Dropshipping vs Holding Inventory Model: What’s Better?

Part of running a successful eCommerce business is knowing what to do with your inventory. To that end, two popular models approach inventorying differently: dropshipping and holding inventory.

While dropshipping is a term many of us are familiar with (and you should be well-versed on the topic, considering I’ve written a lot about it lately), holding inventory may be new to you.

Is this a better option than dropshipping? Is there yet a third inventorying method you should consider instead?

I know the questions are swirling through your mind, but take a breath as you’ve come to the right place. In this blog post, we’ll take a look at the dropshipping vs holding model, the pros and cons of each, scalability, flexibility, and more.

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Key Takeaways

When choosing between dropshipping and holding inventory models, the primary considerations are: initial investment costs, long-term spending, supply chain issues, customer satisfaction, efficiency, and expediency.
Whether one model suits you over the other depends on your goals, budget, and business size. You need more upfront capital to make a holding inventory model work, as you’re responsible for the warehousing.

What Is Dropshipping?

Before I explain which method to use and when I figured a primer on how both models work is in order. Let’s start with dropshipping.

Dropshipping is an eCommerce business model where a seller outsources order fulfillment tasks to a third party known as a dropshipper.

Sellers still take a customer’s order like usual but don’t fulfill it. Instead, once they receive an order, the seller communicates with the dropshipper, sending them the order information. The dropshipper pulls the order materials, packages them, and ships them.

The customer receives their product without necessarily knowing a third party was involved in the process. It’s estimated that upwards of 27% of companies now use dropshipping.

It’s been proven to be at least 10% more effective than affiliate marketing, driving larger profits, and can more easily accommodate the increasing number of digital buyers worldwide.

Dropshipping is advantageous for businesses for a litany of reasons, such as:

It’s less expensive to use dropshipping than for a business to handle order fulfillment.
A company doesn’t need to rent or own warehouse space since they don’t own stock in the order supply.
It’s considered a simple business model, and testing the efficacy is also easy.
Dropshipping is scalable.

However, dropshipping is imperfect, just like any eCommerce model. Some challenges to stay abreast of are potential decreases in product quality and reduced shipping control. If a customer complains that their order is taking forever to arrive, short of calling the dropshipper and giving them a nudge, you can do nothing to help your customer.

What Is Holding Inventory?

The other fulfillment model to look at today is holding inventory. As the name suggests, holding inventory is storing inventory customers have not yet ordered. Besides that, you may also keep the raw materials needed to make products.

The goal is to prevent stockouts, which is another way to refer to an item running out of stock.

There are yet more reasons to consider holding inventory. Like dropshipping, it’s designed to save money on last-minute orders. If your business pays shipping fees, you can reduce shipping costs through bulk ordering. You can also keep your business operating smoothly during supply chain shortages.

Here are some more benefits of holding inventory:

You have much more control over inventory than using the dropshipping model since you have more than you need.
You can maintain product quality and shipping speed, even in supply chain disruptions.

Sounds great, right? Not until you become aware of the drawbacks:

Inventory holding is more expensive, as you require more warehouse space and raw materials.
There are risks of having unsold stock, which undercuts your profits.

Cost Implications of Each Model

Now that you understand both eCommerce models, it’s time to dropship and hold inventory head-to-head. First, let’s talk about the cost implications of both models.

Startup and operational costs

Dropshipping has caught on like wildfire in part because almost anyone can do it.

I’ve written in another post that even minors can start a dropshipping business, albeit with the caveat that a guardian or parent must sign all documentation and might have to co-own the company.

So, why is everyone rushing to try dropshipping? It’s so inexpensive to get started. Here’s what you need:

Business registration
Business license (although this varies by state)
Dropshipping partner or platform
Website, including web design, hosting, and domain expenses
Marketing and advertising

Barring the marketing part, you can spend a few hundred dollars to start a dropshipping business and potentially even less.

Once you operate your own online business, you’ll continue to pay many fees, including marketing and advertising, website fees, dropshipping partner or platform, and additional fees, like hiring extra staff or warehousing.

Holding inventory, which is more expensive initially, includes these costs:

Business registration
Business license (if required)
Website
Warehousing
Raw materials

As your business gets underway, you’ll pay inventory holding costs, which include:

Inventory shrinkage from a phenomenon like damaged, lost, or stolen stock
Item depreciation
Order transportation
Labor
Business insurance

While it varies by business, you can spend between 20% and 30% of your overall inventory costs on holding costs. Factors can influence the price, and they include the following.

