How to get inventory when you're low on cash

For retailers that don't want the overhead of stockpiling merchandise, drop shipping can be a cost-saving option.

Mike, Queens, NY
I started a home-based wholesaling business six months ago and got four credit cards totaling $18,000. I was scammed out of $10,000 and invested another $4,000 into a Web site and advertising. Now my cards are almost maxed out, and I need the cash or credit to purchase merchandise. Business people tell me it takes a few years before turning a profit, but I've worked like the devil these past six months to finally get the contacts and deals I've been searching for, only now I don't have the cash or the credit. Is there anything I can do?

By Kathleen Ryan O'Connor, CNNMoney.com contributing writer
Starting a business from scratch takes time and an incredible amount of energy – and setbacks are inevitable. It can feel like you're knocked two steps back for every step forward.

Lacking working capital is going to make it even harder, unfortunately. Credit markets have grown extremely tight, and the fact that you're using nearly all of your available credit lines pushes down your credit score, which makes you a less attractive candidate to the banks for extending further credit. That's never ideal, but it can be the kiss of death today, when even people with pristine FICO scores and very little debt are finding it difficult to find decent lending options.

So what to do?

One option is to take a break from working on your business full-time and find an outside job that will let you pay down debt.

But if you want to keep forging ahead, you could approach the suppliers you've already lined up and ask if they will open an account for you to buy on their credit terms. That may be tricky: When you run a credit check, you might not rate as a good risk.

Another option is for you to start an account with a drop shipper. Drop shopping is a "buy-as-you-go" model under which you advertise the merchandise, sell it to the customer, and then, after the buyer's money arrives, you complete your purchase of the requested products from the drop shipper, typically via credit card. The shipper then mails the purchased items to the customer on your behalf. The transaction is generally invisible to buyers: Drop shoppers offer a variety of arrangements, from plain boxes to packaging decked out with your logos.

Drop shipping isn't a new concept. One of the few studies on the practice, published in the journal Management Science in 2006, found that about one-third of Internet retailers rely on drop shipping to fulfill orders.

"Early on, there was a lot of hype around drop shipping," says Serguei Netessine, an author of that study and an associate professor of operations and information management at the University of Pennsylvania's Wharton School of Business.

The initial idea was that drop shipping would be a one-size-fits-all "panacea" for e-tailing. That hasn't panned out. In its early days, even Amazon.com (AMZN) used drop shipping, but the bookselling Goliath soon realized the practice wasn't a good fit for the volume of business it was doing. Amazon instead committed to buying its own inventory and building warehouses. It now offers its own drop-ship service to smaller retailers, Netessine says.

"That's kind of a natural evolution," he says.

Among the downsides of drop shipping: You are introducing a middleman into the transaction, the drop shipper, who has to make their own profit, so your margin is going to be smaller than if you acted as the wholesaler yourself. On some products, the profit margin is already so low that drop shipping makes it extremely difficult to make any money at all.

Another challenge: Drop shipping scams are all over the Internet. Key red flags include recurring monthly fees or difficulty in getting a live person on the phone. Try to hit a trade show. If a drop shipper has a booth there, that's probably a good sign. Several Web sites help connect online merchants with drop shippers and wholesalers; WorldWideBrands.com is one example.

And since your shipper will be packaging and shipping merchandise under your name, be certain to pick one that demonstrates a commitment to the same quality and customer service you'd want your customers to expect of you.

Also take care to thoroughly note your shipper's policies on backorders, returns and lost shipments. Chronic problems in order fulfillment have destroyed many a small business, online or not, and savvy consumers used to Amazon or Zappos boxes dropping on their doorstep a day after they've clicked in their order will not look kindly on poor or slow service.

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