Target's Earnings: Key Takeaways for Retailers

Not so jolly margins news

Author: Andria Cheng

November 15, 2017

Target on Wednesday reported better-than-expected fiscal third quarter profit and comparable sales. But it warned that promotions and rising costs will squeeze margins in the holiday fourth quarter.

Here are some key takeaways:

Playing catchup to Amazon means you can’t expect profit growth right away. Target’s Q3 comparable sales rose 0.9% and traffic rose 1.4%, its second straight period of gains after strings of declines. However, the sales gain basically all came from a 24% increase in online sales, which contributed 0.8 percentage points to the same-store sales increase. But fulfilling those online orders isn't cheap: “Digital fulfillment costs” was one key culprit denting gross margin and operating income. Target’s operating profit has declined in seven of the nine quarters, Retail Metrics data showed, and gross margins have declined for four straight quarters.

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Brick-and-mortar stores will play bigger role as online fulfillment centers.  Like other retailers, Target is “blending digital and physical” operations and “rapidly testing and rolling out new fulfillment operations,” in CEO Brian Cornell’s words on a conference all Wednesday. Not only can customers pick up online orders from all of Target's 1,800-plus stores, the number of stores that can process and ship online orders has jumped more than 10 times to 1,400 this year. In fact, more than half of the company’s online order volume is handled by its stores and that percentage will rise to above 80% during peak holiday shopping period, said Target Chief Operating Officer John Mulligan on the call. Stores remain key in Target’s other online-related initiatives introduced this year: Target Restock next-day delivery of household items; same-day delivery now being tested in four stores in New York; and curbside pick-up service currently piloted in 50 locations in Target’s home Twin Cities market.

Don’t give delivery away for free when you don’t have to.  While many studies have showed that consumers increasingly demand free and fast delivery as the key factor before they consider whether to make an online purchase in the first place, Target’s same-day delivery test in New York suggests retailers don’t have to assume they have to swallow all of the last-mile delivery costs all the time and in all markets. The New York same-day delivery test typically costs customers between $5 to $10 per order in shipping charge. Not only is the average transaction six to nine times larger than the average ticket in those four stores, Target actually hasn’t seen any customer resistance to the delivery expense yet. “We’ve seen that in the four stores in New York, there’s no push back at all in the delivery charge,” Mulligan said, adding that the much larger-than-average transaction size ends up “being a highly, highly profitable transaction.”

"Nimble and Flexible" is the new retail mantra.  Retailers across the board are seeking self-disruption of different kinds, and Target is no exception. For example, in Target’s move to open smaller stores in “dense urban” neighborhoods like New York and college campuses to attract new customers, the company has learned to change the way it traditionally selects the location. In the past, Target’s real estate team would be focused on finding space to accommodate its “relatively rigid prototype for a store’s size and layout.” Not anymore. “Today when we find space available in an attractive neighborhood, we custom design a store that can fit the available space,” Mulligan said. The result: those stores generate both higher sales per square foot and higher-than-average gross margin rates, Mulligan said.

Don’t expect a Merry Christmas when it comes to holiday profit. Promotions and other price cuts will be prevalent this holiday season, as will increased costs tied to increasing holiday seasonal hires, in part to process online orders. “We enter every holiday season knowing that it will be highly competitive and promotional,” said Chief Financial Officer Cathy Smith. “We expect to see continued pressure on our gross margin in the fourth quarter.”    


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