Organic Growth

By Daren Fonda Sunday, Aug. 04, 2002
    • TIMOTHY ARCHIBALD FOR TIME

    It's lunchtime at the whole foods supermarket in Plano, Texas, as artist Raquel Brownfield, 57, pulls into the parking lot in her red BMW roadster. She is about to enter foodie heaven: a grocery store brimming with everything from fresh organic produce and dried beans to slabs of hormone-free beef and boysenberry pies. "I usually go in thinking I'm going to spend under $30," says Brownfield, who visits the store a couple of times a week, "but I spend between $60 and $70."

    Few grocery chains are as clever as Whole Foods Markets at enticing shoppers to gorge on fancy fare. With $2.3 billion in revenue and a 20% profit surge last year, Whole Foods trounced its rivals in the conventional-supermarket business; most of them muddled through with 1% to 2% sales growth. Whole Foods, though, doesn't sell just groceries. It offers something more ethereal: a feeling of healthy chic that pervades its stores and products and rubs off on customers. Even if you're buying fat-marbled T-bones and Camembert cheese, you're surrounded by colorful fruits and vegetables and preservative-free whole-grain breads, all lovingly displayed and lighted in a store designed to make you feel good. Says CEO John Mackey: "We've tied together the concepts of food as pleasure and food as healthy."


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    The business model has given investors a hearty appetite for Whole Foods stock. The share price of the chain of 135 "supernatural" stores, based in Austin, Texas, has risen 125% over the past two years and more than 750% since the chain went public in 1992. Analysts marvel that Whole Foods' mature stores (those open more than five years) average 6% annual revenue growth, vs. 1.5% for the typical chain. Annual sales per square foot — a key measure of a retailer's health — are about $650 at Whole Foods, compared with about $450 at many conventional supermarkets. Says analyst Andrew Wolf of BB&T; Capital Markets: "They've become a power retailer like a Home Depot."

    Whole Foods, along with its chief rival, Wild Oats Markets, based in Boulder, Colo., is riding a surge of interest in so-called natural and organic foods. While such foods account for just 3% of Americans' grocery bills, they attract higher-income buyers and yield fatter profits for grocers and producers. And a parade of food scares — mad-cow disease, hormones and antibiotics in meat and milk, pesticides in produce, genetically altered "Frankenfoods" — is propelling more shoppers to go organic. Result: sales of natural and organic foods are growing at an 18% annual clip and are projected to surpass $17 billion this year.

    The industry no longer figures its prime market is Birkenstock-wearing proles hankering for tofu and lentils. It's courting health-conscious consumers of every stripe who want to eat more grains, fruits and vegetables (but not exclusively) and cut back on fat and sweets (but not too much). Marketers are playing up the gourmet aspects of their products — and charging premium prices. "A lot of companies don't want to sell an organic product with a tree-hugger image anymore," says Michelle Barry, an analyst with the Hartman Group, a Seattle-based market-research firm. "They're marketing these products for their taste appeal and the social status connected with them."

    No one does it better than Whole Foods. Its co-founder, Mackey, 48, is a six-time college dropout who grew up on TV dinners, got bitten by the health-foods bug in his 20s and built his business by combining the concepts of health-foods store and gourmet market. Mackey is the son of an accounting professor, and despite his left-leaning roots, he is a carnivorous capitalist. Starting with a single Whole Foods store in Austin in 1980, he took 12 years to expand to five outlets. But after taking his firm public in 1992, he steadily opened new stores and used his equity to swallow competitors, buying 15 regional chains, including New England's Bread & Circus and California's Mrs. Gooch's Natural Foods Market.

    The firm has stumbled occasionally. In 1997 it paid $146 million for a Colorado vitamin business that proved a bust, and it made a costly foray into Internet retailing. But those missteps have helped Whole Foods executives hone their strategy: to create a "supernatural" giant that can withstand the challenge from both conventional chains and the 500-pound gorilla called Wal-Mart, which is selling ever more low-priced organic fare.

    A key step toward Whole Foods' goal was its acquisition of Harry's Farmers Market, an ailing Atlanta-area chain that Mackey scooped up last year for $35 million. Harry's was losing money, and is dragging down Whole Foods' earnings. But the chain provides access to the Southeast, where Whole Foods is weak. And Harry's three megastores fit the prototype for Whole Foods' expansion plans; they are massive, fun (with cookouts on weekends) and strong in perishables and prepared foods — high-margin segments that account for 60% of Whole Foods' sales.

    If Whole Foods has a weakness, it's that occasional shoppers find the stores a bit confusing. Most national brands aren't available, and regional purchasing managers have so much leeway in how they stock shelves that Heinz ketchup, for example, is sold in some stores but not in others. The problem for some shoppers — and the charm for others — is that hundreds of the products Whole Foods sells are made by mom-and-pop producers. Few shoppers outside Austin, for instance, know of Boggy Creek Farm, a family-run business whose sun-dried tomatoes and pasta sauces are sold at local Whole Foods stores.

    Nearly every item is screened for artificial ingredients, but what's blessed as "natural" can seem arbitrary. The chain is phasing out all goods with hydrogenated fats, meaning no more Pepperidge Farm Goldfish and Carr's crackers. But it sells its own chocolates and cheese puffs. Rationale: the chocolates contain organic cocoa and raw cane sugar, and the cheddar puffs contain real cheese and no artificial colors.

