Strategic Analysis of Whole Foods (WFMI)

Whole Foods Market, Inc.

Diego Alvarez, Olga Lefas, Simon Phillip Rost, Ruth Schulder, Rob Tedesco

Advanced Strategy Analysis | Spring ’11 | Prof. Eggers

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Abstract

This paper presents a cross-functional analysis of strategic choices concerning Whole Foods Market, Inc. (WFMI), a U.S.-based natural and organic foods supermarket. After a brief overview of WFMI’s history, generic strategy, and competitive landscape, the analysis turns to three specific topics: 1) WFMI’s acquisition of various competitors to hasten penetration in U.S. markets, particularly the acquisition of then-largest rival Wild Oats Market in 2007; 2) vertical integration decisions made by WFMI, in particular the decisions to acquire certain suppliers (e.g., Amrion natural supplements and Allegro Coffee) and not others; and 3) current strategic options facing the firm, including the opportunity to expand internationally, and the possible extension of its brand horizontally into non-food products.

History, Generic Strategy and Competitive Landscape

The roots of WFMI can be traced to a single Austin, Texas grocery store, launched by its founders in 1978 as “SaferWay Natural Foods”1. This play on words clearly signaled WFMI’s intention to differentiate on various dimensions of product quality, including freshness (45% of suppliers are local, or reachable within a seven-hour truck haul2), purity and healthiness (natural food offerings are “minimally processed” and “largely or completely free of artificial ingredients, preservatives and other non-naturally occurring chemicals”3), and environmental consciousness (organic food offerings are “grown through methods intended to support and enhance the earth’s natural balance”4). Many of these dimensions would remain hallmarks of the WFMI brand for years to come. Today, WFMI operates 301 locations in three countries (see Exhibit 1 for WFMI’s global footprint). Its product mix concentrates heavily on perishable foods, with produce and prepared foods comprising 67% of total sales5.

Generic strategy and price premiums

WFMI employs a generic strategy of differentiation, commanding significant price premiums over the average grocer. The focus on freshness, purity, and environmental friendliness allows WFMI to meet the needs of certain buyers better than do other firms6, driving up consumer willingness to pay. The firm also “strives to transform food shopping from a chore into a dynamic experience by building and operating stores with colorful décor… ever-changing selections, samples, open kitchens, scratch bakeries, and hand-stacked produce”; ambience and store design may thus also contribute to its premiums. Exhibit 2 presents sample data of food prices at both a Whole Foods Market and a Stop & Shop grocer operating in the same U.S. market. On average, WFMI achieves a premium of 15% above the traditional grocer when offering the same national-brand products on its shelves (e.g., brands like Chobani yogurt are, on average, about 15% more expensive at WFMI). Additional sampling at Stop & Shop measured the traditional grocer’s




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“organic premium”: its private-label “Nature’s Promise” organic products were, on average, 42% more expensive than its private-label non-organic products. (These samples are consistent with various industry reports citing 40 to 175 percent retail premiums for organic foods over non-organic counterparts7.) Thus, shoppers at WFMI pay two different premiums: 1) a premium simply for shopping at WFMI, and 2) a premium for buying organic products. These may be thought of as additive, and when analyzing the most expensive product available within a particular product class (e.g. organic eggs), the Exhibit 2 sample data indicates WFMI achieves premiums averaging 55% above traditional grocers. WFMI’s price premiums are captured in both gross margin, which held steadily near 35% from 2008 to 2010, and net income, which has risen consistently during this period (see Exhibit 3 for select financial data). Two large U.S. supermarket firms, Safeway and Kroger, have not fared as well by comparison, unable to capture a similar customer margin, and even struggling to remain profitable in the wake of the global economic downturn. In comparison to such grocers, it can be said that WFMI has enjoyed a competitive advantage, driving a wider wedge between buyer willingness to pay and supplier opportunity costs8. Growth in the organic foods segment

Accordingly, the firm appears well-positioned to capitalize on strong consumer demand for organic foods and beverages. Sales of such products grew from $1 billion in 1990 to $24.8 billion in 20099. Further, the overall growth in demand for organic foods has been bolstered by particularly strong growth in the produce and prepared foods segments (see Exhibit 4), which have been WFMI’s focal point. Prices paid by consumers for organic foods have risen steadily for more than a decade. Specifically, data compiled from United States Department of Agriculture and Economic Research Service reports10 suggest that prices of organic foods have risen in the U.S. faster than prices of comparable or conventional foods. For example, wholesale prices of organic carrots in the Boston market rose by 75% from 1995 to 2008, whereas wholesale prices for conventional carrots rose by only 19% in this period. U.S. wholesale prices of organic poultry rose by 11% from 2004 to 2008, whereas prices of conventional poultry rose by only 7%. From 2004 to 2006, retail prices of organic spinach rose by 41%, whereas conventional spinach prices rose by only 25%. Similarly, growth in the retail price of organic milk outpaced conventional milk by 5% during this period. While a history of price escalation does not specifically foretell continued growth in consumer demand, further industry statistics reinforce the prospect of growth in the U.S. market for natural and organic foods. According to a 2009 report from the USDA/ERS:

“Most evidence does point to a growth in the number of consumers of organic products. The Hartman Group, which conducts the gold standard of industry organic surveys, found that 69 percent of adults bought organic food at least




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occasionally in 2008 (Hartman Group, 2008). Nineteen percent of consumers bought organic food weekly in 2008, up from 3 percent in the late 1990s (Hartman Group, 2000, 2008). The Food Marketing Institute found that 51 percent of shoppers purchased organic food in 2006; in comparison, in 2001, 44 percent of shoppers bought organic food over a 6-month period (Food Marketing Institute, 2006).”11

While no one can say for sure that such growth in consumer demand for natural and organic foods will continue (particularly at such high rates), it also seems unfair to dismiss U.S. consumption of such products as a passing trend or fad. WFMI itself anticipates growth, planning to build dozens of additional stores by 201312. It seems reasonable to conclude that demand will grow, though perhaps at a decreased rate. Competitive landscape and potential obstacles to growth

Competitors include typical supermarkets like Safeway and Kroger in the U.S., as well as smaller natural and organic foods markets, including privately held Trader Joe’s Company. Trader Joe’s operates about 350 stores in 25 states and focuses heavily on private-label goods (accounting for 70% of sales13), whereas store-branded products account only for 11% of WFMI’s mix14. So-called “big box” retailers Walmart and Target also offer food products in some store formats. In addition, WFMI faces competition from a new type of entrant into the organic foods segment: online retailers. For example, New York’s FreshDirect employs 1,500 people, and sells produce and other perishable foods to customers in and around Manhattan through its state-of-the-art food processing facility in Long Island City15. Meats, seafood, and produce are processed in “one of the cleanest, most technologically advanced food processing facilities in the country” and delivered directly to customers’ residences16. FreshDirect’s website features an organic foods section with more than 600 products, and the firm is targeting adjacent markets in New Jersey and Connecticut for expansion17. While the potential for growth is considerable, any outlook for WFMI should address a few areas of potential concern. Many traditional grocers have begun to carry heavier mixes of private-label foods – led by natural and organic food labels – in attempts to vie for the types of customers WFMI targets18. Indeed, natural and organic retailers like WFMI have lost considerable ground to conventional retailers, who today command a much larger share of organic food sales than they once did (see Exhibit 5). Walmart has begun aggressive pursuit of a small-format strategy, opening 182 “Neighborhood Market” stores and announcing publicly plans to open more19. In addition, recent years have found WFMI building fewer new stores, at smaller average sizes, suggesting the firm may be reaching saturation in U.S. markets (see Exhibit 6 for historical store growth and sales mix).




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History of Buying Competitors, and the Acquisition of Wild Oats Market

WFMI has had an aggressive acquisition strategy, buying 11 different chains over the course of its history (see Exhibit 7 for acquisition history). Most of the chains were small operations with just a handful of locations; approximately 25% of the chain's existing square footage came through the deals20. WFMI sought out natural and organic chains that had an installed customer base and long standing ties within their communities. This way, WFMI was able to achieve market penetration by acquiring a customer base and vendor relationships that would allow WFMI to scale faster and cheaper then if they were to enter new markets and build from the ground up. WFMI targeted Wild Oats for these reasons:

• Wild Oats would allow WFMI entrance into 15 new markets, and WFMI had its eye specifically on Florida, the Pacific Northwest, and the Rocky Mountains. WFMI focused in these 3 regions because they would fill the gaps in WFMI’s market penetration, thereby creating a ‘synergistic geography’ where all the surrounding regions could support each other operationally.21 This would result in an increase in quality and service for customers.

