Hedging Supplier Risk When Starting A Dropshipping Venture

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Risk is inevitable in business. Any business executive that’s privy to the nature of randomness and risk will know that using a quantitatively guided approach to hedge and handle risk enhances financial stability along with profitability. It’s almost guaranteed that supply disruptions will happen for any business, in fact, a study in the Journal of Cleaner Production claims that: “Suppliers can be considered as inevitable sources of external risks in modern supply chains.

While dropshipping is very distinct from the typical supply chain management strategy that involves various suppliers and intermediaries that coordinate to deliver products, it still suffers from risks due to supply side disruptions. In a lot of cases, supply side disruptions for dropshippers may be more severe because there is no inventory, so becoming out-of-stock is simply a matter of supplier failure for dropshippers. Therefore, evaluating risk when choosing suppliers and hedging risk by having contracts with a number of suppliers is critical to the proper and long-term success of a dropshipping venture.

Choosing Suppliers as a Dropshipper

AMR conducted research on what supply chain executives and experts considered to be the greatest risks to supply side logistics. They found supplier failure, logistical failure, strategic risk, and regulatory risk to be among the most common issues plaguing supply chain management. Choosing suppliers accurately will help lessen the impact of each of these types of risks.

The matter of choosing suppliers prudently should be the first concern of a dropshipper since it is common to choose a supplier that doesn’t even qualify to service a dropshipping business and may just be masquerading as a wholesaler. The choice of your supplier and how much auditing you do for each is a method of risk mitigation in itself. Choosing suppliers that are more reliable and have better reputations will reduce supply disruption liabilities over the long term.

Having a frame of reference when you choose your suppliers is key to maintaining a successful dropshipping venture. For example, being able to differentiate between a genuine wholesaler and a retailer offering goods at inflated prices will help streamline your selection process and drive down costs as your pick out suppliers. Scrutiny is an essential component to the selection process and as a dropshipper; your supplier should ideally not:

  • Ask for ongoing fees
  • Sell products to the public
  • Ask for pre-order fees
  • Request minimum order sizes

In addition to investigating the background of your suppliers, you should also have some reasonable expectations for the price of a contract that you enter into with certain suppliers. The nature of a dropshipping business implies a frenetic series of customer orders and fulfillment systems, so negotiations will be crucial to a successful arrangement. Having strong service-level agreements (SLAs) along with a transparent reporting method and a fluid customer returns policy will aid this process.

Optimizing The Number of Suppliers and The Amount of Risk

We have two main variables to consider in the case of a dropshipping venture. The first is the cost associated with the number of suppliers that your business makes contracts with. The second is the cost associated with the previously mentioned supply side risks that will inevitably occur during your dropshipping operation.

If we assume that your business is making informed decisions with regards to its suppliers and getting good deals for risk reduction, the problem becomes one of optimization. How many suppliers do we need to contract before the marginal reduction in risk becomes negligible? Think of it this way, if you have one supplier you can reduce the risk greatly by having another supplier; but if you have a hundred suppliers, then having an extra supplier will not reduce the risk by a significant amount.

Therefore, your dropshipping business needs to weigh the risks of a supply outage (measured through the loss of revenue due to being out-of-stock) with the cost of an additional contract with a supplier. There are a number of ways to quantitatively calculate trade offs between factors such as “expected costs, quality acceptance levels, and on-time delivery distributions.” Performing a thorough analysis with a supply chain risk simulation model with the conditions for acceptable trade offs will help your business better structure and evaluate the feasibility of its dropshipping venture.

So, there are two main takeaways for risk mitigation when it concerns dropshipping ventures. Primarily, your business has be selective of the types of suppliers it selects and the contracts that it makes with those suppliers. Investigations into the backgrounds of those suppliers and contextual analyses will help your business gauge if a supplier is reliable enough. Making adjustments based on quantitative evaluations of risk trade offs is also a supply chain management strategy that will yield notable returns.

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