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Target Canada’s supply chain woes

A look at the retailer's distribution infrastructure and the unprecedented challenges the company has faced

In January 2011, Target Corporation purchased 220 store leases of Canadian discount retail chain Zellers for $1.8 billion. Since then, Target has renovated and opened 124 stores and constructed three massive distribution centres in Canada.

In this blog, I’ll discuss the company’s Canadian distribution infrastructure and the unprecedented challenges the company has faced over the past year.

The hype surrounding Target’s acquisition of Zellers sent shock waves through the Canadian retail market and for good reason. In the United States, Target is a highly respected retailer that has consistently been successful in developing and maintaining customer loyalty.

Target is well known for taking care of its employees and also for being a generous company that consistently gives back a share of profits with the community. Customers enjoy Target’s competitive prices and its clean shopping environment.

Behind the scenes, Target is considered to be a strong operator that has innovative and highly effective supporting logistics operations.

When you get right down to it, there’s really nothing to dislike about this company.

With such an excellent reputation south of the border, it is no wonder that Canadian consumers had such high expectations in advance of Target’s arrival to the great white north.

But 2013 was a year best forgotten for Target Canada.

In addition to suffering one of the largest credit card security breaches in history, the company recently announced hefty losses of US$941 million before excluded items on 2013 sales of $1.3 billion.

In hindsight, these results were caused by multiple issues both real and perceived. It is important to understand the difference between the real issues which Target must address and the perceived issues which are a function of the Canadian market place.

One very real and fundamental issue that Target struggled all year long with was its inability to keep its store shelves stocked.

The near-emptiness of the store shelves was so noticeable that it made headlines in the U.S. press (see here for sample).

At first, Target claimed that consumer demand was so overwhelming that they could not keep up with demand. But the situation persisted throughout the year and right through the peak Christmas season.

Furthermore, the empty shelves were not restricted to one or two categories. Almost every merchandise category was short of supply including apparel, footwear, music and DVDs, perishable food, dry grocery, fast moving consumer goods, baby products, and so on.

Clearly, behind the scenes there was a supply chain disaster unfolding and unfortunately for Target Canada, Canadians were not impressed.

On the other hand, while consumer complaints about empty shelves may be fully justified, Canadian consumers have been very vocal about their perception that Target’s prices are higher in Canada than in the U.S.

The age-old cross-border pricing disparity issue is not unique to Target.

Quite simply, the cost to service retail stores in Canada is much higher as compared to the United States. This is due to the fact that Canada has a small population spread across a vast distance.

To better understand this issue, let us take a closer look at Target’s supply chain infrastructure on both sides of the border.

In Canada, Target operates three distribution centers as follows:

1. In Balzac, Alta., Target operates a new 1.30 million sq. ft. regional distribution centre that will support 46 stores from Vancouver to Winnipeg by the end of this year. The furthest store is 844 miles from the distribution centre.

2. In Milton, Ont., Target operates a new 1.32 million sq. ft. regional distribution centre that will support 45 stores in Ontario west of about Kingston. The furthest store is 871 miles away.

3. In Cornwall, Ont., Target operates a new 1.35 million sq. ft. regional distribution centre that will support 41 stores in Eastern Ontario, Quebec, New Brunswick, Nova Scotia, P.E.I., and Newfoundland. The furthest store is 1,644 miles away.

4. In addition, there are four offsite facilities to handle overflow inventory and one National Returns Centre.

Target’s Canadian distribution centres employ about 1,500 people and are outsourced to a third party logistics firm called Eleven Points Logistics which is an operating division of Genco.

Target Canada has also outsourced food distribution to Sobeys which supplies frozen food, dairy, and dry grocery products, including national brands and Target’s private label products.

Target Canada made strategic decisions to outsource these operational components of its business for its own reasons but suffice to say that outsourcing costs money because the profit margins of the 3PL and/or the wholesaler need to be added to the cost of goods.

In the U.S., Target does not outsource its regional distribution centres to 3PLs and the company is currently in the process of moving towards self-distribution for grocery merchandise.

