Whole Foods Streamlines for Growth

For Whole Foods Market, smaller stores in smaller markets are proving to be better — and just as profitable — industry observers told SN.

The Austin, Texas-based chain has developed a smaller footprint that enables it to expand aggressively into more mid-sized markets — like Des Moines (population 570,000); Wichita, Kan. (350,000); and Lincoln, Neb. (250,000) — while maintaining comparable rates of return as it strives to meet its goal of 1,000 stores over the next decade.

According to Walter E. Robb, co-chief executive officer, “I’m confident we can achieve our 1,000-store goal. The question will be how quickly can we go? Right now we’ve put [out] numbers for the next three years, and we’ll see if maybe we can go a little bit faster.”

Whole Foods opened approximately 25 stores in the fiscal year that ended Sept. 30 to finish the year with 340 units, and it plans to open 28 to 32 more in 2013 and 33 to 38 in 2014. “And with 12 operating regions and the infrastructure we have right now, we could easily do up to 50 stores a year,” Robb said in a presentation in July.

Still, the company remains “significantly underpenetrated,” Kate Wendt, senior analyst with Wells Fargo Securities, San Francisco, said, though annual expansion will nearly double within the next two years to annual square footage growth of 9.5%, compared with 5% in fiscal 2011, she pointed out.

“And that growth should be sustainable,” she added, due to three factors: the continuing shift in demand toward natural and organic products; the chain’s efforts to improve its value proposition; and the continued tailwind of share gains from traditional grocery.

Whole Foods’ growth vehicle of choice is a store of 38,000 square feet to 40,000 square feet, rather than the 50,000-square-foot prototype it was building five years ago. According to John Mackey, chairman and co-CEO, the smaller boxes “are less complex to design, build and open.”

Whole Foods began looking more seriously at expanding into smaller cities after its 2007 acquisition of Wild Oats Markets, which was operating smaller stores in smaller cities than Whole Foods. That insight, plus the economic realities of the recession, prompted the company to shift its real-estate strategy “to get the right-sized store into the right community,” Robb explained, “and we have just begun to scratch the surface of what we potentially can do.”

According to Wendt, the flexibility Whole Foods has built into its new-store development program makes broader expansion possible, along with the ability to size each store differently, depending on the market — a combination that has enabled the company to achieve the same returns in the smaller footprint as larger stores produce, due to lower capital and lease requirements, she pointed out.

“Whole Foods realized during the recession that not only did it not need such large stores in many markets but also that it could pare back the costs to build and fixturize them without sacrificing the customer experience,” Wendt explained.

“The result is a less glitzy store that still delights customers but with development costs that fell 22% to $248 per square foot for stores opened in 2011, compared with $316 per square foot for stores opened in 2009,” she said.

Chuck Cerankosky, an analyst with Northcoast Research, Cleveland, said the biggest plus with the smaller stores is return-on-assets, “which is management’s primary focus. “Until a few years ago Whole Foods was opening larger, more opulent stores that didn’t produce returns as quickly as it anticipated, and in some cases returns that were very disappointing.

“But the smaller stores require less investment than those stores, so if all else is right, the company ends up with more dollar profits and a more than adequate ROI.

“What’s so impressive for Whole Foods now is, the small stores are performing well and are contributing to earnings growth as effectively as the bigger stores, without getting as much volume per store but achieving close to the same sales per square foot.”

According to Robb, Whole Foods has been able to boost return-on-invested-capital to close to 15%, compared with 6% in 2007, “which has been a wonderful gain,” and to get stores “coming out of the gate much stronger than they were just three or four years ago.”

He said the 38,000-square-foot prototype is producing average weekly sales of $575,000, or $786 per square foot, with margins of just under 6%. According to Wendt, that compares with $754 per square foot in 2011 at stores averaging 39,400 square feet and $652 in 2010 at stores of 42,600 square feet.

“Whole Foods figured out it had the capability not to be forced into a one-size-fits-all strategy,” she said, “and, with that flexibility, it could not only enter new markets it had not considered before but could also achieve higher sales per square foot by developing stores that are more right-sized for each market.

“For example, it used to enter some mid-sized markets with 50,000-square-foot stores that needed a much larger volume to succeed. But the company realized it can go into similar markets with one 30,000-square-foot store and then add another if [the first one] performs well,” Wendt explained.

According to Jim Hertel, managing partner at Willard Bishop, Barrington, Ill., what’s lost in the smaller stores are “some of the services that have become part of the Whole Foods shopping experience,” including dine-in restaurants, cooking classes and other ancillary services.

What it loses in selling space, however, it makes up for in terms of labor efficiency and labor productivity, Hertel pointed out.

The smaller footprint also forces Whole Foods to be a sharper merchant, he added. “With less display space and with fewer aisles and fewer endcaps or open floor space, secondary display locations must be tighter.”

According to Wendt, although the reduced-size stores do not carry the same depth of selection as the larger ones, “they are still densely merchandised, which in many categories means a smaller selection of each type of product rather than removal of entire product categories.

“There might be fewer prepared food stations than in other stores, but there is still typically an ample prepared foods section for each particular market,” she noted.

Andrew Wolf, managing director for BB&T Capital Markets, Richmond, Va., said he views the reduction of prepared-food offerings as a positive. “The food service sections that have been eliminated were pretty much a drag on profits because of high labor costs,” he explained. “You can’t afford to have people sitting around a barbecue pit or a panini bar, even though they may be attractive sections, because those sections are not going to give you a huge return.

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“The most profitable foodservice sections in the smaller stores are the hot foods bar and the salad bar, which are both self-service,” he pointed out.

Cerankosky said the stores still offer prepared foods, “but with less dine-in space, which was under-utilized throughout most of the day anyway. And by paring back the number of prepared food areas to two or three instead of four or five, it cuts labor costs.”

The loss of shelf space and the tighter assortment that’s required is not a big issue, he added. “Whole Foods can make the stores more convenient to customers by operating two or three small stores instead of one monstrous store, and that works well for the kind of upscale, time-pressed customer to whom it appeals.”