Friendly Fire

As if there weren’t enough competition…Whole Foods Market decides to compete against itself.

One cannot say that Austin, TX-based Whole Foods Market isn’t willing to change. In its May 6, 2015, quarterly conference call, discussing the company’s newly revealed plan to open a completely different grocery brand banner, with smaller, more streamlined and value-priced stores, co-CEO John Mackey remarked, “You have to be willing to do what it takes to serve your customers better, and you can’t not do that because it might possibly take sales from your existing flagship brand.” Bravo, John.

Why the New Strategy?

According to the company, the proximate cause of this voluntary and intentional friendly fire appears to be the 90 million or so millennial generation potential customers who—while wholeheartedly embracing all the values that matter to Whole Foods’ core Baby Boomer shoppers (generation size: 75 million)—don’t yet seem to be willing to afford buying a bagful of these highest-quality groceries from Whole Foods’ flagship stores and bringing them home to their newly forming families.

Mackey, again, “Whole Foods Market's brand is very targeted to a certain type of customer…but there are other customers that it’s less attractive to, and we see a whole generation of young people coming up who are quite interested in natural and organic foods; they’re the millennial generation…[but] they’re also very value conscious,” hence, “…we’ve announced that we’re coming out with a new format that we think will be specifically geared to address an entire generation of people coming out that we think—that line up well with Whole Foods and this new concept.”

Analysts on the call asked how Whole Foods intends to triple the number of its flagship stores—to 1,200 from approximately 400 U.S. stores today—while opening a meaningful number of the new, streamlined, lower-priced stores, without cannibalizing their existing business. Responding, Mackey said, “One thing to understand is that the market is exploding. I mean it’s incredible what’s happening…we go back and we do look at what our sales were per store five years ago, eight years ago, 10 years ago, and our sales [per store] are so much higher, and at the same time, we’ve been so successful that we’ve actually brought a lot more competition…and that’s really, frankly, due to our success.”

Where, Exactly, Are the Millennials?

OK, so the market for natural and organic is exploding, and we’ll take the company’s word that the epicenter of this earthquake targets a particular generation: millennials, aged roughly now 18 to 35. If you were trying to access this generation specifically, where would you put your store?

Well, statistically speaking, the densest concentration of millennials is exactly where the densest overall population resides; in the major metropolitan areas. Haven’t we been noticing this new generation’s embrace of the Big City? Foregoing home ownership, preferring to walk, bike or take public transportation to owning a car (and paying a monthly parking fee higher than some apartment rents), taking advantage of all the fresh prepared foods options at the dozens of ethnically diverse restaurants such cities have to offer?

In the conference call, management informed analysts they have begun negotiating leases for these new, smaller, simpler, standardized stores, and will announce more details sometime before Labor Day. This will be a moment of truth, of sorts, as the company reveals the actual locations it intends for the new concept. Will they be fill-in locations in Manhattan, Queens, Chicagoland, California’s Bay Area or Santa Monica, to capitalize on the largest concentrations of millennials? Or, will they be focused somewhere else?

Drifting Comps

Let’s put aside the question of locating millennials for a moment and look instead at what other factors may be driving Whole Foods’ major shift in strategy. The new competition management referred to has begun to put a crimp in Whole Foods’ growth. Over the last several quarters, Whole Foods’ comparable store sales, or comps—the industry metric most important to the investment community that compares the percentage of year-over-year growth for stores open at least one year—have been drifting lower, from rates increasing in the low double-digits several years ago to the low single-digits today; 3.6% in the latest fiscal 2nd quarter, ended April 12, 2015. While the company attributes some of the downward trend in comps to cannibalization; where its own newly opened stores temporarily take away sales from existing nearby Whole Foods stores, management also candidly admits that the new competition plays an increasing role.

And a couple of these new, aggressive natural and organic competitors are turning in higher comparable-store sales growth rates. While there are several regional natural and organic supermarket chains that are growing, two of the largest publicly traded natural and organic chains in particular—Phoenix, AZ-based Sprouts Farmers Market and Lakewood, CO-based Natural Grocers by Vitamin Cottage—have approximately 300 stores across the country between them, with plans to open dozens more this year, and continuing into the foreseeable future.

