Target Outline

Target
Partnering with Fashion Forward customers to Improve Forecasting
Kenny Kellogg (David Hegarty, Scott Orn, Carolyn Starrett)

Executive Summary
• Demand forecasting is a key success factor in apparel retailing Identifying the opportunity
- Too little supply = lost selling opportunity - Too much supply = significant mark-downs and inventory costs - Studies show 5% gross margin improvements are possible1

• Customer loyalty and involvement drive incremental sales • Target has the potential to harvest both the opinions and designs of their customers Harnessing the potential
- Online game rating the potential success of new clothing - ‘Hot-or-Not’ meets ‘Lucky Magazine’ - Online clothing design tool for user generated clothing - ‘YouTube’ meets ‘Project Runway’

• Successful predictions of ‘hot fashions’ earn ‘Fashionista Points’ and bragging rights
- Target foresees the new hot fashions identified by the ‘Fashionistas’

• Improved forecasting could increase Targets’ gross margins by up to 5%
- Translates into an $404M increase by 2012

Capturing the value

• Increased customer engagement translates into increased loyalty
- Translates into an $127M increase by 2012

• Based on an estimated implementation cost of $21M, the project could result in a NPV of over $600M
(1) Profit Logic and Oracle estimates
Team Kenny Kellogg, McKinsey Business Technology Challenge 2

To continue its tradition of growth, Target will need to use innovation to deliver more of what customers want
  Target has achieved a 12% CAGR over the last 5 years In 2006, 22% of Target’s revenue ($12.7B) came from apparel and accessories In this category, Wal-mart owns the low end and has ~3x Target’s revenue
– Both companies are increasing total square footage at roughly the same rate (8% pa)

Target is successfully balancing high- end fashion demands at a low-end price point…
Zara 56% Gross Margin 39% Gross Margin

Wal-mart 23% Gross Margin

Zara, H&M, and other affordable, fashion forward franchises are looming on the competitive front
– Zara grew sales 22% in 2006 (60% of sales come from outside Spain)

…However, they will need to will need to look to innovation and original business models to stay ahead of the curve

Source: www.target.com, www.walmart.com, www.inditex.com, team analysis
Team Kenny Kellogg, McKinsey Business Technology Challenge 3

An interactive community could help Target generate more of the apparel designs that consumer really want
User rated designs
• Users rate ‘pre-released’ clothing designs
- Both Target and user-generated designs

User created designs
• Users submit new designs via online flash design tool • Designs are fed through user-rating system • Highly rated designs are flagged for production

• Users who correctly predict top selling clothing designs receive ‘Fashionista Points’ • Fashionista points =
- Bragging rights - Converted to Target gift card Example: threadless.com

Example: 1154lill.com

• Target benefits from:
- Improved demand prediction - More accurate inventory forecasting

• Target benefits from:
- User-generate content creation
4

Team Kenny Kellogg, McKinsey Business Technology Challenge

This interactive community builds on many key trends in Target’s customers lives
• Hot or not • Google Image Labeler Game • Public appetite for new, home-grown talent

Online Rating
• Fashion magazine where readers ‘tag’ items

Project Runway
• User generated Super Bowl ads

User-generation trends

Rating trends

Lucky Magazine

Doritos Ad Campaign
• Online userdeisgned handbags • Online Flash based design tool

• Bragging rights from Fantasy Sports • Peer Ranking on eBay or # of friends on MySpace
(See Appendix for more details)

Peer ratings

1154 LILL Studios

Team Kenny Kellogg, McKinsey Business Technology Challenge

5

The t-shirt company Threadless.com is a great example of community generated and rated design
T-shirt designs created T-Shirts voted on Winners produced

• Combination of fame and money solicts the best ideas

• Community tries to unearth best new ideas
- In its self-interest to find coolest new t-shirt
Team Kenny Kellogg, McKinsey Business Technology Challenge

• Community wins with newest and coolest fashion
• Designers win with cash, fame and opportunity
6

An interactive community provides significant benefits to both Target and its members
Increasing # of participants
Benefits to consumer: • More designers = better number of good designs • More people = more opportuntiy for bragging rights on Fashionista Score • Fame amongst larger group is more powerful for designers • Unearthing previously untapped group of designers Benefits to Target: • Significant brand cache to Target
- Grass roots support of young designers

Increasing length of participation
• ‘Fashionista’ reputations developed
- Similar to eBay reputations or number of friends on MySpace

• Designers will put their designs where more people are. Fashionistas will go where best designs are

• Greater identification of true ‘fashionsitas’ and trend setters
- ‘Google Page Rank’ model for evaluating votes - ‘Fashionistas’ vote weights higher

• Greater insight into fashion trends and demand levels by
- Segments - Geography

• Increased customer loyalty • Process transferrable to other merchant categories • Positive brand for Target umbrella brand

Team Kenny Kellogg, McKinsey Business Technology Challenge

7

7

An interactive community positively impacts many of Target’s key profit metrics
Factors 1 2 3 Components Expected Value Logic

