The evaluation of drop shipping option for e-commerce retailers

Many e-commerce retailers use drop shipping to satisfy demand. A retailer simply forwards customers' orders to the manufacturer who fills the orders directly to the customers and is paid a predetermined price by the retailer. Advantages of drop shipping include lower costs of holding inventory, materials handling, and obsolescence. Disadvantages of drop shipping include fragmented order delivery when a single customer order involves products from different manufacturers and longer delivery times. A mix of holding inventory and drop shipping is frequently optimal for e-retailers. In this paper, we design an optimal mix strategy which captures the advantages of drop shipping and avoids many of its shortcomings. We use two different optimization criteria, maximizing the expected profit and maximizing the probability of achieving a target profit. We provide results for uniform, exponential, and normal demand distributions. We illustrate the results with numerical examples.