Where do Sprouts and Natural Grocers locate their stores? Both chains have so far avoided the most heavily populated metropolitan areas where they would more directly compete with Whole Foods in its core markets. Instead, the chains have been selecting real estate in less-populated secondary and tertiary markets. Places like Phoenix, Tucson, and Albuquerque for Sprouts, and Colorado Springs, Omaha and Tulsa for Natural Grocers. The two chains tend to be the largest natural/organic specialists in most of their trade areas, causing major headaches for independent natural products retailers in these markets, but also creating convenient expanded access to natural and organic foods for a whole new layer of mainstream shoppers.

Between a Rock and a Brick-And-Mortar Place

Are these new shoppers exclusively millennials? More likely, customers come from a broad swath of the general public, of all ages, who had previously steered clear of natural and organic foods due to the relative lack of access compared to conventional foods, and to the perception and reality of higher prices. Perhaps here we arrive at the rub for Whole Foods. The primary driver behind the success of the new natural and organic chains is not their appeal to a particular generation of millennials, but their measurably lower prices that have finally begun to convince mainstream households that they can begin to afford natural and organic foods for their families.

So, you can see the dilemma Whole Foods’ management faces. The supernatural pioneer inarguably has the highest-quality real estate in the country across its 400-store portfolio. Locations such as Los Angeles, San Francisco, Chicago and New York City provide the rich vein of highly educated, food-forward customers Whole Foods depends on to appreciate—and to buy—its top-quality offerings.

But Whole Foods’ stores, which average 38,000 square feet, are too big, complex (full kitchen/bakery, wine bar, beer hall) and expensive to locate in lower-population-density trade areas outside the largest metropolitan centers. And, these secondary and tertiary markets are the sweet spot that the new chains like Sprouts and Natural Grocers, with their smaller stores, are rapidly exploiting with great success. Sprouts prefers a more compact 28,000-square-foot gross lease area, while Natural Grocers likes the 15,000 to 20,000-square-foot range. Both chains build simpler, less exotic boxes than Whole Foods’ flagship stores. With these smaller, less expensive footprints, the new competitors can turn a profit more quickly in these less-densely populated, less wealthy trade areas.

If We Don’t Do It, Someone Else Will

So, you can imagine the conversation inside Whole Foods. Sprouts, Natural Grocers and other lower-priced competitors are having a romp across the country, mostly in areas outside the densest metropolitan markets. At the same time, Whole Foods has accurately identified its lack of ability to attract meaningful numbers of millennials into its flagship stores.

While Whole Foods can claim with some justification that its food quality standards are superior to the rest of the grocery world, cost-conscious shoppers in general and millennials in particular appear to perceive the natural and organic offerings from Sprouts, et al., as “good enough” and as clearly better than mainstream conventional supermarket quality. This emerging reality leaves Whole Foods’ flagship stores with a gradually dwindling, if still large and lucrative, Baby Boomer customer base.

John Mackey, again, “…one of the things that people don’t fully understand is that even if Whole Foods Market just stopped; our comps went flat. We were at zero. Our sales per square foot, our return on invested capital, our whole store operating model is still, frankly, light years better than just about any of the other [public] food retailers that we have data on. So it’s going to take a long time before people can catch up with us, but we’re not going to sit still.”

Sitting in Mackey’s seat, I’m not sure we wouldn’t reach the same conclusion. Reinvent Whole Foods II. Blanket the entire U.S. landscape rapidly. Squelch the upstart competition, and it won’t matter whether the flagship stores ever reach 1,200 units. Investors will keep buying the stock. WF

See www.wholefoodsmagazine.com/columns/merchandising-insights for additional Merchandising Insights columns.

Jay Jacobowitz is president and founder of Retail Insights®, a professional consulting service for natural products retailers established in 1998, and creator of Natural Insights for Well Being®, a comprehensive marketing service designed especially for independent natural products retailers. With 38 years of wholesale and retail industry experience, Jay has assisted in developing over 1,000 successful natural products retail stores in the U.S. and abroad. Jay is a popular author, educator, and speaker, and is the merchandising editor of WholeFoods Magazine, for which he writes Merchandising Insights and Tip of the Month. Jay also serves the Natural Products Association in several capacities. In 2014, Jay received the Natural Products Association’s Industry Champion Award for notable contributions to the industry above and beyond commercial success. He can be reached at (800)328-0855 or via e-mail at jay@retailinsights.com.