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Opinions expressed by Entrepreneur contributors are their own.
With the fast-growing trend of starting businesses from home, there are two business models that get mentioned all the time: drop shipping and white labeling. Both harness the power of the internet and can be run from a laptop, but is one better than the other when it comes to passive income?
Pros and cons of drop shipping
Drop shipping can be very hands off. This is when you create a website and list products from other brands. You don’t own the products on your website, nor buy them in batches. You become an authorized dealer for the brands that make the product you want to sell, and when you make a sale you turn around and place the order with the brand/manufacturer. They in turn ship the product to your customer and charge you the dealer price. And since you were paid full retail from the customer, you make a profit.
Almost zero financial risk: You can sell products without having invested your own money until after a customer has paid you for it, so the financial risk is very low.
Hands-off: You don’t have to store the products in a warehouse and have overhead costs associated to storage facilities and staffing. You literally never have to touch a product.
No prior product knowledge required: This may be surprising, but you really don’t need to be an expert of the product you sell from day one. Obviously you should become an expert and learn as much as you can, but you can get started with very little knowledge of the niche.
Competitive: Since it’s so easy to get started with no upfront capital, the barrier to entry is extremely low so it’s a competitive space if you choose to sell products in popular niches.
No control over the supply chain: Since you rely on the manufacturers to ship the products you’re selling, when they run out of stock you run out of stock. This can cause your sales to stop overnight and there’s nothing you can do about it.
Low margins: The manufacturer decides the margins the reseller makes and it’s often non-negotiable. Gross margins are usually around 30%, but if you sell heavy items that require freight shipping, that 30% can be as low as 10%. There are some other payment processing fees too, so 10% is not unusual when all costs are factored in.
Pros and cons of white labeling
White labeling is similar is some ways. Also known as private labeling, you reach out to a factory that produces what you want to sell and you place a minimum order of units of the product. The factory will put your branding on it and ship it to you. Then it’s up to you to sell those units, whether through a website, a physical store or both.
Good margins: Since you are no longer the middleman, you buy directly from the factory so your margins are much better. You can expect anywhere between 50% – 80% profit when you sell full retail price.
Use drop shippers to sell your product: Since you are a brand with your own product, not only will you sell to the customer directly, you can leverage the drop shippers to sell more of your products for you.
Upfront financial investment: Unlike drop shipping, you need to source and order a quantity of the product and have it shipped to a warehouse or fulfillment center. So you have to foot the bill for the order, ship (often from China) and pay for storage. If you don’t have your own warehouse, you can use a 3PL (third-party logistics) company that will receive your containers, store them and ship to your customers when you get orders. The 3PL will charge you for the storage and handling.
Knowledge of the niche: Before spending tens of thousands of dollars on a product, you should know the product and market very well. If you don’t, you could find yourself with a lot of product that is not sellable.
Which business model is for you?
Both have their benefits and challenges, but how do you choose which to start?
If you are already involved in a specific market and know how to improve on an existing product, you can start a white-label brand. Of course, you have to have the cash to get started. If you are looking to earn some extra cash each month without too much of an upfront investment, then drop shipping is a great method for you.
Both drop shipping and white labeling can be somewhat passive. White labeling has the additional logistics to be on top of so it’s a little more hands-on, but you don’t need to see or touch the product if you use a 3PL.
From my experience in ecommerce, I normally recommend starting with a drop ship store selling a product that you know, and when you have understood the market and what all the brands are selling, you can transition into white labeling your own product in that same market.
By starting with selling other brand’s products, you get great insight into what customers really want. You can then go and get it, put your brand on it and make better margins. Eventually, you will have yourself an established ecommerce business with lots of traffic.
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