OPERATIONS

Can E-tailers Find Fulfillment With Drop Shipping?

Drop shipping could help E-tailers completely avoid the enormous costs and risks involved in inventory, warehousing, and fulfillment. But is it the right solution?
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"Drop ship for huge profits!" "Put a drop shipping wholesale company to work for you!" "Drop shipping has opened the door to many e-commerce startups..." "Tap the power of drop shipping!" "A low-risk way to build direct marketing profits!" "No investment! No inventory!"

Current Web come-ons from some wholesalers make drop shipping -- also known as virtual order fulfillment -- sound like the greatest thing that's happened to retail since sliced bread. And the prospect is mouth-watering. Consider this scenario: You establish a Website and advertise products on it -- anything from sporting goods, books, or bath and body products to astronomy equipment, software, home and garden dé cor, wedding supplies, lingerie, or vitamins. When customers send in orders, you simply forward them to your wholesaler or distributor, who ships the orders directly to customers' homes with your company's label on them. You completely avoid the enormous costs and risks involved in inventory, warehousing, and fulfillment. It sounds too good to be true. Is it?

For some e-tailers, drop shipping has actually proved the goldmine it is touted to be. Forbes reported in February 2000 that the CD retailer Spun.com avoided an $8 million investment in inventory by using the fulfillment capabilities of wholesale distributor Alliance Entertainment. Spun.com is still thriving, having recently sold the business to Idealab, a major Internet incubator, while retaining managerial control. In contrast, one of Spun's chief competitors, CDNow, which had its own inventory and fulfillment, has gone bankrupt. The authors say that currently 30% of pure-play Internet retailers use drop shipping as their primary order fulfillment mechanism, and the trend is growing.

But for others, drop shipping has contributed to their downfall: According to an August 2000 article in the now-defunct Industry Standard, when virtual retailer Value America declared bankruptcy, it cited in part an inability to fill customer orders from virtual stocks.

Of course, it can be hard to pinpoint what makes a company collapse: Order fulfillment is one factor among many. But according to Wharton professor of operations and information management Serguei Netessine, successful order fulfillment can often make or break a company, especially an e-tailer. Netessine, along with Taylor Randall of the David Eccles School of Business, University of Utah, and Nils Rudi of the W. E. Simon School of Business at the University of Rochester, has written a paper entitled Virtual Order Fulfillment: Key to Success or Path to Failure? (Netessine and his colleagues refer to drop shipping as virtual order fulfillment because they claim that it constitutes a "virtual" supply chain.)

"If you look at all the Internet retailers that died, many of them blamed their [demise] on order fulfillment," says Netessine, adding that this has been the case whether a company used virtual or traditional fulfillment. While Value America may have lost too many customers because of drop shipping inadequacies, Webvan lost all its cash by spending millions on warehouses.

If switching to the new virtual fulfillment system doesn't work for everybody, who does it work for? The authors conducted interviews with, and did statistical analyses on, 54 publicly-traded Internet retailers that sell a wide variety of consumer goods. They found "that if an Internet company chooses its supply chain type logically -- if it's aligned with its strategy, products, and operating environment -- it's highly correlated with success," says Netessine. In fact, he adds, it correlates much higher than other more commonly adopted measures of financial performance. The authors maintain that "firms making irrational supply chain choices are twice as likely to go bankrupt than those making rational choices." They outline a set of measures that can help a company determine its optimal order fulfillment path.

Randall, Netessine, and Rudi first discuss the potential advantages of using the virtual setup: a greatly reduced investment in inventory and fulfillment; the ability to offer a wider product selection to customers; greater product availability; savings on product handling and warehousing (because the wholesaler can achieve economy of scale), and reduced transportation costs, as the cost of shipping the item to the retailer first is eliminated.

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Last updated: Jul 18, 2002




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