Can Target Displace Its Parcel Providers?

This is an excerpt from Thursday's (4/22) Point of Sale retail supply chain newsletter sponsored by ArcBest.

The best-in-class retailers are aggressively pursuing logistical control over their products (and therefore the customer experience) while trying to avoid patchwork responses to final-mile delivery. These same retailers are also in an intense battle to develop faster and faster fulfillment methods. This week, Target TGT announced that it will enlist the help of its gig economy delivery fleet, Shipt, to deliver more than just bagged grocery and household goods. 

What's Target doing? The new approach is being tested in Target's hometown of Minneapolis, where the company's first sortation center opened last fall. This new sortation center and the underlying strategy will be powered by three of Target's recent supply chain technology acquisitions. For many years, Target's e-commerce strategy has been built with its stores, the one true advantage it feels it has over Amazon (NASDAQ: AMZN), at the center. Target's stores have become much more than retail spaces, with 95% of its sales fulfilled by stores last year. 

With the new strategy, stores remain the primary fulfillment method, but orders for delivery are then sent to a local sortation center, where the proprietary technology Target's acquired in recent years "determine the most efficient way to sort, route and deliver to local neighborhoods," according to a company blog post.

If ship-from-store operations weren't a Rube Goldberg machine before now, this might do it. Here's how it works:

Step 1: Customers place an online order and a store team packages it for delivery.

Step 2: The sortation center collects packages from across the area.

Step 3: Target's technology sorts and routes the packages.

Step 4: Batches of orders go out for delivery.

So orders are still picked and packed by Target employees in stores, but as soon as orders are packed, they can be moved out of the back room or staging area to clear room for more orders. The volume of orders picked and packed by Target stores has erupted over the past 13 months, with digital sales up 145% YoY in Q4 and even higher growth in BOPIS/curbside operations. That level of growth does not come without pain. With the new model, COO John Mulligan said Target will be able to better handle the rising number of packages that pile up in its stores throughout the day. 

The sortation center in Minneapolis will serve all of the Twin Cities stores, of which there are roughly 20 Target locations. This center is the first of its kind, but Target has five more planned this year in densely populated metro areas. Dedicated Target trucks will pick up from the locations multiple times per day and drop boxed online orders at the new sortation center. From there, packages will be delivered to the end consumer by either parcel carriers, or as Target is testing, its Shipt delivery network. Target acquired Shipt in 2017 and has since grown the fleet exponentially to its current level of more than 300,000 drivers. Currently, Shipt drivers deliver bagged orders from Target stores (as well as a few other retailers) for an annual fee of $99 or $9.99 per order. Under the new approach, Shipt drivers will also be picking up orders from the sortation center just as a UPS UPS or FedEx FDX driver would. 

From a customer perspective, it feels no different than a typical parcel drop-off. But Mulligan said it will give the company more control over the customer experience and make e-commerce orders more profitable. As of today, I believe Target is the only retailer in a position to add fulfillment steps and make e-commerce more profitable. The reason is Target, through its relentless focus on in-store unit economics, has been able to achieve near margin parity between in-store sales and online orders picked up in-store. "It's cheaper to ship a box a shorter distance from a local store after it's ridden our supply chain rails all the way to that store. Same-day fulfillment economics look a lot like store economics to us," CEO Brian Cornell said during the company's Q4 earnings call. 

The numbers are astounding. According to Mulligan, orders fulfilled via BOPIS or curbside are 90% cheaper than having that product shipped from a fulfillment center. He said shipping a package from a store rather than a fulfillment center is 40% cheaper. "We start with a place of advantaged economics. This is just a way of continuing to improve speed, continuing to improve costs to create great value for our guests," Mulligan said.

"Shipping is the majority of the cost for getting a product to a guest. Shipping is the big number," Mulligan said in an interview. "We continue to work on picking better and optimizing our pick and optimizing the batches [of packages] for the team — all of that is really important — but the key to the whole game from our perspective is to improve that ship cost."

Since the Minneapolis center opened last fall, it has served as a central pickup location for multiple carriers, but now Target (like Amazon and Walmart) believes leveraging its fleet of gig economy couriers could be key to bringing down cost. Shipt drivers are already delivering groceries and bagged goods to neighborhoods, why not boxed orders? Shipt drivers could serve as an alternative to UPS and FedEx, which have been increasing fees and/or limiting parcels amid surging e-commerce demand.

But does it make sense? If it makes sense for any retailer, it's Target. But even for Target, I'll need more convincing. Target is basically creating a delivery center, not unlike the hundreds Amazon has spread out around metro areas. For Amazon, these often makeshift spaces act as a Postal Service or UPS sortation center where orders are batched and prepped for delivery by Amazon Flex drivers. 

But that's not exactly what Target is doing here because the majority of orders delivered from the sortation center will be completed by UPS or FedEx. Given that Shipt drivers use their own cars to deliver goods, it would take exponentially more of them to eliminate the legacy parcel carriers. To me, this is Target working in reverse order. Unlike its competitors, Target hasn't spent the last decade expanding its warehouse network because it's been solely focused on its stores. And it's worked very well. But now, with the pandemic making Target America's favorite "new" retailer, Target may be outgrowing itself. With orders piling up in the back room, it seems this is an attempt to solve its lack of space at stores by shifting outbound orders to local sortation centers. 

Without a doubt, moving product an extra time increases costs, but Target must believe its investments in Deliv, Grand Junction and Shipt can more than offset the additional costs through optimal order batching and efficient routing. And even if it isn't Shipt drivers making the delivery, sorting packages into batches by neighborhood should make deliveries easier (and therefore cheaper) for Target's final-mile carriers. 

Target is still in the early experimentation process, and there are many kinks to be worked through, such as whether Shipt drivers will be able to deliver both packaged and boxed goods on the same route. Amazon uses two separate systems to fulfill fresh and boxed goods, but Target may be able to batch both types of orders on one route. My biggest unanswered question currently is how Target will deal with perishable and refrigerated products. I haven't heard whether the sortation center has any cold chain areas, but if needed that would increase the build and operating costs substantially. If there is not refrigeration storage at these facilities, will Target simply not send any items from an order with fresh goods to the sortation center? Or will orders be split between fresh coming from stores and not coming from sortation centers?

I don't see the latter as feasible at all. There's a reason Amazon is co-locating its new mini fulfillment centers next to larger FCs and it's to eliminate inefficiencies from shipping products from multiple locations to one destination. On the other hand, if Target decides not to deliver any orders containing refrigerated goods from sortation centers, there may not be enough orders to make this model work. 

My guess would be all orders containing refrigerated goods will continue to be delivered from store, but given Target's strong grocery growth, especially online, such orders are likely a huge portion of online sales. So will Target be able to replace UPS and FedEx from its operations? Not anytime soon and long after Amazon. 

Want more stories about how retailers are rapidly adapting to keep up and influence the way consumers shop? Try Point of Sale, my twice-weekly retail supply chain newsletter: https://freightwaves.com/pos

Image by Francesco Romeo from Pixabay