Why Has Amazon Struggled to Increase Whole Foods' Revenues?

Source: Wikimedia Commons

According to the most recent Amazon earnings reports, the company's Whole Foods Market subsidiary continues to show sluggish sales performance.   Revenues during the most recdent quarter only grew 1%.   Sales were relatively flat in prior quarters.   Why is Amazon struggling to increase Whole Foods' revenues despite repeated attempts to showcase lower prices on key products?  Why hasn't introducing discounts for Prime members been more successful in driving revenue growth?

Yale School of Management Professor Soheil Ghili recently commented on the company's struggles. He told Yale Insights: 

"There might be some non-price factors, but the main challenge is indeed the prices and the “Whole Paycheck” brand image of Whole Foods. It is true that Amazon Prime membership is commonplace among high-income households that are likely to be—or have the potential to become)—Whole Foods customers. However, data on the incomes of Prime customersand U.S. income distribution suggest that the majority of Prime members have household incomes below $100,000 a year. Converting those Prime members to regular Whole Foods customers would require much sharper price cuts than Whole Foods/Amazon is now offering."

Ghili goes to question who the customers are that Amazon is targeting.   The choice of target customer matters a great deal with regard to the appropriate competitive positioning and marketing strategies for Whole Foods.  He explains, 

"Whether you are competing against Trader Joe’s or against Walmart has significant implications on how you want to respond. If you want to poach TJ customers, lowering prices might help with some. (Certainly not all; I for one, don’t see myself leaving TJ for Whole Foods!) If trying to poach from Walmart, you’d better establish cheaper stores and brand them anything other than “Whole Foods.” This, by the way, is something Amazon is already thinking of doing, in parallel to slashing Whole Foods prices."

I find this discussion quite interesting, because I've always been puzzled about the Whole Foods strategy.  The company achieved remarkable success by positioning itself as a highly differentiated, premium price grocer with an exceptional customer experience.  Yes, it is true that the company's sales growth had stalled prior to the Amazon acquisition, as traditional grocers expanded their organic offerings, often at lower prices.  However, it's not clear that the appropriate response by Whole Foods is to try to walk away from the "Whole Paycheck" image.  I fear that Whole Foods runs the risk of being "stuck in the middle" strategically.  They have alienated some of their core customers by weakening the customer service experience and changing the mix of products in their stores.  They have potentially alienated some of their best employees as well.  Meanwhile, the price cuts do not appear substantial enough to bring in waves of customers who would otherwise shop at lower-priced rivals.  Whole Food has to decide who they really want to be when they grow up.  It doesn't seem that they have made a clear choice at this point.  Do they want to be Apple or Southwest?  Which is it?   My gut says that they have a much better chance of thriving as Apple than trying to transform into Southwest. 

Straddling: Whole Foods Discontinues 365 Store Format

Source: Wikimedia Commons

Supermarket News reported yesterday that Whole Foods will not be opening additional 365 format stores. The company had launched the small-format 365 stores two years ago in an attempt to provide a less expensive option targeted at millennial shoopers.   CEO John Mackey explained the move in a memo to his staff: "However, as we have been consistently lowering prices in our core Whole Foods Market stores over the past year, the price distinction between the two brands has become less relevant. As the company continues to focus on lowering prices over time, we believe that the price gap will further diminish."  Count me as someone who was skeptical of this strategy even before Amazon acquired Whole Foods and began to lower prices in the traditional stores.  Let's take a look back at the original rationale for the 365 stores.  Annie Gasparro of the Wall Street Journal reported on the strategy in 2016:

Announcing the plan last month, executives said these new stores would have a trendier atmosphere, with high-tech ways of interacting with shoppers that help keep its costs down.  Some retail analysts said the value-focused chain, which is expected to largely carry private-label foods, could help Whole Foods compete with Trader Joe’s, which tends to attract younger shoppers who want affordable, natural foods.

A Reuters article by Lisa Baertlein, published in 2016, revealed some skepticism about the 365 strategy by industry analysts:

“Our goal is to compete in the marketplace without lowering the Whole Foods standards,” Turnas told Reuters during a recent store tour. He said 365 stores will complement Whole Foods’ premium, full-service sister brand – often dubbed ‘Whole Paycheck’ in popular culture in reference to its perceived higher prices. But the new chain will have to work hard to avoid being labeled “a cheaper Whole Foods”, said Kevin Kelley, a principal at strategy and design firm Shook Kelley, which has worked with Whole Foods and other grocers.

Why did the 365 format struggle to gain traction?   I would argue that it's a classic example of a straddling strategy.   The 365 format was caught somewhere in between the traditional business model of Whole Foods and the very successful contrasting business model at places such as Trader Joe's.  For more on Trader Joe's, you might check out a recent Freakonomics episode in which I participated.   Straddling often occurs when incumbent players try to react to successful entrants.  Consider how the legacy airlines tried to cope with entrants such as Southwest and Ryanair.   Among the failed responses were straddling strategies such as United's Ted, Delta's Song, and British Airways' Go brands.  For more on straddling, check out this short video clip from one of my Great Courses lecture series. 

Whole Foods Inside of Target?

Brian Sozzi of TheStreet.com has reported in recent days rather extensively about Target's disappointing financial results.   Target experienced a 1.5% decline in same store sales in the most recent quarter, while rival Wal-Mart produced a 1.8% gain in same-store sales.  Moreover, Target missed earnings estimates this quarter, and the firm decreased its estimates for 2017 earnings.  Sozzi has some interesting ideas as to how the firm might turn things around.  For instance, he's focused on the grocery part of the business, noting that Target must decide who it wants to be with regard to the food portion of the stores.   Sozzi proposes one solution that might startle some observers:

Food sales represent more than 20% of Target's business, and it's vital it finally gets this business right. Same-store sales were pressured throughout last year, as the company battled with pricing strategies in a competitive backdrop. Further, Target continues to deal with not having a broad enough assortment in fresh categories such as fruit, vegetables and meat and deli (would like it if they sold some fresh fish and more grab-and-go sandwiches at my local Target, for example). 