• WFMI viewed the acquisition as purchasing not only stores, but also tens of thousands of customers, thereby significantly increasing its customer base sooner rather then later, compared to having to build its own stores. This was greatly valuable to WFMI because ‘it is much more expensive to enter a new market than it is to expand in a market that we already compete in’ and it wanted to gain market share in as many regions as possible in order to prevent any significant competition in the organic and natural supermarket space.22

• WFMI viewed Wild Oats as the only food chain that a competitor, either an organic or conventional supermarket chain, could purchase that would pose a significant threat for WFMI. As CEO John Mackey wrote: “our targeted company is the only existing company that has the brand and number of stores to be a meaningful springboard for another player to get into this space. Eliminating them means eliminating this threat forever, or almost forever.”23 Eliminating competitors was high priority for WFMI since the competition vied for sites, customers, and employees. Mackey’s view was the buying Wild Oats was a good purchase on its own, but being able to buy it before a competitor would immense value to the deal because it would give WFMI a significant sustainability advantage by allowing it to be the first mover of its size.

• Wild Oats was an established company with a large customer base and vendor relationships that dated back decades in certain cases. WFMI saw the acquisition of Wild Oats as an opportunity to scale quickly because WFMI would use Wild Oats’ existing resources. Implicitly the assumption can be made that if WFMI had to go into each of these markets and start from scratch, achieving the desired scale would be a slow and arduous process.

• WFMI wanted to acquire the talent of Wild Oats in order to have them support the growth that comes along with purchasing so many new stores.




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• CEO Mackey saw the acquisition as a potential learning opportunity, citing the fact that the company had learned from every previous acquisition to date.

• Financially, WFMI saw this acquisition as very low risk since they predicted that the stock price would increase. If not, they had enough cash to finance the deal anyways. Also, the acquisition would provide an immediate boost in sales growth and provide the company with additional real estate assets.

WFMI paid in total 565 million, which represents a premium of 50 cents per share. On the other hand, despite the transaction costs assumed by the acquirer that were 36 million, WFMI could appropriate more than 80% of the surplus. (See Exhibit 8) Furthermore, in order to test if there is evidence that an effective surplus might be produced after the acquisition, Wild Oats was valuated through the method of cash flow to the firm. (See Exhibit 9) The result of this valuation was $400 million in a very neutral scenario and this amount is similar to the surplus estimated before. Besides, a scenario of the possible outcomes was prepared in which a sales increase and gross margins were the main variables. The figures that suggest an increase in volume and the range of possible outcomes can be seen in Exhibit 10.

WFMI announced that it would purchase Wild Oats in February 2007, after which WFMI

stock rose more than 5% to $48.08 in after-hours trading, while Wild Oats shares soared

more than 17% to $18.43 after being halted24. On June 27, 2007 The FTC sued to block

this transaction, claiming consumers would be hurt by higher prices and decreased

competition; six months later, a federal appellate court cleared the way for the deal when

US district Judge Paul L. Friedman asserted that the acquisition did not violate any anti-

trust laws as evidenced by increased competition that resulted from new entrants to the

organic and natural foods market. Whole Foods shares rose $1.21, or 2.7 percent, to

$45.7525. On October 18, 2007 WFMI stock closed at $48.06, compared with its 52-

week low of $36 and high of $66.2526.

The acquisition of Wild Oats included 35 Henry's Farmers Market and Sun Harvest Market stores, which WFMI immediately sold. WFMI’s strategy with the Wild Oats brand was to close some of the stores, renovate others and ultimately transition everything to assume the WFMI brand. The combination of WFMI’s targeted acquisitions and its building stores in specific markets has proven to be a successful strategy in creating a single company with significant brand identity.

However, the FTC continued its battle against WFMI and legal action ensued. In March 2009 WFMI agreed to sell the Wild Oats Brand, 13 Wild Oats stores, and the leases and assets for 19 more. Stock prices fluctuated following news of the settlement, but closed up 30 cents at $12.08. Mackey stated: "we believe it was in the best interests of all our stakeholders to resolve this matter."27




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Vertical Integration Decisions WFMI has chosen to backwards integrate into three select product areas: coffee, nutritional supplements and fish, through their acquisition of Allegro Coffee (1997), Amrion Inc (1997) and Select Fish (2003). These backwards integrations have given WFMI greater control over its supply sources, and in the case of Allegro Coffee and Amrion Inc, these integrations have also given WFMI the flexibility and stability required to launch distinct store-in-store offerings. The decision to complete these backward vertical integrations is discussed in this section, including the evaluation of whether or not WFMI could have achieved similar results through strategic alliances instead. Amrion Inc.

Amrion developed, produced, and sold nutriceuticals and nutritional supplements. The company, started by a father and son in Boulder, Colorado in 1987, went public in 1989 and in 1993 changed its name to Amrion Inc. The company was involved in several distribution channels selling to consumers, health care professionals, independent distributors and to WFMI under the Whole Foods private label.28

Amrion merged with WFM in 1997 and then with WholeFoods.com in 1999, in what subsequently became WholePeople.com. WholePeople.com was later sold to NBTY, Inc in 2001. The acquisition meant that WFMI was expected to support the construction of a new plant in 1998 for the production of supplements.

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WFMI acquired Amrion for $146M in stock. The agreement was structured such that WFMI paid 0.87 of a WFMI share for each of Amrion’s 5.3 million shares outstanding, equivalent to 4.6 million WFMI shares. As a result of the announcement, WFMI shares fell $1.75 to $30 and Amrion’s fell $0.50 to $24.875.30 Mark Crossen, Amrion’s chairman and CEO, joined the board of directors and executive staff of Whole Foods. Allegro Coffee

Allegro Coffee Company was started in 1977 as the Brewing Market, a specialty coffee business in Boulder, Colorado. The founders came from a family coffee tradition and identified the growing consumer demand for fresh-roasted, high-quality coffee. The company had two retail stores (which were sold in 1985) and a growing wholesale division that was renamed Allegro Coffee Company. Allegro focused on coffee bean importing, roasting and sold its products wholesale. Allegro distributed its products throughout the US by 1995 and had secured a reputation as a leader in specialty coffees by that time31.




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Allegro supplied WFMI with specialty and organic coffees, teas and brewing equipment until it was purchased in December 1997. Allegro’s focus on high quality ingredients and traditional roasting methods meant that two companies shared the ideals of natural and pure food. The company continues its wholesale distribution division, however retail to consumer distribution is exclusively available at WFMI. Select Fish

Select Fish was founded in 1987 in Seattle, Washington by Scott Barton with the mission to support fisheries that used “techniques to ensure the ecological health of the ocean and abundance of marine life.” Select Fish processes and distributes high quality seafood from Alaska and the Pacific Northwest. Barton, an advocate of seafood sustainability and a fisherman himself for 15 years, grew the company by distributing the fish of other fisherman and himself. After WFMI acquired Select Fish and it’s two facilities in 2003, it appointed Barton Facility Team Leader and opened a distribution facility in the south32. WFMI stipulated that this acquisition would allow them to better control the quality of product “from boat to shopping cart” and that it would allow them to increase the variety, availability and freshness of its pristine wild-caught seafood offering.33” Rationale for Vertical Integration

Whole Foods chose to backwards integrate into the coffee, nutrients and fish industries. Given the company’s mission to supply natural and sustainable products to its customers, these industries were targeted for unique reasons, however the general goal was to increase control over the quality of the products WFMI sold, and allowed it to cut out the middle-man and thereby capture higher margins. Corporate level strategies must add value by increasing the value of the firm “such that businesses forming the corporate whole are worth more than they would be under independent ownership that equity holders cannot create through portfolio investing.”34 In the 20th Century, vertical integration became a best practice as improved technology and management techniques helped reduce the internal administrative costs of businesses as compared to the external transaction costs of working with other companies. This relative cost factor helped support vertical integration strategies.35 Interestingly enough, WFMI chose to follow a vertical integration strategy in the mid to late 1990’s when vertical integration was falling out of fashion and outsourcing was becoming the trend due to the benefits of “flexibility and the ability to develop specialized capabilities in particular activities.”36 Organizations recognized inefficiencies due to agency problems, suboptimal capital structures and transfer pricing issues and




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second, individuals could attain greater value buy diversifying their stock portfolios independently. It was possible to achieve the benefits of coordination through different levels of collaboration (ex. Strategic alliances, JVs) and therefore the need for full integration was not as explicit. Nevertheless, under certain circumstances, vertical integration through acquisitions, as we see at WFMI, can be a sustainable strategy. With all mergers and acquisitions, the goal is to drive value through cost savings and/or enhance revenues. As Stuckey and White articulate, the “four main reasons to vertically integrate are:

1. The market is too risky and unreliable – it ‘fails’; 2. Companies in adjacent stages of the industry chain have more market power than

companies in your stage; 3. Integration would create or exploit market power by raising barriers to entry or

allowing price discrimination across customer segments; or 4. The market is young and the company must forward integrate to develop a

market, or the market is declining and independents are pulling out of adjacent stages.”37

This last reason does not apply to WFMI’s case as the company integrated backwards, not forwards, and the market is not declining. Generally, vertical integration occurs when there are high transaction costs, high information asymmetries, few buyers and sellers and switching costs are high. “Where a single supplier negotiates with a single buyer, there is no equilibrium price: it all depends on relative bargaining power.”38 Bargaining is expensive usually due to opportunism and strategic misrepresentation that leads to market inefficiency. Of course, if “transaction specific investments” are made, where one company invests in PP&E for example that is only useful if it works with company B (each invests in complementary facilities), the companies become tied regardless of the number of other buyers and sellers. Furthermore, this dependency or “tie” opens the door for one company to directly impact the other (“hold up”).39 Analysis of Vertical Integrations

Select Fish

Usually it is vertical market failures, driven by the balance of power between buyers and sellers, asset specificity, transaction frequency, uncertainty and opportunism40 that usually drive vertical integration. However, we believe that the acquisition of Select Fish was due to managing the balance of power between buyers and uncertainty.




