As the first company to really offer organic and natural food on a widespread scale, Whole Foods Market (NASDAQ: WFM) benefited from its first-mover advantage and had the luxury of charging premium pricing. However, many other companies have begun to see the potential in this market, including dedicated natural stores like Sprouts Farmers Markets (NASDAQ:SFM) as well as bigger all-in-one retailers like Wal-Mart (NYSE:WMT).
While these competitors each pose unique threats to Whole Foods, its The Kroger Co. (NYSE:KR) that could take the biggest bite out of Whole Foods' market share. Does Whole Foods really need to worry about Kroger?
Kroger gets fresh
In response to consumers becoming more health-conscious Kroger has started its own push to appeal to the organic and preservative-free market with a dedicated natural food private label as well as natural-food-centric stores.
Kroger's natural and organic private label, Simple Truth, already has over 35,000 products and boasts natural ingredients and no preservatives. Simple Truth made $1.2 billion in revenue in 2014, just two years after its launch. Kroger COO Mike Ellis called it the most successful brand launch in the company's history.
Additionally, the grocery chain has started to build new locations and convert existing stores to hybrid models similar in feel to Whole Foods, called Fresh Fare, with prepared food, natural options, and a more local feel. The company currently has around 77 of these stores across the country, with the ability to easily convert many more of its properties to this concept.
Whole Foods' recent momentum -- can it hold?
A study from Bloomberg conducted during May of 2014 concluded that Whole Foods had 13% higher average prices on a basket of nearly 150 branded items, and as much as 22% average higher prices on produce, than its most similar competitor Sprouts Market. With Sprouts and so much other competition, Whole Foods can no longer charge high prices without losing customers to new to the space lower-cost competitors. As a result, the company has begun to cut prices and make its pricing more transparent.
Of course, this price cutting, along with higher total food costs for Whole Foods, has pushed gross profit margin down from 35.8% at the end of 2013, to 35.5% at the end of 2014, and most recently to 34.8% in the first quarter of 2015, which is its lowest point since 2011. While the change toward lower prices and increased volume is probably a good long-term strategy in light of increased competition, it will mean Whole Foods' bottom line could be hurt if the company can't raise volume enough to make up for lowered costs.
Still, Whole Foods can continue growing through its total number of locations. Because Whole Foods is still not in many regions of the U.S., there is still plenty of room for lots of new stores without concern of saturating the market. However, this is where Kroger becomes a real threat.
Why Whole Foods should be worried about Kroger
Whole Foods added 38 new stores in 2014. The company's plan is to triple its store count in the next decade or so, up to 1,200 locations. Currently, the company has over 400 locations, and it's on track to reach the 500-store milestone in 2017.
Whole Foods may have a vision of tripling its store count in the next 10-15 years, but it will have to reach that goal while facing increasing competition from Kroger. In places where Whole Foods has not yet expanded into, Kroger already has a foothold, such as in the Midwest, Colorado, Arizona, etc. And in places where Whole Foods already has a presence, Kroger will soon want to be, such as Florida and the Northwest.
Kroger currently has 2,625 locations under 24 different names (King Soopers, Ralphs, etc.). The company only operates in 34 states, so there is still has room to grow around the country, too, either through new stores or acquisitions.
Case in point, Kroger bought out Harris Teeter in January 2014, giving it immediate access to much of the east coast market and bringing itself into direct competition to Whole Foods in one of its most important regions. Through this kind of expansion, Kroger could easily bring its Simple Truth label and Fresh Fare concept to many consumers who might choose cheaper Kroger products over Whole Foods' offerings.
Whole Foods does have the chance to expand further with more locations, and more locations will make for nice bumps to the top-line. However, Kroger poses a major threat to Whole Foods' new store expansion because Kroger is already such a massive force in the grocery industry – with already nearly 7 times as many locations as Whole Foods -- and now it's competing for natural food market share with Whole Foods in some of its key current and future markets.
When it comes to the ability to make new expansion investments, Kroger's size gives it an advantage over Whole Foods. In Kroger's Q4 and full-year results, released in February, the company posted its 45th consecutive quarter of rising same-store sales. This led to $109 billion in revenue for the year, compared to $14.2 billon for Whole Foods' 2014 fiscal year ended September 28th, 2014.
With so many more stores, the company already operating on a lower-margin business model, and with much more capital for expansion, Kroger is definitely a threat, and Whole Foods and its investors should be worried.
John Mackey, co-CEO of Whole Foods Market, is a member of The Motley Fool's board of directors. Bradley Seth McNew 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.