THE WHOLE STORY

Matthew Enis

IT'S BECOMING INCREASINGLY DIFFICULT to refer to Whole Foods as "that chain of natural food stores." After 25 years of sophisticated merchandising that respects consumers' intelligence; exceptional, years-long same-store growth; and a steady pace of acquisitions and new-store construction of larger stores, the chain is on the verge of becoming a mainstream competitor.

"Most conventional supermarkets don't have well-established brands," John Mackey, the chain's co-founder and chief executive officer, said in April at the company's annual meeting. "What exactly does Safeway mean? What does Albertsons mean? What does Kroger mean? We are Whole Foods Market. We have a very clearly defined message."

That message is being heard far and wide. The newer, larger stores are earning an average of $575,000 in weekly sales -- or $786 a square foot. Customers are willing to spend more in these stores, though the chain is no longer known as "Whole Paycheck." Growth has allowed it to soften pricing in many areas. More important, however, is the chain's pioneering of a whole-store format that allows consumers to patronize one location for all their natural/organic needs and services. Until Whole Foods, finding a one-stop solution for this class of goods was difficult at best.

Plus, they've made shopping interesting and fun -- something mainstream retailers have largely been unable to master.

"In general, competing directly with Whole Foods is a big challenge for any conventional supermarket," said Bill Bishop, president of Willard Bishop Consulting, Chicago. "Part of the challenge is that [Whole Foods] is so clearly positioned. So when customers get up in the morning and decide they want to go get natural or health food, they're going to go there. It's hard for a supermarket that's only partially dealing with this to get a similar share of mind."

Even though virtually everyone seems to agree that the natural, organic and specialty food categories still have a great deal of upside possibilities in conventional supermarkets, few feel the channel is currently maximizing that potential. In WH's recent online survey, 59% of retailer respondents felt that supermarkets would benefit most from health and wellness trends in the coming year, but 82% said the channel was still not taking full advantage of these emerging opportunities [see "Promises, Promises," WH, Winter 2005].

"No one knows how high 'up' is," said Bishop. "So if a store decides to remerchandise, and they get a sales bump, they think that's good. But whether that sales bump was 100% of what they could have gotten -- no one knows."

With 168 stores, Whole Foods is now the largest natural foods retailer in the United States, guided by a moral business compass that directs all of its buying and merchandising practices. As consumers grow more health-conscious, environmentally aware and socially responsible, the chain is poised to become even more of a primary shopping destination.

Starting Out

No one imagined all of this in 1980, when Mackey, the current chairman and CEO, partnered with Craig Weller and Mark Skiles to open the first Whole Foods Market in Austin, Texas. For the next 12 years, the chain grew by a slow, steady process of single-store acquisition and occasional new builds.

Then, in 1992, flush with $23 million from an initial public offering on Nasdaq, the 12-unit operation began buying up natural foods stores from Southern California to Boston. To describe the period as an acquisition "binge," however, would overlook the serious business strategy that lay behind it. Indeed, Whole Foods wasn't on a mission to bulk up, but rather to gather some of the best operators in a fragmented industry under a single corporate umbrella and employ them in reaching a common goal.

"I'm not sure that any single acquisition can point to a change in thinking at the company, but their mode of operating was that they respected the operators and the chains that they brought in, and they learned what they did well," said Scott Van Winkle, managing director of equity research for Adams Harkness, Boston.

For example, the $20 million in cash and $6.2 million in stock that paid for Boston-area Bread & Circus in 1992 not only netted the company six stores with an excellent track record, it also brought to the table a team that knew how to run a successful gourmet prepared-foods business, which the company soon adopted throughout its network.

Similarly, Marc Jonna, second-generation operator of Merchant of Vino in Detroit, became Whole Foods' national wine buyer after his family's six gourmet food and wine stores were purchased in 1997. Lex Alexander, whose two Wellspring Grocery stores in Durham and Chapel Hill, N.C., were acquired in 1991, built Whole Foods' private-label program after joining the company. A.C. Gallo, a former Bread & Circus executive, served as chief operating officer of Whole Foods before being named co-president last year. Collectively, the team has played matchmaker in the unusually vibrant marriage of gourmet indulgence with an eco-friendly health food image.

"You have to remember, not that long ago, people didn't really think of health food as indulgent food or fun food or savory food," said Kevin Kelley, founding partner of Shook Kelley, an architecture and design firm with offices in Los Angeles and Charlotte, N.C. "Health food stores understood their 'Mother Earth' appeal, and I think that Whole Foods probably learned a lot about the indulgent side of food retail from H-E-B and Wegmans. But Whole Foods' tipping point was when they started to understand that they could merge the two."

Whole Foods' timing was also good, as its growth mirrored larger social forces at work, including the aging of the baby boom demographic and the arrival of younger consumers concerned with the environment. The increase in Whole Foods' store count, and the growth of other large-format natural foods stores, began to take some of the crunch out of the health-and-wellness' granola image.

