Here’s how Target aims to make its booming online business more profitable

Target’s online business has boomed during the coronavirus pandemic and that’s pushed the company to solve a riddle for retailers: How to turn rising e-commerce sales into rising profits.

The big-box retailer said in an earnings call Wednesday that it’s looking to new technology and sort centers to help keep up with demand and drive down costs.

On Wednesday, the big-box retailer reported its first-quarter earnings and said that nearly all of its first-quarter sales growth came from online. Its digital sales grew by 141{3c4481f38fc19dde56b7b1f4329b509c88239ba5565146922180ec5012de023f} in the quarter. On average days in April, the retailer fulfilled more orders than last year’s Cyber Monday. And in the three-month period, its stores provided more purchased items through its curbside delivery service than in all of 2019.

“We have been investing and planning the capability support this [online] volume,” said Target Chief Financial Officer Michael Fiddelke said. “We just thought it would be three years from now. So we have seen an acceleration for what we would expected to take three years that has now happened in a matter of weeks.”

But that’s come at a cost. Fiddelke said digital fulfillment and supply chain costs were one of the top three drivers that pressured the company’s margins for the quarter. The company’s profits were also squeezed as the retailer wrote off apparel that didn’t sell and sold more low-margin items, such as groceries, instead of higher-margin ones like home decor.

Target is not alone. As more customers shop online instead of at stores, many retailers have had to absorb higher costs. The sudden change in purchasing patterns has caused whiplash, too. Retailers have had to manage inventory of items quickly cleared from shelves, coordinate complex supply chains and take on more work as employees pick, pack and ship items — or at least have them bagged and ready for store pickup.

To drive down costs, Target has used its nearly 1,900 stores across the country into fulfillment centers. The company said its stores fulfilled nearly 80{3c4481f38fc19dde56b7b1f4329b509c88239ba5565146922180ec5012de023f} of its first-quarter digital sales. It also allows customers to get same-day online orders by walking into a store or driving up — options that reduce the retailer’s transportation costs.

Target Chief Operating Officer John Mulligan said the retailer will soon test another tool: Sort centers for packages. It recently acquired technology and talent from same-day delivery startup, Deliv. The company specializes in the “last mile,” the distance an online purchase travels from a fulfillment center or store to its ultimate destination — such as a customer’s home. The “last mile” is one of the biggest cost drivers for digital sales. Terms of the deal were not disclosed.

With technology from Deliv, Mulligan said the company will test sort centers in areas where there’s a high density of packages. They’ll be smaller than Target’s average store and closer to customers, he said. It will test them in the Minneapolis market, near its headquarters, and then scale up. 

“By eliminating the need to sort packages in the individual stores, the throughput of packages in these locations will naturally increase and we can achieve lower average shipping costs through the scale and route optimization that these downstream centers will provide,” he said on the earning call.

He said Target hasn’t yet decided on a timetable for the test.

Yet, Fiddelke said each digital transaction can’t be measured in just dollars. When customers use the retailer’s curbside pickup service, for example, he said they spend more at Target — not just online, but in stores.

“When we see guests engage with more of our fulfillment choices, they become stronger customers of Target and we build relevance with them in total,” he said. “And that’s where the economics of digital get most powerful.”