Twenty million dollars is a good motivator. That was the amount of extra fulfillment spend Chewy reported in the first quarter after two months of surging demand. Split shipments, longer delivery distances and more expedited orders added expense. Less than three months later, the company opened a new kind of fulfillment center in Kansas City, Missouri, intended to make sure that $20 million bill never repeats. 

The coronavirus pandemic has kept Americans at home, doting on their pets. Pet adoptions have shot up and pet retailers have seen sustained, elevated order volumes since March. Chewy reported a 46% YoY increase in revenue in Q1 and 47% YoY sales growth in Q2. 

Like many e-tailers with demand surges this year, Chewy discovered that its inventory positioning status quo wasn't optimized for this new level of volume.

"For a portion of our volume, we increased the use of express shipments as a way to ensure timely deliveries and protect customer experience," CEO Sumit Singh said on a June earnings call. By the end of Q2, the company had rebalanced its inventory, according to the CEO. But to prevent a "demand shock" from taking a multi-million dollar bite out of profits again, it needed to do more. 

The fix, according to Singh, is a centrally-located fulfillment center with a limited assortment of products aimed at improving the company's readiness for volume spikes. The fulfillment center opened in the Kansas City metro area during the second quarter. 

"This incremental fulfillment capacity added by Kansas City provides us the flexibility to effectively load balance across our other FCs and gives us available buffer capacity as we head into the busy second half of 2020," Singh said on an earnings call Thursday.

Upping the fulfillment velocity

In addition to the flex-fulfillment center, the company will open two full-assortment facilities in Archbald, Pennsylvania, and Salisbury, North Carolina, this year. The locations will give Chewy the possibility of one-day shipping speeds to the population centers on the East Coast.

But a coastal location won't work for a warehouse intended to absorb volume surges from anywhere in the U.S. The Missouri facility allows for two-day shipping from most of the country.

"This new FC is a capital-light, high-velocity operation focused on fast fulfillment during peak demand periods," Singh said. And a lower SKU-count will keep operations simpler and, in theory, execution more dependable. 

Flex fulfillment capacity isn't a new concept in e-commerce. Brian Olsavksy, CFO of Amazon said in July that the company has exhausted all of the flex capacity it saves for peak season. Brick-and-mortar retailers have used their stores to add might during this time of fluctuating order volume. An entire set of startups like Flexe, Flowspace, UPS's Ware2Go and others exist to fill this need with up-front investment lower than a lease. 

But Chewy has chosen to take on a new dedicated facility — a move that implies confidence that demand surges will continue. The risk in such a decision is lowered network utilization and therefore higher cost per piece, but Chewy has a plan for that too. 

Building the total package

Chewy's additions to its fulfillment network in 2020 will increase throughput with the help of automation. The e-tailer will have 11 fulfillment centers covering seven million square feet by the end of 2020, with more on the way. 

Chewy's Pennsylvania fulfillment center, set to open in October, will be its first automated facility. Plans are in place to open another in 2021, also in Kansas City. 

The automated facilities, according to CFO Mario Marte, will increase throughput capacity per square foot for the company by 25%, increase labor productivity by 50% and cut fulfillment cost per unit by 30% — all with a growing footprint. 

"This is especially critical since COVID-19 is rapidly influencing the way we live, shop and server our customers," Marte said of the improved metrics. Retrofitting existing facilities with automated processes could further these improvements, Singh said. 

Chewy executives expect sales growth in the current quarter to moderate somewhat to between 38% to 40% YoY. For the full year, the company expects to land somewhere around 40% sales growth YoY. But speeding up fulfillment network expansion plans and automation adoption, on top of operating in a pandemic, comes at a cost. Chewy's EBITDA margin forecast is somewhere near breakeven with a 30 basis point margin of error — putting it roughly in the same neighborhood as 2019's results when EBITDA margin came in just below breakeven.