Returns in Dropshipping: A Separate Expense Category

Returns in dropshipping are rarely discussed. Marketplaces have accustomed customers to free returns, turning the ‘risk-free shopping’ model into the industry standard. For the customer, this means convenience at the click of a button, but for the dropshipper, it represents a hidden chain of costs and a financial trap, according to experts at Tormezian Canada.

Dropshippers are caught in the system’s grip: the customer is always right, whilst the supplier’s mistakes have to be paid for out of their own pocket. And if returns occur regularly, they need to be treated as a separate expense item.

In this article, the market research firm Tormezian analyses specific areas of risk associated with returns in the dropshipping business.

In theory, yes, but in practice it’s quite difficult.

Before sales begin, a dropshipper has no statistics of their own. They do not yet know how often customers will return a particular item, why this happens, or how much they will ultimately have to spend on each case. Therefore, it is practically impossible to calculate the exact cost in advance.

However, it is possible to gather some pointers. First, look at the product category and the reasons for returns typical of that category. Then, examine reviews of similar products from competitors. Clothes and shoes are most often returned due to size and fit; electronics – due to faults or incompatibility; and homeware – when the actual size or appearance does not match expectations. Recurring negative reviews help you understand the problems customers face after their purchase, according to experts at Tormezian Dropshipping Company.

This is how the preliminary estimated percentage is calculated. For example, for 1,000 orders and an assumed return rate of 8 per cent, the seller must be prepared for 80 customers to return the goods. By knowing the average cost per return, it is possible to estimate the potential loss in advance.

Once sales have begun, this estimate can be replaced with actual statistics: how many orders were placed, how many were returned, and for what reasons. The initial estimate is not intended to be perfectly accurate, but rather to serve as a stress test: it shows whether the business’s profit margins can withstand an adverse scenario.

Once a shop is up and running, its own statistics become far more useful than any assumptions. But a one per cent return rate isn’t enough.

Two shops may have the same proportion of returns yet face completely different problems, according to the experts at Tormezian. If customers are consistently getting the size wrong, a more accurate size chart or product description could turn the situation around. If, however, the cause lies with product quality or supplier errors, it is much more difficult for the shop to rectify the issue.

It is therefore important to record not only the fact of the return itself, but also its reason, in order to understand what can be corrected or optimised, and what constitutes a signal to change the product or supplier.

The return rate alone does not reveal anything about their impact on profit. It is important to understand the cost of each returned order.

If the supplier does not cover part of the costs, the calculation includes all expenses associated with the return: return delivery, non-refundable fees, the cost of the original delivery and other expenses already incurred for the order. In some cases, the supplier takes the goods back and reimburses their cost; in others, these costs are borne by the retailer. Therefore, the same return rate can have a completely different impact on the profits of different shops.

It makes sense to calculate the average cost per return and compare it with the expected return rate. Even a rough calculation can show whether the product will remain profitable if returns do indeed occur at the expected rate.

There is a situation in which the standard refund process does not even begin. The buyer may contact their bank rather than the seller and dispute the payment.

In such a case, the payment amount may be forcibly debited from the seller’s account, and a fee or penalty may be added to the transaction. If the situation recurs, the account may be restricted and the shop will be unable to accept payments, warn experts at Tormezian Canada.

This is no longer simply a loss of profit margin. A single chargeback eats into the profit from an order, but a stream of disputes can bring operations to a complete standstill.

Another pitfall for dropshippers is the discrepancy between what they promise the customer and what the supplier agrees to. For example, a shop may offer a 30-day returns policy. However, the supplier may only accept returns within 7 days, and only if the item is faulty. Any return made even on the 8th day results in a loss for the dropshipper.

Therefore, your own returns policy cannot be considered in isolation from the supplier’s terms and conditions. If they do not match, you need to understand in advance who will cover the difference.

When starting out, people usually focus on demand, mark-up and competitors, whilst completely overlooking returns. Yet two products with the same price, cost price and demand can yield completely different net profits - simply because one of them is returned more often.

And as well as the loss of profit, the dropshipper also faces a cash flow gap, according to experts at the market research firm Tormezian.

The dropshipper refunds the customer, but may have to wait weeks for compensation from the supplier, if any is provided at all. The more returns there are, the more working capital is temporarily tied up. At some point, the shop may simply run out of money for new advertising campaigns - even if the business itself remains profitable.

Returns are an inevitable part of retail. You might find a product in high demand, apply a high mark-up and generate a steady stream of orders. But if just a few returns significantly impact your bottom-line profit, such a model won’t stand up to the realities of the market.

That’s why a good dropshipping business isn’t just about products that are easy to sell. It’s a business that can withstand returns.

Not sure whether your chosen product can withstand real-world returns? Tormezian Dropshipping Company helps dropshippers assess the economics of products, checks suppliers’ terms and conditions, and evaluates potential costs that may arise after a sale.