"Natural food retailers have become a lot more sophisticated," said Mike Gilliland, founder and former CEO of Wild Oats Markets who now operates Longmont, Colo.-based Sunflower Markets. "The box has evolved, and execution has evolved. Stores are bigger, and there's more variety so that customers can do all of their shopping in one place."

CHANGING DYNAMICS

As the stores have grown, so has the message. Today's larger natural foods stores appeal to a broad spectrum of consumers, all worried about issues ranging from the environment to pesticides and artificial ingredients. In one neat package, Whole Foods makes its customers feel that spending their food dollars there is better for them and better for the planet. "When you're spending money at Whole Foods, you're spending on things well beyond groceries," said Bishop.

By contrast, in attempting to be all things to all people, many conventional supermarket chains have found themselves competing from an uncomfortable middle ground: pricier than Wal-Mart, and less dynamic than Whole Foods and other specialty retailers.

Mackey, who declined to be interviewed for this story, believes that when mainstream grocers give the category a slow, overly cautious embrace, they only succeed in driving more customers into natural foods stores. "[Conventional supermarkets] introduce people to these products. Then they trade up to the authentic source," he said at the shareholders meeting.

Wal-Mart Stores has played a role in creating the opportunities currently enjoyed by Whole Foods, argued Van Winkle. "Wal-Mart has reduced service to almost zero, and they've brought price as the primary driver for mass market grocery industry. As a result, the opportunity for specialty operators that bring service, high quality and enjoyment to shopping is getting larger, and Whole Foods is a major beneficiary."

Yet, even as demand for natural, organic and specialty foods grows more mainstream, independent retailers are also beginning to cultivate points of difference to contend with their industry's own emergent category killer.

"[Whole Foods] is a very good operator, wherever they go," said Andrew Arons, president and CEO of Gourmet Garage, New York. "I think coming into New York, they've raised the bar, their competitors can't be lazy, and the net effect is that there's going to be a saturation point where some operators fall off."

Arons said that a couple of stores in his upscale five-store operation had felt some initial weekend pressure after Whole Foods opened its first Manhattan location in 2001, but that business has bounced back.

"We're trying to be competitive by bringing in some great new products and being very customer-service oriented," said Arons. "You really have to be proactive in carving your niche against operators like that."

In the booming Southwest, Gilliland is eking out an untapped space in the market with his new Sunflower format.

"I think Whole Foods does the high end of the market better than anybody right now," he said. "When I was running Wild Oats, I really felt like we were stuck in the middle."

Featuring the tag line "Serious Food ... Silly Prices," Sunflower aims to broaden the appeal of natural and organic foods through lower prices, partly by emulating some key practices of retailers like Trader Joe's and Costco.

"[Sunflower's] model serves people who are interested in health foods -- maybe not your hard-core health food consumer, but someone who is at least conscious of healthy food and either can't afford it, or isn't willing to pay such a high premium for all of the hoopla and the nice fixtures," said Gilliland.

In the Southeast, Mike Cianciarulo, president and CEO of Earth Fare, said that while three of his 11 stores are located near Whole Foods Markets, his company's model and mission have kept its customers loyal and helped the chain grow even in these competitive environments.

"Whole Foods is a great operator," he said. "They really do bring more credibility and exposure to what we've been trying to do in the natural and organic foods industry."

However, Cianciarulo, a veteran of Publix Super Markets, believes Whole Foods is trending toward becoming an upscale retailer. Earth Fare, he said, has instead focused on cementing the loyalty of its customers through its "clean food" product philosophy. Like Whole Foods, the chain won't sell products with additives, preservatives, artificial ingredients, hormones or antibiotics; however, Earth Fare also prohibits items containing ingredients like bleached flour, cottonseed oil and high-fructose corn syrup.

"We've also stayed focused on local growers and farmers," he said. "Even as we've continued to grow, we've gone out of our way to remain that small company for our local communities."

EMERGING CHALLENGES

For now, Whole Foods seems unstoppable. The company more than doubled corporate sales to almost $4 billion during the past five years, all while building larger and larger stores. The company's new flagship location in Austin is 80,000 square feet, and the company is building a 72,000-square-foot location in Manhattan that will occupy an entire city block.

Still, competitive pressures are emerging from within the channel. While Whole Foods was one of the vanguards of the "supernatural" store format, larger and larger stores have since become the prevailing trend among all natural foods chains. Earth Fare, for example, recently opened a 31,000-square-foot store in Greenville, S.C.

Wild Oats, the second-largest natural foods retailer in the United States, has made some significant changes to reverse recent losses, expanding its selection of gourmet, kosher and gluten-free foods, building bigger natural health and beauty care sections in its newer stores, and trying "store within a store" concepts with Ahold USA's Stop & Shop Supermarket Cos. The company has recently attracted some powerful believers to its court, with billionaire Ron Burkle and PC mogul Michael Dell separately investing millions each in the chain's pummeled stock.

Yet, the sleeping giant of natural, organic and specialty foods continues to be conventional food retailers and even big-box stores.

