MBA 590 – Winter 2013

Whole Foods Market, Inc.

Strategic Analysis

Walter Prout

1/26/2013

The Market

Whole Foods Market, Inc. evolved into the world’s largest retail chain of natural and organic supermarkets. In 2003, Whole Foods Market, Inc. was designated the first national “Certified Organic” grocer by the independent federally recognized third party organic certifier Quality Assurance International The USDA defines natural food as “a product containing no artificial ingredients or added color and that is minimally processed.”1 In 2002, the USDA officially established organic labeling standards. Four categories were determined with differing level of organic purity:

100 percent organic: mostly fresh fruits and vegetables grown without the use of synthetic pesticides, sewage-based fertilizers, irradiation, genetic modification, bioengineering, antibiotics, and growth hormones; carried the green USDA organic certification seal.

Organic products: products often processed with at least 95 percent organically certified ingredients, carried the green USDA organic certification seal.

Made with organic ingredients: products with at least 70 percent organic ingredients, could not display the green USDA organic certification seal.

All other products with organic ingredients: products with less than 70 percent organic ingredients, could not use the word organic on the packaging.

In 2007, sales of food and beverages labeled as natural or organic were $62 billion and represented 7.3% of the estimated $850 billion total US grocery sales. However, According to the Organic Consumers Association, sales of organic foods in the United States were $17 billion in 2006, rising 22% from $13.8 billion in 2006. Natural and organic foods combined totaled $28.2 in 2006, up from $23 billion in 2005. Organic food sales were projected to grow to $33 billion in 2008, about 3% of total US retail sales of food and beverages. 31% of overall organic sales went through conventional supermarket/grocery stores and 24% of these sales went through natural foods supermarket chains as Whole Foods Markets, Wild Oats, and Trader Joe’s. Natural and organic products were not a passing fad; natural and organic products were staying in the market available in nearly every product and available in 75% of US retail food stores. Consumer demand for organic foods was growing at about 20% annually. Organic food retailing had become the fastest growing segment of U.S. food sales. Retailers were attracted to organic foods because sales of organic products achieved high profit margins compared to conventional food sales where price competition was strong.

Growth Strategy & Competencies

1 Whole Foods Market in 2008: Vision, Core Values, and Strategy,p.317

Whole Foods pursues: (1) a real estate growth strategy based on the combination of opening new stores and the acquisition of owner-managed chains; (2) selling premium natural and organic products at premium prices; and (3) a differentiated merchandising strategy designed to create an inviting an interactive store atmosphere, turning shopping for food a fun and pleasurable experience. First, Store locations are often located in upscale metropolitan areas on premier real estate sites, potential markets analyzed based on education levels, population density, and income within certain driving times. Management desired to drive growth by opening store ranging from 40,000 to 70,000 square feet. The size of these stores would place Whole Foods on the same square footage standard as Kroger’s and Safeway, food retailers capturing a large portion of market sales. However, most stores Whole Foods opened were between 45,000 and 60,000 square feet and generated annual sales of $32 million. Cash flows from operations in 2005 were $410.8 million, $452.7 million in 2006, and $398.6 million in 2007. Capital expenditures totaled $324.1 million in 2005, $340.2 million in 2006, and $529.7 million in 2007. The average capital cost to open a new store in 2007 was $15.1 million with another $850,000 inventory investment. Growing capital expenditures on premier, urban retail locations represented Whole Foods real estate strategy allowing them to build their open format stores and execute their differentiated merchandising strategy. Building new stores, acquiring existing food retailing chains, and relocating smaller stores to larger sites were core competencies of Whole Foods contributing to their sales growth and capture of the natural and organic food retailing market.

Secondly, Whole Foods could sell premium products at premium prices because the fast growing organic market segment was made up of aging, affluent people integrating a meaningful sense of the environment and social responsibility into their purchase decisions. This demographic marketing segment LOHAS (Lifestyles of Health and Sustainability) was estimated to be 30% of the US population and contained the following characteristics:

• A proven willingness to pay more for LOHAS products and services, with a large majority willing to spend up to 20% more.

• Agreement that their purchase decisions were based on the health and sustainability effect on the world and the environment as well as their personal values.

• A high degree of influence over others: almost three times as likely as the general population to influence and teach others about the benefits of LOHAS-related products and service.

Most importantly, the LOHAS marketing segment demonstrated increased loyalty and decreased price sensitivity. Whole Foods responded by providing 30,000 SKU’s of premium quality natural and organic products at premium prices. Whole Foods ability to charge premium prices is one of their core competencies.

