Whole Foods Market (NASDAQ:WFM) took another big step toward launching its downmarket sister chain last week, naming the new enterprise 365 by Whole Foods Market.
The new chain will be run by Jeff Turnas, a 20-year veteran of the company who has previously served as head of the North Atlantic region and the U.K. segment. Turnas said the new chain would be "fun and convenient" and provide "A modern, streamlined design with innovative technology and a carefully curated product mix [that] will offer an efficient and rewarding way to grocery shop."
Investors shrugged off the news -- the stock remained mired near a 52-week low and more than a third below its all-time high as competition continues to threaten its growth. A month ago, shares dropped 10% in a single trading session, following a disappointing earnings report and the initial announcement of the new chain. Some analysts said they saw the 365 concept as capitulation, as it seems to be an implicit admission by management that its current full-line stores do not offer the best value.
However, reports of Whole Foods' demise have been greatly exaggerated, and the 365 chain seems like a smart move to get its performance back in gear. Here are three big reasons why:
1. Divide and conquer
Whole Foods may be the Cadillac of the supermarket industry, but not every customer wants a Cadillac -- and more importantly, not every customer can afford one. Segmentation, as this strategy is known, is practiced in virtually every corner of the retail industry, from cars (Lexus vs. Toyota) to clothes (Nordstrom vs. Nordstrom Rack) to hotels (Holiday Inn vs. Holiday Inn Express).
Supermarket chains don't shy away from it either. Rival Kroger, the biggest grocery company in the country, counts downscale chains like King Sooper's and more upscale ones like Harris Teeter among its banners.
As the organic market has gone mainstream, demand has grown, and a wider range of the population now seeks healthier foods. Millennials, who may not have the income to be regular Whole Foods shoppers, are a prime target for a chain like 365. Meeting customers' needs at the right price point should be seen as savvy management, not giving up.
2. Whole Foods is still the best
Nobody knows this industry like Whole Foods, which pioneered organic and natural grocery over 30 years ago, and rivals don't have people like Turnas with 20 years of experience in organic grocery to lead new ventures. Whole Foods' supply chain, branding, and human resources will be just as valuable for 365 as they are for the parent chain.
As Whole Foods stock has sunk, a misconception has grown about Whole Foods' performance. While growth has slowed, it's still well above average for the industry. Whole Foods' same-store sales increased 3.6% in its most recent quarter on an overall sales increase of 10%. Meanwhile, nationwide grocery sales were up less than 3% in that period.
Whole Foods' profit margin is still well ahead of the industry, too. Whole Foods sees 4% of sales end up on the bottom line compared to just 1.6% for Kroger, indicating market power. Finally, its brand image also remains strong with customers, ranking near the top in most customer satisfaction surveys, which will lend support to 365.
3. The price is right
The most consistent knock on Whole Foods is its high prices. The company is often derisively called "Whole Paycheck," a stigma that hobbled it as mainstream chains like Wal-Mart embraced organic foods and alternative grocers like privately held Trader Joe's proliferated. Consumers now have more options than they used to, and many are turning to lower-priced alternatives to get their organic fix.
This may be the best argument for the 365 chain, and Trader Joe's success serves as a model. Trader Joe's stores have a smaller footprint than Whole Foods', but bring in double the sales per square foot.
In addition to lower prices and smaller stores, there are other ways that 365 will be mimicking Trader Joe's. By depending more on Whole Foods' private label 365 line, it's borrowing another page from Trader Joe's playbook -- the latter internally sources most of the products it carries and sells very few brand names. This strategy has kept prices down and given Trader Joe's a loyal following. Perhaps it's appropriate that Whole Foods would borrow from the competition, as the competition has borrowed so much from it.
There is no doubt about the growing popularity of organics, as sales are projected to grow 11% this year. Whole Foods is still the best known brand in the space. It just needs to meet those customers where they are. The new 365 line gives it the best opportunity to reach the ones that it's been losing to Trader Joe's, Wal-Mart, and other newcomers.
John Mackey, co-CEO of Whole Foods Market, is a member of The Motley Fool's board of directors. Jeremy Bowman owns shares of Apple. The Motley Fool recommends Apple and Whole Foods Market. The Motley Fool owns shares of Apple 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.