Bigger, Riper, Juicier Analyzing the Retail Natural and Organic Food Industry

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Bigger, Riper, JuicierAnalyzing the Retail
Natural and Organic Food Industry
2
What is the retail natural and organic food
industry?

• Retail outlets ranging from small, local farmers
  markets to large, international supermarkets,
  that supply natural and organic foods.

3
What are Organic Foods?

• Produced using practices that promote and enhance
  agro- and eco-system health and use no
  genetically engineered inputs.
• Livestock are given organically-grown feed,
  treated humanely, and given no antibiotics or
  growth hormones.
• Food processing preserves the integrity of the
  organic product and uses no preservatives.

4
What are natural foods?

• Minimally processed or largely free of artificial
  material, preservatives, or other non-natural
  chemicals

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Why is this industry so exciting?

• A 12 billion dollar industry, but still only a
  niche of the 600 billion food industry overall.
• Growing at 20 a year with plenty of
  opportunities for expansion

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Tremendous Growth Whole Foods Markets
International
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What is the Basic Technology in this industry?

• Labor intensive using organic practices
• Weed and Pest Control Hand Weeding
• Fertilization Green Manure

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How are production costs financed?

• Small organic food retailers rely on small
  business loans and private funds.
• The big firms in the industry are public
  companies (WFMI and OATS)
• Certain states to subsidize the initial costs of
  Organic certification up to 500.
• State specific financing programs are also a
  large help for firms entering this industry.

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Minnesota Financing

• The Shared Savings Loan Program of the state of
  Minnesota offers up to 25K per firm, at an
  interest rate of 3, for firms transitioning from
  traditional to organic farming.
• Their Demonstration Grants offer an additional
  25K per firm, to subsidize the documentation
  costs required for organic certification.

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Who buys organic food products?

• Educated and trendy yuppie consumers
• Sophisticated Sandal brigade
• People who value products that are healthy,
  environmentally conscious, or are perceived as
  more flavorful.
• Often, these consumers also tend to have
  relatively higher incomes. (for example, 50,000
  mean income at Whole Foods vs. 35,000 at
  Wal-Mart)

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How are products distributed?

• United Natural Foods- Largest Supplier
• 2.1 Billion
• 19 annual growth over the next five years
• They are not dependent on WFMI for business. 26
  of business is from WFMI.

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Other Suppliers

• Goods supplied from big distributors often come
  from California and abroad.
• Regional distributors supplied by local farmers
  and suppliers.

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Industry Figures

• Items typically cost 50-100 more than
  traditional counterparts (e.g. bread ranges from
  1.19 at Kroger to 2.69 at Whole Foods)
• Employment 39,000 employees in Whole Foods,
  which represents 31 of the total market.
• Output 12 Billion in sales.
• Imports and Exports 10 of Organic foods (milk
  and citrus) are imported into the US.

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Competitive Structure

• Dominant Firms
• Quasi Natural and Organic Food Supermarkets
• Competitive Fringe
• Traditional supermarkets
• Small, local businesses
• Farmers markets
• Nutrition stores
• Specialty gourmet retailers

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Dominant Firms

• Whole Foods Market Incorporated
• Stores 181
• Employees 39,000
• Market Capitalization 8.88 billion
• Market share 31
• Wild Oats Markets Incorporated
• Stores 113
• Employees 8,596
• Market Capitalization 505.91 million

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Quasi Natural and Organic Supermarkets

• Characteristics
• Often privately owned
• Products and pricing strategies can vary widely
• Generally regionally located

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Competitive Fringe

• Varies by local market
• In Charlottesville
• Integral Yoga Natural Foods, CVille Market,
  Rebeccas Natural Foods, the farmers market,
  Foods of All Nations, Harris Teeter and other
  traditional grocers, and GNC.

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Bertrand Dominant Firm and Competitive Fringe
Model

• Dominant firms can earn positive economic
  profits.
• Whole Foods reported 136,351,000 net income
  after expenses in September 2005, or an average
  of 826,369.50 per store.
• Dominant firms still cannot efficiently serve the
  entire market.

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Profits Attract Entry

• Industry becoming more competitive as large
  retailers expand and the fringe meets more demand
• Barriers to Entry
• Capital costs
• Large firms have established supply chains and
  often their own private labels
• Leasing or renovating run-down buildings is an
  alternative
• Many markets cannot support more than one large
  organic supermarket

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Entry and Exit

• Entry is difficult do to the high costs of
  maintaining organic certification.
• Establishing a food retail outlet involves a lot
  of start up costs including establishing
  distribution networks and logistics.
• As with Wal-mart, Whole Foods is a massive
  competitive force against mom and pop stores.

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Product Differentiation

• Products are often widely differentiated. Most of
  the larger supermarkets carry their own private
  labels.
• Pricing differences can exist
• Organic and fair trade certification
• Local preferences and trend shopping
• Government certifications (e.g. 100 Organic)

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Governments Role in the Industry

• The government is responsible for certifying and
  regulating organic foods and establishing
  standards.