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It can be argued that there were few buyers and sellers of fish caught and processed in a sustainable way, Select Fish and WFMI being examples on either side. Furthermore, with over-fishing, an increase in polluted waters and fish, and fraud41 there was an uncertainty in the future availability of sustainable fish products. At the same time, the trend towards purchasing sustainably sourced and natural or organic food has been growing – in 1990 US sales of organic food and beverages were $1 billion, in 2009 the number reached $24.8 billion, equivalent to 3.7% of total food sales.42 Meat, poultry and fish comprise 2% of that pie.43 Furthermore, sustainability in the area of seafood has become an increasingly important issue in the US. Greenpeace ranked Whole Foods the number 1 seafood retailer in 2010, ahead of Ahold USA (owner of Stop& Shop & Giant) and Target, however WFMI received only 3.9 out of the possible 10 points.4445 Nevertheless, the company has built a name for itself in being trustworthy to providing sustainable seafood to consumers. The WFMI consumer is willing to pay the premium prices WFMI charges partly due to their desire to purchase products from a company they trust and that shares their values for natural, healthy and sustainable food. Since the acquisition, Whole Foods has furthered their cause for sustainable seafood by partnering with Monterey Bay Aquarium Seafood Watch and Blue Ocean Institute to implement a sustainable fish labeling program.46 We believe that this vertical integration helped Whole Foods manage the balance of power and uncertainty of supply, while also ensuring they can build their brand and attract their target consumers. Therefore, the decision to purchase Select Fish was driven by the risk in the fish market. Allegro Coffee

It does not appear that Allegro Coffee and Amrion, each with many buyers and sellers and a relatively low level of uncertainty, was purchased due to vertical market failures. Therefore, their purchases did not help to ensure supply. If WFMI did have this in mind, then it “delude[d] itself [that] internal transfer prices are different from market prices”47 and integration did not add value given this competitive market structure. Of all the backwards integrations, Allegro Coffee is the hardest to justify. In the late 90’s, consumption of coffee was increasing and Starbucks helped to drive that change in the US. It also helped drive awareness and demand for fair trade coffee – a trend that continues today – which “has shown that many consumers are willing to pay more for products that address socially responsible ethics.”48 These trends are concurrent with Whole Food’s mission to supply ethical and sustainable foods, but the real question is whether or not WFMI needed to actually purchase Allegro Coffee. Specialty coffee comprises 40% of total coffee consumption49 and is a competitive market with many buyers and sellers. Fair trade coffee comprises a small fraction of overall coffee sales. There is a specialty aspect to roasting high quality coffees, and due to the rising demand in sustainable coffees, there are several supplier options for Whole




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Foods. Like Select Fish, Allegro shared the values of the company, however it does not clearly satisfy any of the justifiable reasons for vertical integration. We believe that Whole Foods could have extracted economic value through a strategic alliance with Allegro rather than a full backwards integration. Amrion Inc.

Amrion Inc. is an acquisition that also poses some doubts. In certain industries or value chains, for example in manufacturing steel, there are “tightly bound pairs of buyers and sellers” where it makes more sense to integrate in order to lower the cost and risk of transacting. Amrion was already producing WFMI’s private label nutritional supplements, and this relationship while close, did not tightly bind the companies as there were many other buyers and sellers in the nutritional supplement market. It is possible that Amrion invested in specific assets for their Whole Foods business (packaging, labeling) and therefore a “market contract [could] be inefficient due to the costs of negotiating and enforcing a contract, plus bargaining, monitoring, and dispute resolution.”50 On one hand it can be argued that, despite many buyers and few to many sellers, these specific assets could have caused vertical market failures. On the other hand, given that there were other suppliers, Whole Foods may have over-estimated the value of integrating to this area. Another possible justification for the Amrion integration could be related to Market Power where Amrion, the technology holder, could have been extracting a majority share of the economic surplus. Whole Foods may have thought that it could extract greater economic value by integrating. Ultimately, just as in the Allegro case, there is no clear justification for this integration and Whole Foods may have incorrectly based this decision on “spurious reasons” related to supply assurance and the goal of capturing more value.51 Alternative Options to Complete Integration

Generally speaking, it is better to find alternative working arrangements rather than vertically integrating. Integrations are often based on shallow reasons and the dismissal of other strategies that can be better from both a benefits and costs perspective.52 Furthermore, as stated above, conglomerates create inefficiencies that the equity holder can avoid by diversifying their investment portfolios themselves. We believe that Whold Foods was driven to these acquisitions to help strengthen its brand by committing to sustainable and healthy parts of the value chain, and in order to capture more of the economic surplus. In both the case of Amrion and Allegro, we would have recommended a strategic alliance or JV in order to achieve these same goals.




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In actual fact, since these 3 acquisitions, WFMI has entered into a strategic partnership with their “single largest third-party supplier, accounting for approximately 27% of [their] total purchases in fiscal year 2010.”53 UNFI is their primary supplier of dry grocery and frozen food products and they have extended their “long-term” relationship through to 2020. Conclusion - Recommendations for Whole Foods Our recommendation is for Whole Foods to ensure that it applies a very critical lens to all possible future vertical integrations by ensuring that the extension of their value chain satisfies the 4 major reasons to integrate listed above. We would also recommend that WFMI maintains itsownership of Select Fish given the reasons above. The Allegro brand has become associated with the Whole Foods brand, and therefore an exit from that business may be costly. Furthermore, both of these brands help significantly in establishing Whole Foods’ commitment to sustainability and natural products. The integration to Amrion Inc would also be costly to exit, however given the independent brands, we believe that Whole Foods may be able to effectively purchase “any volume at market price, even though the price might seem “unfair”54 relative to costs.” Future Growth Options

International Expansion

This section discusses one of WFMI´s strategic growth opportunities; the company’s international expansion, since WFMI´s Management confirmed that international expansion is a major growth option on the company’s agenda. At first, a brief overview of the Status Quo of WFMI´s international operations is given to understand the company’s expansion reasons and efforts. Potential target locations are then evaluated in terms of target market size, NPV, and competitive situation to determine valid future growth opportunities. The section closes with the identification of key success factors for WFMI´s international expansion and expansion recommendations. WFMI has tiptoed into the Canadian (2002) and the UK market (2004 and 2007) due to the saturation of the US home market. Despite some analyst predictions of a market potential of 500 stores for WFMI55, there has been a slowdown in domestic shop openings in recent years by WFMI. This slow down and the fact that newly opened stores are smaller in size56 are clear indicators for the above mentioned market saturation.




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The company started its international expansion in 2002, with its first store in Toronto, Canada. The company has grown organically in Canada and has opened five additional stores, reaching a total store number of six establishments in the year 201057. The international expansion continued in 2004 to the UK, where the company chose to grow non-organically by acquiring seven establishments of the supermarket chain Fresh & Wild. Possible reasons for this acquisition could have been: time advantage of entrance, acquisition of market knowledge, elimination of a competitor from the beginning or the acquisition of an existing distribution channel. The company continued with the expansion plans and opened its first own full size flag ship store in London in the year 2007. But a disappointing operating loss of $18.4 million and the global economic downturn forced the company to reconsider and slow down the UK expansion in 200858. Today, there are five existing stores in the UK and WFMI plans to add two additional stores to this number by 2013, due to the improved economic situation there59. At the end of the year 2010 four percent of the entire store network consisted of international stores (combining the Canadian and UK-operations), which generated three percent of the total company sales (Exhibit 11). WFMI´s international expansion makes strategic sense, due to the world wide increase in the organic food and the saturation of the US market60. The company’s management mentions in the letter to the stakeholder further efforts in the international expansion61. By evaluating the international expansion in more detail it can be understood that the expansion in the Canadian market seems to be a natural strategic move, because of the close geographic situation of the country and similarities between US and Canadian consumers. The entrance in the UK sets the base for a general market entrance in Europe. Future target countries in Europe could be Germany, France, Spain, Switzerland, Denmark or Italy, due to the countries’ high shares of organic food sales62. In the following part Germany and France are evaluated in more detail as future European targets due to the size, the economical significance of both countries and the Turnover in organic Food (place 2 and 3 respectively after US in Ranking of Domestic Turnover with Organic Food 2008)63. To analyze the potential of the above mentioned markets the following five analyses have been performed:

