Takeaway: There are a few key considerations as it relates to Target's rather bold move to go toe-to-toe with Amazon with free shipping.

1. First off...Historically, retailers in this space have been lemmings. Prior to TGT announcement (taking shipping threshold down from $50 to $25) there were 5 retailers in the space who set the free shipping threshold at $99 (JCP, M, TJX, BELK, Lord & Taylor) and 4 who sat at the $50 hurdle rate (TGT, WMT, Gap, Old Navy). TGT's move shifts the balance of power in the industry and we think that means there are more dominos to fall. 


2. Free Shipping is Inevitable. This is just the first market share grab by a big player which will inevitably lead to free shipping across the board. That's fine if you're a retailer who has a basket size big enough to absorb the incremental cost for both fulfillment and returns a la JWN. But the problem is that the TGT, WMT, JCP, and KSS do not have that luxury and it has profitability implications. Here's the math…

TGT/Retail - Another Step Towards 'Free Shipping'   - TGT   Shipping

3. If we assume that TGT online sales grow at a 23% CAGR through 2019, taking e-comm as a % of sales from 3.5% in 2013 to 12.5%, that equates to 20bps of gross margin pressure per year or $0.15 in earnings. To get there we assume that TGT dot.com sales come in at a gross margin rate 1000bps below brick and mortar sales. We've seen similar numbers out of KSS who you may argue is less efficient. But, when we pair that up with AMZN -- where shipping expense is 10% of total direct sales we think that's a fair estimate.

It's not likely that we will see any impact on profitability in the quarter the company will report tomorrow, because the data breach induced discounting in 2013 will more than offset the effect of free shipping. The same is true for 1Q and 2Q where the company invested heavily to drive traffic. But over a longer duration, you have a zero square foot growth retailer trading near peak multiples with cost pressures accelerating.