Fresh off the holiday shopping season, major retailers are hoping to keep the sales going strong well into the new year. However, to do so, Target (NYSE: TGT ) is taking some risky gambles. There's a lot at stake for the discount retailer as a result of management's recent business decisions. Should Target shareholders be worried? Let's take a closer look at the company's strategy going forward and what it means for investors.
Let the price wars begin
Target's recent decision to price-match online competitors including Amazon.com (NASDAQ: AMZN ) , Wal-Mart (NYSE: WMT ) , and Best Buy (NYSE: BBY ) is a dangerous game to play. Has it not learned anything from Best Buy's experience? The big-box chain, which last year announced it would price-match competitors, lost thousands of dollars this month after trying to match Wal-Mart's ad price on the iPhone 5.
However, outcomes such as this are just the tip of the iceberg when it comes to pricing wars. Shrinking margins are another implication of offering price-match guarantees. Not to mention, neither Target nor Best Buy benefit from the low overhead cost structure of Amazon.
The e-commerce giant doesn't have to pay rent on massive physical storefronts or wages for store employees. This makes it easier for Amazon and other online retailers to offer the lowest prices possible on certain products. That's where comparison-shopping or "showrooming" comes into play. Customers often use Target or Best Buy stores to browse products only to buy them elsewhere online, often at lower prices.
Fighting the good fight
The increasing use of smartphones has only made comparison-shopping more prevalent at bricks-and-mortar retailers. Target CEO Gregg Steinhafel explains, "We know that our guests often compare prices online. With our new Price Match Policy and the additional five percent savings guests receive when they use their REDcard, Target provides an unbeatable value."
Providing value for your customers is one thing, but doing so at the expense of margins is another. I understand that Target is trying to protect its market share, but by extending its holiday price-match policy, the company is creating new problems for itself.
Instead of trying to fight in an area where Amazon has the upper hand, Target should instead focus on what it does best. For example: exclusive merchandise. Target's exclusive partnerships with more than a dozen world-renowned fashion designers has helped differentiate its business from other retailers in the past. These limited-edition designer apparel lines help widen Target's competitive moat. Amazon can't compete with Target in this regard because the items are only available in Target stores.
However, Target's success with its exclusive fashion lines has often benefited auction site eBay (NASDAQ: EBAY ) . The online marketplace has become the go-to destination for sold-out designer pieces. For example, items from the Jason Wu for Target collection, which launched last year and sold out in a matter of hours, could later be found at marked-up prices on eBay.
In spite of that, Target's designer collaborations have proven successful at getting swarms of shoppers into its stores. This is important because Target is at the top of its game when it comes to converting in-store consumers into buyers. A report by Bloomberg this month highlights Target's unmatched strength in terms of store design.
Every aspect of the retailer's stores is thoughtfully laid out in order to maximize sales. Getting visitors to buy more and more frequently is even more important now that Target is matching competitors' low prices. Another way that Target is hoping to encourage repeat visits is by expanding its fresh produce offerings.
It's true that perishable items offer some of the lowest returns on invested capital. However, Target is positioning itself as a one-stop shop by selling essentials such as groceries. The hope is that once in the store, customers will make other, higher-margin purchases.
Is it enough?
Between matching online competitors' prices and a more aggressive push into the food business, Target's profit margins will likely suffer in the year ahead. Longer-term, though, I suspect these initiatives together with differentiated merchandise will help Target grow its market share -- even as other bricks-and-mortar retailers like Best Buy fade into irrelevance.
Target's push into Canada is another growth avenue that should reward patient investors down the road. The discounter is on track to open 200 new stores in the Great White North by 2014. These moves tell me that Target is confidently investing in its future. As an investor, I find this encouraging.
Amazon may have the advantages when it comes to pricing and convenience, but forward-looking investors shouldn't bet against Target just yet.
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