The Whole Foods Secret Formula: A Check-In on Conscious Capitalism

May 29, 2014 — 3 Comments

Last February I got to hear John Mackey give a speech about a better way of doing business. He’s a founder and co-CEO of Whole Foods, and he stopped in at a Raleigh Chamber of Commerce event to promote his book, Conscious Capitalism: Liberating the Heroic Spirit of Business.

John Mackey, Whole Foods CEO Photo Source: Joe M500, Flickr (Creative Commons License)

John Mackey, Whole Foods CEO
Photo Source: Joe M500, Flickr (Creative Commons License)

The book’s premise flies in the face of Milton Friedman’s argument that the business of business is business. While Friedman makes the case that the only purpose of a business is to increase value for shareholders (i.e., maximize profits), John Mackey says its obligations are better understood as a balance among five groups of stakeholders:  stockholders, employees, customers, suppliers and the environment.

Mackey actually takes it one step further. He says companies that serve the interests of all the stakeholders have a competitive advantage. They create more value and are rewarded by the stock market.

After his speech I had the opportunity to ask Mackey a question. “If conscious capitalism is such a good thing,” I asked, “why aren’t more companies doing it?”

He responded by saying, in essence, that it just needed a vocabulary, someone to give it a voice, a demonstration to the world that it is a better way of doing business. “I’m giving all of you a secret formula for building a successful business,” he continued. “It will be copied as others see you succeed with it.”

Whole Foods is meant to be the living example of this better model.

Fast forward to this morning. I’m enjoying coffee with a friend at my local Whole Foods. It seems a good time to reflect on Mackey’s secret formula. Since last year the Whole Foods Market stock price has been cut almost in half, dropping from $65 per share to around $37. It’s been a rough ride.

Visit StockCharts.com to see more great charts.

A few weeks ago Mackey joined a conference call of investment analysts to report his second quarter earnings.  In it he reported the following:

Customers look to us to create and curate new and existing products. We offer thousands of items that can only be found at Whole Foods Market. We continue to develop exclusive partnerships in parts through efforts like our local producer loan program through which we have provided over $12 million in loans building relationships with 176 unique suppliers.

As we raise the bar of differentiation, our customers have responded with sales of mission and attribute based products such as organic, non-GMO, whole trade guarantee, responsibly farmed seafood and grass fed beef, along with sales of our exclusion brand products continuing to grow faster than the store average.

True, Whole Foods stocks its shelves with 21,000 different items in attempts to provide everything to everyone. Its local buyers bend over backwards to get the products its customers ask for. This has been a big part of its appeal, but that strategy might not be working as well today as it used to.

Mackey reported that while revenues reached an all-time high last quarter, sales growth and profitability were trending lower. He told his audience that pressure was on from competition, making it harder for Whole Foods to command the price premium to which it had grown accustomed. Ordinarily the company could increase sales by just raising prices a little bit more, (it’s not called Whole Paycheck for nothing), but that hasn’t been working lately. Its customers have been buying less and taking their business elsewhere.

The brutal truth is that competitors are getting better at copying the Whole Foods model. While Mackey’s company was a trailblazer in teaching people about the importance of organic eating – in essence, creating the market for organic food – there hasn’t been much to stop another store from taking the same approach. Walmart is now selling tons of organic food for far less than you can get it at Whole Foods. Kroger is dedicating more shelf space to organics, also cheaper than Whole Foods. And then there’s the real threat…Trader Joe’s, the store at which my family usually shops for food.

Case in point on the price thing. While in Whole Foods this morning, I walk past an aisle with coconut oil. This is something I use a lot in my cooking. At Trader Joe’s, I have one option for buying it: the Trader Joe’s private label version that costs $6 for a 16 ounce jar. At Whole Foods I get six or seven different brand options with the cheapest coming in at $12 for a 12 ounce jar.

Now I appreciate what Whole Foods has done creating this organic market. I like the brand and what it represents. I applaud its managers for their conscious capitalism ideals. But how can I rationalize spending twice as much to get 25% lower quantity of what amounts to an identical product?

This same pricing discrepancy holds true across almost every grocery item we buy on a regular basis. Our food bill would be about twice as high each month if we shopped at Whole Foods with its overwhelming array of options instead of Trader Joe’s with its 5,000 privately labeled items.

And so, despite loving what Whole Foods represents, we spend our dollars at Trader Joe’s and say, “it’s good enough.”

Back on the the Whole Foods earnings call, when time came for questions and answers, investors expressed their frustrations over the slowed growth. Here’s a testy exchange between a J.P. Morgan analyst and Mackey (from a Seeking Alpha transcript):

Ken Goldman – J.P. Morgan

Thanks. I have to admit, I’m surprised by what I perceive to be a constructive tone on this call. You’re telling us that our estimates for the next couple years are significantly too high. Your stock’s down around 14% after hours. One of the questions I’ve been getting lately is does Whole Foods management appreciate that the world has changed and there’s a lot more competition out there?

I’ve got to be honest. I’m not really hearing anything that’s suggesting management is taking this situation as seriously as some investors want you to. There’s a lot of talk about what’s going, not a lot to talk about what it takes to win the change market. I’m really just curious what are you doing differently versus a year ago other than taking your cost down which I think the market’s telling you may not be enough anymore?

