There’s a natural tension between stocking enough inventory to serve your customers and the financial cost of carrying too much inventory. If you fail to have enough of the right inventory on hand, you risk disappointing a customer who now must wait longer for an order and, as a result, may look for another source. At the same time, the meter is running on your costs to carry and sell your inventory.
Despite advances in predictive analytics, inventory management can still be a gamble in the post-pandemic era, when many longstanding inventory strategies have been turned upside down. Should you plan on just-in-time or order extra for just-in-case scenarios?
Your partners in the finance department tend to zero in on the numbers. Meanwhile, supply chain teams are motivated by pushing for higher service levels — often without balancing expense and performance considerations. Your CFO might look for lower inventory levels, while your sales and customer service staff will want to fulfill customer orders as quickly as possible.
Both perspectives have merit. But there’s a better way to manage the tensions that result. The most cost-effective inventory is the inventory that doesn’t exist on your books, and the best way to keep inventory off the books without losing fulfillment capacity is through dropshipping. Dropshipping helps you optimize your supply chain by delivering to end-users directly from the distributor’s warehouse with faster lead times and lower shipping costs.
U.S. retailers are sitting on
$740 billion in unsold goods1
What is dropshipping?
Dropshipping is a wholesale fulfillment model in which businesses outsource the procurement, storage, and shipping of products to a third party. The seller never takes possession or handles the product.
It’s the alternative to a traditional third-party logistics (3PL) model that outsources stocking and fulfilling company-owned inventory from a vendor-owned warehouse or distribution center.
Dropshipping has been behind some of the biggest success stories of the e-commerce era, including Amazon. It’s the secret behind subscription boxes and companies with a vast catalog of items available at the click of the Buy Now button. Now, more traditional B2B and B2C companies are adopting the practice to reduce inventory costs and improve customer service.
How does it work? Your customer places an order. Your company’s order management system forwards the order to the distributor, who picks, packs and ships the order to the consumer. Your company doesn’t touch the product — dropshipping enables companies to sell goods they don’t own.
While dropshipping has been emphasized for consumer e-commerce, it’s also becoming a more common option for B2B distributors in a range of industries. Dropshipping enables a distributor to compete with national rivals in other markets without having an operational presence. It relies on the virtual inventory and capabilities of the wholesaler.
As a service offering from a wholesaler, the cost of items will be a few points higher than direct from the manufacturer. Companies often focus on buying at the lowest end stock cost and overlook the advantages of buying wholesale.
The product may cost slightly more, but wholesale distribution and especially drop shipping can increase inventory turns and free up cash flow. Depending on payment terms, you could generate revenue for the order before you pay the distributor for the product or within a few days.
“Distributors reduce their inventory position 60% through wholesale solutions – generating cash flowequivalent to 9% of cost of goods sold,” said Doug Weber, supply chain strategist with Essendant, a wholesale distributor and 3PL provider. “Companies typically realize the free cash flow in about 90 days.”
The decision of whether to use wholesale or manufacturer-direct buying and then embrace dropshipping is based on deep analysis of a company’s sales history and forecasts down to the SKU level.
For many companies, the ideal solution is a mix of manufacturer-direct buying and wholesale, with opportunities for dropshipping along the way. For example, it may make sense to stock high-velocity items from the manufacturer, while slower-moving nuisance items ship as needed from the wholesaler.
As a component of a company’s fulfillment strategy, dropshipping offers an array of financial and operational benefits that will delight the CFO and keep the supply chain humming.
Distributors reduce their inventory position 60% through wholesale solutions – generating cash flow equivalent to 9% of cost of goods sold.
Doug Weber | Supply Chain Strategist
How dropshipping can improve financial performance
Getting inventory right is one of the biggest issues in the supply chain today. Over the past few years, companies suffered as much from too much inventory as too little. Rising inflationary pressures mean every company must manage cash flow. Inventory on the warehouse racks is like money sitting on the shelf.
Despite vast improvements in demand forecasting, it’s not an exact science. “Best in class is 70% to 75% accuracy; it’s not possible to get it 100% right all the time,” said Bart De Muynck, a strategic advisor for the supply chain industry.
Companies that buy manufacturer-direct may face lead times of up to 10 to 14 days, which translates to nine inventory turns a year. By working with a wholesale distributor, lead times could fall as low as the next day. Increasing inventory turns, even incrementally, can significantly impact the company’s financial position.
“You’re going to reduce inventory layers, and that frees up cash you can invest in other categories and capabilities,” Weber said.
CFOs may balk at higher pricing for wholesale buying, as the wholesaler adds margin for their part in the supply chain. However, companies get the benefits of working with an experienced wholesaler that can lower the total cost of goods sold.
