Why Wal-Mart and Target Won't Hurt Whole Foods' Profits As Much as You Think

On April 10, Wal-Mart Stores  announced plans to introduce a line of organic items into its stores. Wal-Mart is making a growing effort to compete with specialty grocery retailers such as Whole Foods Market and Trader Joe's.

Wal-Mart plans to sell a line of organic pantry items under the Wild Oats label. This expansion comes just several days after Target announced similar increases in its own organic line of products. 

Whole Foods shares are down 20% from their 52-week high. The media has had concerns regarding the long-term viability of specialty retailers due to retailers' attempts to eat up market share. However, I would like to encourage organic grocery shoppers: Wal-Mart will not put your favorite specialty retailer out of business any time soon.


Change in consumer preferences
For the past 14 years, specialty retailers have taken less of a stake in the organic market. To some this might suggest that Whole Foods is on its way out of the market. Not true. Whole Foods' market share is decreasing, but the reason is because the organic market is quickly growing.

Organic grocery sales in the U.S. totaled $3.3 billion in 1996. Conventional retailers, like Wal-Mart and Target, totaled approximately 7% of sales. Specialty retailers, such as Whole Foods Market, earned 66% of sales.

By 2010, conventional retailers generated 54% of sales, while specialty retailers earned 39%. However, while specialty retailers saw their percentage of total sales decrease, total profits from sales increased. Put another way, the pie had been enlarged.

In 1996, at 66% of $3.3 billion in sales, specialty retailers made approximately $2.2 billion. In 2010, at 39% of $28.6 billion, specialty retailers made approximately $11.2 billion in sales. This represents specialty retail sales growth of 409% despite a 27% drop in absolute market share.

The decline in the percentage of sales and increase in profits from sales are attributed to public demand for organic grocery products. Wal-Mart and Target aren't playing a zero-sum game with Whole Foods. Specialty retailers like Whole Foods have a smaller piece of the pie, but the pie has increased eight times over.

Sales growth
Sales grew 15%-17% annually in the early 2000's before stagnating following the recession in 2008. This high growth rate enticed conventional retailers to enter the market to satisfy pre-existing consumers, resulting in quick market share gains by the conventional retailers.

Conventional retailers are not necessarily stealing sales away from specialty retailers. The decrease in market share for specialty retailers masks the reality of continuous revenue increases.

Going forward, I think that specialty retailers will survive and thrive for two reasons.

1. Wal-Mart and Whole Foods aren't selling the exact same things

Wal-Mart's introduction of a new organic line comes in non-perishable pantry products. Non-perishables, such as tomato paste and chicken broth, make up less than 30% of Whole Foods' sales. 

Nearly 65% of organic grocery sales made by Whole Foods lies in produce and prepared food. Therefore, a major push from Wal-Mart in pantry items is very different than Wal-Mart opening its own version of Whole Foods.

The prices of some pantry items like olive oil, pasta sauce, and balsamic vinegar are even lower at Whole Foods in comparison to similar items at conventional retailers.

Wal-Mart will not steal sales from specialty retailers unless it expands its line of organic offerings. In contrast, Target's new line of organic perishable items puts it in the best position of conventional retailers going forward. This is because its organic products more closely mirror the majority of products that Whole Foods sells.

2. Brand-loyalty trumps all
Whole Foods boasts the best brand loyalty of any grocery retailer, according to a Consumer Edge survey . I anticipate that faithful consumers will not walk away from tomato paste at Whole Foods to pay $0.50 less at Wal-Mart.

About 54% of groceries at Wal-Mart are deemed unacceptable for sale by Whole Foods. The demand for Whole Foods' high-quality organic groceries will not automatically evaporate just because similar items are now available at Wal-Mart and Target.

Final thoughts
The recent rush by the media to assume the downfall of Whole Foods and other specialty retailers is premature. In order to compete with specialty retailers, Wal-Mart must offer more organic perishable items.

Furthermore, I believe that loyal customers will continue to shop at specialty retailers, even with lower prices offered at conventional retailers. Preferences for higher-quality products will push consumers toward the specialty retailers.

Stockholders must temper expectations of rapid organic sales at Wal-Mart at the expense of Whole Foods. Don't sell Whole Foods quite yet. It hasn't spoiled.

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The article Why Wal-Mart and Target Won't Hurt Whole Foods' Profits As Much as You Think originally appeared on Fool.com.

John Mackey, co-CEO of Whole Foods Market, is a member of The Motley Fool's board of directors. Article by Jared Billings, edited by Marie Palumbo and Chris Marasco. None has a 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.

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