Dropshipping Profit Margin: What Is It and Why Does It Matter?

As a dropshipper, I used several ways to price my dropshipping products and also took into account my advertising costs. I learned many things from these experiences—things I will share with you today.    

Here are the things I will discuss:

• Ways to price your products
• Common business terms for profit 
• Typical cost of starting and maintaining a dropshipping business

Key Takeaways: 

• The average profit margin is around 15-25% 
• Organic marketing will have higher margins, but often less volume
• Paid traffic often leads to less margin but more volume
• Product type and competition also play a huge role in the profit margin

In the end, I am sure you will become familiar with common profitability terms, and also learn how to calculate them properly. Armed with this knowledge, you should be able to plan how to reduce your operating costs and increase your profit margins. 

What is the average profit margin for dropshipping?

The average profit margin for dropshipping is between 15% and 20%. While this may look small, it only makes sense, considering that dropshippers do not spend money on inventory, physical stores, or employees.

Your goal is to hit a profit margin that is higher than 20%. In addition, the 20% margin is not a default. For example, if your product capital is $1, it is not advisable to sell it for $1.20. That margin of $0.20 will not cover your cost of labor, time, and payment processing fees.

It is not impossible to target profit margins of 200% or more. For example, you can find a coffee mug in Printify and Printful that costs only $10, including the print. You can sell this mug for $39.99 if you want, giving you a profit margin of 300%.

If you want to increase your profit margins, one thing you can do is focus on organic marketing. Do not spend a lot of money on ads. Instead, create viral videos or blogs that can ring traffic to your store.

Paid traffic, on the other hand, is the most common way to get traffic. What this does is you get more traffic to your store, and also get more sales. The thing is that you are paying for your customer acquisition. As such, your advertising costs will eat away at the edges of your profit margin.

Finally, you can increase your profit margins by watching over your competition. If possible, always attempt to sell products that are better than what the competition offers. This way, you could increase your prices and bump up your margins, with the justification that your product is superior to the rest. 

How much does it start to start dropshipping?

You can start a dropshipping store for as little as $25 per month. It is your payment for your store subscription. Particularly, I am referring to a Shopify subscription plan. Please note that prices can change and that my price quote here may not be the same as Shopify’s current pricing anymore. 
At this rate, you will do all the work, including looking for winning products, importing the products to your store, designing the store, installing plug-ins, and so much more.

Such is the nature of a business, especially for dropshippers. We need to bootstrap and make do with what we have. It is also the reason why dropshipping requires so little capital. Overall, the barrier-to-entry to dropshipping is low, but the potential gains or profits are high!

Common Dropshipping Fees and Expenses

In this section, I will discuss the costs of dropshipping, but I will focus on the common cost only. As such, I will no longer include plugins that add functionality and flair to your store. The list of plugins available to us dropshippers is endless, so let us concentrate on the basic cost of dropshipping.   

1. Marketplace or Store Cost 

There are many ways to build a dropshipping store. You can even dropship on Etsy, Amazon, and eBay. There are e-commerce platforms you can use such as BigCommerce, Ecwid, etc. The two biggest platforms, however, are Shopify and WooCommerce. 

Shopify and WooCommerce are the two platforms that I strongly recommend. Not only are they easy to use, but they also offer a lot of plugins you can use to improve your store. 

Shopify offers several plans, and the one I recommend if you are new to dropshipping is the Basic plan, which costs $25 per month. If you pay on an annual basis, the cost goes down to $19 per month, but you need to pay for the entire year in advance.         

Here are the three Shopify plans for your reference:

• Basic – $25 per month 
• Shopify – $65 per month
• Advanced – $399 per month 

The Shopify and Advanced plans give you more bells and whistles, but you do not need them right now. The Basic plan is more than enough to start a fully functional dropshipping store. 

WooCommerce, on the other hand, is completely free. To use WooCommerce, you must install it on a website that runs on the WordPress content management system. To do that, you have two options:

1. Buy a subscription from WordPress.com
2. Subscribe to a hosting service provider, and use both WordPress and WooCommerce for free

Between these two, I recommend Shopify, as it is easier to build a store with the Shopify platform. All it takes to build a Shopify store is to select a theme, and then replace the images on that theme. You can immediately upload your products, or import them, without tinkering with plugins or custom code as you would with WooCommerce and WordPress.   

