Drop Shipping (Dropshipping)
Drop shipping (dropshipping) is a retail model in which the merchant sells goods but never stocks them: the supplier or manufacturer ships them on the merchant’s behalf directly to the end customer. The merchant acts only as the contracting and invoicing party, without ever physically handling the goods.
Drop shipping (dropshipping) is a retail model in which a merchant sells goods that it neither keeps in stock nor ships itself. Instead, the merchant forwards the order to its supplier or the manufacturer, who then delivers the goods in the name and on behalf of the merchant directly to the end customer. The goods thus take the shortest route – from supplier to customer – while the merchant handles only the commercial side: closing the contract, invoicing the customer and paying the supplier.
The German term „Strecke“ comes from wholesale and describes supplying the customer directly while bypassing the merchant’s own warehouse; „dropshipping“ is the English term common in e-commerce for the same principle. At the core of the model is the separation of the flow of goods from the flow of money: the goods flow directly from supplier to customer, whereas the money and invoicing flow runs through the merchant. The merchant earns the difference between its selling price and the purchase price paid to the supplier, without tying up capital in inventory or running its own logistics.
At a glance
- Selling without your own stock: the supplier ships directly to the end customer
- Separation of the flow of goods (supplier → customer) and the money/invoicing flow (via the merchant)
- Advantages: no capital tied up, no inventory risk, fast assortment build-up
- Disadvantages: lower margin, dependence on the supplier, little control over shipping and quality
- Modelled in the ERP as drop-ship orders: a sales order automatically generates a purchase order with direct delivery
How drop shipping works
A drop-shipping transaction follows a fixed chain. The end customer orders from the merchant – in the online shop, on a marketplace or via a classic order. The merchant accepts the order, concludes the sales contract with the customer and at the same time triggers a purchase order with its supplier. This purchase order does not carry the merchant’s own warehouse address as the destination, but the delivery address of the end customer. The supplier picks, packs and ships the goods directly to the customer, often with neutral shipping documents or under the merchant’s brand.
Running separately from this is the commercial track: the merchant invoices the end customer for its selling price, and the supplier invoices the merchant for the agreed purchase price. The difference is the merchant’s trade margin. Critical to the model is up-to-date stock and availability data from the supplier: only if the merchant knows whether and when delivery is possible can it reliably keep its promise of availability to the customer. That is why the data connection to the supplier – stock levels, prices, shipping status – is the nerve centre of every dropshipping operation.
The three parties and their roles
Drop shipping always involves three parties. The end customer orders from and pays the merchant and is legally the merchant’s contracting party. The merchant runs the assortment, sales, marketing and customer service, bears the warranty and returns risk and is the party issuing the invoice. The supplier (wholesaler or manufacturer) holds the goods, handles storage, packing and shipping, and delivers on behalf of the merchant. The customer usually has no contact with the supplier and often does not realise that the goods come from a third party.
Advantages and limits of drop shipping
The biggest advantage of drop shipping lies in the low capital requirement. The merchant does not have to pre-finance any goods, run a warehouse or bear the risk of slow-moving stock or write-downs. This enables a fast assortment build-up: new items can be offered as soon as the supplier carries them, without a purchasing decision or putaway. Especially in e-commerce this significantly lowers the barrier to entry and makes it possible to test a broad assortment without investing in inventory. Bulky products or those needing explanation can also be sold this way without your own logistics.
Against this stand clear limits. The margin is usually lower than in classic drop shipping with stockholding, because the supplier provides the logistics service and takes a cut. The merchant is heavily dependent on the supplier: its stock situation, delivery time, packaging quality and adherence to deadlines directly determine customer satisfaction, even though the merchant has little influence over them. With several suppliers per order, partial deliveries arise with separate parcels and shipping costs. And processing returns is more complex, because the return usually goes to the supplier and not to the merchant.
Distinction: drop shipping vs. stock business and fulfilment
Drop shipping is distinguished from the classic stock business by the fact that the merchant never physically owns the goods. In the stock business the merchant purchases, stores the goods, picks and ships itself; it bears the inventory costs and risk, but has full control over availability, packaging and shipping speed. With drop shipping these costs and risks fall away – at the price of lower control and margin. Many merchants combine both models: fast movers are stocked in-house, slow movers and special items are sourced via drop shipping.
Dropshipping vs. third-party fulfilment
Dropshipping is often confused with fulfilment by a logistics service provider (such as a 3PL or marketplace-owned programmes). The difference lies in ownership of the goods: with fulfilment the goods belong to the merchant and merely sit in a service provider’s warehouse, which ships them on the merchant’s behalf. With genuine drop shipping the goods belong to the supplier until the sale; the merchant only purchases once the end customer has ordered. Economically this is a central difference: fulfilment ties up capital in inventory, dropshipping does not.
Drop shipping (dropshipping) in the ERP system
In the ERP system drop shipping is modelled via the so-called drop-ship order (direct delivery). If the merchant flags an item or an order line as a drop-ship item, the system automatically generates a purchase order to the assigned supplier from the incoming sales order – with the delivery address of the end customer instead of its own. The sales order and the purchase order stay linked, so that status, dates and backorders can be tracked end to end. The merchant’s stock is not affected, because the goods never pass through its warehouse.
This interlinking requires clean master data: the item master must hold the drop-ship supplier, purchase prices and replenishment lead times, and the supplier master the terms and payment periods. Central to it is the connection to the supplier via an interface: through an API or a data import-export, stock levels, prices and shipping status – ideally tracking numbers – are transferred automatically. Without this automation drop shipping quickly becomes error-prone, because availability and shipping status would have to be maintained manually. In the ERP, invoice verification against the supplier invoice and invoicing the customer also come together.
DACH specifics: VAT and chain transactions
For tax purposes, drop shipping in the DACH region is a chain transaction (Reihengeschäft): several entrepreneurs conclude supply transactions over the same item (supplier to merchant, merchant to customer), while the goods pass directly from the first to the last party. Under VAT law, in a single movement of goods only one supply can be the „moving“ (and thus potentially exempt) supply; the other is deemed a „resting“ supply. In intra-Community or third-country constellations the allocation quickly becomes complex, so the correct VAT treatment must be examined carefully.
Also relevant in practice are consumer protection and invoicing: the merchant remains the contracting party towards the end customer and is liable for warranty, right of withdrawal and a proper invoice. The invoice issued by the merchant to the customer must meet VAT requirements and must not disclose any internal purchasing data of the supplier – which is why drop-ship deliveries are usually sent neutrally. For the audit-proof archiving of documents, the principles of proper bookkeeping (GoBD) apply, which additionally favours drop shipping that is fully posted in the ERP.
Example
Example: furniture online shop sells bulky goods via drop shipping
A small online shop for garden furniture wants to offer large-format lounge sets without renting its own warehouse for bulky goods. It agrees a drop-shipping arrangement with a wholesaler: the shop lists the items with the images, descriptions and stock levels supplied by the wholesaler, but keeps not a single set in stock itself.
When a customer orders a lounge set, the ERP automatically generates a purchase order to the wholesaler from the sales order, with the customer’s delivery address. The wholesaler ships the palletised goods by freight carrier neutrally to the end customer and reports the tracking number back via the interface, which the shop passes on to the customer. The customer pays the shop price, the wholesaler invoices the shop for the purchase price. In this way the merchant can carry a bulky assortment without bearing warehouse space, handling and tied-up capital for goods that are hard to plan.
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