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Government Standards

• "100 Organic"
• Product must contain only organically produced
  raw or processed material, excluding water and
  salt.
• The name of the certifying agent must appear on
  packages, and use of its certifying seal is
  optional. Use of the USDA "organic" seal is
  optional.

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Government Standards

• "Organic"
• Product must be at least 95 organically produced
  ingredients.
• The label may also state the percentage of
  organic ingredients.
• The name of the certifying agent must appear on
  packages, and use of its certifying seal is
  optional. Use of the USDA "organic" seal is
  optional.

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USDA Seal

• The USDA has developed a special seal that
  organic producers can choose to place on their
  products that meet the federal requirements for
  "100 Organic" or "Organic" labeling. While
  voluntary, the USDA Organic seal provides yet
  another level of assurance of organic integrity.

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Organic Rule

• All products labeled as Organic must carry the
  USDA seal. This ensures that the product was
  produced, handled, and stored according to the
  Organic definition.
• Organic products cannot even come into contact
  with traditional products.

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The Effect of Government Intervention

• Firms use this label to justify higher prices.
• The high marginal costs of ensuring an organic
  certification limits entry into the market.

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Whole Foods Role in Government Regulation

• WFMI was the only retail outlet representative
  involved in the drafting of the Organic Rule.
• They are exercising capture or lobbying for
  regulation. This is obviously a rational,
  economic act to bar new firms for entry.

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Organization

• Smaller companies produce baked goods and
  prepared meals such as sandwiches and salads.
• Large firms are semi-vertically integrated and
  have the resources and networks to offer their
  own private food label.
• Inputs are largely purchased from outside
  suppliers.

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Whole Foods Private Labels

• WFMI owns are variety of private label food
  subsidiaries.
• This includes 365, 365 Organic, Whole Kids,
  Whole Paws, Whole Catch, Allegro Coffee, Whole
  Ranch, and Whole Fields

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365 Profits

• These private labels account for 12 of their
  sales and are directly responsible for the
  companys solid profit margins.

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Price Discrimination

• As with any food retail store, organic markets
  offer sales and specials to entice people into
  the store.
• They already know they are attracting people with
  a higher willingness to pay.
• Whole Foods has the resources to offer cheaper,
  private label brands.

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Labor Practices

• Many larger firms pay employees wages higher
  than the union standard, and frown upon labor
  unions.
• Team members at Whole Foods
• Hawaiian shirts at Trader Joes

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Business Practices

• Advertising Relies mostly on word of mouth and
  brand reputation
• WFMI Spends less than .05 of sales on
  advertising.
• Whole Foods invests in educating the public on
  the benefits of organic foods.

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Business Practices

• Decentralized Environmentalism- Whole Foods
  grants operating freedom to their stores allowing
  them to take advantage of local environmental
  subsidies.
• John Mackey, President of Whole Foods, says that,
  We see the environment as a stakeholder in the
  business.

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Business Practices

• Corporate Leadership in Environmental
  Stewardship, and the positive image that firms
  project to their consumers.
• Whole Foods combines idealism -- selling organic
  food and making environmentally conscious
  business decisions -- with an eye still focused
  squarely on the bottom line driven by aggressive
  growth.

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Business Practices Real Estate

• Whole Foods takes advantage of their real estate
  market power, choosing locations in high-end
  mixed-use developments .
• Whole Foods is able to negotiate rent rates
  significantly lower than competing grocery
  anchors. WFMI is currently located in 39 of the
  top 50 US metropolitan markets.

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Investment Analysis

• Pro
• Potential for expansion into new markets
• Whole Foods estimates opening 25-30 new stores
  beginning in 2007 and doubling annual earnings by
  2010.
• Con
• The market may be a fad
• Earnings estimates may be too high
• More fringe competition may hinder growth

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Stock History

• Whole Foods Market Incorporated (WFMI)
• Stock Price 63.91
• P/E Ratio 60.87
• Earnings per Share 1.05
• Wild Oats Markets Incorporated (OATS)
• P/E Ratio 161.18
• Stock Price 17.73
• Earnings per Share 0.11

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Verdict Whole Foods and Wild Oats Stock
Jim Cramer on Whole Foods Even though the
retailer's fundamentals still look strong, this
is one falling knife that I wouldn't try to catch
and I believe that Wal-Mart's push into the
organic grocery market adds just one more
potential land mine to the equation.
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An Alternative Venture Capital

• Trader Joes philosophy buy old, dilapidated
  buildings and turn them into successful retail
  outlets for specialty foods
• Private labels
• Buyout less lucrative large retailers
• Potentially less expensive than outright stock
  ownership, but also potentially more risky

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Strategy for Managers

• Managers should expect increased competition as
  fringe firms seek to enter the market. We
  recommend that managers
• Continue to avoid labor unions, and embrace
  sandals brigade type employee teams.
• Practice decentralized environmentalism
• Promote stricter government legislation for the
  industry, in conjunction with leadership in
  environmental stewardship.
• For large stores, keep the product unique by
  focusing on cafes and other value-added services
  (valet service, specialty bagging, consumer
  culture)
• Whole Foods should consider marketing their
  private label as competition from traditional
  retailers move into the organic food industry.