The retailer has to decide whether it wants to be a grocery store and, if so, how it could do it more effectively. Becoming a successful grocer could lift sales throughout the store. As I have said in the past, Target should consider outsourcing its grocery department to a Whole Foods (using its new 365 value banner) in the same fashion as it outsourced its pharmacy business to CVS Health. Let someone with the expertise in food service handle the business, freeing up Target to focus on what it does best -- higher quality general merchandise vs. Walmart at good prices.

I certainly find the concept intriguing.  By all accounts, Target made a wise decision to outsource its pharmacy business to CVS Health.   It did not have the same capabilities as CVS, and yet, having a strong pharmacy in the store had important benefits in terms of building foot traffic.  CVS made for a perfect partner.  However, the Whole Foods partnership raises some questions.  Yes, Whole Foods offers strong capabilities in the grocery business.  However, Whole Foods has a very premium image, and it is known for high prices ("Whole Paycheck").  Yes, Target hopes to differentiate itself from Wal-Mart and offer a premium shopping experience for guests.  Is Whole Foods a bit too far in that direction though?  Will it turn off shoppers looking for good value (Expect More, Pay Less)?  Sozzi recommends using the new 365 value banner from Whole Foods, but that store concept is not yet proven.   Perhaps more importantly, Whole Foods is facing many struggles of its own right now, both trying to reinvigorate its flagship stores as well as launch the 365 stores.   CVS Health was a strong, high performing partner for Target.  Is it the right moment to partner with a firm such as Whole Foods, given the challenges that the grocer is facing at the moment?   Finally, outsourcing 20% of your business is a far different decision than shifting the small pharmacy unit to CVS Health.  Sozzi certainly raises an interesting idea though, and I'm sure others will press Target's management to consider similar moves if same-stores sales growth does not improve.  

Whole Foods: Could it Get Stuck in the Middle?

Companies pursuing a differentiation strategy often face a serious challenge when low-cost competitors begin to infringe on their turf.   Some customers may opt for lower-priced options.  As growth slows for the differentiated player, it may try to boost profits by cutting costs.  If it goes too far though, the differentiated player may further erode willingness-to-pay on the part of some customers.  The company may get caught "stuck in the middle" at some point, no longer clearly as premium and differentiated as it once was, but clearly with higher costs and prices than the most efficient low-cost and low-priced rivals.   

Whole Foods faces this conundrum today, as reported this week by the Wall Street Journal.  The company faces slowing growth, in part because low-cost rivals such as Kroger have expanded their organic food offerings, while offering consumers much lower prices.  Whole Foods has responded by announcing a  plan to "save about $300 million a year by September 2017, partly by eliminating more than 2,000 jobs." That plan involves centralizing some key tasks and streamlining processes to generate more efficiency.   Whole Foods Co-CEO John Mackey understands the risks. He said, "We want to evolve the structure in such a way that we take out redundancy and waste, and at the same time though, we’re not diminishing the culture, the empowerment efforts that make Whole Foods Market special." 

 The Wall Street Journal article goes on to explain, "Transferring more authority to headquarters and automating more tasks risks harming Whole Foods’ customer-friendly reputation and turning off shoppers who place a high value on local products, such as blueberries and hometown pasta sauces, and niche items, said Jim Hertel, senior vice president at retail consulting firm Willard Bishop,a unit of Inmar Inc."   

Whole Foods clearly still has a solid position as one of the premium players in the supermarket industry.  However, the warning signs are there.  They must be careful about compromising their well-crafted and highly successful competitive positioning, as they cope with lower growth rates.  

Whole Foods Suffers Large Drop in Share Price

Whole Foods experienced a dramatic drop in its share price this week.  The shares fell 20% as the company projected slower growth in the future.   What's affecting the company's growth rates?  Many new rivals have emerged, including conventional grocers who are allocating much more shelf space and attention to the organic food category.  Moreover, Whole Foods has tried to emphasize value more so than in the past, so as to compete more effectively with these conventional, lower-priced rivals.  The company, after all, does have a reputation as "Whole Paycheck."  Whole Foods also has felt pressure to emphasize value as it has moved into new geographic markets within the US where customers are not as affluent.  The emphasis on value, i.e. lower prices, naturally has a short term negative impact on sales growth (as each item generates less revenue), though it may help bolster growth in the long run.  

What's the danger here for Whole Foods?   If they drop prices and emphasize value in a big way, they may take away from their high quality, high service, differentiated positioning.   If they don't pay attention to value at all, they may sacrifice growth and lose market share in the organic category.     In short, Whole Foods faces a conundrum many differentiated, premium players encounter as they begin to saturate their original niche and as new rivals emerge.  Whole Foods would be well-advised to take great care that they don't allow a desire for growth and market share to cause them to dilute a strong brand and to hurt a premium image.  Many other premium niche players have made that mistake, and they have learned that it is very hard to recover from such an error. 

Whole Foods Parody

If you haven't seen comedienne Kelly MacLean's hilarious essay about Whole Foods, you must take a look.  Her post appeared this week on the Huffington Post blog, and it has become a viral sensation.  I'm a big fan of the store, as is MacLean, but it's still very funny.  I haven't seen any official response from the firm.  It would be interesting to see if they have fun with a response, or if they choose to just ignore the blog post.