How you use your warehouse

If your warehouse is only used for storage, it won’t drive a profit. If you also offer services, you can charge for warehouse usage.

The types of orders you receive

Are you involved in B2B fulfillment? Your warehouse will soon fill with pallets, leaving you with little room to store any other type of order. You might run out of warehouse space sooner, requiring you to lease or buy more.

By comparison, if you specialize in direct-to-consumer or DTC fulfillment, your warehouse won’t fill up nearly as quickly. These types of orders usually have fewer units.

How long it takes inventory to sell

Inventory that sits unsold becomes a liability for your business.

The longer it remains unsold, the more its quality degrades, ultimately lowering the money you can sell the stock for.

How much inventory you store at once

There are different levels of holding inventory to explore. For example, a company that stores three month’s worth of items will likely have more warehouse space than one that stores a year’s worth.

The only instance in which that wouldn’t apply would be if the items are all larger.

Hidden costs for each model

Then there are those pesky hidden fees. In holding inventory, utilities in your warehouse are one most people don’t think about until they get charged their first bill.

As for dropshipping, if you don’t purchase your products wholesale, you could be left surprised that you must pay the full cost for all the raw materials or products you buy.

Dropshipping service fees and unsold inventory write-offs for holding inventory businesses mustn’t be forgotten. Both business models must take storage fees into consideration.

Cost-effectiveness scenarios

Although dropshipping is largely the more inexpensive model of the two, some scenarios may make holding inventory the smarter idea financially. For example, if a long-term supply chain disruption emerged, your ability to use dropshipping would be impacted.

However, following the holding inventory model, you could continue shipping out orders for as long as you stockpiled them.

Scalability and Flexibility of Each Model

The goal of owning a business is growth. Embracing fulfillment orders geared toward that growth is paramount, so let’s talk about dropshipping vs. inventory holding in scalability and flexibility.

How scalable is dropshipping?

Dropshipping is very scalable.

You don’t need to purchase inventory beforehand, allowing you to meet customer demand as it arises. If your audience is picky because trends change, or if you’re still defining your audience and what they like in your early business stages, you have the freedom and flexibility to do so with this model.

As your business grows, you can expand your outsourcing further. You don’t have to purchase or rent more warehouse space since you never kept any. You can scale up your production and your entire fulfillment process without physically doing any of it.

You can also begin automating routine business tasks with software, further growing your online business while taking a more hands-off approach.

This will free up your time, schedule, and mental capacity to handle other business tasks, such as new product ideation.

How scalable is holding inventory?

Holding inventory is also scalable, but admittedly, nowhere near the same degree.

Since you don’t outsource your inventorying but handle it all yourself, scaling up to you means increasing the number of warehouses you own/lease or upgrading to larger warehouses.

Both come at a cost and are more than the lease or rent. You also need additional staff to man the warehouses, and you must spend on raw materials and item storage.

Another downside of scaling in a holding inventory model is that responding to customer taste fluctuations is much harder. Let’s say your audience loved red hoodies, so you bought 10,000. You also have the raw material to make 5,000 more.

Then, whoops, your audience likes blue hoodies now. You’re stuck with all those red hoodies and can’t respond to the demand as quickly as a dropshipping business model can.

Which model is more flexible?

Dropshipping is undoubtedly more flexible regarding testing new markets and product offerings. The only way to make a holding inventory model comparable would be to order small amounts of stock and raw materials at a time.

Quality Control and Customer Satisfaction

Let’s look at the quality control issues and customer satisfaction for each model.

Dropshipping vs holding inventory for product quality assurance

The risk of lower product quality assurance exists more with the dropshipping model.

Once you get third parties involved, they may not always be able to determine if a product is counterfeit until it’s already shipped out to the customer.

Oppositely, if your business follows the holding inventory model, you have the raw materials to make the product, so you understand what it should look like and will have rigorous quality control standards in place.

That’s not to say there’s an absence of quality control standards for dropshipping, just that the more hands there are in the pie, the harder those standards are to enforce. Training on recognizing counterfeits and managing quality will benefit everyone.

Strategies for maintaining customer satisfaction for dropshipping

You must communicate well with your dropshipping partner so that when customers raise questions about order delays or have complaints, you can get the issue dealt with expediently.
Select quality suppliers, requiring an interview process before you team up with anyone to ensure more of your orders go through on time.
Request customers to leave feedback so you can determine which areas of your order fulfillment process need refining.

