January, 2015

Fruits of Thought

Whole Foods' Reaction To Organic-Margin Squeeze Threatens Efforts To Boost Consumption

For many years, the organic industry provided a disproportionate share of the industry’s profitability, extending from growers to retailers. It makes sense. The requirement that land being used for conventional growing cannot be certified organic without a three-year transitional period holds supply in check. As Wal-Mart learned in its various efforts to sell more organic produce, even the mighty power of its PO cannot instantly and magically summon massive increases in the production of organics.

Anyone in the business knows that growers are their own worst enemies — anxious to plant as much as they can and often undermining their own markets. This is not their fault; it is a kind of “tragedy of the commons” problem in which the individual interest trumps the communal interest. Allowing one’s own animals to graze “on the commons” before someone else’s eat the grass is a classic example.

There is, however, indication now that the organic market is at a tipping point, and although the category may continue to grow, it will not be disproportionately profitable in the future. Part of it is seen in the sales numbers. In its most recent survey, the Organic Trade Association found that organic sales increased 11.5 percent year-on-year. That is growth, but not Silicon Valley-style growth. One doesn’t get the sense that the production is straining to meet the demand.

And some of this growth is not really representing increased demand for organics at the consumer level. Some of the growth in organics at the fresh produce level is accounted for by retailers deciding to go 100 percent organic on low-volume items such as herbs. This is not because consumers are screaming for organic items. It is because there is a certain segment of the market that wants organic and others that don’t care. These are not deeply price-sensitive items as they are bought in low quantities, so if retailers can simplify their operations, avoid multiple SKUs and just sell organic, they would do so as it allows them to simultaneously access the whole market and simplify their operations.

However high-end food retailers around the country tell us that they are finding resistance to higher prices on organics, and this resistance is leading to margin compression in the category. This makes sense as well. With all food retailers looking to sell organics, from giant Wal-Mart on down, consumers have more choices and will increasingly resist paying more for parity products that they can buy elsewhere less expensively. It is a natural outgrowth of the existence of national organic standards. If the government sets the standards, then one can get the same product whether one buys organic bagged salad at Whole Foods or the “Bargain Basement.”

This, of course, is a very big problem for a retailer such as Whole Foods. It can reduce prices to be competitive, but that is a direct hit to profitability. To maintain its pricing differential, it needs to maintain a positioning differential — thus its first national advertising campaign, which is themed around a “values matter” tagline.

The idea is simple, persuade consumers that even though other retailers may offer products that appear to be the same or similar, they are actually very different. Why? Because Whole Foods has “values” that other retailers do not have, and these values are used as a kind of filter to select what products are sold in its stores. So what seems like a parity product is not, because the back story that Whole Foods created — the way the growth of the products affects the environment, the way the labor is treated, etc. — is very different.

In produce, Whole Foods is promoting a “responsibly grown” program with an elaborate “good, better, best” matrix. Unfortunately, using terms like “responsibly grown” on proprietary programs is specifically designed to make the offerings of other retailers look “irresponsible.”

This would be unreasonable under any circumstances. Whole Foods is a comparatively small organization. It sells only a tiny percentage of the produce sold in America, Canada and the U.K., which are the markets it operates in. It doesn’t make much sense to say that its less-than-1-percent market share is the only responsibly grown produce.

The criteria is not very transparent for earning the various levels of “responsible growing.” Most of what is known is idiosyncratic and not widely recognized as “responsible” or “irresponsible.” For example, Whole Foods wants to ban certain legal pesticides, but it hasn’t presented any analysis that what replaces those pesticides improves the food, the environment or anything else.

And it is not even clear there is much of a difference. Most produce at Whole Foods comes through the same supply chain that is used by the rest of the world. That is why Whole Foods was recently mentioned, for example, in the big Los Angeles Times series on abused Mexican laborers [further details in the Perishable Pundit excerpt on page 20]. The company doesn’t have unique capabilities to monitor worldwide production sites.

Whole Foods is straining to find a new point of differentiation in a world in which organic is being commoditized. But in the course of doing this, if it implies that consumers should shy away from produce sold by other retailers because their produce is “irresponsibly grown,” it will hurt the health of consumers as they avoid produce altogether and buy less healthy products. A decline in produce purchasing will break the market for farmers. Values do matter, but what values are being expressed by a program that casts aspersions on perfectly honorable producers and scares consumers away from fresh produce?    pb