Target (NYSE:TGT) isn't messing around this holiday season. In addition to boosting its holiday hiring by 20%, the retailer is aiming to undercut Amazon (NASDAQ:AMZN) Prime by offering free two-day shipping on hundreds of thousands of items to all customers, with no minimums and no memberships.
That no-strings-attached two-day shipping starts on Nov. 1 and runs through Dec. 22, Target announced on Oct. 23.
The story so far
Target has taken aggressive steps this year to boost its online business. It rolled out its year-round free two-day shipping offer in March, which requires a $35 minimum purchase for shoppers paying with a credit or debit card, with no minimum for those paying with a Target REDcard.
It also revamped its Restock service, which provides next-day delivery of home essentials and nonperishable groceries shipped directly from a nearby store. REDcard holders pay no fees beyond the cost of the items, while everyone else is charged $2.99 for the service. The service has no order minimums.
Amazon offers a similar service, Prime Pantry, but that requires a Prime membership, an additional $5 monthly Prime Pantry membership, and still requires a $40 minimum purchase to avoid a steep $7.99 shipping fee.
These online initiatives have helped Target accelerate its online growth. The company managed to grow digital sales by 41% year over year in the second quarter, up from 32% growth in the prior-year period.
Winning the holidays
Target's digital sales grew by 29% during the fourth quarter of 2017, a respectable but not world-beating number. The company is far behind in terms of online market share -- just 5.5% of its total sales, or roughly $4 billion, came from digital channels in 2017. A higher growth rate is essential for the company to close the gap with Amazon.
The holiday free two-day shipping offer should help. With no order minimums, Target won't automatically lose sales of smaller orders to Amazon. Tens of millions of Amazon Prime members in the U.S. have been conditioned to abhor order minimums.
Target is also expanding its Drive Up initiative ahead of schedule. The company expects its curbside pickup service to be available at nearly 1,000 stores by the end of October, providing an alternative to waiting for an online order to arrive. Drive Up orders are ready within an hour, and the service carries no additional fees.
Target is able to offer free shipping with no minimum in part because it now fulfills most online orders directly from its stores. Over two-thirds of its online growth in the second quarter was fulfilled from Target stores, according to CFO Cathy Smith during the second-quarter earnings call. Its nationwide store base has allowed the company to compete on free shipping without needing to replicate Amazon's massive distribution network.
Selection and margins
While Target's holiday shipping offer should help the company grow online sales at a quicker pace this holiday season, the company still has one big disadvantage. Target's free two-day shipping will cover hundreds of thousands of items, but many millions of products are available via Amazon Prime. High-volume items, like popular toys, won't be a problem. But the more obscure the item, the more likely Amazon becomes the best, and possibly the only, option.
This no-minimum free shipping deal could also hurt Target's margins. The company blamed digital fulfillment expenses for a slight gross margin decline in the second quarter and an increase in operating costs. But it still managed to grow earnings at a double-digit rate, thanks to a much lower tax rate.
Target's bottom line will get a similar boost from a lower tax rate in the holiday quarter, but the more aggressive free shipping offer may have a larger impact on margins. And if online growth exceeds expectations, fulfilling orders from stores could have a negative impact on the in-store experience.
While Target's holiday strategy does come with risks, the company is doing what's necessary to grow its online business.
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Timothy Green has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Amazon. The Motley Fool has a disclosure policy.