Can't Match This Retailer

Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

I'm sure many people heard that Target (NYSE: TGT) made the decision to offer price matching year round. The company said that they would match prices offered by (NASDAQ: AMZN), Walmart (NYSE: WMT), Best Buy (NYSE: BBY), and ToysRUS. While on the surface this sound like a great move to make sure they don't lose sales, there are two big problems that Target might be inviting by making this offer.

As most people know, Target has become sort of the higher-end Walmart for many customers. The company's name has even been played with in mainstream America and is pronounced Targe' or Tarjay. According to the Urban Dictionary website, this word play “aims to make the shopping experience seem more upscale than it really is.” While the Urban Dictionary seems to suggest that Target isn't as upscale, there are millions of shoppers that seem to disagree. 

Target didn't get the nickname Tarjay by offering the lowest prices on everything all the time like Walmart tries to. The company's brand identity is prices that are competitive with Walmart, but in a better environment, with better clothing selection, and better housewares options. The company has brought in big name designers to do special sales at the store, and these specials usually cause a compete sellout of whatever the designer offers. Target also isn't afraid to tell Amazon where they can stick it. Make no mistake about it, Target's decision to stop carrying the Kindle Fire lineup was a calculated shot at Amazon. Given that Target is still growing despite not having the cheapest prices, what is the company thinking by offering this price match option?

The price match option is more complicated than it seems, and it also brings the focus right where Target doesn't want it -- to Amazon and Walmart. If you look at the gross margins of these four large retailers, Target easily leads the way. Take a look at both the current and historical gross margins of Target compared to their competitors.

<table> <tbody> <tr> <td> <p><span><strong>Name</strong></span></p> </td> <td> <p><span><strong>Current Gross Margin</strong></span></p> </td> <td> <p><span><strong>Avg. Gross Margin Last 3 Years</strong></span></p> </td> </tr> <tr> <td> <p><span>Amazon </span></p> </td> <td> <p><span>25.25%</span></p> </td> <td> <p><span>22.44%</span></p> </td> </tr> <tr> <td> <p><span>Best Buy</span></p> </td> <td> <p><span>24.05%</span></p> </td> <td> <p><span>24.83%</span></p> </td> </tr> <tr> <td> <p><span>Target</span></p> </td> <td> <p><span>31.67%</span></p> </td> <td> <p><span>32.06%</span></p> </td> </tr> <tr> <td> <p><span>Walmart </span></p> </td> <td> <p><span>24.94%</span></p> </td> <td> <p><span>25.27%</span></p> </td> </tr> </tbody> </table>

(author calculated from Yahoo Finance financial statements) 

You'll notice two things from this table. First, Amazon is the only one that has improved its gross margin relative to their three year average. Second, Target's current gross margin is higher than their competitors by far. This is exactly my point. If customers take advantage of this price match option, they are being told to look at the prices. Instead, Target should act like the Wizard of Oz and say, “pay no attention to the man behind the curtain.” Customers don't shop at Target with a laser focus on price, but by offering to match prices the company is trying to make that a focus. Worse, the strategy may not work.

The way Target's price match works is this. A guest has to buy the item at Target first. “If they see the identical item for a lesser price within seven days, Target will match the price.” Many guests are going to realize that Target's prices are higher than those of competitors. Why would a guest go to Target, buy an item, and then have to prove that a competitor has a lower price? Why not just buy the item from the lower-priced competitor in the first place? The hassle of finding out if a competitor has a lower price will likely cause more comparison shopping than would happen otherwise. So who wins and who loses with this move?

In my opinion, strangely enough Best Buy might be the worst off. The company is already under attack by Amazon in electronics, and Best Buy already carries the lowest gross margin of the group. If Target has what the customer wants, the store is more convenient than Best Buy. You can go into Target and buy groceries and a television, but you can't go into Best Buy and buy the same items. The fact that customers are already in Target may just save them a trip to Best Buy. I'm personally a huge fan of both stores, but if I can price match at Target, Best Buy is in trouble.

Walmart and Amazon would seem to be the biggest beneficiaries. Both companies offer rock bottom prices, and contrary to popular opinion, Walmart is often equal to Amazon on prices. The difference currently is customers don't pay sales tax in all cases at Amazon. However, the frequency of visits to Walmart gives the company a competitive advantage, and if customers compare Target and Walmart, they are likely to find Walmart slightly cheaper. Amazon comes out ahead because, quite honestly, the fastest way to compare a Target price is to head over to Amazon and compare directly. The ability to download an Amazon app for your smartphone and even use a barcode to find the right item makes this a win for Amazon.

The bottom line for Target is this is not a good plan. Management needs to immediately think about whether this needs to be brought to the public's attention again. A company that doesn't compete on price bringing more attention to their pricing is a bad move. I think Target will do fine, but the more the company trumpets this idea the less confident I would be in the company's future. The faster Target backs away from this the better.

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