NATURAL GROWTH 1996

ELLIOT ZWIEBACH

The biggest players in the natural foods retailing industry are becoming more formidable through consolidation.

The almost simultaneous mergers of Whole Foods with Fresh Fields and of Alfalfa's with Wild Oats Community Markets would leave the industry with only two major operators. The moves would shore up these companies' resources as conventional supermarkets continue to get deeper into natural foods merchandising.

The merger of Alfalfa's and Wild Oats, both based in Boulder, Colo., is expected to be consummated today, while Whole Foods, Austin, Texas, is scheduled to complete its acquisition of Fresh Fields, Rockville, Md., in September.

Following the mergers, Whole Foods, already the nation's largest natural foods chain, would operate 69 stores in the Northeast, Midwest, Texas and California, doing a volume of $710 million; while the combination of Alfalfa's and Wild Oats would create a chain of 49 stores in the West and Southwest doing a combined volume of $250 million.

Natural food executives told SN they believe getting larger will position them to compete more effectively with conventional supermarket operators. "As natural food companies get bigger through consolidation, they'll get more sophisticated in their advertising, marketing and promotions," Hass Hassan, president and chief executive officer of Alfalfa's, told SN. "They'll learn how to talk to consumers better and have a better understanding of how to bring people into their stores and make the industry stronger. "That may not make the traditional supermarket's job any more difficult, but it will make us better competitors." According to Peter Roy, president of Whole Foods, natural food stores will have some major assets when battling conventionals.

"Our goal is to offer the best perishables in each community we serve, because we will never have as many locations as conventional supermarkets and we've got to provide a compelling reason for customers to drive a further distance to shop with us. "But like membership clubs and nontraditional operators like Eatzi's in Dallas, natural food retailers will provide competition for the conventional supermarket as niche players competing for the consumers' food dollars," Roy said. Natural foods -- generally defined as products without artificial additives, preservatives or colorings and a minimal amount of processing -- account for approximately $8 billion in annual sales, with the overriding portion of that going to smaller operators. In comparison, the supermarket industry posts nearly $400 billion in sales.

Interest in the natural segment is running high, with a growing number of conventional supermarkets adding space in their produce and grocery departments for natural foods. "Natural foods have grown 22% in sales in each of the last two years, so I'm not surprised to see other people looking for opportunities in that segment," Roy told SN. For instance, observers said Star Market Co., Cambridge, Mass., plans to open a natural food store of its own, called Wild Harvest. Executives at Star could not be reached for comment. In interviews with SN, executives from the various natural food chains discussed the upcoming mergers and the challenges they face. According to Roy, " The natural food industry has been highly fragmented, with a lot of small operators. But the fastest growing segment has been the large-format operator, with Fresh Fields being the fastest growing company in the history of our industry over the last five years. "We've known their principals for some time, and we've had conversations over the years, and the timing just seemed right for a merger that would benefit shareholders of both companies." Mark Ordan, co-founder, president and chief executive officer of Fresh Fields, told SN his company had been considering various options to increase shareholder equity, including a public offering, but opted for Whole Foods' buyout offer "because they were able to pay a price that made it worthwhile to sell." Ordan is part of the Fresh Fields management team that would be leaving the company once the merger has been completed.