1. Market environment 2. Competitive Situation 3. Consumer analysis 4. SWOT 5. NVP analysis (for both countries together)




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Country Analysis of German Market

Market Environment

Germany is the largest European Economy. With a number of over 82 million consumers and consumer spending of more than €130 billion in food and beverages, Germany is the largest market in the EU64. The German Research Consulting Firm “Ingo R. Titze Research & Consulting” determined the total organic food sales to be € 5.3 billion in 200965. The German Food Retail market is said to be one of the most competitive Markets in the world. 85% of the market is divided among six major players Real, Edeka, Lidl, Rewe, Aldi Süd and Aldi Nord66. The resting 15% of the market is divided among small players, such as butchers, bakeries and fruit & vegetable stores. Thus, the food retail market can be defined as a fragmented market with oligopolistic market dynamics. The food retailing market is saturated and just grew two percent in 201067. The consulting firm Euromonitor International predicts a positive development of the market in the coming five years due to the recovery of the German economy triggering a boost in consumer confidence68. An important difference between the German and other European markets is the prevailing food retail formats. So called food discount shops (Aldi/Lidl) have a combined market share of 43% and compete on low cost and low price69. This prevailing shop format challenges hypermarkets and supermarkets and drives small shops out of the market. Furthermore, the food discounts triggered a reduction in the general number of establishments towards a growing sales area per store. The losers in this game are the outlets with a sales area smaller than 400 sqm70. Competitive Situation

The German food retail market is dominated by the following six food retailers: Metro group AG, Schwarz Group, Rewe, Edeka, Kaiser´s and Tengelmann and Aldi Group. In this section each competitor is described in detail.

Metro Group AG: The Metro Group is the world 3rd largest Retailer and Germany’s leading retailer in revenues71. In the food sector the group competes with two sales Brands: Real and Metro Cash and Carry. The Real sales brand consists of 429 super and hypermarkets72 with retail space ranging from 5,000 to 15,000 sqm and total sales revenue of €11.5 billion. The product assortment, which can reach up to 80,000 articles in a store, includes Bio and organic products. It is worthwhile to mention that the company focuses on strong private label branded products that are sourced from local suppliers, less expensive and comparable in terms of quality to branded products.




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The Metro Cash and Carry concept consists of 687 stores and total sales of €31.1 billion. The sales brand is a leading player in self-service wholesale with a product assortment of 20,000 different food items and 30,000 non-food73. Schwarz Group: The Schwarz Group is a privately owned company and the world’s 5th largest retailer and Germany’s 3rd food retailer74. The Group consists of the two subsidiaries Lidl and Kaufland. Lidl is one of the two leading Germany food discounts, competing on low costs and low prices. The company has 9,000 establishments in Europe, and 3,000 of them are located in Germany. Lidl employs about 170,000 people, 90,000 of them work in Germany. The company is not publicly traded, thus the available information is limited75. Kaufland is based in Neckersulm and has about 1,000 subsidiaries. The company employs 120,000 people in six countries in Europe76. Aldi Group: In Deloitte’s World Retailer Ranking Aldi occupies the 8th place77. Aldi is a privately hold family company that belongs to the Albrecht family. Thus, the company does not publish business figures. The company is divided into two regional businesses: Aldi Nord and Aldi Süd. Following the latest report of the German consulting company Planet Retail, the combined Aldi businesses generated sales of €52.8 billion, operated 8,200 stores in 18 countries and employed over 150,000 people in 200978. Rewe Group: The Rewe Group is Europe’s 3rd food retailer79. Deloitte ranks Rewe on rank 12 among the world’s retailer80. The company operates 3,300 supermarkets and hypermarkets in Germany and employs about 210,000 people. The company’svalues and culture together with the strong focus on quality and healthy products make the company most comparable to WFMI´s business model81. Edeka Group: Deloitte ranks the Edeka group as world´s 14th power in the retail business82. The Edeka group claims to be Germany´s largest employer83. Furthermore, Edeka focuses its strategy on two business models: The supermarket chain Edeka and the discount concept Netto. Together the company operates 12,000 food markets in Germany and employs 290,000 people. The Edeka supermarkets are the core business of the Edeka group, meanwhile the Netto markets are the growing stars. In year 2009 the company grew 18.7% in Revenues and employed additional 27,000 people84. Kaiser Tengelmann AG: In Deloitte´s World Retail Ranking the Kaiser Tengelmann Ag is still among the Top 100 Retail Powers ranking on place85. The company operates in 16 European countries, has 4,519 establishments and employs 84,516 people. In the food retail sector in Germany the company competes in the supermarket sector with its two brands Kaiser and Tenglemann. Furthermore, the company owns the major stake of the American supermarket chain A&P86.




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Consumer analysis

With 82 million inhabitants, Germany is the most populated country in Europe87. The country is divided in 16 states with Nord Rhine Westphalia (about 18 million inhabitants), Bavaria (about 13 million inhabitants) and Baden-Wuertemberg (about11 million inhabitants being most populated states. The largest and economically most important cities in the country are Berlin (about 3.3 million residents), Hamburg (about 1.7 million residents), Munich (about 1.2 million residents), Cologne (about 1 million residents) and Frankfort (about 0.7 million residents)88. The latest studies of the German consulting company GfK indicates that the total German purchasing will be € 1,610.2 billion in 2011. Thus the average German is expected to have a purchasing power of €19,864 in the coming year and 11.4% of this money is dedicated to food. Regarding purchasing power Germany is ranked as the fifth country in the world and the largest in Europe89. Concerning German food habits there are four trends evolving in the last years:

1. organic food, i.e. green produce 2. low fat & wellness products 3. convenience food 4. fair trade offers

Germany has been one of the largest producers and consumers of organic food in the world. Organic food increases its importance in the German food retail market in all retail formats, even in the discounters, which compete on price. Total organic food sales exceeded € 5.8 billion in 2008 and 50% of sales are represented by the discount format90. A recent study from Ernst and Young about organic food in Germany indicates that91:

- 35% of interviewed German consumers often or always look out for the organic food label (Bio)

- 78% of interviewed German consumers would pay at least 10% more for organic products

- 75% of interviewed German consumers would change brands in favor of an organic product

- 56% of interviewed German consumers would change retailers if an enhanced range of organic products were offered elsewhere

These results indicate that there is a potential market in Germany that demands a larger variety and accessibility of organic food.




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SWOT Analysis

To build on the Market, Competitor and Consumer analysis a SWOT has been performed to analyze the possible fit for an international expansion of WFMI in Germany.

Strengths Weaknesses

Threats Opportunities

o WFMI is a established company and has a

proven business model in the US that would

bring innovation to the German market.

o The company´s positioning fits with German

organic savvy and health conscious consumer.

o WFMI already has presence in Europe, thus the

company can build on this advantage.

o Improvement in Germany's purchasing power

and increasing consumer confidence.

o Increasing organic and health trend in Germany.

o Inexistence of sole organic supermarket chain.

o Organic savvy consumer base in Germany.

o The WFMI brand has no brand awareness in the

German market.

o The word play of “wholesome food” within the

brand name has no meaning in German language.

o The company has no established supply chain in

Germany.

o The physical shop concept has to be adapted for

the German market due to smaller retail space in

German cities.

o Saturation of the German food retail market.

o Highly competitive situation and direct

competitor.

o Possible answer to the market entry by the big

Retail groups.

o Skepticism among German consumers towards

American companies and their Marketing efforts.

o Cultural difference between German and US

customers.




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Country Analysis of French Market

Market Environment With 62 million inhabitants, France is the second largest country in the EU. The country ranks 3rd in Europe and the 8th in the world regarding purchasing power92. In total there are 25 million households (10 million of those are single households) spending 13.4% of the disposable income in food items. The market form is similar to the German market, with the difference that eight retail groups divide the market among them. These groups are Carefour (market share of 26%), Leclerc (market share of 16.1%), Casino (market share of 13.1%), Intermarché (12.8%), Auchan (market share of 12.4%), Système U (market share of 8.7%), Cora (market share of 4.2%) and others (market share of 6.7%)93. The market growth in the last years was pushed mainly by discounters, who count for 14.3% of the market in 2009. 67% of the market is divided between the formats of hypermarkets (market share of 34%) and supermarkets (market share of 33%). 17% of the market is owned by independent retailers, such as butchers, cheese stores and bakeries. The resting 16% of the market is distributed between convenience/freezer centers (market share of 9%) and other retail formats94. Private Label brands have a relatively low market share of 25.2% compared to the UK, where the private label brands own 40% of the market. French retailers have segmented the private label offer into five categories:

- entry price - premium - organic/fair trade - kid - healthy

The predictions ffr the coming years are especially positive for the organic food sector in France. Organic Food has a market share of 1.7% of the overall food retail market and the French institute Percepta predicts the organic market to grow 8-10% in the coming year 201295. Competitive Situation

The French food retail market is dominated by the following seven food retailers: Carefour, Leclerc, Casino, Intermarché, Auchan, Système U and Cora. In this section each competitor is described briefly. Carrefour: Carrefour is after Wal-Mart the world’s second power in retailing96. The Carrefour group is Europe´s largest retailer and operates 15,000 stores in 34 countries. The business model of the group is a mix between company-owned and franchised stores. Carrefour managed 7,892 company-owned stores by the end of 2010. In France the




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retailer manages 1,551 stores in the following retail formats: Hypermarkets (204 establishments), Supermarkets (575 establishments), Hard Discounts (1,761 establishments) and Cash and Carry (12 establishments)97. Carrefour´s strategy focuses on three strategic pillars:

1.) Client orientation culture 2.) Transformation 3.) Innovation

At the end of 2010 the group generated revenues of €107.2 billion and employed 475,000 people98.

