Dive Brief:

• Digital order fulfillment is still taking some toll on Target's margins, but after an historic peak season, the company is confident that the strain is lessening over time. "We believe, we have reached a point in which the operating margin rate, headwinds and tailwinds will generally balance," CEO Brian Cornell said on a recent earnings call, emphasizing "moderation in unit fulfillment costs." 
• Going into peak season 2018, Target had not quite cracked the code on delivering what Cornell calls an "unmatched suite of digital fulfillment options," profitably. Drive-up, same-day delivery, ship-from-store, in-store pickup and more, all were resonating with customers, said Cornell on his November earnings call, but the mix wasn't being kind to the retailer's margins. In the fourth quarter, the CEO saw the progress he had previously promised as scale and supply chain investments started to pay off. 
• Digital sales grew 36% in 2018 and margin slide decreased somewhat from the third to fourth quarters. "Along with the changes that we're going to make and the benefits that we'll see through new fulfillment capabilities, we expect that to strengthen our gross margin, our operating income over the years to come," said Cornell. 

Dive Insight:

This week Target executives took somewhat of a victory lap after facing what they described as years of skepticism regarding their store-centered model of order fulfillment. In fact, COO John Mulligan said Target's omnichannel success is proof the store-based fulfillment strategy is working. 

"Using our more than 1,800 stores in neighborhoods across the country to handle online orders not far from the guest who bought them," said Mulligan. "Many retailers are just starting to talk about this concept, but we've been doing it."

The COO added that shipping online orders from stores makes order fulfillment 40% cheaper per unit on average and pick-up or drive-up are 90% cheaper. And delivery for in-store purchases has increased basket size by five-fold for those orders. 

The benefit is clear. Fulfilling orders from a large store network puts the goods closer to consumers without needing to invest in more real estate or expensive warehouse build-outs. As Mulligan put it, the chain is using buildings they already own where the lights are already on. 

But this model requires an advanced inventory allocation system to get merchandise where it is needed, without a burdensome increase in gross inventory. Automation becomes the big concern here because, besides fulfillment, the other big supply chain cost for Target in past quarters has been inventory processing, especially immediately before and during peak season. 

Last year, Cornell said the company was on a two to three year technology journey and Tuesday Mulligan offered a window into what's still to come. 

"We're building a custom automation solution like the one you see here from our Perth Amboy facility outside New York City to better support our stores. This is the future," said Mulligan of the company's first "flow center." This facility gets a product ready for the shelves, cutting down labor at the store level.

It's these "flow centers" that also allow Target to penetrate urban markets with prohibitive real estate markets. Smaller stores plus big populations and little storage require relentless and exacting fulfillment. 

"What we're doing in supply chain is the reason we're able to grow in dense urban areas," Mulligan said.