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Target's Digital Strategy Is Paying Off

By Adam Levy - Updated Apr 18, 2019 at 10:14PM

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Online sales continued growing rapidly during the tough holiday season.

Check out the latest Target earnings call transcript.

Target (TGT 2.46%) recently reported early results for the November-December holiday period, and digital sales stood out. Sales originating from Target.com increased 29% year over year, leading to 5.7% growth in comparable-store sales. That's on top of 3.4% comparable-store sales growth in the same period last year. The 29% growth in digital sales matches its results for the full fourth quarter last year.

Management provided an interesting detail in its announcement: The company's digital sales growth "was driven entirely by growth in store-fulfilled digital sales."

Target has made significant investments in fulfilling orders from its stores in 2018. That includes shipping more items from stores, offering curbside pickup, and expanding its same-day delivery service. Its holiday results, in the face of stiff competition, indicate the investments are paying off.

A Target employee bringing an order to a customer's car.

Image source: Target.

Order online, pickup in store

Online orders picked up at stores increased 60% year over year in November and December. Store pickup orders accounted for one-quarter of all online orders, the company said.

One of the driving forces behind that growth is Target's Drive Up service. Drive Up is a curbside pickup service, which is the height of convenience for in-store pickup. Walmart (WMT 0.08%) has quickly grown its online grocery business via its curbside pickup service.

Drive Up expanded from a few stores in Minnesota in October 2017 to nearly 1,000 of Target's 1,800 stores by the end of October last year.

The combination of Target's selection and convenience (there's a store within 10 miles of three-quarters of the U.S. population) made it an excellent option for holiday shopping.

It's worth noting Target doesn't support curbside grocery delivery like Walmart, but it handles just about everything else. Online grocery delivery has been fueling Walmart's online sales growth over the past year, so it may be an opportunity for Target to expand. Target currently handles online grocery ordering via Shipt, its same-day delivery service.

Not without its downsides

Target's digital sales are fueling its comparable-store sales growth, but relying on stores to fulfill online orders has a couple major downsides.

First, using store inventory to fulfill online orders makes inventory management even more difficult. Walmart, in particular, ran into trouble in the fourth quarter last year when it had difficulty keeping items in stock. It took a big sales hit as a result.

Target is investing in supply-chain technology to manage inventory levels across its stores to support expected in-store and online sales. But there's still greater risk of its stores going out of stock as they devote more inventory and resources to online sales.

Second, Target's greater hands-on fulfillment comes with greater expenses. Target needs to hire more store personnel to handle online orders fulfilled from stores than it would if it fulfilled orders from a handful of central warehouses. It also needs to hire workers to deliver items to cars. And Shipt is as hands-on as it gets, with individuals picking and delivering orders while maintaining direct communication with customers.

All that has led to lower gross margin for Target. The company posted a third-quarter gross margin of 28.7% compared to 29.6% in 2017. However, increased same-store sales helped mitigate the impact on the bottom line. Operating margin only fell 40 basis points year over year to 4.6%. Walmart is also experiencing margin pressure, but not quite to the degree of Target.

Overall, Target's strategy is paying off. It's growing online sales and bringing tons of customers to its stores at the same time. In 2019, the company expects more profitable growth by scaling its fulfillment operations. As long as Target can avoid the potential pitfalls of fulfilling online orders from stores, the growth of online sales ought to maximize the efficiency of its in-store employees.

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