Groupe Auchan: The Company positions itself on the 15th place in the Deloitte world retail power ranking99. The Auchan group operates 1,317 stores in 12 countries. In France the group is represented by the four sales brands: Auchan hypermarkets (hypermarkets), Simply Market supermarkets (supermarkets), Immochan (Real estate) and Banque Accord (retail banking). In total Auchan operates 124 hypermarkets and 272 supermarkets in France generating revenues of € 15.2 billion. On a global scale Auchan employs 290,000 people and closed the year 2009 with revenues of € 42.5 billion100. Leclerc: Deloitte ranks Centres Distributeurs Leclerc on rank 22 among the world’s largest retailers101. The group is a network of independent markets that share a joint organization of tasks. The company operates 560 establishments in France. The business focus lies on Hypermarkets (391 establishments), followed by supermarkets (131 establishments) and specialized stores (39 establishments). Leclerc operates all over Europe (six countries) and generated revenues of € 29.5 billion in 2009102. Groupe Casino: Casino occupies the 26th place in Deloitte´s world retail ranking103. The company operates 11,663 stores in the world, 9,461 of those in France. The company is one of the leading players in France and includes all the different retail formats: Hypermarkets (Geant Casion), Supermarkets (Casino, Monoprix and Franprix), Convenience and specialized markets (Naturalia, Petit Casino, Spar and Vival) and hard discounts (Leader price). It is worthwhile mentioning that the group operates the specialized Organic food supermarket chain Naturalia. In addition, the company includes organic product brands such as, Casino Bio, Monoprix Bio, Leader Price Bio, Club des Someliers, etc. in all its sales brands. The company employs 230,000 people and generated sales of € 29.1 billion in 2010104.




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Intermarché: The company intermarché belongs to the world´s Top 30 retailers ranking on the 27th place105. Intermarché operates 2,000 supermarkets in six countries. 90% of those establishments are located in France. The company bases its strategy on three core values:

1.) Everyday low pricing 2.) Shopper friendly stores 3.) Proximity

Intermarché builds on being available to its consumers in specially adapted establishments. Furthermore, the company has the most widespread retail network in France (one store each 17 kilometers)106. Système U: Système U achieves the 42nd position in Deloitte´s Ranking, thus the company is the 6th French Retail Chain107. The group is a cooperative of independent hypermarkets and supermarkets operating around 900 stores in three countries108. Système U operates four sales brands (Hyper U, Super U, Marché U and Utile) and competes in three retail formats (hypermarkets, supermarkets and small specialized stores). The company generasted sales of €16.1 billion in 2008109. Cora: Cora belongs to the Provera France group. The company operates 61 hypermarkets in France and employs 22,000 people. Cora has a market share of 4.2% of the food retail market, competing only in the hypermarket format. The company is not publicly traded thus little commercial information is available110. Consumer analysis After Germany, France is the second largest country with 63 million inhabitants and the third largest economy regarding its GDP111. France is divided in 27 administrative regions, 22 of those are in metropolitan France112. There are three areas showing major population concentration: 18% of the country’s population lives in greater Paris area, 10% in Rhône-Alpes; 8% in the Provence-Alpes-Cote d’Azur. The largest city in France is Paris (2.2 million inhabitants, followed by Marseille (0.81 million inhabitants), Lyon (0.42 million inhabitants) and Toulouse (0.37 inhabitants)113. The consumer price index for food has increased 0.8 points from 2009 to 2010. The total French disposable income was € 1.232.111.95 million in 2010, thus the average French had a yearly disposable income of € 19,727.55. The consulting company Euromonitor predicts an increase in disposable income of 1% for the year 2011114.




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The Irish Food Board Bord Bía publishes yearly studies about the consumer behavior of Europeans. Several key consumer trends concerning food consumption of French consumers can be observed115:

- Increase in healthy and organic products (20% of French buy local organic products and 70% of French try to eat healthy)

- Increase in convenience food (78% of French find ready meals a good substitute for home cooking when their time is limited)

- Increase in skepticism regarding the healthiness of “low fat” or “reduced fat” products

These trends towards healthier nutrition are supported by stricter food advertising laws and government actions. Furthermore, Bord Bía evaluates the shopping patterns of French customers. The French make yearly about 80 shopping trips (lower than the average European) and shop in 5.4 different establishments. The French consumer has a higher average ticket size than the average European and assigns great value to the proximity of the establishment (source: Linéaires, Periscope 2010). The French consumption of organic food reached € 2.6 billion in 2009 and the French consulting company OF+Consulting, as well as the Irish Food Board Bord Bía, predict a positive trend for organic food consumption with growth figures between 8-10% until 2012116.




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SWOT Analysis

To build on the Market, Competitor and Consumer analysis a SWOT has been performed to analyze the possible fit for an international expansion of WFMI in France.




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NPV-Analysis for Germany and France

In order to assess the feasibility to enter in both the German and French market a NPV analysis has been performed considering the following assumptions: the initial metric is the potential consumption per customer who has been defined as a family with three members. The estimated is based on current statistics sourced from official and or consulting news releases. Also, we have the number of shops that may be progressively installed until getting at least a number of establishments that are currently functioning in the UK. Because the strategy of differentiation will be applied in Europe (as in the USA) in order to permit command premium prices, additional budget to publicity and promotion has been considered (including variations between 2% and 10% of revenues). To express the figures in US dollars the current exchange rate of the euro has been utilized and nominal values have been utilized to obtain the cash flows. Those cash flows were discounted at the averaged cost of capital. The NPV for Germany and France in the base case scenario are 136 million and 124 million respectively. (Exhibits 12 & 13) The scenario of expansion for Germany shows that the accomplishment of introducing the brand to this market is very sensitive to the ability of the company to increase its WTP and focus its strategy on commanding its premium prices from customers. Because of the wide spectrum of competition that WFMI would face in Germany, a niche to target is necessary since the awareness of the organic consumption is already well positioned in the country. Due to the large propensity of the population to consume organic products, the assumptions made on the number of stores and the number of clients per shop used in the model seems that are not relevant issues for weather or not taking the risk. However, if the value created for the demanding German Public is not immediately well positioned, there would not be enough volume to satisfy the equation. The opportunity supply cost should stay stable due to the fact that Germany counts on almost one million of hectares cultivated owned by 21 thousands farmers117. Thus, the risk of lacking qualified sourcing of products would not exist and as a consequence capturing value from suppliers would not be an issue. In consequence, the WTP that WFMI can produce will depend on the options to aggregate value to a product already existent in the market. For instance, an attractive environment that enriches the experience to buy in WFMI instead of the supermarket would be a possibility. In the case of France, the same variables and framework have been used to obtain the possible value created. As seen in Exhibits 12 & 13 the scenarios are barely below the results to Germany because the size of the market and family composition is smaller. As a consequence, despite the fact that scenarios may forecast positive results from entering the French market, a careful analysis of probabilities might provide valuable supplemental information.




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Conclusions - Recommendations for Whole Foods

The results of the country entrance analysis (market environment, competitive situation, consumer analysis, SWOT and NPV analysis) confirm that both countries are potential candidates for international expansion into Europe. Strongly confirming factors are the Net Present Values of both countries, the market size, the increasing growth of organic food consumption in both countries and the positive acceptance of organic trends by the consumers. The intensive competitive situation in Germany (with five of the players in the German market ranked by Deloitte among the world’s Top 20 Retail Powers), the language barriers (limitation for the use of Whole Food brand) and the perception of American companies by German and French customers can be stated as limiting factors. If WFMI decides to enter these markets the following recommendations should be assigned special importance.

