WHOLE FOODS DISCOVERS BIGGER IS BETTER

DAVID GHITELMAN

AUSTIN, Texas -- Whole Foods Market here said it has discovered an as-yet unstoppable growth formula: build more and larger stores and consumers will come shop in them.

John Mackey, Whole Foods' chairman, president and chief executive officer, said, "What we have found is the interest in natural and organic foods and healthy lifestyles has continued to compound on an annual basis. Our ability to add stores to markets continues to brighten with each passing year.

"When we went public 10 years ago, I thought 100 stores would saturate the market. Clearly, I was wrong."

In an unusually candid conversation for this typically tight-lipped company, Mackey and other senior executives outlined their plans for Whole Foods earlier this month in a conference call with industry analysts following the release of second-quarter results. Mackey said the company's goal is to operate 400 stores and have annual sales of $10 billion by 2010. Whole Foods currently operates 132 stores and had sales of $2.3 billion last year.

"We're going to continue to fill out markets that we're in. We're only in 30 of the Top 50 metro markets now. By 2010, I suspect we'll be in all 50. I don't think there's a market that we're in that we've completely saturated with our stores."

In New York City, where the company has only one store, Mackey suggested that expansion is imminent. "We've got some irons in the fire in New York," he said. "We've got some pretty exciting opportunities we're working on."

Last month, Whole Foods opened a unit in Toronto, its first store abroad. "It is too early to say how Toronto's going to do," Mackey said. "It had a lot of publicity, so the store started very well. We'll have to see what happens in the nitty-gritty over the next few months."

Mackey noted that he is contemplating taking Whole Foods even farther away from home than Canada. "Given the right circumstances and the right opportunities, we do think our concept will travel beyond the United States," he said.

Asked about whether Western Europe might be part of those travel plans, Mackey replied, "That would not be unreasonable."

Mackey said the company currently has 21 stores in development, about 20% of them in new markets. In the second quarter, Whole Foods opened new stores in Kansas City, Mo.; Denver; and Portland, Ore., with Denver and Portland being new market entries. All three stores, he noted, are performing above expectations.

Along with expanding geographically, Whole Foods' units have been steadily growing in size. The company's 72 stores that are more than five years old average 25,300 square feet; its 32 stores that are between five and two years old average 32,800 square feet; and its 15 stores (including relocations) that are less than two years old average 37,100 square feet. The average size of the stores under development is 37,000 square feet.

Currently, the company's largest stores are the three Atlanta-area natural foods megastores, ranging in size from 54,000 to 70,000 square feet, that Whole Foods acquired in October from the now-defunct Harry's Farmers Markets, Roswell, Ga.

The company has been moving carefully to integrate them into the chain. A.C. Gallo, Whole Foods' executive vice president for operations, said, "It took us a little while to get to understand the business and get to know the people. I think we held off on certain things, certain remodeling, until we understood what was going to work.

"From the standpoint of remodeling, we're now working on plans for a full remodeling of the Alpharetta store, which will be starting late spring or early summer and [will] be completed before the holidays. We'll be making quite a few changes in the other stores, but we're going to do the first remodel and see how things work out in this store before we commit to major remodeling on the other two."

Mackey noted, "It takes between one and two years to integrate stores and turn around stores that have had declining sales. We've gone about this in a very systematic and methodical fashion.

The company has also been moving carefully as it slowly brings other, older acquisitions under the Whole Foods banner. Gallo explained that in Providence, R.I., where the company opened a new store earlier this month, it also had an existing store that had been operating under the Bread & Circus banner for the past 10 years. The company reflagged the older stores as a Whole Foods Market and opened the new store under the same banner.

"Within the next two years, we're going to be able to get everything in the East under the banner of Whole Foods."

Last month, Whole Foods said it would build an 80,000-square-foot store, its largest, as part of a new headquarters it would erect here. The company has also said it plans to expand its Plano, Texas, store from 31,000 to 62,000 square feet.

Commented Mackey, "The bigger our stores get, the better they tend to do. They're more successful in drawing in that crossover customer. The bigger statement we can make with our perishables, the more inviting and receptive our stores are."

Whole Foods is not putting a size limit on its future units. "I don't know what the upper limit is," said Mackey. "If you told me six years ago all the stores we're going to be opening would be 40,000 square feet, I would have been hard-pressed to believe that. That just seemed an unbelievably big number six years ago.

As for the proposed Austin store, Mackey said it will be "unlike any other we've created thus far. It's going to be a more educational, interactive and theatrical store than any we've ever done."

