What You Need to Know About Product Sourcing for Your Online Business

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Deciding on a product type is one of the most difficult and critical aspects to starting an e-commerce business.

You may have a particular niche interest that you are passionate about and wish to monetize, or you may be less discriminating and simply want to find a market segment that you think will maximize your chances of success. On either side of this spectrum, you must keep in mind that your method of supply/production leads to highly variable models of how you will operate your business.

Digital Products

We are firmly entrenched in an age where people can make a substantial living off of items that are completely made of bits and bytes. E-books in particular took off in the middle of the 2000s and video/e-training courses are especially profitable right now.

Digital products are perfectly viable in our economy and seem almost to good to be true since they have virtually no manufacturing, storage, or transit costs. Of course, they come with some considerations:

  • You will have to spend some upfront time developing these products and will have to regularly provide new content in order to create a consistent revenue stream.
  • You will have to consider negotiating with freelancers in order to produce some or all of your content. This will involve communication overhead and require you to get upfront capital before releasing the product.
  • You may have to wait considerable time before you see meaningful and continuous earnings (even compared to other business models).
  • The lack of production costs does not mean a lack of sales and marketing costs. The comparatively low sale price of digital products means that you need a large volume in order to see sufficient profit, and in order to get this volume you will need to invest a great deal into creating an online brand and drawing people towards your shopping cart.
  • If you go global, you will have to abide by local standards and customs – not all jurisdictions have guarantees of free speech.
  • You will have to find the time and resources to fight piracy, including legal counsel. If you are operating within the United States, this means getting intimate with the Digital Millennium Copyright Act (DMCA) and being ready to use it to protect your property.

Handmade Goods

Even though digital goods have become a hot category of commerce, we are also seeing something of an artisanal renaissance online as well. People who have creative talents – whether hobbyists or MFAs – can make solid livings through totally hand-crafted items. Even famous internet skeptic Clifford Stoll (who declared we would never trade in the experience of shopping in-person) sells Klein bottles through an online portal.

Subsisting off of goods made by hand is certainly the definition of living the dream to some, but to do this for the long term you must have a very strong business acumen just like any other entrepreneur:

  • You are at the opposite end of the spectrum compared to digital goods in that your items tend to have the maximum lead time required to fill orders.
  • You have to develop and maintain your own supply chain.
  • A custom supply chain will require you to examine very carefully where you source your raw goods. In some limited cases you might able to get materials through everyday retail, but in most cases you will only be able to maintain your business if you use wholesale channels. In order to do so, you will have to have your Employee Identification Number (EIN), sales tax license, business registration, and generally a merchant banking account all squared away.
  • You may also be able to use reclaimed materials – think recycled glass or abandoned wooden pallets – as “up-cycling” is a new consumer trend. However, you will have to stay on the hunt for these discarded items and it could mean limits to your inventory.
  • You retain your customer bases by providing objects with much finer craftsmanship or sentimental value than mass-produced goods (one additional reason why you should put a lot of care into where you source your materials). You will primarily grow your business by selling at a premium, and this introduces the challenges of finding and appealing to a relatively small base of higher-earning consumers.

Third-party Inventory

Just like any physical retail store, you can decide to stock up items manufactured by others. Given all of the complexities of digital goods and handicrafts, it is easy to see how going this route can benefit you as an online business. Let us look at two of the main methods for procuring products this way:

Reselling

If you have ever flipped an item purchased at a garage sale or exchanged an old jacket from your closet for cash at a second-hand store then you have acted on a small scale as a reseller. It is possible to scale this activity up using the web and develop it into a viable business. Here are the main concerns of online resellers:

  • You will have to have a very strong understanding of the market for your products and be able to distinguish good-as-new secondhand items from ones that have depreciated to the point where they are not worth stocking.
  • There is a good deal of overhead involved in finding and sourcing items. While eBay, yard sales, and estate sales are usually good on a very small scale, if they are the sole method of finding inventory then it will become difficult to grow or find inventory with consistent quality.
  • While exchanging items for higher value than you paid for them is perfectly legal on a one-off basis, if you intend to create a business out of it most localities will require you to obtain a resellers license. It will be necessary in order to turn your operation in to a legitimate high-volume online store.
  • Speaking of having a resellers license and increasing volume, you will need one in order to partake in the best source of secondhand inventory, online auctions. Services such as Liquidation.com list large lots of name-brand goods that come at around 70-90 percent off of the retail price. This is the best way to build huge amounts of quality stock but requires you to know what you are doing since you will have to bid against others and will have to take the entire lot as-is.
  • As an online reseller, you will be completely responsible for the warehousing costs and logistics of your items. While it is feasible on small scales to keep them in your own garage, for example, for any serious efforts you will likely need to find some professional-grade space with adequate security that you can insure for reasonable rates.

Drop Shipping

One of the key points of this article that you may have picked out is that just because your store may exist online, that does not mean that it is free from most of the hassles of physical stores. As we pointed out above, you should never underestimate the costs of holding on to inventory.

This is why drop shipping has become such a boon to online business. This is the practice of ordering directly from a distributor that ships to customers. It allows you to sidestep most of the headaches of stocking and fulfilling your own items. Despite the benefits, it comes with a set of caveats:

  • The distributor takes on the cost of warehousing and shipping. While the arrangement made with them will usually lead to affordable goods, they will add a markup that will make your items more expensive than wholesale.
  • If you have to deal with a customer concern – say you promised to replace any broken or defective items – then you will have to account for the communications channels of the distributor, which will often not be in the same time zone and will be busy handling the concerns of many other clients. You will be at their mercy for many critical issues.
  • The quality of drop shipping operations varies greatly and scams abound in this space. You will need to be extremely diligent when selecting a drop shipping partner.

Contract Manufacturing

Finally, we come to manufacturing through an offshore contractor, a method of getting products for online business that brings together a lot of the concepts that we detailed above.

Unlike selling digital goods, it allows you can sell your items at a reasonable markup and is less of a gamble because physical goods tend to have more predictable levels of demand. It also allows you to leverage the demand for other goods – e.g. the rise of phone cases correlates with the rise of smartphones.

It allows you to put your custom touch on the item and build a unique, differentiated brand, much like the artisan making handicrafts. But unlike the artisan, you will be able to scale your business with much more ease and rely on the expertise of others to optimize the production process. It also ensures that you can get a steady amount of salable inventory and will not have to scramble to find the best deals sitting on some bulk palate that a failed department store has auctioned off.

If you have the skills to sell with a drop shipping operation, then you can leverage those same skills to sell original products over which you will have much greater control.

Of course, all methods have their pros and cons. Here are the top things you should take into account when working with a contract manufacturer:

  • You will have to invest upfront in the design and testing of your product and also incur all costs of prototyping. Though prototyping costs have gone down substantially thanks to new technology, an industrial grade of this known as injection mold can cost upwards of tens of thousands of dollars.
  • You will have to have the skills to translate your design into a manufacturing process that preserves quality. In this case, you may need to hire a designer or engineer who can work offshore with the manufacturer and can help direct the process. This could be a significant cost.
  • As with drop shippers, quality of manufacturers varies greatly. You will need to put as much care into the selection of your contractor as you do into the design of your product.
  • You will need to develop a strong contract. This can require high levels of expertise and a long lead time that delays the beginning of your operation. If outsourcing to China, for example, you will need to understand the differences in IP protections and how the law assigns responsibility for compliance with local regulations. This process will invariably involve outside legal counsel and it can be difficult to find counsel that has the specific level of knowledge needed.
  • Using a contract manufacturer is not a fire-and-forget process. You will need to regularly step up and ensure that the partner is engaging in sufficient cost reduction initiatives, is operating within compliance of all applicable standards, and is holding true to the price structures as outlined in your original contract.

Conclusion

An online business can definitely be the best way to build a sustainable business that grows at a steady rate and affords you a flexible, rewarding lifestyle. However, whichever route you choose for sourcing/developing products, you will have to put in huge amount of work and be armed with the proper knowledge in order to ensure that you are doing it right.

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