John Mackey – Co-Chief Executive Officer

Well, we’re lowering prices. We’re making investments on price. We’re cutting expenses. And we’re…

Ken Goldman – J.P. Morgan

You’ve been doing that for years. You’ve been taking price down for years. I mean, it’s hard to understand.

John Mackey – Co-Chief Executive Officer

No, we haven’t. I mean, if you look at we had rising gross margins for the last five years. So we haven’t been investing in price as aggressively as we probably needed to do. So we’re going to be investing more aggressively in price going forward while continuing to take our expenses down and continuing to innovate and differentiate. That’s our t strategy. We’ve laid it out. So there you have it.

Ken Goldman – J.P. Morgan

All right. Thank you.

Shareholders responded by continuing to sell their stock the next day. Its price dropped 20% after Mackey’s update.

The thing that has been working for Whole Foods all these years might not be working anymore. That same thing has allowed the business to charge enormous premiums for its products. Let’s bring it back to conscious capitalism now. Even though John Mackey suggested to me that his enlightened approach to running a business is one of the reasons for Whole Foods’ success, is it possible he got it backwards? Maybe Whole Foods’ success – those huge profit margins from charging high prices – were the reason it had the luxury of practicing conscious capitalism.

So now the real test comes. With these new market challenges, with this need to cut prices (and expenses) to compete with stiffer competition, and with persnickety shareholder community agitated over recent performance…can Whole Foods respond in a way that honors its commitment conscious capitalism?

My own recent experience suggests this will be tough. On the heels of Mackey’s speech last year to Raleigh’s Chamber of Commerce, I asked a colleague whether conscious capitalism was possible for a business with shrinking market share and declining margins. “For example,” I asked, “could we expect a VCR repair business to pay its employees a living wage plus benefits and still remain competitive?”

He was thoughtful as he answered yes. “If you’re doing things right and doing them well,” he told me, “you’ll always find a market.” At that time business seemed good. We were talking a lot about love and our responsibility to show it to our colleagues, our customers, even our competitors. But as conditions soured, speeches about love turned into talk of “going to war.” The lofty ideals to which we subscribed when the world offered us an abundance found fewer takers when we began to face scarcity.

Let’s not be too hasty with conclusions. These stories play out over a long arc with lots of ups and lots of downs along the way. The turbulence at Whole Foods might turn out to be a temporary rumbling to which the business can adapt and regain its footing. I think that’s a real possibility, and that’s the outcome I’m rooting for.

My heart wants to believe that John Mackey is right; that conscious capitalism can be a new way of doing business by an enlightened generation of corporate leaders. But my head sees human nature as the one constant variable. Through time immemorial, if groups get threatened, virtues quickly give way to survival reflexes. When the boat springs a leak, love does not get the first life jacket.

My head tells me there’s a pecking order to these things, and I’m afraid conscious capitalism might be a luxury practiced when times are good and easily sacrificed when the going gets tough.

But I’m watching you John Mackey and rooting that your secret formula can demonstrate that my head has it wrong. Show me that conscious capitalism can work even when you’re under attack. Prove my heart right.

(Tiny Essay 3)

Paul Dryden

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3 responses to The Whole Foods Secret Formula: A Check-In on Conscious Capitalism

  1. Daniel Johnson May 29, 2014 at 7:11 pm

    Interesting read. I share your hope but wonder if his philosophy is as much marketing as it is a genuine, revolutionary approach to business. Where does Trader Joe’s fall on the “conscious capitalism scale?” They seem closer to Whole Foods than to Wal-Mart. Are there any adherents to this philosophy that market to middle class and poor consumers who can’t afford the premium that seems to come with this approach?

    • Thanks Daniel. Conscious capitalism has definitely become a part of the Whole Foods brand, so there’s a marketing benefit to it. I don’t believe Whole Foods charges high prices for the fun of it. They actually use the prices (and consequent high gross margins) to pay fair wages to their employees, to pay a fair price to their suppliers in order to support practices like organic farming and sustainable fishing, and to leave a smaller environmental footprint. These are good things that just wouldn’t be possible if they cut too deep into their margins. The problem is whether customers want to subsidize these practices by paying huge price premiums when they have “good enough” options like Trader Joe’s (which, as you point out, doesn’t seem half bad with its own approach to doing good things with its profits). You don’t get those things our of Wal-Mart because it charges so little and – in offer to maintain decent margins – makes the difference by paying employees poorly and squeezing every last point out of suppliers (who then can’t afford to pay their own people well in a chain reaction).

      So if customers are satisfied with Trader Joe’s and force Whole Foods to compete more on price, will the resulting margin reductions change its approach to doing “business good?” My uber-logical side says yes. But I hope I’m proven wrong.

  2. I think the main difference today versus when Whole Foods reigned is, as Paul points out, there’s a lot more competition. As a consumer of organic goods and sustainable practices, Trader Joe’s has always impressed me (on a gut level) as the type of company that more closely espouses “my brand” of conscious capitalism. The prices are affordable and the customer service is second to none. You walk around the store and see the values everywhere. Employees are fun, engaging, and committed to customer satisfaction. In contrast, I have always felt that Whole Foods was more about appealing to “the beautiful people” who feel superior because they shop at Whole Foods and can pay the higher prices. I’m not saying that the Whole Foods brand of conscious capitalism isn’t genuine, but they do seem to be stuck in their ways and unable to hold their ground in the midst of more competition (which includes companies that also practice conscious capitalism.)

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