Retailing and Moats

target-logo-copyFew 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, at Sears, and at Best Buy appear virtually indistinguishable; the same Dockers line the walls of Sears, Kohls, and JCPenney. Yet, more of our family’s dollars find their way to Target than any other, even though Wal-Mart 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 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! [link]” 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.

* Schroeder, Alice.  The Snowball: Warren Buffett and the Business of Life (Random House, 2008): 332.

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2 responses to “Retailing and Moats

  1. Pingback: Valuing Target « Wide Moat Investing

  2. Pingback: An Earnings Trade in a Beaten Down Company | Options Profits Daily

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