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Whole Foods Real Estate Strategy

• Managers at Whole Foods should avoid locating
  stores where demographics are driven by
  condominium constructions.
• Managers should avoid high priced locations in
  new markets, unless there are very healthy
  demographics supporting the site.

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Sources

• www.wholefoodsmarket.com
• Wild Oats Markets Inc. MarketWatch . 23 Apr.
  2006. www.marketwatch.com
• Whole Foods Market Inc. MarketWatch. 23 Apr.
  2006. www.marketwatch.com
• Armstrong, Larry. Trader Joes, the Trendy
  American Customer. BusinessWeek
• Online. 24 Apr. 2004. http//www.businessweek.com/
  magazine/content/04_17/b3880016.htm
• Trader Joes Specialty Gourmet Stores Trader
  Joes Homepage. 23 Apr. 2006. Traderjoes.com
• Cramer, Jim. Mad Money Mailbag Whole Foods not
  as Tasty The Street.com. 23 Mar.
• 2006. www.thestreet.com
• Whole Foods Market. Whole Foods Market
  Homepage. 23 Apr. 2006.
• www.wholefoodsmarket.com
• Whole Foods Targets Sales Goal of 12 Billion.
  The Gourmet Retailer. 3 Mar. 2006.
• www.gourmetretailer.com

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Sources Continued

• The Economist. "Face Value A Wal-Mart for the
  Granola Crowd." July 28th 2005.
• http//www.economist.com/PrinterFriendly.cfm?story
  _id4222115
• Whole Foods Market Press Release "Whole Foods
  Market Makes Largest Ever Purchase of Wind
• Energy Credits in United States."
  http//www.wholefoodsmarket.com/company/pr_01-10-0
  6.html
• Whole Foods Market Company Facts.
  http//www.wholefoodsmarket.com/company/facts.html
  
• Borden, Mark. "Producer Michael Funk/United
  Natural Foods." Fast Company Magazine.
• March 2006.
• Aina, Abiodun and Cruise, Bill. Whole Foods
  Market Inc. Yale School of Management 2005.
• Gogoi, Pallavi. Wal-Marts Organic Offensive.
  Business Week. March 29, 2006.
• Warner, Melanie. A Struggle Over Standards in a
  Fast Growing Food Category. The New York Times.
  Nov. 1, 2005
• Wild Oats Markets Inc. MarketWatch . 23 Apr.
  2006. www.marketwatch.com
• Whole Foods Market Inc. MarketWatch. 23 Apr.
  2006. www.marketwatch.com
• Armstrong, Larry. Trader Joes, the Trendy
  American Customer. BusinessWeek
• Online. 24 Apr. 2004. http//www.businessweek.com/
  magazine/content/04_17/b3880016.htm

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Sources

• Whole Foods Targets Sales Goal of 12 Billion.
  The Gourmet Retailer. 3 Mar. 2006.
• www.gourmetretailer.com
• Wild Oats Natural Marketplace. Wild Oats
  Homepage. 23 Apr. 2006.
• www.wildoats.com
• Integral Yoga Natural Foods Integral Yoga
  Homepage. 23 Apr. 2006.
• www.iyfoods.com
• The Store to Explore Foods of All Nations
  Homepage. 23 Apr. 2006
• www.foodsofallnationsl.com
• Quinn, Steve. Whole Foods Impresses Customers,
  Investors. AP Business. 16 Apr.
• 2006. www.ap.org.
• The Economist. "Face Value A Wal-Mart for the
  Granola Crowd." July 28th 2005.
• http//www.economist.com/PrinterFriendly.cfm?story
  _id4222115
• Whole Foods Market Press Release "Whole Foods
  Market Makes Largest Ever Purchase of Wind

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Sources

• Whole Foods Market Company Facts.
  http//www.wholefoodsmarket.com/company/facts.html
  
• Borden, Mark. "Producer Michael Funk/United
  Natural Foods." Fast Company Magazine.
• March 2006.
• Desmond, A. Jolly. Statistical Analysis of
  Organic Foods Consumers. Cooperative Extension
  Specialist, Department of Agricultural Economics,
  University of California, Davis.
• Harrison, Christy. The (still) high cost of
  organic food. Grist Magazine. 22, Apr. 2006.
  www.grist.org
• Midwest Food Connection. The Natural Food
  Network Homepage. 27, Mar. 2006.
  www.naturalfood.com
• The Federal Register Rules and Regulations.
  United States Department of Agriculture. 29,
  Mar. 2006. www.aphis.usda.gov/ppd/rad/webrepor.ht
  ml

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Thank You!!

• Any Questions?