1.) Analyze all fitting options and chose the right entrance strategy 2.) Create supplier ecosystem to build up a collaborative advantage 3.) Position the WFMI brand strategically and develop an attractive communication

concept Regarding recommendation 1.) Analyze all fitting options and chose the right entrance strategy: The choice of the right market entrance strategy is crucial for WFMI. The Food and Agriculture Organization of the United Nations defines the following Market Entry Strategies: Exporting, Piggybacking, Countertrade, Sales subsidiary, Licensing/Franchising, Joint Ventures, Acquisitions and Ownership118. To be able to chose the best market entry strategy WFMI should develop a Benchmark of all the possible options taking into account the following variables; company goals, size, resources, products, remittance, middle man characteristics, competition, environmental characteristics, number of markets, market feedback, international market learning, control, marketing costs, profits, investment, administrative personnel, foreign politics, flexibility and risk119. After viewing the existing entry strategies it can be suggested that just Sales Subsidiary, Acquisition and Ownership fit the WFMI business model. The WFMI brand, the corporate culture and the relationships with suppliers are important assets for the company’s success abroad; the other entrance strategies (exporting, piggybacking, countertrade, licensing/franchising and joint venture) would not allow WFMI to use these assets to its best extent. Regarding acquisitions of existing market players, WFMI should evaluate the learnings of the market entry in the UK to avoid mistakes. Furthermore, the competitive response of other competitors should be predicted and monitored (especially in the German Retail market).




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Regarding recommendation 2.) Create supplier ecosystem to build up a collaborative advantage: To seek for an additional competitive advantage WFMI should stimulate the collaboration between business units and suppliers along the newly created value chain. To achieve this competitive advantage WFMI should develop knowledge and service sharing activities throughout all management levers. These efforts, if implemented well, can result in best practice transfer (cost savings), problem solving, better decision making, process and product innovation, cross-selling, cross-pollination and bold ideas. There are also potential limitations and downsides to collaboration, such as time management problems of employees, decreased performance and increasing complexity in decision making. In their article “How to build collaborative advantage”, Mortan T. Hansen and Nitin Nohria suggest a road map to develop human resource procedures and lateral cross-unit mechanisms to guarantee the successful implementation of collaborative initiatives. WFMI should follow this roadmap to establish an ecosystem of stakeholders to build up collaborative advantage120. Regarding recommendation 3.) Position WFMI brand strategically and develop an attractive communication concept: The cultural differences between Germany, France and the USA are enormous. WFMI should customize its marketing and branding activities to meet consumers’ expectations. German and French consumers have a conservative attitude towards marketing and are do not always engage in extensive marketing activities. Wal-Mart failed to enter the German market in 1998, and admitted that the “American Concept” did not fit the German consumer needs and the company revised their strategic expansion in Germany and closed down operations in 2003121 It is of great importance for WFMI to analyze and respect the cultural differences and different lifestyles in the European company. This way the company will be able to design a tailor-made marketing and communication concept that fits the target markets. Horizontal Diversification As an alternative or in addition to pursuing a growth strategy of international expansion, WFMI may choose to broaden the scope of its domestic business. Opportunities may exist to leverage the firm’s brand equity in creating one or more businesses related in some way to the activities of offering natural and organic foods. The strength of the “relatedness” between possible non-food offerings and WFMI’s core business activity is worth discussing at this point. Strategists (Palich et al.) have argued that “performance increases as firms shift from single business strategies to related diversification, but performance decreases as firms change from related diversification to unrelated diversification,”122 suggesting that WFMI would be wise to consider expanding




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horizontally into non-food products that bear similar characteristics to its core offerings, but not to spread itself too thinly across a wide variety of unrelated business. For example, WFMI might diversify into non-food goods and services which exhibit the familiar “green” qualities of its natural and organic foods: locally-sourced, produced without excessive unnatural components, in an environmentally friendly manner. Such products might appeal to both WFMI’s existing customers, who have demonstrated a willingness to pay for environmentally friendly products, and other like-minded consumers. The average WFMI customer has an annual income of over $50,000, and three-quarters of WFMI sales come from individuals “interested in an organic lifestyle”123. Given that consumers with higher levels of education are more likely to buy organic products than less-educated consumers124, WFMI’s target customer can be painted as having an above-average education and income level, with a strong desire to consume natural and organic products. In short, it seems reasonable to conclude that WFMI’s customer would be interested in purchasing other natural and organic products besides food products. Again referencing Palich et al., a variety of products and services might be stretched across an inverted U-shaped curve (see Exhibit 14), indicating the expectation that firm-level performance will increase as WFMI engages in more and more related activities, but decrease as WFMI begins to pursue unrelated activities. Exhibit 14 shows activities currently undertaken by WFMI, and also a few inactive lines of business into which WFMI might extend horizontally. The lines of business in which WFMI is currently active are clustered in a reasonably tight fashion near its core or “single” line of business. Adjacent to (A) core food products, WFMI offers (B) cooking classes at its Culinary Centers in 30 stores nationwide. All stores also include (C) a Whole Body section of natural and organic personal care products, and most stores include (D) a section of locally-sourced flowers (with varying degrees of organic, natural and ethical trade certification125). With continued reference to Exhibit 14, we examine four possible non-food expansion candidates as they relate to the framework developed by Palich et al.:

(1) In-store services and seminars. For example, services such as naturopathic health clinics and yoga or other fitness classes might appeal to WFMI’s target market. The focus on health and well-being demonstrates proximity of such offerings to WFMI’s core business, with relatedness further emphasized by WFMI’s image of itself as a “third place, besides the home and office, where people can gather, interact and learn”126. Moreover, it is unlikely that the supplier relationships needed to deliver such services are dramatically divergent from those relationships WFMI cultivates with local food producers or Culinary Center employees. (In other words, finding a local yoga expert to work out of a recreational space owned by WFMI should not be a complex undertaking.)




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(2) Home furnishings. While a limited number of home furnishings are currently available at some WFMI stores (perhaps a vestige of WFMI’s minority interest in Gaiam, Inc.127), the firm has not aggressively explored a full-fledged home furnishings initiative of its own. For example, a “Whole Home” line of locally-sourced furnishings might complement the existing “Whole Body” line of personal care products. Several incarnations of such an approach may be viable. For example, WFMI might expand those stores in close proximity to vibrant communities of local artisans, to include a new aisle or department dedicated to home furnishings. Alternately, WFMI might acquire a company like At West End (an online retailer of home décor made from recycled materials) or Etsy (an online marketplace of products hand-crafted by independent vendors from more than 150 countries). The merits of these approaches are discussed in further detail below.

(3) Clothing. WFMI formerly offered clothing online through its now defunctWholePeople.com website (the Internet operations of Gaiam, Inc. and Amrion were once linked128). While WFMI still holds a minority interest in Gaiam, the firm has no direct presence in the clothing segment. It is likely that organic clothing may appeal to some, but certainly not all, members of WFMI’s customer base. The activities undertaken to source organic clothing are probably not much different than those required to source home furnishings, with the notable exception that there are fewer organic clothing producers than organic food producers (described in more detail below). However, the clothing segment’s volatility (e.g., rapidly changing trends in consumer tastes, seasonality) introduces challenges in marketing, broadening the gap in relatedness to WFMI’s core activities.

(4) Alternative energy, transportation, etc. Those consumers identifying positively with the WFMI brand may also prefer to consume clean energy and ecologically friendly transportation. While it is difficult to imagine a precise implementation of such an extension, it is possible that future advances in clean energy and transportation put WFMI in a position to deliver certain products and services to fill demand (e.g., batteries or charging stations for hybrid or electric cars). The lack of relatedness of such initiatives to the procurement and sale of organic and natural foods is evident, and so by the time WFMI finds itself heavily expanding into these arenas, a decline in firm-level performance may occur.