Operational Impact

− Collect and leverage customer 5% improvement Profit Logic and insight in gross margin Oracle − Leverage data for better inventory over 5 years projections management and fewer markdowns − Typical internet adoption curve − Network effects of online communities 10% of current Target customers Web 2.0 forecasts

Customer Penetration

4

− More time spent on portal Increased share of wallet − Increasing customer loyalty and purchase occasions − New (more appealing) styles

10% increase in Reasonable purchases estimate

5

Demand creation Implementation costs

− New styles 5% uplift − Additional media attention and viral through new customers marketing

Reasonable lower bound

− Tool development, hosting, and maintenance − Manufacturing for custom design items Source: Trendwatch, Oracle, team analysis − Advertising and promotions

$6M in upfront Bottoms up development estimates costs, $15 -21M ongoing

By effectively harnessing the impact of the community, there is potential to significantly grow earnings

Net Incremental Impact: $1,004M

NPV: $622M

(1) Projected based on prior 5-year CAGR (2) Based on 2006 results (3) See logic on slide 8 (4) Share of revenue associated with portal customers

Assumptions: 2008-2012 CAGR Base Forecast % Apparel sales Total apparel and a Base gross margin (from 2 Projected gross ma Incremental share of walle
1 2 3 4 5

There are significant returns across even conservative scenarios
 No Operational Impact: – No gross margin improvement  No Demand Impact: – No increase in top line  Conservative: – Max 1.8% GM improvement – Max 6% revenue gain  Aggressive – Max 6% GM 5 improvement – Max 12% revenue gain  See appendix for additional detail

$400.0 $350.0 $300.0 $250.0 $200.0 $150.0 $100.0 $50.0 $$(50.0) 0 1 2 3 4

Base Forecast Conservative

No Operational Impact Aggressive

No Demand Impact

Four Phases of the Implementation Plan
Plan & Construct Promote & Populate Critical Mass Harvest

Q3 - Q4 2007
Technology: –Hosting Infrastructure –Page Rank algorithm –Customize off the shelf design tool Marketing: –Market research to validate interest –Secure pilot test group Manufacturing & Supply Chain: –Establish custom manufacturing capabilities Design: –In-House contributions Key Milestones –Test Group has high # of rankings & minutes spent on system –Execute on a few chosen designs

Q1 - Q4 2008 Technology: –Add Features: My Favorite Designers, Friend Lists, etc Marketing: –Promotional Partnerships with Project Runway, iVillage, & Oxygen Network –Print & Multimedia Advertising Manufacturing & Supply Chain: –Scale custom process Design: –Cont. pro-submissions Key Milestones –500k unique users –10k apparel design submissions –50 apparel submissions reach market

2009 - 2010

2011 & Beyond

Technology: Technology: –Extend design tools to –Integrate into Portals & all Target merchandise Social Networks Marketing: Marketing: –Add partners with focus –Continue spend to on large social networks promote repeat use and portals Manufacturing & Supply Manufacturing & Supply Chain: Chain: –Program’s extended –Ability to customize reach means Target Target-wide merchandise becomes custom manufacturer for the Key Milestones people –Millions of unique users Key Milestones –100k design submissions –Steady user and annually submission growth –500 submissions & 1 –Thousands of apparel Blockbuster reach submissions reach market annually market –Annual contribution –Contribution margin of margin of $10M-$50M $200M-$500M annually

11

Risks and Mitigations
Risks
 Fast Follower - Exposing designs & rankings to the public allows competitors like Wal-Mart to piggyback on designs.  Boredom – Will merchandise maintain it’s freshness in the stores after consumers have already viewed it online?

Opportunity & Conversion  Let Them Follow Us - Further solidifies Target’s status as fashion forward relative to competitors.  The Blogosphere Lights Up - Customers will be upset if Wal-Mart rips off their designs. The bad press will pile up quickly.  Pride vs. Boredom – While boredom is a concern, the pride generated by playing a part in design and approval should be more powerful.

 Brand Conflict – WalMart’s “TheHub” initiative failed miserably, why is this different?

 Data Mess – With the wide range of customer segments contributing, will the rankings be actionable?

 Always Designer Brands - Target’s emphasis on designer brands makes it more fashion forward and better suited to this than Wal-Mart’s “Always Low Prices.”  100% Authentic – Voters and Submitters are real people, not actors filming company approved videographies like Wal-Mart’s efforts on TheHub.  Sub-rankings - A segmentation effort will need to be included, with geographic or age related 12

Appendix: Target should capture the trends demonstrated in other websites
HotorNot.com Google Image Labeler Sellaband.com

 Users rate the pictures of other users  Surprisingly addictive! 1154 LILL Studios

 Google made attaching ‘Tags’ into a ‘game’  Consumer’s attached ‘tags’ to earn competitive points eBay Ratings

 A music ‘stock-exchange’  New bands post their music  Listeners invest in the bands they like Lucky Magazine

 Use flash based software to custom design handbags  Handbag shipped directly to you

 The web’s original ‘user rating system’  The oldest but still the best example

 Lucky is a fashion magazine  Each issue comes with a set of sticky tabs to allow you to highlight the