Finding Products for Your Business

How Does It Work?

There are several product sourcing methods available. Many revolve around wholesale suppliers, but a couple don't, such as liquidation, closeout and overstock buying. The most successful retail operations use a variety of methods that complement one another to drive the highest profits.

First, we will talk about the product sourcing methods that are the most stable and reliable--the methods that involve wholesale suppliers directly, from the least expensive startup entry point to the most expensive.

1. Drop-shipping: A drop-shipper is a legitimate wholesale supplier who will deliver a product from the wholesale warehouse directly to your customer. You, as the retailer, never have to touch the product. You use the wholesaler's product literature, including images, description, pricing and warranty info, to make the sale, and then the drop-ship wholesaler delivers the product straight to your customer's door. You don't actually pay for a drop-shipped product until you make the sale to your customer, so you are never spending any money on inventory.

This method is best suited for e-commerce because customers who shop online expect to wait for a product to be shipped to them in the first place. The customer doesn't know (and probably doesn't care) if the product is shipped from your own in-house stock or from a wholesale supplier's warehouse.

However, many physical retail stores use drop-shipping as well. For example, high-end patio furniture stores might have display rooms full of expensive patio tables and chairs, but no physical warehouses. When you buy a patio set from these kinds of stores, they order it and have it delivered to your home. What they have done is purchased one of each of the items they want to sell for physical display purposes. They make the sale using the display model, then fulfill the sale through drop-shipping. That keeps their inventory cost extremely low.

There are many other physical stores that stock some of the products they carry and have display models of other products (usually the more expensive ones). That way, they quickly turn over their more inexpensive, in-house inventory, but take less risk by not pre-buying and holding the more expensive inventory in stock. Some physical stores that do this don't even bother carrying the more expensive display models. They simply have a catalog of the more expensive items available and have them drop-shipped to the customer when they make a sale from the catalog.

Although drop-shipping is an inexpensive product sourcing method in terms of upfront costs, it is important to remember that there is a back-end cost associated with drop-shipping. Because the wholesale supplier is doing all the work of picking, packing and shipping individual orders for you, they have to charge a little more for the products. It costs the wholesalers more to drop-ship individual orders for you than it does for them to sell products in bulk, and they have to recoup that cost somehow.

Some drop-shippers do this by charging a slightly higher wholesale price for the products that you have drop-shipped. Most do it by charging a drop-ship fee, which is a set fee per order. With small products, that fee can be anywhere from $1 to $5. With larger products, like high-end patio furniture, the charge can be higher.

Most retailers who use drop-shippers build that drop-ship fee into the handling part of the shipping and handling fees they charge their customers, so they don't have to raise their product prices.

Drop-shipping is a practical, low-cost product sourcing method that has been in use since long before the internet existed. It is basically the same concept as Sears' or Montgomery Ward's catalog shopping, which was popular for many years. If you use drop-shipping, it should be part of your product sourcing efforts, but not all.

2. Light bulk wholesale: In product sourcing, it's important to understand that most legitimate wholesale suppliers require considerably large minimum orders of their products. Generally, it's not cost-effective for a wholesaler to sell a single case of a product to a retailer. Wholesalers sell products in case lots, or minimum numbers of cases. Wholesale order minimums can range from $3,000 to well over $100,000, depending on the types of products. Usually, when a retailer orders from a wholesaler, the wholesaler will reduce the unit cost (cost of each product) on large orders as an incentive for the retailer.

However, there are wholesalers who will consider selling at reasonably low unit costs, even with a low ($500 or less) minimum order. These purchases are called "light bulk wholesale."

These light bulk wholesalers are a good intermediate-cost entry point into the world of bulk wholesale buying. You pay for your products upfront, but you'll pay less per unit than you would with drop-shipping (no drop-ship fee or percentage), and you won't have to place large minimum orders.

With an e-commerce business, a savvy entrepreneur will use drop-shipping to identify products that sell well, and then buy them in light bulk quantities to further reduce the cost of the product and help increase profit margins.

For physical stores, light bulk suppliers are a great way to test a product in the store without committing to a large, costly initial order.

3. Large volume wholesale: By far, the greatest number of available wholesale suppliers are large volume suppliers. Although many wholesalers are willing to work with retailers who want to start out with lower volume orders, there is only so much they can do. Most wholesalers do require significantly large wholesale orders.

Most large volume wholesalers will allow retailers to purchase a "mixed" order. The wholesaler may require a $5,000 minimum order but allow the retailer to include $500 worth of one product, $700 worth of another product and so forth.

Again, it's important to remember that the larger your wholesale order, the lower the unit cost, so buying in large volume can help increase your profit margin.

For an e-commerce business, large volume wholesale only makes sense once a certain product has been identified as a very good seller. Purchasing a large number of those hot-selling products can reduce the unit cost to a level that makes the investment worthwhile. E-business owners have to be careful, though, not to buy more of the product than they can reasonably sell in a short period of time. The last thing you want to do is get stuck with inventory you've paid for but can't sell.

For physical store retailers, larger volume makes more sense. Most physical store owners have a business plan and have done the research that provides evidence for which products will sell well. So buying mixed orders in larger volume can be a good solution for physical retailers.

4. Variable-cost methods: Variable-cost methods include liquidation, closeout and overstock buying. These methods are described as variable cost because the retailer will never pay the same amount more than once, which is vastly different from direct wholesale buying.

Liquidated products are usually sold at rock-bottom prices. Most people think that's good. It's important to remember, though, that if products are being liquidated, it means whoever owns them now wants to get rid of them so badly, they are willing to lose money on them through liquidation. This may mean there is little or no market for the items.

It is also important to remember that liquidated products can show up damaged, missing parts, dirty, out of the box and so forth, even if the seller claims they're in good condition.

Closeout products are generally products that are no longer made. Older-model products left over in wholesalers' warehouses become closeout merchandise. Closeouts can be a good strategy to augment your product sourcing by creating "loss leaders." Offer a closeout product at a cheap price (break-even or less) to get customers into your physical or online store, then immediately show them the newer, more expensive models you sell. This is a time-tested technique employed in the retail world, and even if your customer buys the loss leader and nothing else, you have earned a customer you can market to in the future. The same caution about liquidations applies to closeouts: Be very careful about whom you deal with, otherwise you could end up with a pile of junk.

Overstock products are products that manufacturers and wholesalers simply have too many of and need to get rid of at reduced prices. Again, keep two things in mind: First, these are products that wholesalers and other retail stores can't sell. Do you really want to try? Second, if you are not careful about whom you deal with, you might end up with products that belong in a junk pile, not in a warehouse.

Importing products directly is another product sourcing method, but one that is generally not practical for the startup entrepreneur. Importing is very expensive, risky for the individual entrepreneur and involves delivery times that average three months or more. Startup entrepreneurs, and even many experienced entrepreneurs, are much better off sourcing from established wholesale suppliers. Importing is something to consider once your business is established, strong and able to take greater risks.

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This article was originally published in the February 2007 print edition of Entrepreneur's StartUps with the headline: Straight to the Source.

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