Why Target missed its mark so badly

Target’s decision to wind up its struggling Canadian operations after racking up $2.5 billion in losses in 24 months serves as a warning to other U.S. retailers eyeing growth north of the border.

The Minneapolis-based big-box retailer, known for its “cheap chic” image, said Thursday that it planned to close all of its 133 stores across the country, affecting about 17,600 employees. The retailer’s Canadian subsidiary, Mississauga, Ont.-based Target Canada, has also filed for protection from its creditors in a Toronto court.

The decision to shutter its two-year-old Canadian operation came as a surprise despite Target’s well-publicized struggles in Canada. Many believed Target would be able to recover from a rocky launch and go on to replicate the success it has enjoyed south of the border. However, the retailer’s top brass said they didn’t see enough evidence that the turnaround plan was working, so they pulled the plug.

“The Target Canada team has worked tirelessly to improve the fundamentals, fix operations and build a deeper relationship with our guests,” Target CEO Brian Cornell said in a statement. “We hoped that these efforts in Canada would lead to a successful holiday season, but we did not see the required step-change in our holiday performance.”

Target launched in Canada in March of 2013 after paying $1.8 billion for the leases of hundreds of Zellers locations two years earlier. Plans for a rapid roll-out created instant buzz in the retail sector, with many analysts predicting dire consequences for domestic rivals like Canadian Tire and Loblaws. But it wasn’t long before Target discovered it was the one in trouble.

The chief complaint among shoppers was higher-than-expected prices. Many Canadians, it seemed, were disappointed when they discovered that boxes of cereal and cute area rugs cost more than they did in the United States. While it’s not unusual for retailers operating on both sides of the border to charge more in Canada, including rival Wal-Mart, Target appears to have suffered more than most—ironically, because many Canadians were so enamoured with its brand that they routinely travelled across the border to shop at its U.S. outlets.

At the same time, Target Canada suffered from inventory issues that resulted in many of its Canadian locations routinely being sold out of popular products, and being overstocked with those that weren’t selling. That created a poor first impression from which Target proved unable to recover.

Target also claims in court documents that its rapid roll-out, designed to quickly achieve scale in the Canadian market, had the unintended effect of limiting the impact of new store openings in some cities. The lack of a Canadian online presence may have also hurt the company, Target claims.

The struggling Canadian expansion, and the huge losses associated with it, were among the reasons that Target CEO Gregg Steinhafel resigned earlier this year. As his successor, Cornell initially promised to fix the Canadian operations, but now says “we were unable to find a realistic scenario that would get Target Canada to profitability until at least 2021.”

Total cumulative operating losses for the Canadian operation is estimated to be $2.5 billion, or about triple the expected losses for that period, the company said in court filings. Target estimates that it has spent a total of $7 billion on its Canada expansion project since 2011.

Scott Mushkin, an analyst with Wolfe Research in New York, estimates that Target was only averaging about U.S. $140 of sales per square foot in its Canadian stores. By contrast, the company would have needed closer to U.S. $250 a square foot to break even and U.S. $300 a square foot to match the performance of Target’s U.S. outlets. “Exiting Canada frees up management to focus on the company’s U.S. business where we believe there are significant opportunities to improve current store productivity and increase market penetration in core geographies,” Mushkin wrote in a research note.