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How to Risk Proof Your Drop-Ship Contracts?

Posted by Chris C. Han | May 18, 2022 | 0 Comments

Drop-shipping might be a profitable way to carry out your business transaction, whether you are a freshly opened small business that still has to establish its niche online or a well-established company with deep-seated roots. It does, however, come with its challenges and risks. The good news is that you can easily avoid them by risk-proofing your drop-ship contracts.

Let's start with the basics: What is drop-shipping?

What is Drop-Shipping?

Drop-shipping is an e-commerce business model where the goods bought from a seller-merchant are directly delivered to the customers by suppliers, such as manufacturers, distributors, wholesalers, and the like. The seller-merchant only has to have an online store, market their products, and take orders from the customers.

Once the customer places an order on the merchant's website, the information regarding the order, the product details, delivery address, and so on are sent to the supplier. The supplier then packages and ships the product ordered directly to the customer. This process cuts the need for the seller-merchant to have a warehouse and keep an inventory, thereby substantially reducing costs and risks associated with maintaining an inventory and other business risks involving selling goods, hence increasing the chance of profitability.

The order-shipment of goods process mainly involves five steps:

  1. A customer orders a product from a dropshipping retailer.
  2. The retailer processes the order and sends the details to the supplier.
  3. The supplier receives the order from the retailer.
  4. The supplier ships the product.
  5. The customer receives the product.

What are the Benefits of Drop-Shipment?

Drop-shipping is the preferable choice for doing business for most online stores. Thus, it is essential to know and understand the benefits of this retail strategy before diving into it. It is beneficial in ways such as:

  • A low barrier to entry. Drop shipment is not as expensive as other transaction methods for getting started. If you were to create your products, it would require raw materials in bulk which costs a lot. With drop shipment, you can build up your website and online store with that extra money.
  • It takes away the burden of supply chain hassle. As a result, you can cut down on expensive and time-consuming activities such as buying, storing, packaging, and delivering products all on your own.
  • It offers an opportunity for sustainable growth. With drop shipment, you are not forced to put in a hefty amount of money to grow big. Instead, you can invest small sums of money and build your e-commerce store from there slowly and gradually.
  • It brings flexibility to a business. This is because a company can run from anywhere, offer various products, and easily change the type of products if the market demands them.
  • It eliminates inventory risks. With drop shipment, a small business could sell a broad selection of productions without the worry of storing them. In addition, it allows for them to be on equal footing with much bigger companies.

What are the Risks Involved for Retailers adopting to Drop-Shipping?

While drop-shipping can be a beneficial business model in so many ways, it does not always come without its risks. There are several risks attached to this e-commerce strategy. To name a few, these risks may include:

  • Having Less Control. The retailer depends entirely on the supplier to fulfill its orders. The retailer tends to have little or no control over the quality and delivery of the products. If many damaged products are delivered to the customers, it might damage your profit margins and business reputation.
  • Competition is High. An estimated one-third of all online stores have adopted drop shipping as their preferred business model. This means that many of your competitors enjoy the same benefits as you. Moreover, the products that a retailer sells are not made exclusively by them but are relatively mass-produced. This means the same manufacturer probably supplies the same products to your competitors. This implies that you do not have your product as a unique selling point of your business.
  • Suppliers Delays. Sometimes, one manufacturer cannot be relied upon to deliver products to your customers and serve your business. The manufacturer can leave you to serve your competitors. This comes as a downfall of depending heavily on one supplier for most of your business.
  • Lower Profit Margins. The drop-shipment supplier takes care of everything from storing to packaging to shipping. Thus, they will most definitely take a cut of every order a retailer receives to cover the costs of these services.

How to Manage the Risks With Contracts?

As with most business models, the risks associated with drop-shipping can be managed through a well-drafted and negotiated contract between the parties involved. The drop-shipment supplier and the retailer can sign a sale of goods contract, covering several things that will help reduce and allocate risks involved in the drop-shipping arrangements.

A sale of goods contract includes clauses that protect the retailer and the wholesaler. The contract can consist of several terms such as:

  • Identifying the parties involved: It is essential to define who the supplier and the retailer are. This will help avoid scammers who draw up fake identities to defraud businesses.
  • Description of the services and goods: This is one of the most important clauses of any sale of goods agreement. It lists specific products and quantities that the retailer has placed the order. This will help in avoiding the risk of minimum order quantities.
  • Payment Term: The payment term is the most negotiable of all the clauses. It is, therefore, vital that you put in writing when and how the payment will be made.
  • Delivery: If you want to avoid the risk of any delays in delivering the products to your customers, it is then essential that you mention details about delivery in your contract. These details may include the cost, method, place, and delivery time.
  • Inspection of products: Since the drop shipping method allows for less control over the quality of products, adding a clause that will require the manufacturer to inspect the product thoroughly is advisable. Such a clause will help garner much more control over the quality of the products.

Drop-shipping is an easy and fast-growing method of doing a sale transaction, and its pros certainly outweigh its cons. It is one of the simplest ways of starting an online business and helps ease work for you. However, it does have its advantages and disadvantages, just like any other business model. The good news is that by having a contract signed between you as a retailer and your drop shipment supplier, it is possible to avoid its risks.

If you have an existing drop-ship contract, it is time to review it again and see if there are terms you can improve on with the suppliers.

About the Author

Chris C. Han

Founding & Managing Partner


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