Roughly 23.5 million people in the United States live in urban and rural food deserts where fresh fruit, vegetables, and meat remain unavailable or unreachable without a vehicle or public transportation. Independently-owned convenience stores and small corner grocery stores, gas station mini-marts, and fast food restaurants typically provide unhealthy, processed food with little nutritional value to people in some of these areas.
Other people living in food deserts are not so lucky – they may have to drive 10 miles or more to the nearest grocery store.
With plans to open 114 new stores by the end of 2014 (in both food deserts and non-food deserts), Whole Foods Market (NASDAQ: WFM) has expanded into recognized food deserts located in states such as Michigan, Louisiana, Illinois, Minnesota, New Jersey, and California.
To succeed in these areas, Whole Foods needs to anticipate slightly lower operating margins , price goods appropriately to consistently achieve high volume sales, and anticipate increased competition from other chains.
More than just a grocery store
Creating an environment where people can feel more connected to their community has helped Whole Foods maintain strong comps (same store sales) and strengthen its brand in these areas. For example, the Detroit, Michigan store features a breakfast bar while the Brooklyn, New York store has an open rooftop where customers can sit and enjoy craft beer.
Whole Foods reported weekly store comps of $742,000 per store for established stores and $503,000 per store for new stores (those established within the past eight quarters) during Q2 2014. Since opening in 2013, the Detroit store reported sales of organic products totaling 30% and the company's exclusive brands totaling 12%, which match established store percentages. This demonstrates strong profit potential in food deserts.
A tricky balance
Two groups typically live in food deserts – those with limited income and those with limited access (those who don't own a vehicle, have to drive long distances to reach a grocery store, or rely on public transportation) to grocery stores.
For Whole Foods, this means maintaining that delicate balance of pricing items appropriately while maintaining healthy operating margins to sustain profits. Whole Foods works with local food companies to provide fresh bread, fruits and vegetables, meats, and prepared foods to customers. The company also continues to expand its private label, 365, which generated about $1.7 billion in sales over the past year. Private label products help companies reduce transportation and inventory costs by managing transportation in-house with the flexibility of sending specific products to locations where these products sell quickly.
Unfortunately, due to their small size and limited revenue, some local food companies have difficulty filling large orders on a consistent basis because they simply don't have enough space, equipment, labor, or ingredients. This can limit selection, which could affect long-term profits since grocery stores like Whole Foods survive by earning revenue from high volume sales.
To secure long-term relationships and maintain inventory, Whole Foods created the Local Producer Loan Program which provides funds to rent larger spaces, hire additional employees, and purchase more materials and equipment. So far, the company has loaned over $12 million to local businesses.
Convenience vs. brand loyalty
With competition increasing in food deserts, a wider selection of healthy foods, breakfast bars and rooftop resting spots may not be enough to create a loyal customer base.
Reporting a 5% increase in comps for its Neighborhood Market Stores for the past two quarters, Wal-Mart plans to open an estimated 120 to 180 new locations in 2014.
Neighborhood Market Stores, smaller than traditional Supercenters, feature fresh produce, meats, and prepared foods. Thanks to smaller square footage, these stores allow Wal-Mart to enter more urban food desert markets. Wal-Mart is also testing online grocery delivery, now available in Denver, Colorado, San Jose, California, and San Francisco, California.
Whole Foods does not currently offer online grocery delivery services, but does feature online ordering for pick-up at certain locations. Sprouts Farmers Market, another potential competitor in food deserts, reported same store growth between 8% and 9% for Q2 2014 and has plans to open as many as 24 new locations through the U.S. in 2014. The company does not currently offer online grocery delivery or pick-up service at its locations.
Whole Foods, Neighborhood Market, and Sprouts Farmers Market feature similar items, so for customers--especially those who rely solely on public transportation to get to the grocery store or who lack the time to spend shopping for groceries--it may come down to the convenience of home delivery or store pick-up over which brands they like best.
A brief history lesson
Opening store locations in low income, low access areas isn't a new concept – but it's one that can provide steady profits if Whole Foods continues to monitor operating margins and maintaining strong store comps. In 1930, east coast-based King Kullen Supermarkets became one of the first documented supermarket chains in the United States. Its founder, Michael Cullen, decided open a store that sold groceries and other household items in run down, low rent areas. Few thought the store would succeed, but thanks to low rents, careful inventory control, and a community in need of a grocery store, the chain grew.
The moral of this story: keep a watchful eye on how Whole Foods works to maintain lower prices and profitable operating margins while dealing with increased competition because as history begins to repeat itself, Whole Foods could really profit from a diverse economic mix of customers.
John Mackey, co-CEO of Whole Foods Market, is a member of The Motley Fool's board of directors. Erica Thinesen has no position in any stocks mentioned. The Motley Fool recommends Whole Foods Market. The Motley Fool owns shares of 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.