Strategies for maintaining customer satisfaction for holding inventory

Get to know your audience and understand what they like. Before taking a chance to order a large stock of products or raw materials, be sure that the demand will be there.
Store items in ambient warehouse conditions. The ideal temperature for a warehouse is 68 to 76 degrees Fahrenheit. You won’t have to worry about products degrading prematurely at this temperature.
Implement a feedback system to discover ways to make your holding inventory model more customer-efficient.

Risk Management

Neither dropshipping nor holding inventory is without risks, so let’s explore which dangers exist on both sides to help you mitigate them.

Supplier reliability

Supplier reliability is a top priority in dropshipping. As I mentioned before, doing your due diligence researching suppliers, and interviewing the ones you’re interested in will help you feel confident about your decision.

Here are some questions to ask a potential supplier during an interview:

What kind of payment methods do you take?
Do you have minimum requirements for order amounts and revenue?
Do you have any involvement in marketing, or do I have to do that myself?
How often do you charge?
How do you handle returns?
Do you charge a subscription fee?
Do you charge a drop fee?
Where do you keep your products? What are the warehouse conditions like?
How can I best communicate with you? How long will it take me to hear back from you?
Do you have support for multiple currencies?
Do you only work with national customers or international ones?
Can you tell me about the packaging you use?
Can I personalize the packaging?
Do you offer order tracking?
How long does it take you to ship dropshipped orders?

Upfront costs

By choosing the holding inventory model, you may spend less later but have greater upfront costs.

Then again, that all depends on how well your products sell. If they don’t, and you try to branch out into different products, you may need to pay for additional warehousing to store your new products.

The depreciation of old products would also hit your wallet.

Long-term spending

Both order fulfillment models have long-term spending, but the holding inventory model has a higher risk. Budgeting will help you control your long-term spending so you’re not wasting profits.

After all, you want your business to do more than break even. You want to push it into the green.

Stockouts

Dropshipping and holding inventory models are both at risk of stockouts, but it’s more likely if you’re a dropshipping business.

You don’t have the safeguards against supply chain management issues like you do if you follow a holding inventory model.

Further, you’re beholden to third parties, so even if you tried to manage inventory more expeditiously, they might not, which could still lead to stockouts.

Stockouts can happen with a holding inventory model, especially if you don’t order enough ahead of time. Projecting customer demand is a major part of holding inventory success, which you have to practice.

Preventing stockouts with a dropshipping model requires strong communication between you and the supplier.

Supply chain disruptions

The risk is usually higher for dropshipping businesses, although those following a holding inventory model can also feel the effects of supply chain disruptions eventually.

Perhaps you can avoid their wrath if you order a year’s supply in advance, but that requires a lot of warehouse space and good faith that your customers won’t tire of the product you specialize in.

Unfortunately, there are no hard and fast ways to prevent or avoid supply chain disruptions. They involve far too many parties. The best you can do is stay aware of supply chain news and how you may be impacted, then prepare for the worst.

Conclusion

Selecting the right order fulfillment strategy for your business requires measuring the advantages and downsides of dropshipping and holding inventory.

I recommend assessing market conditions and your internal capabilities before you make this important choice.

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Frequently Asked Questions (FAQ)

1. Which business model is better for a quick startup?

Dropshipping is the better choice for a startup, as you don’t need nearly as much capital upfront as you do for holding inventory.

2. How do return policies differ between dropshipping and holding inventory?

In dropshipping, you must have a return policy between you and the supplier about when the customer can ship an item back, what condition it must be in, and where they ship it to.

You can then either refund the customer (fully or partially) or give them store credit. Holding inventory requires you to have the additional warehouse space for a returned item, which can cause warehousing constraints if you get a lot of returns.

3. What are the long-term financial implications of each model?

While dropshipping is more inexpensive to start, the profit margin can sometimes be lower.

The holding inventory model costs more at first, but the fees become more reliable over time, although not necessarily less expensive.

4. How can I switch from one model to another if needed?

If transitioning from dropshipping to holding inventory, you’ll need your own warehouse and staff, as you’ll be in charge of producing, storing, and shipping orders.

Going from holding inventory to dropshipping is easier. You can sell or lease the warehouse space to someone else, then find a dropshipping partner or platform.

5. What are some successful businesses that use each model, and what can I learn from them?

Some of the biggest names in dropshipping are Meowingtons, Notebook Therapy, Be Activewear, and Modalyst.

Fishbowl, Netsuite, and Extensiv are examples of inventory management companies. These businesses prove that either order fulfillment strategy can be effective.