"I think down the road, Whole Foods is going to have a challenge because these natural and organic foods are going to become more and more accessible to conventional, everyday grocers," said Arons of Gourmet Garage. "Eventually, they're going to have to deal with companies such as Costco. Eventually, there are not going to be any barriers to entry to this category."

Van Winkle dismissed the idea, noting that conventional supermarkets and mass merchants have been increasing their presence in the category every year for the past five or 10 years, with no discernable impact on Whole Foods' growth. Still, as Bishop pointed out, most chains have not aggressively adopted the category.

In addition, a minority of core category consumers are ambivalent about the chain's skyrocketing growth.

"We think they're a mixed bag," said Ronnie Cummins, executive director of the Organic Consumers Association, an activist group committed to issues like organic and sustainable farming practices.

"They're selling about 10% of all the organic food products sold in the U.S. right now at retail, and they're certainly the most innovative in terms of developing an environment that attracts new consumers to the category. The downside is that, as they've grown, they've been operating more and more like a traditional grocery store chain in terms of their attitude toward trade unions and sourcing. They now seem more concerned with buying at the lowest unit cost rather than sourcing from local or regional farmers."

Cummins did praise Whole Foods' willingness to listen to its customers and frequently to respond by changing corporate policies. The company's recent launch of the Animal Compassion Foundation for more humane treatment of farm animals and its decision last month to start labeling its private-label products as free of genetically modified ingredients were both sparked by communication with food and animal rights activists.

Still, he said that he's seeing growing concern about such issues as "food miles," or the distance produce and other products travel from farm to plate, expressed among OCA's members. As a result, he described an "explosion of interest" among the hard-core organic community in farmers' markets and direct buying.

Certain core customers may feel alienated by the rapid course of growth Mackey has charted for Whole Foods, but the chain's slogan has seemingly spoken to greater plans and a much larger retail mission.

"The beautiful thing about our growth is that we're changing the world," Mackey said at the shareholders meeting.

Indeed, he might argue the point one step further: Making a profit is not a betrayal to the cause when the ultimate goal is "Whole Foods, Whole People, Whole Planet."

Whole Foods Growth

Year: Average Weekly Sales (in millions); Sales; YOY Increase; Store Count; Same-Store Sales Growth*; Sales Per Sq. Ft.; Average Sq. Footage

2000: $324,710; $1,839; 23.2%; 117; 7.0%; $660; 27,000

2001: $353,024; $2,272; 21.3%; 126; 8.0%; $689; 28,500

2002: $392,837; $2,690; 20.7%; 135; 8.7%; $700**; 31,000

2003: $424,095; $3,149; 17.0%; 145; 8.1%; $716; 31,000

2004: $482,061; $3,865; 22.8%; 163; 14.5%; $786; 32,000

1Q05: $516,277; $1,328; 22.4%; 168; 10.7%; n/a; n/a

* Excluding relocations and expansions **Estimated Source: Whole Foods Market

1980 -- First store opens in Austin, Texas

1986 -- First acquisition, Dallas-based Bluebonnet Natural Foods Store

1988 -- Expansion outside Texas: New Orleans-based Whole Food Co. acquired

1991 -- Chapel Hill and Durham, N.C.-based Wellspring Grocery acquired

1991 -- Premium Label brand launched

1992 -- Whole Foods IPO raises $23 million

1992 -- Boston-area Bread & Circus acquired

1993 -- Los Angeles-based Mrs. Gooch's Natural Foods Market acquired

1995 -- Aventura, Fla.-based Unicorn Village, Campbell, Calif.-based Bread of Life and Evanston, Ill.-based Oak Street market acquired

1996 -- Rockville, Md.-based Fresh Fields Markets acquired

1996 -- Seafood supplier Pigeon Cove Trading Co. acquired

1997 -- Detroit-area Merchant of Vino acquired

1997 -- Acquisition of Amrion, vitamin, herb and supplement manufacturer

1997 -- Company launches "365 Every Day Value" brand. In 1998, the brand exceeds 10% of total nonperishable sales

1998 -- Whole Kids brand launched

1998 -- Allegro coffee company acquired

1998 -- "Fresh Shopper Rewards" loyalty card program launched

1999 -- Boston-area Nature's Heartland and Walnut Creek, Calif.-based Good Nature Grocery acquired

1999 -- WholeFoods.com launched as an e-commerce portal offering 6,000 SKUs

2000 -- Amrion and WholeFoods.com e-commerce businesses merged as WholePeople.com. Business is quickly discontinued due to losses

2000 -- Sonoma County, Calif.-area Food For Thought Market & Deli and Atlanta-based Harry's Farmers Market acquired

2002 -- "365 Organic Every Day Value" brand launched. "Authentic Food Artisan" brand debuts one year later

2003 -- Whole Foods becomes America's first national certified organic grocer

2003 -- Seattle's Select Fish acquired, seafood processing facility opened in Atlanta

2004 -- Expansion into Europe with acquisition of U.K.-based Fresh & Wild Holdings