Target: Customer Passion Still Compels Profits

Few retailers benefit from an enduring economic moat because many goods stocked on their shelves reside at their competitors. Seemingly the only thing to distinguish their goods is the price. Hence in retail, the widest and best moat is found around the business that consistently offers the lowest price.

As Charlie Munger observes, “retail is a very tough business. [Warren and I] realized that we were wrong. Practically every great chain-store operation that has been around long enough eventually gets in trouble and is hard to fix. The dominant retailer in one twenty-year period is not necessarily the dominant retailer in the next.”*

Though only fools would dare position themselves contrary to Munger, it is striking, when one surveys the American retail space, how many retailers appear to thrive. Of course, Circuit City and Linen ‘n Things have recently taken the fall, but the majority still remain, even amid this dire economic environment. Yet, when I survey the survivors, it is hard to discern any economic moat, much less a wide one. The washing machines at Lowe’s (LOW), at Sears (SHLD), and at Best Buy (BBY) appear virtually indistinguishable; the same Dockers line the walls of Sears, Kohl's (KSS), and JC Penney (JCP). Yet, more of our family’s dollars find their way to Target (TGT) than any other, even though Wal-Mart (WMT) often offers better prices. Are we doubly fools, or does Target offer something which its competitors do not?

Looking at the numbers, Target has 351,000 employees, which produce 64.95 billion in sales, at a gross margin of 28.6% and an operating margin of 6.78%. Sears is likely their most similar competitor—in inventory, assets, and sales—and it has 324,000 employees, producing 46.77 billion in sales, at a gross margin of 27.05% and an operating margin of 1.31%. Wal-Mart, with its gargantuan 405 billion in sales, brings a lower gross margin of 24.52% and an operating margin of 5.6%. So that’s what we should mean when we say we will make it up on volume.

With these numbers, Target’s excellent margins leap from the page—an observation which seemingly runs contrary to our opening thesis: that offering the lowest price produces the best competitive advantages in retailing. So the question is: how can Target sell the same stuff for higher prices than its competitors?

My hypothesis is that Target offers a unique shopping experience, one which many women in their 20s, 30s and 40s particularly love. I say women largely based on my own idiosyncratic anecdotal evidence. For one, my wife and her sisters craft their weekends and shopping needs around a weekly excursion to Target, and it is indeed an excursion, because most of the trip involves just walking around, picking over shoes, accessories, clothes, baby gear, towels, sheets, and household décor. For all of these items, I have never seen any of them make a purchase from Wal-Mart or Sears. And of course, once you’re in the door, the convenience brings household goods and groceries into your cart.

Perhaps more interesting and illustrative is a simple Google (GOOG) search for “I love Target” or “Why I love Target.” Compared to competitors, the fan base is quite remarkable. “Target Brand Boxed Riesling is packaged in such an irresistibly cute green box that I could not resist it.” “Tonight I popped in Target after teaching a Kindermusik class… I ran across these shoes [picture].” “This is why I love Target… I want to kiss the person who designed them and make out with the person that decided to only charge me $30! LOVE IT!” Sure, such banter is fun, spontaneous, and whimsical, and not too much should be drawn from it. But it does strike me that Target has established a shopping experience, shared by many, that compels sales of superfluous goods at profitable prices.

Fans talk about wide, uncrowded aisles, the shoe designers, the lighting, the employees. The reasons are multiple, but the passion is earnest. When thinking about the prospects of Target’s moat, it is hard to interpret the competitive advantage expressed by this passion. But certainly something is there that other retailers are missing.

Disclosure: I, or persons whose accounts I manage, own debt of Sears Holdings at the time of this writing.

Comments

[SedonaLover:]

There's another aspect in addition to those pointed out in the article: personal values. The "lowest-price" reason for shopping Wal-Mart fails to address the morality of how Wal-Mart treats employees vs. Target (or Costco or ...). There's a reason why Wal-Mart is in the courts so often, be it for discrimination against women or blacks, or for allowing managers to force employees to work overtime off the clock (and then be "shocked" to learn of the practice), or ...etc. If the current suit alleging discrimination against women is certified as class actionable (2 million women+ !!!), and the EFCA is passed, then MAYBE there is a Wal-Mart in my shopping future as the company is dragged, kicking and screaming, into a world where employees are not treated like dirt. Until then, Target and Costco get my business. And that's a PASSION for ME.

Mar 27 01:08 PM

[oppie2009:]

Target is one of my favorite shopping places, the ailes wide are easy to shop, it has a consistantcy of excellence that other stores lack, the majority of their stores have a familiar layout making it easy to shop intheir signage is great, and their cleanliness is above par.
Keep up the good work, your pricing is right at your clean well managed stores and are appreciated, especially by our senior friends, price checking is easily available and the staff is really friendly, even if Wal Mart had a better price the condition of their stores, restrooms and overall cleanliness is not appealing to me, why would I want to shop in a store that is cluttered dirty, and have filthy bathrooms?? Thankyou ! NOT for me.

Mar 28 01:31 AM

[BlueOkie:]

Didn't a senior marketing executive move from target to walmart? Walmart may get cleaning and more spacious stores. Their clothes line have improved. I still prefer target because it is upscale.

Mar 28 08:42 AM

[reddog:]

The common but mistaken perception is that Target is more expensive than Walmart yet when comparing like items as a whole, the difference is very marginal. But what sets Target apart product wise is the unique in house and designer designed products, non-commodities in a commodity market. There is more style offered, yet prices are well below the traditional designer goods available elsewhere. The result is more value in the products, combined with more value in the overall shopping experience, which is well documented.

This is why margins are higher, as they should be. The tough market is hurting Target in that people are cutting back on non-essential goods. This can't last forever and eventually consistent results will return.

Mar 28 11:07 AM

[H.J. Huneycutt:]

I'd agree with reddog. Target has a lot of unique home products that seem "high quality" for a discount department store. That's one reason why people enjoy shopping there so much. It also has a nice atmosphere, whereas, most Wal-Marts have this third world sweatshop feel to them.

That said, I wouldn't say that this gives Target a "moat". It just gives them a competitive advantage that others could duplicate. The important thing to realize that Target is a trend. It could remain a trend for the next decade or two; then again, maybe it won't.

It's also important to consider that Target's success was largely a product of the consumer mania of the '90s and earlier this decade. Now that they've established a niche, they probably aren't going away any time soon, but that doesn't mean they'll be booming forever. Does Target thrive in an age where consumers are focused on staples and "necessary purchases"? I'm not sure to be honest.

Here's a positive factor in favor of Target that most don't think about --- Wal-Mart is truly a suburban oriented store. Target has had much more success penetrating urban markets. As gasoline prices go higher and the re-urbanization trend continues over the next few decades, Target is positioned much better than Wal-Mart to grow. So, I guess I see a mixed bag with Target.

One thing is for sure --- the history of American department stores is littered with examples of companies like Target that found their niche, gained strong loyalty from customers, and thrived. And most of those companies eventually died. Target doesn't have to be one of the companies, but I see no reason why 30 years into the future, they couldn't be a candidate.

Apr 10 11:58 AM