Whole Foods executes an effective, differentiated merchandising strategy to command premium prices. Management created a “third place,” separate from the home or office, where people could gather and interact while educating themselves through the food shopping experience. Whole Foods developed an expert merchandising presentation – “from bright colors of the produce displays, to the quality of foods and customer service, to the wide aisles and cleanliness.”2 Merchandising skills were a distinct competency creating return customers – with annual sales of $800 per square foot of space. The company customizes each store layout to best display a product mix for the store’s target customers. One reason for this successful merchandising competency was that 67% of Whole Foods sales in 2007 came from perishables, fresh fruits and vegetables. Fresh fruits and vegetables represented Whole Foods commitment to their customers by offering high quality foods that met freshness, nutrition, appearance, and taste standards included a 100% guarantee on satisfaction. Shoppers who came to purchase fresh fruits and vegetable often came back to the store two to three times a week. Whole Foods merchandising strategy created large numbers of repeat customers; and coupled to shoppers that were willing to pay premium prices, a highly valued brand demonstrated the success of the company’s strategies. See merchandising images below:

3

Financial & Key Performance Metrics

Whole Foods Market, Inc. had sales of $6.6 billion in 2007, just under 1% total US grocery sales and had 276 stores in the United States.

2 Whole Foods Market in 2008: Vision, Core Values, and Strategy,p.3303http://www.google.com/search? q=Pictures+of+Fresh+fruits+at+Whole+Foods+Market&hl=en&tbo=u&rlz=1C2GGGE_enUS467US467&tbm=isch&source=univ&sa=X&ei=j9UCUYmjLqL3igLa7YCYAQ&ved=0CC0QsAQ&biw=1366&bih=600

(in $thousands)1. Gross Profit Margin 2007 2006 2005 2004 2003

Total Revenues 6,591,773$ 5,607,376$ 4,701,289$ 3,864,950$ 3,148,593$ Total Cost of Revenues 4,295,170$ 3,647,734$ 3,052,184$ 2,523,816$ 2,070,334$ Gross Profit (Margin) 2,296,603$ 1,959,642$ 1,649,105$ 1,341,134$ 1,078,259$

Gross Profit Ratio 34.84% 34.95% 35.08% 34.70% 34.25%

Whole Foods Market, Inc (in thousands)

2. Operating Profit Margin 2007 2006 2005 2004 2003

Total Revenues 6,591,773$ 5,607,376$ 4,701,289$ 3,864,950$ 3,148,593$ Operating Expenses* 1,999,152$ 1,640,633$ 1,419,372$ 1,124,488$ 911,150$ Operating Income (loss) 297,451$ 319,009$ 229,733$ 216,646$ 167,109$

Operating Profit Margin 4.51% 5.69% 4.89% 5.61% 5.31%

*Operating Expenses: Exhibit 9, Whole Foods Market Statement of Operations, Fiscal Years 2003-2007.Direct Store Expenses Whole Foods Market in 2008: Vision, Core Values, and Strategy, P.339General & Adminstrative ExpensesPre-opening & Relocation Costs

3. Profit Margin 2007 2006 2005 2004 2003

Net Income (Loss) 182,740$ 203,828$ 136,351$ 133,000$ 104,000$ Total Revenues 6,591,773$ 5,607,376$ 4,701,289$ 3,864,950$ 3,148,593$

Profit Margin 2.77% 3.63% 2.90% 3.44% 3.30%

4. Inventory Turnover 2007 2006 2005 2004 2003

Total Cost of Revenues 4,295,170$ 3,647,734$ 3,052,184$ 2,523,816$ 2,070,334$ Inventory 288,112$ 203,727$ 172,438$ 145,047$ 121,784$

Inventory Turnover 14.9 17.9 17.7 17.4 17.0

5. Current Ratio 2007 2006 2005 2004 2003

Total Current Assets 560,685$ 542,028$ (Not Available ) (Not Available ) (Not Available )Total Current Liabilities 784,516$ 509,770$ (Not Available ) (Not Available ) (Not Available )

Current Ratio 0.71 1.06 #VALUE! #VALUE! #VALUE!

6. Asset Turnover 2007 2006 2005 2004 2003

Total Revenues 6,591,773$ 5,607,376$ 4,701,289$ 3,864,950$ 3,148,593$ Total Assets 3,213,128$ 2,042,996$ (Not Available ) (Not Available ) (Not Available )

Asset Turnover 2.05 2.74 #VALUE! #VALUE! #VALUE!

