As I walked home from Whole Foods this week I wondered just how different John Mackey’s stores are from the rest of the food retailing industry. On the surface they seem very different – Whole Foods is richly appointed relative to the other supermarkets I frequent. How can they afford to do this?
To answer this question, I decided to take a look at a few financial operating metrics for Whole Foods and a set of publicly traded competitors. Since I’m interested in operating difference, I chose to start by examining each firm’s return on assets (ROA).1 Data is readily available for:
- CostCo – Membership retailer focused on low costs. Groceries are a significant portion of volume.
- The Fresh Market – Supermarket with similar appearance to Whole Foods. Footprint primarily on the east coast.
- Delhaize – Global supermarket operator with several grocery brands in the eastern US. Brands include Food Lion, Hannaford and Sweetbay.
- Publix – Employee owned supermarket chain in the southeastern US
- Safeway – National operator of large supermarkets
- Kroger – National operator of large supermarkets under multiple brands
Unfortunately, it is difficult to disaggregate Wal-Mart’s grocery performance from the rest of their business. Given that Wal-Mart is the top food retailer in the US by sales volume, excluding it will admittedly leave out one of the most important players. On we must go…
As you can see, Whole Foods (in green) is among the best performers in this set of supermarket competitors. Performance slipped during 2006-2008 as Whole Foods struggled to raise the performance of over 100 recently acquired Wild Oats stores. While this begins to tell the story, we can dig a bit deeper to gain a better understanding of what has driven the difference in performance between these companies. Specifically, the net income margin and asset turnover can shed light on how profitable each supermarket is, and how well each utilizes its assets.2
Competition among supermarkets is fierce – most mass-market players have net income margins between 1 and 2% of sales. Only Whole Foods and Publix have consistently achieved greater margins. It is interesting to note that the Wild Oats acquisition more than halved Whole Foods net income margin from 3.5% to 1.5%.
Whole Foods performs near the bottom of its peers in asset turnover, however. CostCo achieves relatively high turnover with its concrete floors, metal shelving and huge pack-sizes. Kroger has improved significantly over this time frame, although on the surface the drivers of this improvement are unclear. Either Kroger has become much more efficient, or they have allowed their assets to depreciate with low reinvestment or maintenance expenditure.
Margin performance can be further disaggregated3 into:
Here we start to see the true differences between Whole Foods and other supermarkets. Whole Foods has the lowest cost of goods sold (COGS) among its competitors, which is synonymous with a greater markup above what Whole Foods pays for its products.In addition, Whole Foods has the greatest selling, general and administrative (SG&A) costs as a percentage of sales.4 This money is likely spent on additional staff in each store to provide a high level of service. Alternatively, CostCo has by far the greatest COGS and therefore the lowest markups. In addition, CostCo spends very little on SG&A. These financial metrics align perfectly with each company’s strategy. Whole Foods provides high quality products at a higher price point delivered with a high level of service, while CostCo focuses solely on delivering products at the lowest possible price. In fact, CostCo derives most if not all of its profit from membership fees. Products are priced to simply cover operating expenses.
Asset turnover can similarly be disaggregated:
Again, the finer level of detail uncovers differences between Whole Foods and the competition. Whole Foods (and The Fresh Market) turn their inventory significantly faster than other supermarkets. This performance is likely driven by a greater proportion of perishable goods (produce, meat, seafood, deli items) which drives more frequent shopping trips. Additionally, Whole Foods’ low non-inventory asset turnover (COGS / non-inventory assets)5 implies that Whole Foods provides a more luxurious (more expensive) shopping experience. CostCo again provides a useful contrast. Inventory turnover is middle-of-the-pack, while non-inventory asset turnover is significantly higher than others. Whole Foods provides a very luxurious shopping experience for the grocery customer, offset through greater inventory turns. CostCo focuses on a no-frills shopping experience, and therefore has very high non-inventory asset turns.
Bringing it all together allows us to examine the impact each operating driver has on supermarket performance:
Overall, Whole Foods has constructed a unique operating model relative to other supermarkets. They have chosen to focus on high-margin, faster turning perishable goods, which provides the money and operating flexibility to provide both better service and a more luxurious shopping experience. It will be interesting to see whether Whole Foods can fully raise the performance of the Wild Oats stores to Whole Foods standards, as well as whether The Fresh Market can provide a legitimate competitive threat.
Bonus: Equity performance of a few supermarkets since 2002. After being hit hard by the recession and the Wild Oats acquisition in 2007-2008, Whole Foods has made an impressive recovery. One could imply that the market is reflecting a consumer trend toward either high-end (Whole Foods) or low-cost (CostCo) food retailers.
- I should note that return on invested capital (ROIC) is typically considered a better metric than ROA for analyzing a potential investment in a company. However, in company’s with similar capital structures and working capital needs, ROA and ROIC are similar. In addition, ROA can be easily disaggregated into granular components to gain a better view on the drivers of performance. [return to reading ↩]
- Note that (net income margin) x (asset turnover) = return on assets, or (net income / sales) x (sales / total assets) = (net income / total assets) [return to reading ↩]
- 1 – COGS/Sales – SG&A/Sales = Net income/Sales [return to reading ↩]
- For the purposes of this chart, SG&A was calculated as Sales – COGS – EBIT [return to reading ↩]
- Note that non-inventory asset turnover is a non-traditional metric, but it provides a useful proxy for the quality of the infrastructure that supports the shopping experience. In this analysis, non-inventory asset turnover is calculated as (COGS) / (total assets – inventory) [return to reading ↩]