What Whole Foods Inc. Could Learn from Costco Wholesale Corporation

By Markets Fool.com

Things aren't going according to plan at Whole Foods . Despite its leadership position in the fast-growing organic food industry, the grocer last month reported slowing quarterly sales growth. That surprise dip helped push the stock close to a new low for the year.

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Investors aren't happy that Whole Foods is losing ground to competitors such asKroger and Costco . These rivals both credit surging natural and organic food sales for lifting their results lately.And they're winning the market share battle through lower prices, which isn't Whole Foods' strong suit.

Clashing approaches
In fact, the grocer's entire approach to retailing clashes with the idea of being a price leader. Here's how Whole Foods' management described the mission of its stores in its latest 10-K: "We strive to transform food shopping from a chore into a dynamic experience by designing and operating stores with a lively, inspirational atmosphere."

Source: Whole Foods.

To achieve the inspirational vibe, typical stores feature luxuries including wood-burning pizza ovens, juicing stations, sit-down eating areas, wine bars, and chair massage services. Whole Foods locations are designed to be places where "people can gather, interact and learn while discovering the many joys of eating and sharing food," according to the company.

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Compare that with Costco's store description: "Because shoppers are attracted principally by the quality of merchandise and the availability of low prices, our warehouses are not elaborate facilities."

Source: The Motley Fool.

Kroger's strategy is similar to Costco's. This is how management described its organic food pricing strategy in a conference call with investors last year:"Our customers are very clear [that] they don't want to have to pay a premium for natural and organics. And we're trying to make sure that they can get a good quality product at a price that's comparable to the non-organic brands and in some cases actually the same price."

To that end, the company made over $3.5 billion in price reductions in just the last year.

Bending the brand
Sure, Whole Foods' upscale approach generates significantly higher earnings than its peers earn. Its gross profit margin was 36% of sales last year, compared to 21% for Kroger and 13% for Costco. But that gap is becoming more of a liability as organic groceries move into the mainstream.

Still, Whole Foods can't compete on straight price without hurting its brand. Co-CEO Walter Robb admitted as much in last month's conference call discussing the first-quarter results.

We can continue to be aggressive in gradually lowering some of our prices, but the Whole Foods Market brand stands for the highest quality, the best selection, the highest degree of service. So -- that brand can bend a little bit, but we can't break it. We're not willing to break it.

To protect the core brand while defending against the challenge from no-frills grocery competitors, Whole Foods announced that it will launch an entirely new store concept under the brand "365 by Whole Foods Market." We don't know all the details yet, but the layout will likely strip out many of the luxuries that make a Whole Foods shopping experience unique in order to achieve a cost profile that can deliver lower prices. In a press release, the company said the 365 stores will provide an "efficient and rewarding way to grocery shop."

Where the Whole Foods brand can't go
It will be interesting to see if this move helps Whole Foods steal market share back from rivals. While investors aren't yet sold on the idea, management believes it is the right response to rising competitive threats.

"We think we can create a complementary brand that can go places the Whole Foods Market brand cannot effectively go," Robb said.

The article What Whole Foods Inc. Could Learn from Costco Wholesale Corporation originally appeared on Fool.com.

John Mackey, co-CEO of Whole Foods Market, is a member of The Motley Fool's board of directors. Demitrios Kalogeropoulos owns shares of Apple, Costco Wholesale, and Whole Foods Market. The Motley Fool recommends Apple, Costco Wholesale, and Whole Foods Market. The Motley Fool owns shares of Apple, Costco Wholesale, and Whole Foods Market. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.