Whole Foods operates 47 stores in the Northeast, Midwest, Texas and California, with premerger sales of $496.6 million. It has grown beyond its original Texas base in large part through acquisitions of regional chains, including Bread & Circus in New England and Mrs. Gooch's in southern California. Fresh Fields operates 22 stores in the Northeast and Midwest with annual sales of $213.5 million; it has grown primarily through new construction. Roy said the merger would lead to expectations of $1 billion in sales by 1997. The combination with Fresh Fields would give Whole Foods a foothold in New York and Philadelphia -- areas it was in the process of entering with single units -- while strengthening its position in Washington and Chicago, he said. Whole Foods does not plan to alter its expansion program, he added, with growth still targeted at 10 to 12 new stores per year over the next couple of years -- primarily in California, New York, Philadelphia, Washington and Chicago, Roy said, "and we will look for good locations in Texas and other parts of the Midwest as well." Following the merger, Whole Foods stores would average 24,000 square feet, and newer units are being built at 30,000 square feet to accommodate additional perishables, Roy said. Whole Foods has said it would drop the Fresh Fields logo and rename the stores Whole Foods. Roy said Whole Foods plans to convert its Mrs. Gooch's stores in southern California to the corporate name next week -- though it will retain the name Wellspring Groceries on three North Carolina locations and nine Bread & Circus stores in New England for another year or two. "We plan to change the name on all our stores eventually because we feel it's in the long-term interests of Whole Foods to operate under one name," Roy told SN. Alfalfa's and Wild Oats are taking a different approach, planning to maintain both logos on stores depending on which one seems to have more strength in a given area, Hassan said. Alfalfa's operates 11 stores in Colorado, New Mexico, Washington and Vancouver (where it operates under the name Capers), with total sales of $90 million; Wild Oats has 38 stores in Colorado, California, New Mexico, Kansas, Nevada, Missouri and Utah, with total sales of $160 million. "The merger will give us greater financial resources, more management skills and the opportunity to build stores more aggressively," Hassan said. "We think we can be more effective collectively than we can individually." According to Mike Gilliland, president and chief executive officer of Wild Oats, "We think this merger represents a great opportunity to take advantage of the respective strengths of both companies. We look forward to focusing our energies on both serving our present customers better and providing health foods to new customers in new markets." Hassan would be president of the new company and Gilliland would be CEO. Hassan said he expects the merged operation to expand further in Colorado and New Mexico, with additional expansion likely in Canada and the Pacific Northwest. Gilliland told SN he believes most expansion within the natural food industry will be confined to the East and West Coasts, "probably in more progressive areas and often in college towns," he said. However, he said he sees the format expanding to other parts of the country "that we didn't used to consider." For example, Wild Oats opened a store in Kansas City, Mo., last year and plans to expand into St. Louis shortly "because we're seeing changes in the mind-set of customers all over the country," Gilliland said. Wild Oats stores range from 4,000 square feet up to 35,000 square feet, with most falling into the 20,000- to 30,000-square-foot range, while Alfalfa's units range from 9,000 to 24,000 square feet. The only geographic area in which Whole Foods and the combined Alfalfa's-Wild Oats operation overlap is California. Asked if a merger between the two companies might happen someday, Roy told SN he doubted it because the latter group of stores tends to be smaller than the Whole Foods average of 24,000 square feet. According to Hassan, the ideal size for a natural food store is 20,000 square feet "because that's big enough to be a one-stop shopping place that offers all the variety we need, including perishables, while still small enough to offer convenience." However, such stores in dense, urban areas with a highly educated population have become harder to find in the last five years, he noted, "because of the growth of category killers, which have been taking over many of the 20,000- to 25,000-square-foot former supermarkets that the supermarkets don't want anymore and which, at one time, no one else was interested in." Gilliland said future consolidations within the natural food industry may involve some of the 6,500 independent natural food stores that operate all over the country. "The bigger chains have already done most of the consolidating of larger units, but there is likely to be some consolidation within that group of stores whose sizes run around 10,000 square feet," Gilliland said. Wild Oats was involved in a consolidation of some of those smaller units last month when it acquired three stores called New Frontiers in Salt Lake City. The three units -- ranging in size from 8,000 to 10,000 square feet -- account for sales of about $12 million annually and will be converted to the Wild Oats logo in the fall, Gilliland said.

Natural food retailers are being challenged to build store labor and systems at a pace that keeps up with their growth, according to executives in the industry.

According to Mike Gilliland, president and chief executive officer of Wild Oats, Boulder, Colo., finding and training knowledgeable store labor is becoming more difficult. "There used to be a much larger employee base interested in natural foods," he said. "But with the proliferation of natural food stores, the challenge is to find people who have enough interest so that we can train them because it's an interest that's tough to fake. So far we've been lucky." Wild Oats is expected to merge with Alfalfa's, also based in Boulder, in a deal that is due to close today.

Peter Roy, president of Whole Foods, Austin, Texas, said the human resource "is the most limited resource we have now, and finding and training people is our most pressing challenge. That's one of the reasons we make acquisitions -- to add high quality people." Whole Foods has agreed to acquire Fresh Fields, Rockville, Md., in a deal expected to close in September.

Hass Hassan, president and chief executive officer of Alfalfa's, said the greater proliferation of natural food stores over the last couple of years has been constrained primarily by people and systems. "Our stores rely on people who are believers in the product and get really excited about it because our customers expect high levels of knowledge and service, and we need people who are passionate about the products and concepts," he said. He said natural food operators generally have the systems in place that they need -- "perhaps not cutting-edge systems, but certainly within the wedge right behind cutting edge," he noted. Alfalfa's also handles advertising money as a precious resource. The company doesn't have funds for mass media promotions, "but we provide a lot of product information through our employees, through in-store signage and through our regular newsletter, which is our advertising vehicle," Hassan explained. Originally published monthly, the newsletter now comes out twice a month and is distributed through direct-mail and as a newspaper insert. Because of a relatively small, spread-out customer base compared with traditional supermarkets, Wild Oats does virtually no media advertising, Gilliland said, preferring instead to take a grass-roots approach to promoting its stores "based on consumer education and entertainment, such as monthly tasting fairs that create a sense of theater."