As far as hosting goes, there are so many choices out there. A good example is Bluehost because you can build a dropshipping store for as little as $2.95 per month with it. However, you have to pay this on an annual basis, so prepare at least $35.4. 

2. Product cost and Shipping Fees

Although you do not need to buy inventory in dropshipping, you need to prepare the money to fulfill orders, including the fees you must pay for shipping.

So, let us say that you are dropshipping this item: 

You have to pay this seller $3.59. This product is free to ship, so you do not need to pay for any shipping costs. Imagine if you have 10 orders of this in a day. You need to prepare $35. Process all these orders.

There is no telling how much money you need to spare for product and shipping costs. My recommendation is to prepare your credit card for this purpose.  

3. Advertising Expenses

It is rare for a dropshipping store to succeed without advertising. You would need to create viral content to make your dropshipping products known. In addition, many platforms such as TikTok and Instagram will not even allow you to put links in your posts unless your post is a paid ad. 

There is no single answer to how much money you should spend on marketing or advertising. There were times I spent $100 on a single ad on Facebook and never made a sale. Not because ads do not work, but because advertising is an entirely different beast to tackle when it comes to dropshipping.  

4. Affiliate Marketing Expenses

Lastly, there are some expenses you need to prepare for if you want to go the route of affiliate marketing. 

Affiliate marketing is a type of marketing where you convince people (affiliate marketers) to promote your products. If their promotion methods result in a sale, you pay them a commission. 

For example, if you commit a commission of 20% for a product you sell for $100, you will pay that affiliate marketer $20 for every product he sells. Because of this, you will have less profit. 

You can forego both advertising and affiliate fees. If you are new to dropshipping, the store maintenance and the product/shipping costs should be your primary financial worries.

As you get deeper into the world of e-commerce, you can learn how to advertise and take things slowly (in a financial sense) when you launch ad campaigns.

All in all, all it takes to start a dropshipping business is no more than $225 per month, excluding the cost of goods sold.

How To Price Your Dropshipping Products

Is there a proper way to price dropshipping products? Well, yes and no. Pricing your products depends on several factors, most notably your competitors. If someone is selling the same item as yours for $50, will you sell yours for $60?

In this section, I will provide you with some strategies to price your products appropriately. There is no right and wrong way, but you have to choose the method that best applies to your situation. 

1. Fixed Dollar Addition 

Fixed dollar addition is a straightforward way to price your dropshipping products. If the COGS is $25, and you add another $25 and sell it for $50, then you have just done a fixed dollar addition. It is a pricing process that works best if you do not have a lot of expenses in your dropshipping business. 

2. MSRP

MSRP refers to the manufacturer's suggested retail price. You will typically see this suggested price if you use dropship directory tools like SaleHoo or Ecomhunt. 

I suggest that you use MSRP if you have a lot of competitors. You do not have to cut your prices just to make your products more appealing. The MSRP is pretty much the price that customers are willing to pay. 

3. Fixed markup

This is a pricing strategy where you determine a certain percentage to add to your COGS. For example, let us say that you decided to add 100% markup on every product.

If the product COGS is $25, 100% of that is $25, so you will sell your product for $50. This pricing strategy is also commonly called cost-plus pricing strategy.

The only downside to this is that your product price may no longer be attainable. As such, you must keep watch over the final price. 

Common Terminologies and Formulas for Dropshipping Profit Margins

The world of business has standards—like science, there are terms that you must know because these terms can help you manage your business better. In this section, I will show you several of these terms, along with their formulas and some examples.     

1. Cost of Goods Sold (COGS)

COGS refers to the total cost of the product you sold. Typically, it is much more complicated to calculate in a restaurant business, considering that, for example, a hamburger patty is not just made of meat. It has salt, pepper, wrapper, etc.

In dropshipping, COGS is straightforward: it is the cost of the product you sold or the capital for it. So, if you sold a bag that costs $3.59 in AliExpress (or from your supplier), and you sold it for $9.99, your cost of goods sold, or COGS is $3.59. 

