Time for Target to clean up its toys

It would appear that the real start of the attempt to turn around the ailing brand within Wesfarmers’ portfolio of retail businesses will get under way this week when Target announces the detail of the mooted large-scale job losses at its Geelong headquarters.

Target, once arguably the best-performing department store brand in the country, has lost its way in recent years.

Its most recent half-yearly result showed earnings before interest and tax of $148 million and an EBIT margin and annualised return on capital of 7.1 per cent. Only three years ago it generated EBIT of $279 million in the same half, had an EBIT margin of 12.8 per cent and a return on capital of 12.6 per cent. For this full year Target has forecast EBIT of only $140 million to $160 million – it will be barely profitable, if it is profitable at all, in the second half.

So concerned has Wesfarmers been about the downward spiral in Target’s earnings that it has redeployed one of Coles’ key executives, Stuart Machin, to try to arrest the deterioration despite his importance within the team reinvigorating the supermarket business.

The widely-signalled job losses in Geelong point to one of the key factors in Target’s decline. There were reports at the weekend that there are 1200 people in Target’s head office. That’s about 300 more than there were two years ago – it would appear that there has been a substantial blowout in the group’s cost base even as its sales and profitability have been going backwards.

It is unclear how or why that could have been allowed to happen, although it could be that as Target’s performance fell away the response was to throw more people at it, adding buyers, marketing executives, general management and consultants in, with hindsight, a misguided and quite dramatic expansion of the head office and its cost base.

Wesfarmers has previously referred to the high levels of costs associated with the transformation program launched by former target managing director Dene Rogers and it would appear a key component of Machin’s brief is to immediately rebase the group’s costs and undo the cost inflation of the past two or three years.

Target also has $100 million of excess inventory it has to get rid of and it is running a remarkable 200,000 stock-keeping units (SKUs), which will have to be rationalised. (There might just be some connection between the sheer number of products Target stores are carrying, the blowout in inventory levels and the confusion around Target’s positioning in the market).

In some respects, while it will be painful for the group and its people, that’s the relatively easy part of Machin’s role given that he is an experienced retailer and has been through the challenging Coles’ turnaround program.

While getting the cost structures right is an unavoidable and essential first step to turning Target around, the tougher part will be to reinvent the brand and its offer to make it more relevant in a rapidly evolving retail environment.

Unlike his Wesfarmers colleague Guy Russo, who has transformed Kmart, Machin at least starts with a profitable business which does have brand identity and loyalty and a good portfolio of stores to work with. It also has some direct sourcing and an online presence (albeit not a very good one) that he can build on and a customer base that covers the full demographic spectrum.

Somehow he has to re-position Target, once regarded as a value proposition, to take account of the changes in the retail landscape created, not just by Kmart’s disruptive new model of very low prices for a narrower range of core products, but by the rise of online retailing, the emergence of new fast-fashion competitors and the continual repositioning of its traditional competitors.

The cyclical conditions are also not helping – it is a difficult and volatile environment for general merchandise and apparel retailers, with consumers in a defensive mode – but the better retailers are at least holding their ground.

Somewhere in the past few years Target’s positioning as a mid-tier department store lost the clarity and strength that it once had.

That may be because, as its performance deteriorated, its managements responded by adding SKUs and people confused the offering. It could also be, however, because competitors were offering similar quality products at lower prices in an environment where the concept of ‘value’ was overwhelmed by the consumer focus on simple price.

It hasn’t helped that, as Kmart once was, Target seems to have become addicted to promotions, which tends to educate customers not to pay full price because they know they will get goods cheaper if they wait and they also know they won’t have to wait long.

Getting the cost base and its inventory levels right is the first order of business. There will inevitably also be some restructuring of Target’s supply chain over time and Machin made it clear at Wesfarmers’ most recent strategy day that he thinks there are gains to be made from more direct sourcing.

In the longer term, however, the challenge for Machin and his team will be to develop a simpler, clearer and more compelling proposition for customers and to leverage the still-considerable levels of brand recognition and loyalty.

At the strategy day Machin talked about offering on-trend products and styles with quality and everyday prices that customers could trust. It would appear he is going to severely prune the range of products Target stocks, reduce the level of promotional activity and try to improve Target’s buying to make the product range more current.

That’s a program that will take some time but after only about eight weeks in the job it appears Machin is about to embark on his attempt at transforming the group by getting his core costs back in line with the condition of the business before tackling the more complex issues that he has to address.

As the third managing director of Target in less than two years it is, given the rate at which Target’s performance has deteriorated, an open question what would happen to the group if he were to fail. It is, however, one without any answers that don’t involve considerably more trauma than is anticipated to occur within the business this week.