    And that, perversely, is a key part of Whole Foods' appeal. "It's about whole foods, not holy foods," says A.C. Gallo, vice president for East Coast operations. "We try to educate people, but we're not going to preach that the only thing you can eat to be healthy is brown rice and vegetables." Research indicates that Whole Foods' hard-core shoppers think of themselves as gourmets more than all-natural eaters, yet they are enticed by the healthy atmosphere. As a result, the firm started downplaying the healthy, ramping up the fresh and taking to heart what its regional managers were doing to court local yuppies. West Coast stores had a thriving gourmet-pizza business, for example; the Portland, Ore., outlet had housewares sections and a cooking school; and in many areas local chefs were coming in to teach shoppers how to use organic and natural ingredients in recipes. The formula appeals to customers like Matt Marchbanks, 25, who shops at the chain for almost everything — except Krispy Kreme doughnuts and disposable diapers. "If I want good meat, I come here," he says.

    The food industry is responding to Whole Foods' success. Organic produce is no longer the wilted stepsister of conventionally grown fare, and that's largely because national chains such as Whole Foods are demanding — and getting — a better-looking product. "Big retailers have gotten past the point where they think organic has to mean ugly," says Roger Pepperl, marketing director for Stemilt Growers, a large Washington State orchard. Growers such as Stemilt, which has 2,000 acres under organic management, benefit from new economies of scale. Says Pepperl: "We're more scientific and efficient with water management, planting and fertilization techniques, pest management. And our packaging has evolved so as not to bruise the produce."

    Organic-foods manufacturers are devoting more resources to the healthy-chic set. Horizon Organic, the nation's largest organic dairy producer, is getting out of the commodity milk-production business and focusing on expanding distribution and developing new products. Horizon recently introduced single-serving puddings, as well as milk boxes, which Starbucks carries. But even as its volume grows and production costs fall, Horizon won't be cutting prices. "Our data suggest a consumer tolerance for price premiums," says CEO Chuck Marcy. His pitch to supermarkets: "Take out your third- or fourth-selling brand of sour cream or cottage cheese, sell our product and make 30% to 40% more on the margins. That resonates." Horizon's stock is also resonating. Since January 2001, its share price has more than doubled.

    Meanwhile, the food industry's giants are expanding their organic efforts. Heinz plans to launch a premium-priced organic ketchup later this summer, and PepsiCo's Frito-Lay division is test marketing natural and organic versions of its snacks. The multinationals have also been snapping up small organic- and natural-foods firms, retooling their offerings and bringing more marketing and distribution savvy to the mix. Since Heinz bought a 19.5% stake in the Hain Celestial Group — a conglomerate that includes Celestial Seasonings teas and Earth's Best organic baby food — the ketchup king has pushed Hain products into Sam's Clubs and Costcos. Kellogg has had similar success with Worthington Foods, which it acquired for $307 million in 1999. Kellogg eliminated Worthington's money-losing lines and focused on its top brand, Morningstar Farms veggie burgers. The upshot: Morningstar's market share grew from 57% to 61%, with sales up 19%, to $150 million last year. Kellogg is extending the Morningstar brand to other packaged convenience foods, such as frozen meat-substitute "chicken" nuggets.

    Traditional grocery chains, saddled with flat sales and shriveled margins, find they need to sell more gourmet-health fare to compete against the likes of both Whole Foods and Wal-Mart, the nation's largest grocer. Regional supers such as Pratt's Food Supermarkets — a chain in the Oklahoma City, Okla., area — are fighting back with more organic dairy, meats and dry goods. Kroger, the nation's No. 2 grocer, has carved out "natural food" departments in nearly a third of its 2,400 stores and is expanding its private-label organic brand, which includes cereals and potato chips, with soy milks and pasta.

    Taking on Whole Foods directly, though, is starting to look as tough as going up against Home Depot or Wal-Mart. Wild Oats tried by rapidly acquiring stores in markets where Whole Foods operates. But Wild Oats could not execute; it overpaid for real estate, wound up in poorly trafficked neighborhoods and struggled with labor woes, according to analyst Scott Van Winkle of the Boston investment firm Adams, Harkness & Hill. Wild Oats has since shuttered 28 stores, and is planning, under new management, to grow by propping up sales at existing stores and expanding its branches. It squeezed out a slim operating profit in the first quarter, after losing money for the previous year, and the stock has rebounded.

    Wild Oats may have to play catch-up for a long time. Whole Foods' sales have risen more than 20% for 10 straight quarters, and the chain has 21 new stores in development and plans for a total of 400 by 2010. The firm is steadily building its private-label brands, from bottled water to organic macaroni and cheese.

    Mackey is a model CEO when it comes to bang for the buck. Last year he took home a relatively modest $350,000 in wages and bonus and $2.2 million from selling Whole Foods stock. (He owns only 1% of the shares outstanding.) The firm is running so smoothly these days that Mackey has all but disappeared. Since early April he has been hiking the Appalachian Trail; he intends to finish its entire 2,168-mile length by the fall.