Black Friday sale: Up to $1400 off bookkeeping, 100% tax-deductible.
We’ll cover fundamentals specific to drop shipping, as well as everything you need to know to get your business legally up and running. And we’ll also dive into topics some first time dropshippers overlook—like figuring out sales tax and setting up your accounting for success.
1. Review the details: What is drop shipping?
Quick refresher: A drop shipping business is an ecommerce business where inventory and shipping are managed by a third party.
You take care of running the online store and advertising products—your specialty is getting customers to the point where they click “Checkout.” Once they pay for a product, you transfer the wholesale price, plus the cost of shipping, to the vendor or vendors supplying the product, and keep the rest for yourself.
The vendor ships the product, and after that, your only job is to make sure it gets to the customer and that they’re happy with their purchase. You can do that by tracking the package and sending follow-up emails to customers to make sure they’re satisfied.
2. Pick a drop shipping method
There are two ways to set up your drop shipping business and get products to customers. One is to connect directly with drop shipping suppliers. The other is to use a drop shipping marketplace.
If this is your first drop shipping business, you’re better off starting out with a drop shipping marketplace, and then establishing relationships with individual vendors. You can see why when we compare the two methods.
Drop shipping directly from suppliers
When you dropship directly from suppliers, you open vendor accounts with them in much the same way you would if you were running a traditional retail store. Meaning, you establish a relationship with them as a seller, with agreed-upon prices and order thresholds.
The only difference between this method and a traditional retail store is that the suppliers will package and ship orders individually. You don’t need to order stock from them, then keep it in inventory and fulfill orders yourself.
The main benefit of this method is that you’ll have a higher profit margin. When you seek out individual suppliers as opposed to using a drop shipping marketplace, it’s less likely that other drop shipping stores will be selling their products. Less competition means less need to undercut other stores, so you can set your prices higher.
But there are downsides to this method if you’re new to drop shipping. Most individual suppliers require a minimum order threshold—meaning you need to maintain a minimum number of orders with them each month. That’s hard to do when your store is brand new. Many suppliers will refuse to work with a new, inexperienced drop shipping business.
On top of that, drop shipping marketplaces streamline a lot of tasks for you. Individual suppliers don’t, so it’s up to you to sink more money into marketing assets and store admin.
Don’t give up now, though. One day, once your store is established and getting lots of customers, you’ll be able to set up relationships with individual suppliers. For now, though, you should set your eyes on a drop shipping marketplace.
Using a drop shipping marketplace
A drop shipping marketplace takes a lot of the footwork out of setting up your online store. Typically bundled with existing sales platforms like Shopify, a marketplace lets you shop around for wholesale vendors, and add products to your store quickly: No contacting suppliers, taking product photos, or building out web pages from scratch.
The benefit of this method is that you get access to millions of products, potentially from wholesalers all over the world. Adding and removing products to your store is almost as easy as putting something in your shopping cart on Amazon. That means you get lots of flexibility experimenting with different products and prices, and figuring out the ideal customers for your store.
The downside is that many other dropshippers get the same, easy access to those products— meaning you’ll have more competition. It takes more work fine-tuning your marketing campaigns and pricing in order to attract customers and make a healthy profit margin.
However, while your drop shipping business is still in the marketing phase, you’ll get the chance to experiment, develop your skills, and hopefully build up enough monthly orders that you can transition to working with individual vendors.
3. Pick a drop shipping marketplace
There are a few things to take into consideration when picking a drop shipping marketplace:
- Platform. Different marketplaces work with different platforms. For instance, if you’re already familiar with Shopify, and you want to open a Shopify store, then Oberlo is your go-to marketplace. On the other hand, if you’re planning to run your store as a Facebook or Instagram account, you may want to choose a marketplace that works with one of those platforms—like Spocket.
- Cost. Many marketplaces are free, but some charge a monthly rate to use them.
- Location of suppliers. Some marketplaces, like AliExpress, will connect you with large scale suppliers in China. Others specialize in smaller vendors located in Europe or North America. The types of products you’re planning to sell will affect your choice of marketplace.
Your best bet is to sign up for different free services, and try them out. This is usually the only way to get a feel for each platform, and to see what kinds of vendors they connect with.
Best drop shipping marketplaces
4. Research your business
Typically, when you start a business, the first step is to do research. That means seeing what your competitors are doing, what demand is like in the market you’re targeting, and what customers are looking for.
But because of the way drop shipping works, you’re able to take a more hands on approach right away.
Research by the seat of your pants
One of the best ways to do research is to start running your business right away.