Given these considerations of relatedness to WFMI’s core business, it is useful then to analyze the impact that such horizontal expansions might have on the varied elements or activities of WFMI as an organizational system. As such, activity maps for WFMI are presented by Exhibit 15 (the top map illustrates current activities, with the bottom map adding each of the four candidates for horizontal expansion). With the premise that “coreness means connectedness129,” the central perishable and prepared foods businesses have spawned core activities of quality control and purchasing




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within WFMI. In other words, quality control and purchasing are central activities, given their connectedness to a large number of other firm activities. Quality control, a rigorous practice, touches a variety of aspects of the firm’s business: each new product is carefully examined (e.g., to validate any claims that the product is natural, organic, free-trade compliant, etc.), the firm’s ongoing activism efforts provide information on new quality standards and techniques, product quality is heavily emphasized in signage and other marketing, and employees are trained to understand the genesis and environmental impact of the products they sell. In describing its crucial purchasing function, WFMI states, “the majority of our purchasing… occurs at the regional and national levels, enabling us to negotiate better volume discounts with major vendors and distributors while allowing our store buyers to focus on local products and the unique product mix necessary to keep the neighborhood market feel in our stores”130. If undertaken, each of the four candidates for horizontal expansion would impact WFMI’s activity system differently. For example, adding a home furnishings or clothing line may “thicken” the core element of purchasing131 – the routine of sourcing local vendors of quality foods is reinforced by an elaboration of the business model, which now asks WFMI to apply this expertise to new product categories. (This is particularly true if these lines of business are launched anew by WFMI, and not acquired in some turnkey fashion from another firm.) It is also possible that a horizontal expansion turns a “non-core” activity into a core activity. For example, adding a variety of in-store services and seminars may reinforce employee training. Both the in-store services and home furnishings lines would imaginably thicken store design activities, as new spaces must be conceived to accommodate guests engaging in activities, or to display larger, oddly shaped products. Given WFMI’s competence in designing attractive spaces, the firm’s stated goal to become a “third place” for consumers, and the “relatedness” of the lines of business to WFMI’s core, the in-store services and home furnishings expansions appear to be more attractive than other options. These expansion options present WFMI with an opportunity to carry its brand premium (estimated at 15% per the sample data in Exhibit 2) to different categories of products. Consumer willingness to pay for WFMI-branded in-store services and home furnishings may be greater than willingness to pay for similar products without the WFMI brand. Additionally, given the relatedness to WFMI’s core and the implications of this relatedness to WFMI’s activity system (described further below), it is likely that the cost in-store services and home furnishings expansions will be lower than expansions into clothing and alternative energy. In short, the in-store services and home furnishings expansions seem to provide the best opportunity for WFMI to expand the “wedge” between willingness to pay and supplier opportunity cost132, generating the prospect of sustainable competitive advantage133. To implement these expansions, then, the company has a variety of options to consider: 1) the manner of integration of the new activity among existing retail practices (i.e., determine whether non-food products be sold in separate stores or in existing stores); 2) whether to source the products from a variety of smaller independent vendors, or




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concentrate on a relationship with one or more larger-scale suppliers, and 3) determine the most appropriate relationship structure if working with a large-scale supplier of non-food products (e.g., weight the relative advantages and disadvantages of acquisition, joint venture, or contract-based alliance given the particulars of the situation). Each of these decisions will be discussed in turn. Level of Integration: Separate Retail Space, or Part of Existing Store?

It is our recommendation that WFMI concentrate its in-store services and home furnishings expansion efforts by integrating products into existing retail stores, rather than by opening retail outlets dedicated specifically to the sale of non-food products under the WFMI brand. A variety of data support this conclusion. To begin, note that the firm has grown same-store sales in the U.S. consistently over the past few years, perhaps illustrating that shoppers visiting Whole Foods Market stores are amenable to coughing up larger and larger shares of their wallet (see Exhibit 6). An emphasis on additional products which carry related attributes that drive willingness to pay may extend this trend of wallet capture. Further, WFMI has dipped its toe in the water in the creation of a dedicated-purpose retail space for non-food offerings only once – it did so six years ago and has yet to expand – and so there may be evidence that the approach has not worked for the firm. Specifically, WFMI opened one “Lifestyles Annex” store, carrying an assortment of third-party produced, non-food products including “eco home” furnishing products (e.g., organic cotton towels) and “eco baby” clothing products (e.g., “natural accessories for your baby’s nursery”)134. The venue, opened in West Hollywood in 2005, is adjacent to a Whole Foods Market and is built entirely with sustainable materials135. As of this writing, it remains the only “Lifestyle Annex” or non-food store of its kind under the WFMI brand. A number of factors may explain WFMI’s hesitance to expand the Annex concept further. One, sales at the Annex may be weak (WFMI does not report data at the store level). Two, perhaps the West Hollywood market represents a rare overlap of potential customers within the brand’s target demographic and spacious zoning, making it easier to justify an entire store dedicated to non-food products in this particular location (the brand has more stores in California than in any other state136). Three, WFMI may find the sourcing of qualified non-food products from third parties to be more difficult than the sourcing of organic and natural food products. Currently, brands available at the Annex include “Loomstate, Edun, World of Good, Green Babies, Little Earth (handbags made from old license plates) and Lenore bags (purses made from recycled phone books)”137. Thus, while a broad-scale expansion into products like organic home furnishings may be possible insofar as the firm plans to add an additional department, aisle, or alcove to its existing stores, there simply may not be enough supply so as to afford cost-effective openings of dedicated purpose “Whole Home” stores around the country. The issue of




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relative scarcity of organic home furnishings providers is explored in further detail in the subsequent section. While it is difficult to ascertain which of these factors is most influential, some combination of them seems to have precluded WFMI from a larger-scale rollout of Annex stores. This seems to speak against advising WFMI to open more dedicated purpose non-food stores. Moreover, by incorporating new products and services within Whole Foods Market stores, a variety of assets may be shared so as to generate additional value without incurring large incremental cost increases. For each Whole Foods Market store already in operation, the firm has made significant investments to train its labor force, showcase expensive wood fixtures and other aesthetic touches, and generate best practices that “prolong dwell time” of its shoppers (e.g., allowing customers to interact with comment boards, or relax in small areas designed to entertain children)138. These can be leveraged across small sections of new, non-food products in a way that more closely captures value than if separate stores were opened; even if an Annex were placed immediately next door, entirely new investments would be required in ambient lighting and wood fixtures, child play areas, employee training, or assets of similar ilk to generate the “experience effect” of shopping in a Whole Foods Market store. Finally, consumers purchase food items in greater velocity than they purchase home furnishings. Referencing a previously cited report from the Hartman Group (2008), nineteen percent of consumers bought organic food weekly in 2008, up from 3 percent in the late 1990s. Consumers purchase home furnishings in a markedly different shopping pattern (only 35% of U.S. consumers were forecasted in 2010 to buy home furnishings in 2011139), and so it would be difficult for a dedicated-purpose store to generate the sales volumes required to pay off the expensive fixed cost investments characteristic of the WFMI retail experience. Sourcing Non-Food Products

Our recommendation is that WFMI source home furnishing products at the national level, and labor for in-store services at the store level. Concerning home furnishing products, as stated previously, the majority of WFMI’s food purchasing occurs at the regional and national levels, with 45% of products sourced from local vendors. When comparing food sourcing to home furnishings sourcing, attention must be paid to the relative strength and number of suppliers in each segment. Turning to Exhibit 16, there are more than 6,000 farms in the U.S. which operate on 50 or more acres of certified organic farmland, presenting a large supply of perishable organic foods at the local and regional levels. Further, WFMI’s relationship with UNFI provides large-scale supply of non-perishables at the national level.




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Contrast this with the relative scarcity of supply in certified organic household products and textiles: the Organic Trade Association (OTA) has certified hundreds of food suppliers across numerous subcategories as organic, whereas the OTA has certified only seven producers in its household products category and five in its textiles category140. Given these statistics, it would seem difficult for WFMI to acquire home furnishings products at the local level, or even at the regional level (particularly given its stringent sourcing guidelines). Given the labor-intensive model of an in-store services expansion, it seems clear that WFMI should apply its best practices in employee training at the local level when scouting and hiring individuals to run seminars, activities, or other paid services. Briefly focusing on yoga, it may be possible for WFMI to attain high-quality, high-integrity instructors simply by leveraging its existing hiring protocols, which put applicants through a background check, screening interview, full-scale interview involving multiple team members to asses cultural and interpersonal fit, and finally an orientation period which concludes with a team-wide vote on candidate acceptance141. High instructor quality combined with the WFMI brand premium can drive willingness to pay in excess of incremental costs in areas such as human resources (e.g., WFMI might hire just a few regional managers to coordinate service offerings across a region, leaving the actual interview process to existing team members) and marketing (e.g., store marketing managers who understand local customer tastes can tailor a few extra programs that promote available services at the store level). Structure of Relationship with Non-Food Suppliers

Again focusing on the home furnishings segment, we recommend that WFMI enter into a contractual alliance with a large provider of organic home furnishings, rather than attempt to acquire such an organization or embark on a formal joint venture. Specifically, a sensible opportunity exists for WFMI to align with Etsy, Inc., a Brooklyn-based e-commerce venture that sources handmade products of various types from individual artisans around the world. As shown by Exhibit 17, Etsy’s website features more than 100,000 handmade products which are tagged as “organic” (including 3,767 organic “Housewares” products, 1,826 organic “Ceramic and Pottery” products, and so on). Individual sellers submit detailed descriptions and photos of their products online to Etsy, and the site then provides a platform to connect the sellers to consumers demanding unique, handmade items. Etsy charges the seller 3.5% of the transaction price (among other small fees)142, and the seller fulfills the item directly to the buyer. Etsy adds value through its highly navigable and searchable website and broad network of individual suppliers. A supply contract with Etsy might allow WFMI to source organic, handmade housewares and other items which have already been vetted as popular, through sales thresholds achieved on the Etsy site. For example, WFMI might have interest in those items listed in certain categories (e.g., Housewares), which are labeled as organic, and have surpassed a




