What is Arbitrage?
Arbitrage is the practice of taking advantage of a “price difference” between two or more markets (due to imbalance or inefficiency in the market). It’s continuous buying and selling an asset to profit from the differences in the price of the asset.
It is a regularly used trading strategy, and probably one of the oldest trading strategies to exist. Traders who leverage this strategy to make profits are called Arbitrageurs – like a bank or brokerage firm.
A definition for Retailers: the act of buying items in retail stores (like Walmart or Target) and then selling them on a different marketplace like (Amazon or eBay) for a profit.
As a simple example of arbitrage, let’s say:
If you went into a store and see that certain products are on sale, whether due to seasonal discounts or because the store’s clearing old stock, you may see that the price of a certain product used to be $30 but now, on sale, it costs $15.
So, you buy about 50 units of the product and then list the product on a different online marketplace like eBay, Amazon or any such, for a dollar or two less than the retail selling price – such as $29 or $28 rather than the original $30.
Since the prices are only a dollar or two cheaper than the actual listing, the lower pricing seems convincing enough for a buyer to make a purchase without any second-thought and you actually end up making a profit on an item that you bought on sale – all without even dealing with the manufacturers, wholesalers or suppliers.
Sellers can also fulfill their orders or they can use the Amazon FBA service, where they handle the shipping and order fulfillment and also offer customer service.
How Can Retail Arbitrage Work For You?
Retail Arbitrage makes you profit when you buy items at a significantly lower price from the wholesaler than selling them on a marketplace with higher yet lesser than the retail rates.
But earning a profit isn’t that easy – you need to invest some amount for marketplace fees and shipping costs.
For example, let’s say you can buy a denim shirt for $9 on the shelves at your local Walmart, and it’s selling for $21.99 on Amazon. After considering all of the fees and shipping costs, Amazon will pay you $15 once the item gets sold. In this example, you would make a profit of $6 on your initial investment of $9.
An example: FBA and Retail Arbitrage
The characteristics of Fulfillment By Amazon (FBA) lends itself well for all third-party sellers looking to make retail arbitrage work. The primary advantage compared to fulfilling orders on your own from your home or another location– with FBA – you aren’t limited by storage space, so in theory, you can sell unlimited products.
If you find a great deal on a product that you know you can resell at a profit, you can buy as many units as circumstances allow, without having to worry about finding space to store the items while you wait for them to sell (although Amazon charges for the space utilized to store your products).
Your time will be saved, less human workforce, less hassle by using FBA for retail arbitrage since Amazon handles all of the order fulfillment logistics and shipping details.
Also, having your products eligible for Amazon Prime and free one/two-day shipping means you have an active customer base at your fingertips.
So, it’s not a surprise that for many third-party sellers, FBA and retail arbitrage is a perfect match for profit.
Some Drawbacks Of Arbitrage
Retail arbitrage has its downsides. The risk is comparatively low while arbitraging on a small scale, but it gets exponentially higher when you try to scale up your operations.
- Low ROI: Everyone wants their cut: whether its manufacturer, the distributor, the retailer or— of course — Amazon. This will always cut into your margin.
- Advanced technology has significantly reduced arbitrage opportunities. It has led to the advent of automated trading systems programmed to monitor real-time fluctuations or price differences. These systems are able to identify and act on the inefficient pricing setups so rapidly that the price difference of similar financial instruments and arbitrage opportunity is immediately eliminated.
- What if you buy inventory at a highly discounted rate, however it didn’t get sold? Maybe the product is out of fashion or had a recall issued. What if the competition is too high? In such cases, you might not be able to get rid of the stock at a profit after all your expenses. As, your margins would be already tight, so getting stuck with inventory can be a big risk.