2. Average Order Value (AOV)

The average order value is merely an average of how much people spend when they buy. The formula is total revenue/number of transactions (or the number of orders). 

Here is an example:

• Customer 1 – bought a total of $49.99 in one transaction
• Customer 2 – bought a total of $37.5 in one transaction 
• Customer 3 – bought a total of $76.5 in one transaction 
• Customer 4 – bought a total of $85.4 in one transaction  
• Customer 5 – bought a total of $12.4 in one transaction 

In this case, the total revenue is $261.79. If we divide that by the five transactions, the average order value is $52.36.

The AOV, $52.36, tells us that on average, a customer spends around $52.36 per transaction. As an entrepreneur, we can tell ourselves that we want to increase that AOV. The higher the AOV, the higher the revenue is going to be.

There are many ways to increase the AOV, such as bundling several products together—we sell three products in one bundle. The customer pays higher, but we also make a lower profit margin. 

3. Conversion Rate

The conversion rate is a percentage that represents how many people took action against the number of people we expected to take action. In business, we usually measure conversion rate (CVR) in our ads, and the action we consider conversion is sales. 

Here is the formula: number of people who bought the item/number of people who saw the ads. 

So, if 1,000 people saw the ad and 100 of them made a purchase, the CVR is 100 / 1,000 = 0.1. Multiply 0.1 x 100 and you get 10%.

The conversion rate tells you how effective your campaign is. The higher the conversion, the better it is. According to Shopify, a good conversion rate is around 2.5% to 3%.

4. Customer Acquisition Cost (CAC)

Customer Acquisition Cost refers to the amount of money you spend to acquire a customer. Usually, we associate this cost with ads. 

For example, let us say that we spent $100 on one advertising campaign. From this advertising campaign, seven customers made a purchase. 

In this case, our CAC is $100 / 7 = $14.29. It means that we had to spend $14.29 to acquire a customer. If our AOV is only $2, then we are at a loss, right? We are spending more money on customer acquisition than what a customer spends on our store. 

As such, your goal is to reduce your customer acquisition cost. For example, if you spent $100 on an ad, and 1,000 customers made a purchase, your CAC is $0.1. If the AOV is $10, then you are spending merely $0.1 (to acquire a customer) for every $10 revenue you make.  

5. Gross Profit Margin Formula

The gross profit refers to the amount of money you make after you deduct the COGS. This formula allows you to determine your markup. 

The formula for Gross Profit Margin is this: Revenue – COGS.

Let us say that you are dropshipping a bag that costs $15 from your supplier. If you sell this for $50, your gross profit margin is $35.

From here, we divide $35 over $15 and multiply it by 100 to get our markup. The solution looks like this: 

• $35 / $15 = 2.33
• 2.33 x 100 = 233% mark-up

While many experts will tell you that there are ideal mark-ups and profit margins, I will tell you now that these numbers are not set in stone. Every business is different, so you need to figure out what profit margin is realistic to keep your business running.

6. Formula for Net Profit Margin 

Finally, we have the formula for the net profit margin. The Net Profit Margin refers to the amount of money left after all your expenses, including your taxes, have been paid. 

Here is the formula for net profit margin: Net Profit Margin = Net Profit ⁄ Total Revenue x 100

Let us say that your total revenue for the month is $100 and below are your expenses: 

• COGS = $30
• Payment for Shopify = $25
• Tax = $10

Your total expense is $65. Your net profit is $35. We will now divide $35 by $100 (your total revenue) and multiply it by 100 to get the Net Profit Margin. 

Here it goes:

• $35 / 100 = 0.35
• 0.35 x 100 = 35%

The net profit margin is 35%. The higher the net profit margin is, the better it is for your business. As an entrepreneur, your main goal is to increase your net profit margins to ensure that your dropshipping business is profitable. 

Calculate Your Profit: Use Our Dropship Profit Calculator 

All the mathematics for calculating profit margins can be mind-boggling, so we made it easier for you. If you create an account with us, you will have access to our various calculators. The one I will show you in this section is our Dropshipping Profit Margin Calculator.    

Here is what it looks like: 

The numbers I highlighted in red are automated. These are the results of calculations based on your inputs. In this case, we are selling an item for $25 per piece, and the cost of goods sold is $10. 