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certain sales threshold. A contract may then give WFMI the option, but not the obligation, to negotiate a larger-scale purchase of such items from the individual sellers, with Etsy earning a matchmaking fee from WFMI each time such a deal is consummated. There are several advantages to such an arrangement. One, WFMI can source from a wide variety of unique, handmade, organic products which its customers are likely to demand. Two, Etsy’s relationships with individual sellers around the world could allow WFMI to market certain housewares as produced by local artisans (see Exhibit 18 for Etsy’s supplier footprint). Three, Etsy is motivated to deliver high quality leads to WFMI, as the retail sales channel of WFMI stores is likely non-dilutive and incremental to the fees Etsy makes from e-commerce. Four, Etsy and WFMI can most likely manage the relationship without much difficulty or incremental cost; for example, each firm might hire a small handful of individuals charged with managing the relationship, reconciling payments, and so on. Lastly, and perhaps most importantly, the ultimate decision on whether or not the product meets WFMI’s quality control standards can be made by WFMI, leveraging the firm’s unique skills and capabilities to ensure products that are labeled as “organic” are proven to be such. When considering a hypothetical merger between WFMI and Etsy, it is likely that the costs of subsequent integration could be quite high given the disparity in operations between the firms; one organization has a formal and informal culture designed around e-commerce, and the other has a stated focus of establishing itself as a “third place” within the physical world. Additionally, Etsy’s unique strengths and capabilities in developing a high-touch, consumer-facing website are far more valuable to Etsy than they are to WFMI (whose focus, again, is not in the realm of e-commerce), and so from a perspective of strategic factor markets, it is unlikely that the firms will achieve consensus on the valuation of Etsy’s assets in this area143. When considering a hypothetical joint venture between WFMI and Etsy, we apply the “Four C’s” framework144: 1) the firms are somewhat complementary in that Etsy’s strengths are different from WFMI’s, 2) the firm’s strategic goals do not appear to be congruent given the divergence of their business models (it is possible, however, that knowledge sharing, an important consideration in corporate alliances145, may be a reasonable goal for each firm: WFMI may have interest in Etsy’s process of electronic sourcing from individual vendors, and Etsy may have interest in WFMI’s quality control practices), 3) the firms do not appear highly compatible given the aforementioned cultural differences, and 4) it is likely that as the situation changes, WFMI will need Etsy less (e.g., WFMI may circumvent Etsy in time, and develop direct relationships with some of Etsy’s most successful vendors). Finally, as stated, the complexity (and thus cost) of contracting is probably not high; Etsy would simply earn a bounty based on the quality of the individual vendors it sources to WFMI and the size of the order.




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Exhibit 1: Global Footprint

Source: Kantar Retail iQ




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Exhibit 2: Sample Price Data and Premium Analysis




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Exhibit 3: Select Financial Data for WFMI, Safeway and Kroger

S a l e s 9 , 0 0 5 , 7 9 4$ 1 0 0 % 8 , 0 3 1 , 6 2 0$ 1 0 0 % 7 , 9 5 3 , 9 1 2$ 1 0 0 %

C o s t o f G o o d s S o l d 5 , 8 7 0 , 3 9 3$ 6 5 % 5 , 2 7 7 , 3 1 0$ 6 6 % 5 , 2 4 7 , 2 0 7$ 6 6 %

G r o s s M a r g i n 3 , 1 3 5 , 4 0 1$ 3 5 % 2 , 7 5 4 , 3 1 0$ 3 4 % 2 , 7 0 6 , 7 0 5$ 3 4 %

N e t I n c o m e 2 4 5 , 8 3 3$ 2 . 7 % 1 4 6 , 8 0 4$ 1 . 8 % 1 1 4 , 5 2 4$ 1 . 4 %

S a l e s 4 1 , 0 5 0 , 0 0 0$ 1 0 0 % 4 0 , 8 5 0 , 7 0 0$ 1 0 0 % 4 4 , 1 0 4 , 0 0 0$ 1 0 0 %

C o s t o f G o o d s S o l d 2 9 , 4 4 2 , 5 0 0$ 7 2 % 2 9 , 1 5 7 , 2 0 0$ 7 1 % 3 1 , 5 8 9 , 2 0 0$ 7 2 %

G r o s s M a r g i n 1 1 , 6 0 7 , 5 0 0$ 2 8 % 1 1 , 6 9 3 , 5 0 0$ 2 9 % 1 2 , 5 1 4 , 8 0 0$ 2 8 %

N e t I n c o m e 5 8 9 , 8 0 0$ 1 . 4 % ( 1 , 0 9 7 , 5 0 0 )$ - 2 . 7 % 9 6 5 , 3 0 0$ 2 . 2 %

S a l e s 8 2 , 1 8 9 , 0 0 0$ 1 0 0 % 7 6 , 7 3 3 , 0 0 0$ 1 0 0 % 7 6 , 1 4 8 , 0 0 0$ 1 0 0 %

C o s t o f G o o d s S o l d 6 3 , 9 2 7 , 0 0 0$ 7 8 % 5 8 , 9 5 8 , 0 0 0$ 7 7 % 5 8 , 5 4 4 , 0 0 0$ 7 7 %

G r o s s M a r g i n 1 8 , 2 6 2 , 0 0 0$ 2 2 % 1 7 , 7 7 5 , 0 0 0$ 2 3 % 1 7 , 6 0 4 , 0 0 0$ 2 3 %

N e t I n c o m e 1 , 1 1 6 , 0 0 0$ 1 . 4 % 7 0 , 0 0 0$ 0 . 1 % 1 , 2 4 9 , 0 0 0$ 1 . 6 %

W h o l e F o o d s M a r k e t , I n c .

S a f e w a y , I n c .

T h e K r o g e r C o .

2 0 1 0 2 0 0 9 2 0 0 8

2 0 1 0 2 0 0 9 2 0 0 8

2 0 1 0 2 0 0 9 2 0 0 8

Source: Compiled from Annual Reports




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Exhibit 4: Organic Sales Growth by Segment

Source: Nutrition Business Journal, 2009




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Exhibit 5: Sales of Organic Foods by Retail Channel

Source: Natural Foods Merchandiser, various issues; Nutrition Business Journal, 2004; and Organic Trade Association, 2006.




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Exhibit 6: Historical Store Growth and Sales Mix

Source: 2010 Annual Report for Whole Foods Market, Inc., p6




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Exhibit 7: History of Acquisitions

Exhibit 8: Wild Oats Surplus

(Figures in excel file attached)

Exhibit 9: Valuation of Wild Oats acquisition

(See excel file attached)

Exhibit 10: Scenarios

(See excel file attached)




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Exhibit 11: Sales Distribution by Geographic Area

Source: 2010 Annual Report for Whole Foods Market, Inc., p9




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Exhibit 12: Net Present Value Calculation for Germany EXPANSION IN GERMANY

IN US$ MILLIONS

SCENARIO OF AVERAGE

PRESENT VALUE CUSTOMERS 2.000 3.000 4.000 5.000 6.000

PER SHOP / ANNUM/ ANUM

Average gross margin 25% 9 16 22 29 35

30% 38 59 79 100 121

35% 66 101 136 171 206

40% 95 144 193 242 292

45% 123 187 250 313 377

Exhibit 13: Net Present Value Calculation for France

EXPANSION IN FRANCE

IN US$ MILLIONS

SCENARIO OF AVERAGE

PRESENT VALUE CUSTOMERS 2.000 3.000 4.000 5.000 6.000

PER SHOP / ANNUM/ ANUM

Average gross margin 25% 8 14 20 26 32

30% 34 53 72 91 110

35% 60 92 124 156 188

40% 86 131 176 221 266

45% 112 170 228 286 344




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Exhibit 14: Horizontal Diversification and Inverted U-Shaped Performance Curve

Source: Adapted from Leslie Palich, Laura Cardinal, and C. Chet Miller, Strategic

Management Journal, Chichester, Volume 21, Issue 2, February 2000.




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Exhibit 15: Activity Maps for WFMI

Current activities:

P e r is h a b le N a t u r a l a n d O r g a n ic F o o d s

N o n -

P e r is h a b le F o o d s

P r e p a r e d F o o d s

E m p lo y e e T r a in in g

Q u a lit y C o n t r o l

P u r c h a s in g / V e n d o r S o u r c in g

P r o d u c t io n

C u lin a r y C e n t e r s

A c t iv is mR & D

S it e

S e le c t io n

S t o r e D e s ig n /

M ix

P e r s o n a l C a r e

D is t r ib u t io n

M a r k e t in g

With new activities:




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Exhibit 16: Organic Farmland Data

Source: USDA, National Agricultural Statistical Service, 2007 Census of Agriculture, table 48




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Exhibit 17: Organic Products on Etsy.com

Source: Screenshot from Etsy.com




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Exhibit 18: Etsy’s Supplier Footprint

Source: Screenshot from Etsy.com




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Strategic Analysis of Whole Foods (WFMI)

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