3PL vs Dropshipping: Choosing the Right Fulfillment Model for Scaling Businesses

Both dropshipping and third-party logistics (3PL) sectors have experienced significant growth within the logistics landscape. With a surge in demand for outsourced logistics, the global dropshipping market, valued at $155.6 billion in 2021, is projected to soar to $1,670.1 billion by 2031. Dropshipping isn't slowing down either, with its low upfront costs and scalability making it a favorite among entrepreneurs. Statista predicts the global dropshipping market is set to reach $301.11 billion in 2024. 

These trends underscore the increasing reliance on outsourced logistics solutions and the growing preference for e-commerce platforms that facilitate dropshipping, reflecting a shift in consumer behavior and the strategic adaptations of businesses in a digital economy.

What is 3PL and How Does It Work?

Third-party logistics (3PL) refers to the practice of outsourcing logistics services, including warehousing, inventory management, order fulfillment, shipping (both full truckload [FTL] and less than truckload [LTL]), reverse logistics, and kitting and customization. 3PL providers are specialized firms that take over the logistics operations for their clients, offering a suite of services that can be tailored to the specific needs of each business. 

How Does 3PL Work?

Third-party logistics (3PL) providers act as an extension of your business to handle three primary functions — warehousing, order fulfillment, and shipping.

• Warehousing: 3PLs provide warehousing solutions that go beyond mere storage. They manage the entire warehousing process, including receiving, storage, and inventory management. 3PLs perform quality checks, update inventory levels, and organize products within their warehousing facilities. Most 3PL providers leverage warehouse management systems (WMS) to track inventory in real-time, ensure accurate stock levels, automate processes, and facilitate efficient retrieval for order fulfillment.
• Order Fulfillment: Once a customer places an order, the 3PL receives it electronically from your sales channel. A order picking list is generated, directing warehouse staff to retrieve the correct items from their storage locations. After picking, items are packed using appropriate materials, considering both product protection and cost-effectiveness. 3PLs may offer custom packaging options to align with the business's branding needs.
• Shipping: 3PL providers often have established relationships with multiple carriers, allowing them to negotiate cost-effective and timely shipping options. They handle everything from choosing the optimal shipping method (parcel, LTL, FTL) to coordinating with carriers for pick-up and tracking shipments. In most cases, the 3PL providers also provide the necessary tracking information, ensuring both the business and its customers can monitor the delivery status of orders.

Benefits of 3PL

Leveraging third-party logistics (3PL) providers presents a strategic advantage for businesses aiming to scale operations efficiently and effectively.

1. Scalability for Success

3PLs allow businesses to rapidly scale their operations in response to market demands or seasonal fluctuations, either to expand into new markets or scale down during slower periods. Their extensive infrastructure eliminates the need for in-house investments in warehousing and transportation, enabling you to accommodate increased order volumes without long-term capital commitment.

2. Optimized Costs through Efficiency

By leveraging economies of scale and shared resources, 3PLs offer cost-effective solutions across warehousing, fulfillment, and shipping. They possess the negotiating power with carriers to secure competitive rates and implement operational efficiencies, leading to reduced overhead for your business. 

3PL billing can also be customized based on SLAs and specialized services including transportation, warehousing and inventory management, customs and compliance, freight consolidation, and other VAS. According to a study by NTT Data, 64% of 3PL users and 86% of 3PL providers agree that the use of 3PLs has reduced overall logistics costs. 

3. Access to Specialized Technology

Modern 3PLs invest heavily in advanced warehouse management systems (WMS), warehouse execution systems (WES), and transportation management systems (TMS). Tech-enabled 3PLs provide real-time visibility into inventory levels, order status, and shipment tracking, leading to data-driven decision-making, reduced errors, and improved supply chain efficiency.

4. Strategic Expertise at Your Fingertips

3PLs, with a vast network of strategically positioned warehouses and an extensive carrier network, allow businesses to get their products closer to their customers. This extensive carrier network gives them greater reach and flexibility to find the most efficient and cost-effective shipping routes for your products. Since most 3PL providers have high-volume shipments, it gives them significant leverage when negotiating rates with carriers, ensuring you get the best possible prices.  

Expedited shipping goes hand-in-hand with their deep expertise in logistics management, navigating complex regulations, and optimizing supply chains.  Be it international customs, freight forwarding, and international shipping, 3PLs ensure a smooth and efficient journey for your products.

Challenges of 3PL

The adoption of third-party logistics (3PL) services, while beneficial in many aspects, can present certain challenges. These drawbacks can particularly impact businesses where tight inventory control and rapid fulfillment are critical to customer satisfaction and operational efficiency. You should carefully consider the advantages and disadvantages of 3PL if you are a:

• Businesses dealing with perishable or time-sensitive goods.
• Company with a highly localized customer base that prioritizes ultra-fast delivery.
• Business that requires a high level of customization and personalization in their fulfillment process.

1. Reduced Control Over Inventory

With your inventory managed in a 3PL warehouse, you relinquish a degree of direct oversight.  Medium to large-sized businesses and wholesalers, which often deal with a vast array of products and complex inventory needs, may need more direct oversight. It can lead to difficulties in ensuring inventory accuracy, managing stock levels effectively, and making swift adjustments in response to demand fluctuations.

2. Complex Shipping Coordination

While 3PL providers work to optimize shipping routes and consolidate shipments for efficiency, the additional layer between the product and the end customer can sometimes introduce delays. Longer shipping times can be a critical issue for e-commerce platforms that compete on the basis of fast delivery. Businesses operating on a global scale may encounter complexities in international logistics, further exacerbating shipping time concerns. 