7. Debt to Equity 2007 2006 2005 2004 2003

Total Liabilities 1,754,324$ 638,853$ (Not Available ) (Not Available ) (Not Available )Total Stockholder's Equity 1,458,804$ 1,404,143$ (Not Available ) (Not Available ) (Not Available )

Debt to Equity 1.20 0.45 #VALUE! #VALUE! #VALUE!

8. Debt to Assets Ratio 2007 2006 2005 2004 2003

Total Liabilities 1,754,324$ 638,853$ (Not Available ) (Not Available ) (Not Available )Total Assets 3,213,128$ 2,042,996$ (Not Available ) (Not Available ) (Not Available )

Debt to Assets Ratio 0.67 0.31 #VALUE! #VALUE! #VALUE!

9. Return on Assets 2007 2006 2005 2004 2003

Net Income (Loss) 182,740$ 203,828$ 136,351$ 133,000$ 104,000$ Total Assets 3,213,128$ 2,042,996$ 1,893,764$ 1,546,512$ 1,195,402$

Return on Assets 5.69% 9.98% 7.20% 8.60% 8.70%

10. Return on Investment 2007 2006 2005 2004 2003

Net Income (Loss) 182,740$ 203,828$ 136,351$ 133,000$ 104,000$ Average Total Assets 2,628,062$ (Not Available ) (Not Available ) (Not Available ) (Not Available )

Return on Investment 6.95% #VALUE! #VALUE! #VALUE! #VALUE!

11. Financial Leverage 2007 2006 2005 2004 2003

Total Assets 3,213,128$ 2,042,996$ 1,893,764$ 1,546,512$ 1,195,402$ Total Stockholder's Equity 1,458,804$ 1,404,143$ 1,363,510$ 970,803$ 776,119$

Financial Leverage 2.20 1.45 1.39 1.59 1.54

12. Return on Equity 2007 2006 2005 2004 2003

Net Income (Loss) 182,740$ 203,828$ 136,351$ 133,000$ 104,000$ Total Stockholder's Equity 1,458,804$ 1,404,143$ 1,363,510$ 970,803$ 776,119$

Return on Equity 12.53% 14.52% 10.00% 13.70% 13.40%

16. Sales to Inventories 2007 2006 2005 2004 2003

Total Revenues 6,591,773$ 5,607,376$ 4,701,289$ 3,864,950$ 3,148,593$ Average Inventories 245,920$ 188,083$ 158,743$ 133,416$ 60,892$

Sales to Inventories 26.80 29.81 29.62 28.97 51.71

Market Measures17. Price to Earnings Ratio 2007 2006 2005 2004 2003

Market Price Per Share 40.80$ 46.93$ 67.23$ 42.90$ 27.60$ Earnings Per Share* 1.29$ 1.41$ 0.99$ 0.99$ 0.79$

P/E 31.63 33.28 67.91 43.33 34.94

*Diluted earnings per share

18. Earnings Yield 2007 2006 2005 2004 2003

Earnings Per Share 1.29$ 1.41$ 0.99$ 0.99$ 0.79$ Market Price Per Share 40.80$ 46.93$ 67.23$ 42.90$ 27.60$

Earnings Yield 3.16% 3.00% 1.47% 2.31% 2.86%

19. Dividend Yield 2007 2006 2005 2004 2003

Dividends Per Share 0.8700$ 2.4500$ 0.4700$ 0.3000$ (Not Available )Market Price Per Share 40.80$ 46.93$ 67.23$ 42.90$ 27.60$

Dividend Yield 2.13% 5.22% 0.70% 0.70% #VALUE!

Store Operating Statistics

21. Store Metrics 2007 2006 2005 2004 2003

Number of Stores 276 186 175 163 135Total Square Footage, All Stores 9,312,107 6,376,817 5,819,943 5,145,261 4,098,492Sales Per Total Square Foot 0.71$ 0.88$ 0.81$ 0.75$ 0.77$ Average Store Size, Square Feet 33,740 34,284 33,200 31,566 30,359Average Weekly Sales 616,706.00$ 593,439.00$ 536,986.00$ 482,061.00$ 392,837.00$

The company had cash of $30 million and $100 million available on existing lines of credit in November 2008. Total debt had increased to $929 million in

previous quarters because Whole Foods’ capital expenditures could not be financed from operational cash flows.4

SWOT Analysis

Whole Foods has the following strengths which allow the company a competitive advantage over its competitors:

A powerful and effective strategy – increasing revenues and stable gross margin

Core competencies: core values and mission statement aligned to strategy execution in real estate acquisition, premium pricing in food retailing, natural and organic product mix, and economic value added team based store management creating team member loyalty