In spite of its persistent growth, the company said it has not had trouble staffing its stores.

Gallo added, "In Toronto, where we hired about 205 team members, we had over 2,000 applications for those positions."

However, Mackey did admit to some worries about finding enough good real estate to open nearly 300 new stores in the next eight years. "Because we have a very disciplined real-estate approach, we always have a concern about being able to fill the pipeline with stores that meet our strict guidelines."

He also acknowledged -- in not much detail -- that Whole Foods has made some management errors in the past, notably its ill-fated ventures into the Internet shopping and vitamin supplement fields. "The bad investments we made in the past -- the acquisitions of vitamin and Internet companies -- that stays in the capital base, but it becomes less and less relevant as your store base grows, and those just remain past mistakes that eventually wash away."

That experience perhaps lends additional credence to Mackey's response when he was asked if Whole Foods might again branch out into some non-grocery areas. "No," he insisted. "Food, food, food. We're food-focused, and we will continue to be food-focused."

The company's concept and execution have been met with high praise from the analyst community. Meredith Adler, equity analyst, Lehman Brothers, New York, told SN, "Despite this economic environment, they are continuing to drive their comps. The comps actually got better for the older stores. That's a very positive sign when you can drive comps on older stores."

In its second-quarter results, Whole Foods said it has average comparable-store sales of 6.2% at stores more than five years old, 12.4% at stores between two and five years old, and 27.7% at stores less than two years old.

Jonathan Ziegler, San Francisco-based managing director for Deutsche Banc Alex. Brown, New York, said Whole Foods' major challenge is "getting the right sites for their demographic at the right price." He noted that the company is currently opening stores at a run rate of 15 a year, but if they are going to meet their goal of 370 additional units in eight years, "new openings will have to escalate."

Asked if he thought they could do it, Ziegler replied, "I don't see why not. They have an aggressive profile."

Andrew Wolf, equity analyst, BB&T Capital, Richmond, Va., called Whole Foods "the dominant player in a very large niche," a niche that is moving from a fringe group to the mainstream.

"They have the attributes of a category killer. They're a destination center, like Home Depot."

Wolf noted that Whole Foods has managed the retailing trifecta, pleasing customers, shareholders and employees at the same time.

The company's emphasis on quality products and customer service has made its customers "very happy," he said

However, Wolf observed, the company in the past "hasn't managed labor hours very well." That is beginning to turn around, he noted, through a program that gives store-level department managers a periodic profit-and-loss statement to measure against their department's labor hours. "That's a shareholder-friendly thing to do."

To maintain worker morale, he added, "they have a gain-sharing, essentially a profit-sharing, plan. So that some of that profitability [from increased worker productivity] goes back to employees.

"They're translating all this sales growth into earnings growth by cutting labor costs."

Be Prepared

Whole Foods Market said it has found success with prepared foods, an area where many other supermarket operators have stumbled. A.C. Gallo, Whole Foods' executive vice president for operations, said, "I think the primary thing that we're looking at in the new stores is the prepared-foods area.

"Despite the slowdown in the economy, there's still a growth in people's desire to get high-quality food that they can bring home and cook after work, or not cook after work.

"So we've really been focusing on refining our prepared-foods concept, and not just in our prepared-foods departments but how to put value-added items in other departments like meat and seafood, items that people can bring home and maybe have a short preparation or have already been cooked for them.

"Frankly, it's very interesting that despite the slowdown in the economy this past year our prepared-food sales continue to be one of our highest comping areas."

New Age Food, Old Time Values

John Mackey, Whole Foods Market's chairman, president and chief executive officer, can offer a sociological explanation for the company's success.

"The baby boom generation continues to age, and people are wanting to eat healthier foods," he noted. "They're concerned about pesticides in their food. They're concerned about longevity. If they have families, they want their children to eat better, to not eat junk foods. They're very concerned about GMOs, genetically engineered foods.

"Mainstream America's largely been asleep regarding food politics and how food has been altered in our country in the last 50 to 100 years, but it's waking up at a very rapid rate, and as people become more conscious, more aware, that really plays to Whole Foods Market's strengths."

Still, although Mackey is selling a New Age approach to food, he is remarkably traditional in his emphasis on the importance of strong business leadership.

Asked during the conference call for the reasons Whole Foods' sales vary from region to region, Mackey took no comfort from social science.

"I think it has a lot to do with the leadership capabilities of the region," he replied. "The regions that tend to have the strongest regional presidents, best coordinators and best store-team leaders consistently have the best comps.

"I think it has to do with execution."