What Is Dropshipping and How Does It Work?

Dropshipping is an order fulfillment model that lacks in-house inventory ownership. Instead, the retailer acts as an intermediary, listing products supplied by a wholesaler or manufacturer on their online storefront. When a customer places an order, the retailer forwards it directly to the supplier, who handles packaging and shipment. This allows retailers to expand their product offerings without incurring inventory holding costs or managing complex logistics.

The key stakeholders in the dropshipping model are:

• Retailer: Manages the online store, markets the products, and maintains customer relations. The retailer is the face of the sale and is responsible for the customer's shopping experience.
• Supplier: Sources or manufactures the products, manages inventory, and handles the fulfillment process, including packaging and shipping.
• Customer: The end consumer who purchases products from the retailer's online store.

The success of the dropshipping model hinges on the seamless interaction between these stakeholders. In fact, dropshipping accounts for an estimated 23% of all e-commerce sales. Now, let’s break down the dropshipping workflow to understand how the process works in theory.

• The retailer selects products from suppliers and lists them on their e-commerce platform. This step involves market research to identify in-demand products and potential suppliers.
• A customer places an order on the retailer's online store. The retailer's e-commerce system captures the order details, including the customer's shipping information.
• The retailer forwards the order to the dropshipping supplier. This can be done manually or automatically through integrated dropshipping software or platforms that connect the retailer's store with the supplier's system.
• Upon receiving the order details, the supplier processes the order. This involves preparing the necessary resources and production materials to fulfill the order, if not already manufactured.
• The supplier conducts quality checks to ensure the product meets the required standards and is free from defects. This step is crucial to maintain customer satisfaction and reduce returns.
• The supplier packages the product, often with the retailer's branding, and ships it directly to the customer. The supplier is responsible for the logistics of getting the product from their facility to the customer's doorstep.
• Once the product is shipped, the retailer provides the customer with tracking information. This communication is typically automated and allows the customer to track the delivery of their order.
• The retailer handles customer service, addressing post-purchase issues, returns, or exchanges. The retailer acts as the point of contact for the customer, even though they do not handle the product directly.

Benefits of Dropshipping

Dropshipping offers a range of strategic advantages for businesses seeking to scale with agility and minimal risk.

1. Low Upfront Costs

Dropshipping significantly reduces the barrier to entry for businesses by eliminating the need for substantial upfront capital investment in inventory. This significantly reduces financial risk, particularly for early-stage businesses testing product-market fit and exploring new sales channels. The financial resources typically allocated for inventory procurement can instead be directed toward marketing, customer acquisition, and other growth-oriented activities.

2. Minimal Inventory Management

The dropshipping model transfers the burden of inventory management to the supplier, freeing the business from the complexities of stock control, warehousing, and handling. This outsourcing of inventory management reduces the operational overhead and logistics responsibilities for the business, allowing for a leaner operation. It also mitigates the risks associated with overstocking or stockouts, as the retailer does not hold any physical inventory.

3. Flexibility in Product Offerings

Dropshipping provides businesses with the flexibility to quickly adapt and update their product offerings in response to market trends, consumer preferences, and competitive dynamics. Without the constraint of pre-purchased inventory, businesses can test new products with minimal risk and scale successful lines more rapidly. 

4. Wide Selection of Products Without Geographical Limitations

Businesses utilizing dropshipping can offer a wide array of products without being limited by geographical constraints. Since the supplier handles fulfillment, businesses can source products from anywhere in the world and sell them to customers globally. This global sourcing capability enables businesses to diversify their product lines and cater to a broader market, enhancing their competitive edge and market reach.

Drawbacks of Dropshipping

While dropshipping offers flexibility and low startup costs, there are inherent challenges to consider — particularly for SMEs and startups. Businesses must weigh these factors against the benefits of dropshipping to determine if it aligns with their operational goals and market positioning.

1. Lower Profit Margins

Dropshipping typically involves higher per-unit costs compared to purchasing inventory in bulk. Suppliers charge a premium for the convenience of dropshipping, covering their costs of warehousing, handling, and shipping individual orders. As a result, dropshipping can result in lower profit margins for the retailer, as the markup between the wholesale price and the retail price must absorb these additional costs. According to Shopify, typical dropshipping profit margins range from 10-15%.

Businesses operating in highly competitive markets or those with price-sensitive customers may find this squeeze on margins particularly challenging. The impact is more pronounced for small to medium-sized enterprises (SMEs) and startups, where every percentage point of profit margin is crucial for sustainability and growth.

2. Reliance on Suppliers' Inventory

Dropshipping businesses are entirely dependent on their suppliers for inventory availability. This reliance can lead to challenges in stock consistency and order fulfillment, particularly if the supplier experiences stockouts, discontinues a product, or faces logistical issues. The retailer has limited control over these aspects, which can result in customer dissatisfaction due to delayed shipments or unavailability of products.

Differentiating between 3PL and Dropshipping

If you are in the process of expanding or scaling your business, take a minute to understand the nuances between third-party logistics (3PL) and dropshipping: 

3PL vs Dropshipping: Choosing the Right Fulfillment Model

While each business will have unique factors to consider, below is a simple decision tree to guide you in the initial stages of decision-making.

Next Steps

Choosing between 3PL and dropshipping is a strategic decision that directly impacts your business's scalability, efficiency, and customer experience. This choice should align closely with your short and long-term goals, financial objectives, and the unique characteristics of your products. Carefully consider factors such as inventory control, shipping speed, branding needs, and budget to understand the most suitable model for your business.  Always involve key stakeholders in decision-making to ensure all perspectives are considered.