Trying out new products in your store is typically free. Running test marketing only costs as much as you’re willing to pay. You can start experimenting right away, without doing tons of competitor profiling or market analysis first.
You have the freedom to try different platforms and different marketing channels before settling on just one. So go ahead and start enjoying that flexibility—even if you’re just dipping your toes into drop shipping, and haven’t got your business 100% set up.
Research drop shipping products
For a lot of new drop shipping business owners, trial-and-error research can be thrilling. But if you’re coming to drop shipping with only the foggiest notion of what you plan to sell, and how you’ll market it, you may want to start off with some traditional research methods.
Here are some of the most straightforward ways to narrow down which products your business will sell.
Scout the competition
If you already have a product category in mind, a Google search will quickly give you a taste of your competition. Look at the most prominent sellers for the products you’re considering, and ask the following questions:
- How do they brand themselves?
- What is their social media presence like? How many followers do they have?
- What are they charging?
- Based on the wholesale price of similar products, what kind of profit margin are sellers making?
If there’s no way to compete with other, established suppliers, you may want to try a different category of products. Or, if you think you may be able to offer similar prices, look for an angle that gives you an advantage.
Do your competitors have zero content on their websites, and low follower counts? Those are sales channels you may be able to exploit. Stores full of spelling errors and weird grammar? A more straightforward storefront could make you appear more trustworthy to customers.
Dig through Amazon bestsellers to find gold
Researching on Amazon is free and easy. By checking out best selling products, you can find out what types of items customers are already searching for, and how much they’re willing to pay.
Start with Amazon’s complete directory, and start drilling down through the categories and subcategories.
For instance, did you know that the bestselling novelty item under “Dining & Entertaining” is a Bob Ross coffee mug that paints a soothing landscape when you add hot liquid?
Maybe you can’t find a supplier who ships Bob Ross mugs at a competitive price. But research like this can spark inspiration. Maybe it’s worth exploring nostalgic coffee mugs as a drop shipping product.
Infiltrate a niche market
There are millions of online communities based around users’ passions. Finding an overlooked corner of the internet could unlock a brand new market.
Research hobbies and pastimes, and take a deep dive into Facebook Groups to find the people who are obsessed with them. Specifically, seek out “buy and sell” groups. They’ll show you what people are interested in buying.
Say you want to try drop shipping craft supplies, and you know that polymer clay is a popular material people work with. A quick Facebook search brings up a polymer clay buy and sell group with thousands of members.
But when you join, you find lots of people buying and selling pasta machines. Do a little more research, and it turns out pasta machines are a popular tool for flattening clay.
Now, you can research suppliers who sell inexpensive pasta machines, market them in your store specifically as polymer clay tools, and target enthusiasts with your ads. Best of all, since you’ve immersed yourself in the world of polymer, you’ve already researched which demographics to target.
5. Plan your (small) initial investment
You don’t need much money to start a drop shipping business. In fact, a $1,000 cushion should be enough to help cover the basics—like the cost of setting up an online store, signing up for a paid marketplace plan, and hiring freelancers to design brand assets.
In fact, you’re better off spending as little money as possible while you get started. Hiring designers, programmers, and marketers to run your business for you doesn’t just cost you a large share of your profits: It costs you valuable experience. Creating your business hands on, from scratch, you’ll learn how every part of it works. That gives you total control of how it operates, and also sets you up to create future drop shipping businesses should the inspiration strike.
6. Pick a business structure that protects you
Your business structure establishes how you’ll file your taxes. It also determines your liability. Certain business structures can protect you from being personally being sued, or having your personal property tax levied.
The four main types of business structure are:
Each has its benefits and drawbacks. But, for the sake of starting a drop shipping business, you’ll most likely be forming a sole proprietorship or an LLC.
A sole prop is the default business entity type for small businesses. As soon as you start earning an income on your own—that is, without an employer—the IRS considers you to be operating a sole prop.
An LLC can serve much like a sole prop—you’re still the sole owner of your business—but with added protections. “Limited liability” means your personal and business finances are separate. If your LLC can’t pay its debts, gets sued, or even goes bankrupt, it won’t affect the money in your personal bank accounts. Only your company, as a separate tax entity, it liable.
The degree to which an LLC protects you from liability can vary according to the state where you’re operating. To get a better idea of whether to form an LLC or a sole proprietorship, check out our guide to business entity types.
7. Name and register your business
As soon as you start operating under a title other than your own, you need to register your business name.