Factoring in the shipping cost, fees per order, and cost of acquisition, we see at the bottom right that our profit margin is 48%, which is about half of our revenue.

I encourage you to go to our Dropshipping Profit Margin Calculator and play around with it. Use it to calculate how much money you make—our calculators can help you make informed decisions on how to manage your business’s financial health!

Ways to Increase Dropshipping Profit Margins

To become a profitable dropshipping company, your primary focus is to increase your dropshipping profit margins. Based on the calculations that we did earlier, we will now look at the most common ways to improve your profitability.

1. Reduce Customer Acquisition Cost

Let us say that you spent $500 on an ad campaign. The ad resulted in 50 transactions or 50 customers. In this case, our customer acquisition cost is $10. It means that we spent $10 to acquire each customer.

If a customer orders a product that is worth $20, we only make $10 from that customer. Why? Because we spent $10 to acquire that customer. 

As such, we want to reduce our CAC by a significant amount. The way to do this is to either spend less money on ads or make the ads more effective. A more effective ad can result in more customers at the same price that we paid for that ad.

For example, if our ad were any better, and we spent $500 but this time, 200 customers made a purchase. The customer acquisition cost is now $2.5. If, on average, a customer spends $20, then our profit margin from this customer is $17.5.   

2. Reduce Cost of Goods Sold (COGS)

This is a no-brainer—the cheaper your products are, the higher profit margins you will have. Let us say that SUPPLIER A offers a bag for $25, and SUPPLIER B offers the same bag for $20. 

If you sell the bag for $50, you would have made a $25 profit margin from SUPPLIER A, but $30 from SUPPLIER B. To take this approach, you need to spend some time scouring supplier databases for the best price. 

Look at this toy car from a seller called DreamWorks Toys Store:

Now, look at the same toy sold by another supplier:

See the difference? 

• DreamWorks sells it for $21.62
• Children’s Day sells it for $19.16

The difference is $2.46. It is not a small difference, as $2.46 is 11% of $21.62. If you dropship with Children’s Day, you will make $2.46 more than if you dropshipped with DreamWorks.  

3. Increase Your Average Order Value

Increasing AOV means increasing the average amount of money that a customer spends in your store. How do you do this? You either raise your prices or make better offers. One example is by offering your products as a bundle.

Here is an example: 

In this case, a customer will buy only one item. If ten customers bought a shirt, your average order value is $25 x 10 / 10 = $25. 

Now, let us do a bundle of all three. Instead of selling the bundle for $90, you sell the bundle only for $80.

If ten customers bought the bundle, your AOV is $80. Your total profit is $300($30 per customer x 10 customers).

If we only sell the shirt on its own, and ten customers make a purchase, our profit is only $100 ($10 profit for each shirt x 10 customers). 

As you can see, selling in bundles does not always result in a profit reduction. In addition, you will also make more money from the same cost of acquisition.

4. Reduce Your Operating Expenses

Lastly, I suggest that you reduce your operating expenses. Do not spend too much money on plug-ins. Many of these plug-ins are free, but then you have to pay a monthly fee if you want more features. 

Tell you what: these features are not all so important right now, especially if your dropship store is new. If I have to choose between these features and spending money on ads, I will go with the latter.

FAQ: Dropshipping Profit Margin 

How much profit can you make from dropshipping?

You can make a lot of profit if you manage your pricing and advertising costs the right way. At the very least, I can say that you must target a net profit margin of 30%. 

What is a realistic profit for dropshipping?

The average dropshipping profit margin is between 15% and 25%. This number, however, is not your limit. You can set higher targets and standards based on the quality of the product you sell.

How do you calculate dropshipping profit?

The general formula for profit is: Revenue – (minus) All Expenses. 

Will dropshipping make money?

Yes, of course. Dropshipping is a legitimate way to make money. However, it isn’t magic. Making money from dropshipping is not easy.

Summary

The next step I recommend is to try our Dropshipping Profit Margin Calculator. This tool is a big help when it comes to calculating your profit margins. It is also accurate—you do not have to waste a lot of time doing manual calculations.

Sign up for a free 7-day trial with Dropship.IO. I encourage you to explore all our tools that will make your dropshipping life easier!