Distinctive competency: store location, merchandising strategy, and branding Supply chain management: ownership of two produce procurement centers

facilitating the distribution of produce; operated nine regional distribution centers; two seafood processing facility; and local store procurement of local organic produce

Excellent product quality, product breadth and proven sales North American and United Kingdom geographic coverage

Whole Foods has the following weaknesses:

Small net (profit) margins Cash shortage from operations leading to debt financing to pursue real estate

acquisition strategy to open more stores Rising debt to equity and debt to assets ratio Declining inventory turnover ratio 0.5 percent of revenues spent on external advertising Increasing Selling, General, and Administrative expense Questionable ethical corporate leadership: John Mackey and the anonymous

blog postings on Yahoo Finance concerning Wild Oats

Whole Foods has the following opportunities:

Large market share still to capture of total US grocery sales and Europe Serve a different market segmentation than LOHAS: change pricing strategy

though store differentiation to capture less affluent buyer or expand the product line to be affordable

Launch a lower cost, lower price product mix based on smaller square foot stores

Acquire rival firms such as Trader Joe’s or merge with industry leaders such as Safeway or Kroger’s

4 Whole Foods Market in 2008: Vision, Core Values, and Strategy,p.341

Vertical integration to control farms and farmland, seafood processing, and other natural and organic products: secure supply of organic produce

Raise capital through equity: stock issuance

Whole Foods has the following threats:

Strong competition from rivals: Trader Joe’s, Safeway, Kroger’s, Costco with strong distribution and retailing assets and competencies

Entry of smaller scale – economic competitors; food co-ops and corner stores” Regulation from FTC over monopolistic competition: acquisition strategy may

be hindered by federal regulation Purchasing power of the LOHAS market segmentation changes due to

reduced income level: adverse demographic changes Bargaining power of distributers, such as UNFI, Inc.; increase leading to

increase capital expenditures on more in-house distribution Labor unionization Reduction of certified organic farmland or natural and organic product

suppliers: seafood and meat Lack of adequate capital to acquire or build new stores

SWOT Matrix

Strengths Weaknesses Core competencies: core values

and mission statement aligned to strategy execution in real estate acquisition, premium pricing in food retailing, natural and organic product mix, and economic value added team based store management creating team member loyalty

Distinctive competency: store location, merchandising strategy, and branding

Small net (profit) margins Cash shortage from operations

leading to debt financing to pursue real estate acquisition strategy to open more stores

Rising debt to equity and debt to assets ratio

Declining inventory turnover ratio

Opportunities Threats Serve a different market

segmentation than LOHAS: change pricing strategy though store differentiation to capture less affluent buyer or expand the

Strong competition from rivals: Trader Joe’s, Safeway, Kroger’s, Costco with strong distribution and retailing assets and competencies

product line to be affordable Vertical integration to control

farms and farmland, seafood processing, and other natural and organic products: secure supply of organic produce

Regulation from FTC over monopolistic competition: acquisition strategy may be hindered by federal regulation

Labor unionization

Strategy Recommendations

Although Whole Foods strategy has been very effective, the company faces a new stage regarding growth. Whole Foods should create new store models differentiated from the premium pricing and premium product model they currently pursue. New store models need to be built in other geographic areas where high quality organic food can be sold at less than premium prices to capture market demographic segments which still have LOHAS values but are capable of paying lower prices. Store brand image needs to match a high quality, lower price organic food model where greater population number can access quality natural and organic foods. Whole Foods should explore cost saving distribution methods, inventory control technology, and lower merchandising costs so the company can lower food prices which will appeal to a wider population demographic. Brand image should not be diluted and the food shopping experience still contains elements of the “third place.” Secondly, Whole Foods markets should vertically integrate the supply chain in order to develop and control more organic farm land. Organic farmland in the U.S. totaled 4.1 million acres – 1.7 million acres of cropland and 2.4 million acres of rangeland and pasture. Because 67% of Whole Foods sales come from fruits and vegetables, organic farmland development is key to generating growth. Whole Foods should invest in local organic farming either though ownership or through investment in strategic alliances. Creating alliances with local farmers will build a stable supply as well as increase the economic growth of rural areas. Lastly, Whole Foods should explore merger possibilities with Trader Joe’s. Gaining the knowledge base of Trader Joe’s pricing policies and distribution capabilities would allow Whole Foods to capture a greater share of the natural and organic market while appealing to a different customer base. Acquisition of Trader Joe’s would expand the customer base into population demographics not traditionally served by Whole Foods aging, affluent buyers.