Make sure your name is unique
First, do some searching online to see if a similar business is using the same name as your store. Then, visit your county clerk’s office to see if anyone locally is using your name. Finally, if you want to be completely certain you aren’t infringing on someone else’s name, consult with a patents and copyright attorney.
Register your name
If you’re a sole prop, you can register your name by filing a DBA with your state.
If you’re forming an LLC or any other business structure, you’ll register your name when you elect that structure for federal or state tax purposes. However, if you’re planning to operate under a different name than the one you elect—"Paul’s Polymer Boutique” instead of "Paul’s Polymer Pantry”—you’ll need to file a DBA with your state.
8. Get federal and state tax IDs
The IRS uses a tax ID number to keep track of your business when you file taxes. To apply for a tax ID at the state level, visit your Secretary of State’s website.
At the federal level, “tax ID” refers to a variety of different ID numbers, any one of which can serve as your tax ID. That’s a bit confusing. Luckily, it means you may already have a tax ID you can use for your business. To sort it out in plain English, see our guide to federal tax IDs.
9. Apply for local licenses
Luckily, drop shipping is a pretty low impact business. The key components are you, your computer, and somewhere comfortable to sit. Compared to a restaurant or car dealership, the number of permits and licenses you’ll need to operate is minimal.
Still—make sure you know which official pieces of paper you need, and get them. Common must-haves include a general business license and a sales tax permit. Visit your Secretary of State’s website to find out what licenses you need to get your drop shipping business off the ground.
10. Open a business bank account
Even if you’re operating as a sole proprietorship, and for tax purposes you and your business are identical, it’s essential to keep your personal and business finances separated.
When you have separate accounts, you pay for expenses and collect revenue in your business account, then transfer income to your personal account. That makes it easier to manage bookkeeping and file your taxes. Plus, it can help you build a relationship with your bank—which could be helpful if you decide to apply for a loan in the future.
Opening a business bank account is straightforward, so long as you know what you’re looking for. Learn more about the best banks for small business.
11. Figure out sales tax
What’s the relationship between sales tax and drop shipping? It’s complicated.
If your state requires you to pay sales tax, but the buyer is based in a different state, and the company sending your product out is based on a different continent—who collects sales tax? Who pays it?
Our guide to drop shipping sales tax has all the answers. Even better? It’s short. Check it out to get up to speed on sales tax in no time.
12. Set up bookkeeping, track your profit margin
Spend much time lurking in online communities for dropshippers, or follow the social media accounts of any drop shipping luminaries, and you’ll realize that profit margin is a major preoccupation.
That’s because, for a lot of drop shipping businesses, the only way to make sales is to undercut competitors. It’s a race to the bottom as competitors try to outprice each other and get more customers. For high volume products, a difference in profit margin of ½ cent can mean the difference between breaking even for the month or going into the red.
Even if you don’t immerse yourself in the cutthroat world of high volume drop shipping, it’s important to keep track of your margins. Profit margins for drop shipping businesses are lower than they are for traditional retail stores—think 15% instead of 50%—so every penny counts. A comprehensive bookkeeping system shows you how money enters and leaves your business, so you know how much you need to sell at what profit margin in order to earn an income.
Luckily, there are ways to set up complete, professional bookkeeping without ever walking into a bookkeeper’s office or learning your way around Quickbooks. Bench is one of them. Learn how Bench does your bookkeeping to see how smart finances from day one can help your drop shipping business take off.
13. Start automating now
Once your drop shipping business is steadily making sales, you may want to put day-to-day tasks on cruise control so you can focus more time on hunting down new products or exploring new markets. Luckily, there are many ways to automate your small business, handling tasks from social media posts to customer support hands-free.
One problem with this plan: Right now, as you start your business, your time is more precious than it will ever be. Even if you’re only spending a couple hours a night on your drop shipping side hustle, the more time you can put into research, planning, and experimentation, the sooner you’ll be on the path to a steady income.
For instance, good customer support is key to maintaining good ratings for your business and attracting new buyers. Buy you may not have time to reply to every email or message personally. That’s when a service like ZenDesk—which outsources your customer support to real humans—becomes useful.
So, get in the habit of saving time now. Check out these easy ways to automate your small business.
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We’ve covered the bare bones essentials of starting your dropshipping business. To take a deeper dive, and learn about business plans, insurance, and other factors affecting your company, check out our in depth article on how to start a business.
This post is to be used for informational purposes only and does not constitute legal, business, or tax advice. Each person should consult his or her own attorney, business advisor, or tax advisor with respect to matters referenced in this post. Bench assumes no liability for actions taken in reliance upon the information contained herein.