Target’s Canadian supply chain covers a span of 7,082 km. To put this into perspective, this distance is 18% of the earth’s total circumference of 40,075 km. Within this vast geography, Target will operate 133 stores by the end of 2014.

Now consider that 18% of the world’s population is about 1.2 billion people as compared to Canada’s population of 36 million. Canada has a low population density relative to the rest of the planet.

The Target U.S. Supply Chain

In the United States, Target operates 1,797 retail stores as at the start of 2014 with stores located as far away as Alaska and Hawaii. To support its retail network, Target operates a U.S. distribution infrastructure as follows:

1. Twenty-six regional distribution centres (RDC) totaling 39.9 million sq. ft. The average RDC is 1.53 million sq. ft. with 800 employees servicing 69 stores.

2. Four import warehouses totaling 7.4 million sq. ft. These facilities are positioned near major ports to receive and store imported merchandise that is replenished to the regional distribution centres.

3. Four semi-automated and fully-automated perishables food distribution centres totalling 1.36 million sq. ft. with two more facilities coming on-line in 2014. Target is in the process of taking over its food supply chain so that sourcing from wholesalers is replaced by self-distribution.

4. Three distribution centres totaling 2.0 million sq. ft. to support direct-to-consumer Internet order fulfilment.

5. One national returns centre in Indianapolis.

6. For more detail, the Target distribution network in the U.S. is documented in full detail here.

Cross Border Pricing Disparity

There are important concepts which need to be understood to fully appreciate the reasons for cross-border pricing disparity.

Below are three fundamental issues that quickly come to mind and certainly there are others that can be cited.

1. The risks associated with conducting international business such as currency exchange fluctuation and the higher cost of doing business in Canada (e.g. wage rates, taxes, legislation, multilingual packaging requirements, duplication of administrative overhead, etc.) imply that American companies quite naturally seek a higher rate of return to compensate for their risk. This shareholder expectation is an important contributing factor to cross border price disparity.

2. The travel distance from the distribution centres to the retail stores is substantially lower in the U.S. than it is in Canada. The cost of fuel in Canada is substantially higher than in the U.S. For the sake of discussion (i.e. numbers are not actual), let us say that Target’s outbound transportation expense is about 2% of sales revenue. With 2012 sales of $73.3 billion/year, this would amount to nearly $1.5 billion in annual outbound transportation spend to service stores in the U.S. Now let us say that the U.S. market had the exact same characteristics as the Canadian market and a cost penalty of say 25% is incurred due to the stores being further away from the distribution centres and due to higher fuel costs. This would introduce a $367 million cost penalty to the business that in turn would have to be paid for by consumers. The point being that the Canadian market will always be more expensive to serve due to its large geography and low population density.

3. The cost of operating distribution centres is higher in Canada than in the U.S. Aside from wage rate disparities which are regional, consider the fact that Target operates 28,800 sq. ft. of distribution centre space per retail store in the U.S. versus 40,300 sq. ft. of distribution centre space per retail store in Canada. Space costs money and the only way to change this dynamic is to increase the number of stores being serviced through the distribution centre. The typical Target RDC in the U.S. services 69 stores versus 42 in Canada. This is why it is so important for retailers to leverage as much volume as possible through their distribution infrastructure.

The moral of the story is that it costs less to service a country with a high population density than it does to service a country with a low population density.

If you have ever driven across Canada as I have (on a bicycle) then you know that Canada has a very low population density for many long and lonely miles.

All this to say that the consumer perception that Target has higher prices in Canada than in the U.S. is unfair as prices in Canada are truly driven by market place dynamics.

In short, Target’s supply chain issues are real. When stores have near-empty shelves customers simply don’t spend money.

As the old saying goes, you can’t sell from an empty cart. But let’s cut some slack about perceived cross border pricing disparity criticism.

The only thing that should matter to Canadian consumers is how Target Canada’s prices and service levels compare to Walmart Canada and other Canadian retail competitors.

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