Target (TGT 0.57%) is adding groceries to its curbside pickup program, Drive Up. After successful tests in Minneapolis, Target expanded grocery pickup to 400 stores in the Midwest, and it plans to cover all 1,500 stores by the holidays.

While all of e-commerce is growing rapidly amid the coronavirus pandemic, online grocery sales have led the way. The shift to online grocery shopping has the potential to upend the $700 billion U.S. grocery industry.

Target has taken the opposite path of Walmart (WMT 0.83%) in its curbside pickup strategy. But the spike in online grocery orders and Walmart's ability to attract new customers through the service has put Target behind its larger rival.

A man in a Target shirt talking to a woman while she sits in her car.

Image source: Target.

Consumers prefer curbside pickup

Online grocery shoppers prefer to pick up their items at the store instead of getting them delivered. Grocery pickup orders climbed 81% in 2020 through mid-June, according to Nielsen. Delivery is up just 33% during the same period.

While customers still have to drive to the store to pick up their orders, it can actually be more practical than delivery. A shortage of delivery drivers for Walmart or Amazon Prime Now orders could mean a significant delay for grocery purchases. Many delivery time slots may not be convenient for customers, either. And some customers may prefer driving to the store instead of paying for delivery (and tipping their driver). Picking up orders provides customers with greater control.

Curbside grocery pickup had a meaningful impact on Walmart's e-commerce growth in Q1. Digital sales climbed 74% for the company during the quarter ended in April. About two-thirds of that growth came from online grocery.

Meanwhile, Target's digital sales climbed 141% during the same period, with same-day services growing nearly twice as fast. Management noted food and beverage sales spiked in mid-March as states started shelter-at-home orders, but didn't note if they remained elevated in late April as general merchandise sales started climbing again. It did, however, see its fastest growth in digital orders in April.

The potential for groceries in curbside pickup

Adding groceries to its Drive Up program could get customers to pick Target instead of Walmart. Target may be more conveniently located for some customers, or they may prefer the brand. 

It's important to note, however, there's a potential cost to offering groceries through Drive Up. Groceries are already very low-margin items. Adding the additional labor cost of picking items and bringing them out to cars could make grocery-only orders unprofitable. 

Walmart doesn't break out financial results for e-commerce, but it's estimated to have lost about $1 billion from its digital business last year. Granted, not all of that is attributable to its rapid expansion of online grocery, but head of U.S. e-commerce Marc Lore has indicated grocery fulfillment on its own is likely unprofitable.

In order to make the service profitable, Walmart's adding more general merchandise items to its curbside pickup program. Target, meanwhile, already offers general merchandise through Drive Up. If Target can get shoppers ordering more regularly through Drive Up, bringing them in through groceries, it could make the service profitable through general merchandise sales.

Target could also make a profit on customers using Drive Up for groceries if it leads to similar results as previous Drive Up customers. Management said it sees customer spend increase by 25% after they make their first Drive Up order.

The addition of grocery to Drive Up will have a negative impact on Target's gross margin. But it could create more consistent curbside pickup customers and lead to incremental sales for the retailer. Target still has a lot of catching up to do in online grocery, as Walmart has been very aggressive despite the pressure on its profits.