Friday, May 13, 2005

Food for Thought

Established in Austin, Texas, upscale grocery retailer Wholefoods is the nation’s largest chain of natural foods. For the fiscal second quarter of 2005, the company’s sales increased 20% and net income was up 22% to $42 million. As recently as 1991, the company had only a dozen stores in three states. Today Wholefoods is a publicly traded company, boasting 168 stores across the US. Its quarterly sales exceed $1.1 billion, and profit margin per square foot is double the industry average. Scott Van Winkle, analyst at Adams Harkness, says the company should be able to grow earnings at “a 20% to 22% rate consistently over the next five years and still have only achieved half of its market opportunity”. That said, is Wholefoods’ growth trajectory sustainable? The stock trades at an enterprise value-to-revenue ratio of 1.6, pricey relative to other leading retailers including Wal-Mart and Costco.
Wholefoods differentiates itself from its competitors by cashing in on the “shopping experience.” Buying groceries is no longer a chore when buying at Wholefoods. Shopping is “showtime” and “you don’t need a ticket”. At Wholefoods you will not only find foods free of artificial preservatives, colors, and flavors but a shopping experience designed to wow the customer. There is Candy Island, where you can dip a fresh strawberry into a chocolate fountain, Lamar Street Greens, where you can have an organic salad handmade for you, Fifth Street Seafood, where you can have any of 150 fresh seafood items cooked for instant eating, and Whole Body, where a massage therapist will give you a 25 minute deep tissue. Each section in Wholefoods is designed to create an intimate feel with self-contained architecture so that shoppers feel like lingering. The lighting is the same as that used in art galleries, and the store stereo plays calming classical music. The store is not just about groceries: you will find, among other things, organic baby clothing, Wi-Fi hot spots, and wholesome prepared foods. Wholefoods has done what traditional supermarkets do not – it lures customers in and makes them want to linger.
Wholefoods draw comes at a time when chic urban living has regained popularity and leading healthy lifestyles a must. City sophisticates enjoy shopping at Wholefoods and do not mind dropping a wad of cash doing so. The retailer charges premium pricing, and one will not be surprised to find a vat of almond butter for $89.99. Wholefoods gets away with its pricing because it is in essence selling a way of life. John Mackey, CEO of Wholefoods, says that Wholefoods attracts the educated, who in turn are more likely to be rich enough to afford shopping at Wholefoods.
Despite these growth figures, Wholefoods has further potential for growth. The European and Asian markets are yet untapped, and the company expects to expand into the UK, Netherlands, and Ireland. Fresh & Wild, owned by Wholefoods, has already made its debut in the UK.
Wholefoods’ performance is not by chance. Similar to the Enterprise model, each store is an “autonomous profit center composed of an average of 10 self-managed teams…with designated leaders and clear performance targets”. Each team and store competes with each other in the areas of quality, service, and profitability. The results of these competitions translate directly into bonuses, recognition, and promotions. Each team screens and hires its members, and it takes a two-thirds vote and a 30-day trial period for a candidate to become a full-time employee. This hiring methodology affects the behavior of everyone from the job candidate to the team to the store team leader. It exacts performance measures on employees, who are pressured to perform by their peers rather than their superiors.
The results are obvious: staff is cheerful, knowledgeable, and eager to answer questions. Produce is “gleaming, stacked head high, perfectly arranged, each apple stem and celery stalk facing in the same direction”. In short, Wholefoods organizational structure is its competitive advantage.
We believe Wholefood’s internal structure is very sound, but the firm is vulnerable to external factors- potentially threatening Wholefoods’ dominance and profitability in the long run within the organic grocery segment. The company’s success is driven by its margins in the organic produce department. While healthy living is very much the fashion today, it might not be tomorrow.
Wholefoods could also face competition from a low cost provider, as there are no real barriers to entry. The market for organic produce might be too small today to attract potential entrants, but this might not always be the case.
Lastly, the company’s premium pricing means that its sales and profitability (per square foot) could suffer in an economic downturn. Currently Wholefoods bucks the industry trend by building 50,000 square foot supermarkets as the rest of the industry shrinks its stores to an average of 34,000 square feet. It is has become a metropolitan magnet and “must have” for residential developers in swank new buildings. This could set Wholefoods up for a tremendous fall if consumer confidence dropped or if the real estate bubble burst. Wholefoods needs to be wary of this scenario and plan its contingency plans accordingly.
Wholefoods has done a stellar job of differentiating itself from other grocery retailers. Its’ competitive internal organization drives profitability and ensures high quality service. Growth opportunities exist both in the US and internationally. Combined with the current healthy living fad, Wholefoods is on an upward trajectory to success.
While there could be threats from a low cost organic grocer, Wholefoods has made such an effort to differentiate itself that we believe that it will be able to retain its market share going forward, as long as the economy and consumer spending remains robust. In addition to its current emphasis on store growth, we urge Wholefoods to strategize for the alternate scenario and build up additional resources and new competitive advantages.
Ho, Huang and Sambasivan


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