a communication system, and the 3PL provides the infrastructure to immediately begin processing your orders. However, there is a fee for everything associated with your product, including:
receiving it into the facility,
moving it around the facility
Any functions and materials necessary to successfully store and ship your goods have fees associated with them. Since this is set by a predetermined rate card, there is no leverage gained as volume increases. You pay the same cost for the first unit as you do the ten-thousandth unit.
This is why understanding your financials is so important. In most cases, it will be beneficial at the launch of your dropship business to utilize a 3PL. While volume is low and your business gains traction, a 3PL allows you to ship a significant level of volume with the same amount of money you would have had to invest just to build out a facility and produce no volume. But there will be a breakeven point at which volume exceeds the initial investment capital you would have spent to build out your own facility. You will also begin to leverage that higher volume to reduce your processing costs below what you are spending on 3PL processing. At that point, you will want to seriously consider making the leap to launch your own facility.
Missing just one of these factors could mean the difference between a short-lived experiment and a long-term profit stream for your company. Understanding your financials at this depth can be a daunting task, especially if you don't have the expertise in-house to begin the analysis. Peak Velocity Consulting is here to solve this problem and "Ship Your Business Forward."