An off-target time for Target as the macro-environment undermines its omni-channel success story

After Walmart crashed earlier in the week, with digital growth stalling to one percent, the big question was whether omni-channel champion Target would stumble in the same way?

It did.

And it did in even more dramatic form than Walmart as the retailer turned in a 52% drop in Q1 profits. Revenues were up four percent year-on-year to $25.17 billion, but Wall Street was badly spooked and gave Target’s stock price its worse day since the Black Monday crash of 1987.

Only two months ago in New York, Target CEO Brian Cornell was revelling in validation that the firm’s omni-channel transformation program, built with an emphasis on overhauling the role of the physical store as well as investing in digital, had worked. He said then:

Today, I stand in front of you, as the head of $106 billion growth company, with a long list of proof points that our strategy is working…Five years ago, we had 1,800 stores. I announced the plan to add stores and upgrade the stores we had. And I saw jaws drop and our stock price dive for a while. At that time, retail was about closing stores, not opening them. Many [analysts] questioned our approach. Now, five years later, we have almost 2,000 stores and we are still re-modeling and building new stores. We also know the way we run our stores is the secret to growing digital sales.

Stuff happens

So what’s gone wrong? The answer to that is simple, but troubling - events! Nothing has happened that undermines the achievements of Target in becoming what diginomica regards as the benchmark for omni-channel retail transformation. But, as with Walmart, the global supply chain crisis, the ongoing COVID crisis and rampant inflation, all matters outside of the firm’s control, have taken their toll over the past few months.

Within digital, growth continues to be driven by same-day services and Drive Up, but that growth is now in the “mid-teens” compared to north of 100% growth a year ago.

As such, it was a more subdued Cornell who told analysts yesterday:

As expected, our business continued to grow in the first quarter on top of huge gains a year ago, underlying the resilience of both the consumer and the ability of our team to serve them. However, due to a host of factors, this growth was challenged by unusually high costs, resulting in profitability well below what we expected to be and where we expect to operate over time…More specifically, we saw much higher-than-expected rates and transportation costs and a more dramatic change in our sales mix than we anticipated. This resulted in excess inventory, much of it in bulky categories, which put additional strain on an already-stretched supply chain.

Customer behavior has also morphed, he added, with the cost of living crisis having an impact:

Not surprising, when we talk to our guests, they often express their concerns about a host of rapidly-changing conditions, ranging from geopolitics to the high and persistent inflation they've been experiencing, particularly in food and energy. 

Supply chain issues

The hit from the wider supply chain crisis is of particular note with Target. The firm’s transformation program over the past five years has been laser-focused on supply and distribution, using physical stores to enormous effect to support digital sales. Chief Operating Officer John Mulligan admits that the firm has been dealing with two issues over the past couple of years:

With the acceleration in sales in early 2020, our inventory wasn't growing fast enough to keep up with the expansion of our sales volume. As a result, we weren't maintaining in-stock levels consistent with our standards. Following two years of effort to catch up, by the time we entered 2022, we had made considerable progress. Overall inventory levels were aligned with both the level of sales we had already achieved and our near-term growth expectations. As a result, we began to see improvements in both in-stocks and product availability…A separate challenge our team has been facing, which became more acute in the back half of 2021, is driven by capacity constraints in both the global and domestic freight markets. These issues continue to make it more difficult and more expensive to move inventory where we need it to be.

He adds: 

Coming into this year, we anticipated we'd see continued tight conditions and elevated costs in freight markets, but the actual conditions and costs have been much more challenging than expected. More specifically, first quarter freight and transportation costs came in hundreds of millions of dollars higher than our already elevated expectations. And for the full year, we're now expecting about $1 billion of incremental freight costs, even compared to our expectations only three months ago.

The current issues are likely to continue to impact the business in the coming quarter, but Mulligan expects improvement in the second half of the year:

We'll have had enough time to adjust inventory levels and receipt volumes to match the pace of sales, even in longer lead time categories. In addition, capacity in our supply chain will continue to build throughout the year as the new buildings we opened last fall continue to ramp up their productivity while we work to open additional buildings in the years ahead.

From Cornell’s perspective, the priority now is remaining flexible to customer needs and steadying the operating performance against a backdrop that looks very different to what it was at the start of March:

We did not anticipate the rapid shifts we've seen over the last 60 days. We did not anticipate that transportation and freight costs would soar the way they have as fuel prices have risen to all-time highs. While we were certainly anticipating the impact of overlapping stimulus and consumer and guest returning to more normal activities, we did not expect to see the dramatic shift in many categories…like TVs to luggage, from small appliances to toys, and guests celebrating, being out with friends. That certainly impacted our business in the first quarter, and we expect that to continue in Q2. And we certainly didn't anticipate the impact that would have on our supply chain costs.

So things changed rapidly after we sat on stage in New York. We own that. It's what we're adjusting as we build our plans for the balance of the year.

My take

Christina Hennington, Target’s Chief Growth Officer, summed up the challenge now facing Target (and other retailers) when she said:

What we're seeing is that the consumer has taken control of their environment more so because the macro environment feels out of control. And so despite the fact that they might have worries about inflation, they're in charge. And they're making decisions based on their preferences and what they value, which means going back out, if that's what they want to do, traveling because they've missed it, seeing their friends and family again. And it's about moderating those behavior shifts and accommodating our assortment and our messaging and our relevance based on how those shifts happen.

This was an unaccustomed bump in the road for Target which, as noted above, has been a champion for omni-channel turnaround and transformation. Wall Street inevitably had a panic attack/hissy fit - delete as applicable - on news of the profit drop. That’s short-sighted in the extreme. Target’s track record over the past five years gives every reason for confidence and there was a welcome emphasis yesterday on continued investment and expansion.

For Cornell and Co, the best advice is surely - hold the line!