ROI of increasing inventory turns:
- Reduce inventory cost
- Shorten cash cycle
- Improve resilience and agility
- Get favorable pricing terms
- Mitigate risk of stockouts
For example, Essendant uses data analytics tools to calculate the results of a wholesale engagement based on years of transaction history. The average cash cycle is 53 to 55 days. Transitioning to wholesale can reduce the cycle to 15 days. Depending on the terms with Essendant, dropshipping allows the seller to generate revenue 30 days before payment is due to Essendant.
Companies often take small steps toward wholesale buying with a product line that’s a slow seller and has high minimum order levels direct from the manufacturer.
“Distributors consider those nuisance lines, and those types of product lines are better relegated to wholesale than direct,” Weber said.
While lowering inventory costs is critical, companies can’t overlook margins. There’s no one-size-fits-all answer. Look at specific products and the market forces involved. For example, products with a petroleum base could be subject to frequent price increases that could change the margin equation.
You need to look at the overall competitive landscape to see which metrics they need to focus on.
Bart De Muynck | Strategic Advisor for the supply chain industry
How to use dropshipping to optimize your supply chain
There’s a difference between an efficient supply chain and an optimized supply chain. An optimized supply chain is built on flexible order requirements and short lead times. Flexible order requirements allow distributors to purchase product at efficient levels without creating surplus inventory. Short lead times (one to three days) maximize forecasting accuracy and reduce inventory.
One of the most critical factors in favor of wholesale buying is lead time for product fulfillment. Buying manufacturer-direct typically involves extended lead times for the large minimum quantities, often 10 to 14 days at best. Wholesale solutions with low minimum order quantities offer lead times of one to three days, vastly increasing inventory turns. Dropshipping cuts those lead times even more without the overhead cost of inventory.
Companies should improve their access to actual lead time data so they can better plan their inventory, replenishment and demand planning. The data the supply chain creates is starting to play a bigger role in strategic planning, not just for execution.
Bart De Muynck | Strategic Advisor for the supply chain industry
These days, shipping times are a major consideration in the buying decision. Consumers expect fast shipping without paying for it. Competing on shipping time and cost is tough if you only have a few distribution centers across the country.
Dropshipping can give your company nationwide reach without adding locations. You can promote low-cost or free two-day shipping and fulfill products from the distributor’s location nearest the customer. Doing this lets you improve customer satisfaction and sales without breaking the transportation budget.
Dropshipping from the wholesale distributor allows companies the freedom to experiment with new lines without heavy investment. You can try small runs and then gauge the response to see if it makes sense to add those lines to the list of products kept in stock.
Fill rates are another key metric. You might argue that investing in inventory will ensure higher fill rates for better customer service. However, Essendant’s research shows no correlation between higher inventory investment and enhanced fill rates. Fill rates are driven by accurate forecasting, which is best achieved through a shorter planning horizon.
Quick wins come from the targeted use of wholesale buying. By converting the bottom third of slow-moving items to a wholesale solution, you can lift the performance of the total inventory. Some large manufacturers encourage their distributors to buy a portion of goods from wholesale because it increases inventory turns and makes the overall supply chain more efficient.
Manufacturer direct vs. wholesale buying isn’t an either/ or proposition. Many leading companies use a hybrid of both strategies, tailored to how quickly different products sell. They reevaluate on a regular basis. Depending on factors such as costs and demand, shifting between the two options as needed makes sense.
“You have to align your inventory strategy based on demand patterns,” De Muynck said. “You may have products that turn over once a year and some that turn over once a week. How do you deal with that?”
Use dropshipping for a finance and supply chain win-win
Your CFO may have their eyes on the balance sheet, but other metrics, such as net promoter scores (NPS), weigh heavily on supply chain and customer service operators. Managing inventory well, avoiding stockouts, and low-cost or fast shipping will keep customers coming back. A drop in service levels can be linked to lower customer satisfaction scores and, ultimately, a hit on revenues.
To succeed with wholesale and dropshipping, changing your perspective about how much inventory you need to stock is critical. Accumulation of safety stock or just-in-case inventory in the warehouse prevents an organization from investing in growth. It’s common for companies to shift to wholesale buying to support a larger financial strategy.
“Our customers often know how they’re going to use the additional cash flow, whether to add new products or categories, or build up e-commerce capabilities,” Weber said.
Ultimately, dropshipping creates opportunities for operational efficiencies, organic growth and category expansion.
“To get the full benefits, companies must understand how their products move, with insights into SKU velocity, and then be able to make the calculations of one versus the other,” De Muynck said. “It will take some deep analysis to find that tipping point.”
1 “Thinking beyond markdowns to tackle retail’s inventory glut,” McKinsey, https://www.mckinsey.com/industries/retail/our-insights/thinking-beyond-markdowns-to-tackle-retails-inventory-glut