Personal Finance

Why Starbucks Succeeded While Whole Foods Stagnated

In 1980, John Mackey co-founded Whole Foods (NASDAQ: WFM) -- a store that looked to redefine what grocers could accomplish. He focused on holistic principles: offering the healthiest food possible, creating an equitable workplace, and encouraging sustainable agricultural practices. He later coined the phrase "conscious capitalism."

Seven years later, Howard Schultz bought out what is now Starbucks (NASDAQ: SBUX) . Like Mackey, Schultz has a long track record of offering generous benefits for employees, as well as encouraging sustainable practices by coffee farmers across the globe.

The very first Whole Foods. Image source: Whole Foods.

In many ways, these two companies couldn't have been more alike: a focus on food and drink, run by founder/CEOs who focused on more than just the bottom line. They became "lifestyle" brands for the affluent, conscientious consumer.

Both saw their stocks -- and their underlying businesses -- suffer during the Great Recession, but as we've pulled out of that mess, Starbucks has achieved notable success and seen its stock more than triple in the past five years. Whole Foods, on the other hand, has found no such success, seeing its shares advance just 14% while the overall market surged 60% during the same time frame.

Both were first movers in under-appreciated niches

There was nothing in particular that Starbucks was offering up that other coffee shops couldn't. But for years no one thought patrons would willingly return to pay $2.00 for a cup of coffee.

Potential competition ignored the underlying goal: to become the "third place" in people's lives -- aside from work and home. Two dollars was a pittance to have a friendly place to socialize and work. And between 1995 and 2011, Starbucks increased net income by 20% per year.

Inside Starbucks' original Pike Place location, circa 1977. Image source: Seattle Municipal Archives, via Wikimedia Commons.

Whole Foods likewise didn't have a monopoly on organic produce. But for the longest time, no one took the natural/organic movement seriously enough to devote requisite shelf space. It was a very profitable venture -- net income increased by 43% per year over the same time frame

But here's where they diverged

Coming out of the Great Recession, the competition had caught on. Mom-and-pop coffee stores -- as well as fast-casual restaurants and even fast-food stalwarts like McDonald's -- realized that offering coffee, Wi-Fi, and an inviting place to gather was key.

And grocers quickly saw that the natural/organic food movement was here to stay. In what seemed like the blink of an eye, Kroger became a huge seller of organic goods; Costco was offering it in bulk; and even Wal-Mart developed its own private-label organics.

So why has Starbucks continued to prosper while Whole Foods hasn't.

In a word: convenience.

In its 1996 annual report, Starbucks stated that, "its customers choose among retailers primarily on the basis of quality and convenience , and, to a lesser extent, price [emphasis added]." By the time 2011 rolled around and the competition had caught on, it was too late: Starbucks was by far the most convenient national chain to go to.

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As you can see, the company underwent two building sprees. The first was domestic and took place from 2003 to 2007, when it increased its store count by 30% per year -- adding almost 7,000 new locations. The second was international, and took place between 2011 and 2015, when the number of stores jumped 25% per year -- adding over 6,000 locations worldwide.

But Whole Foods had a different take on its advantages. In 1996, the company stated that it offered, "a broad selection of foods at competitive prices with an emphasis on customer service [emphasis added]."

There's no doubt that Whole Foods succeeded in upping the ante for grocery store customer service. The problem is that any grocer can start a new chain -- or rebrand an old one -- with a focus on customer service. The idea of "convenience" never came up as an important differentiator or strategy in the annual report.

That helps explain why Whole Foods only increased its store count by an average rate of 10% per year -- less than twice as fast as Starbucks.

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Note as well that the 26% yearly expansion rate between 2005 and 2007 was largely due to the acquisition of Wild Oats' locations. Without that, growth would have only been 7% per year during that period.

Real world examples: Which do you find more convenient?

I live in rural Wisconsin with my family. Five years ago, if we wanted organic products, we usually had to travel 30 miles to downtown Milwaukee. The Whole Foods there was one of only two locations in the entire state of Wisconsin. But then, Kroger subsidiary Roundy's opened a new grocery store that was half the distance and was basically a carbon copy of the Whole Foods experience. We don't go to the Whole Foods anymore.

But with Starbucks, there were already three locations in our tiny town of 10,000 people five years ago. While other options have surfaced, I still go back to my local Starbucks regularly. It's just that convenient.

Of course, some will argue that opening a new coffee shop is much less capital-intensive than opening a grocery store -- and they'd be right. But they'd also be missing the bigger point: It was also cheap for Starbucks' competitors, and expensive for Whole Foods' rivals.

What we thought was wise, was foolish -- and what we thought was foolish, wise

For a number of years after the Great Recession, Whole Foods adopted a strategy of opening new stores only with cash from operations. That seemed like a fiscally responsible and wise tactic.

But it ignored what was happening: the commoditization of Whole Foods' business. Had the company decided to take on debt -- or issue more shares -- to accelerate the pace of store opening, it might be in a much better competitive position today.

Of course, shareholders at the time wouldn't have been happy. But then again, that's part of running a public company -- convincing others that you can see around the corner to prepare for what's coming.

Starbucks opened so many stores in the mid-aughts that we made jokes about Starbucks locations opening inside the bathrooms of existing locations. And when Schultz returned to the helm in 2008, he wasn't happy about the rapidity of openings. But in the end, that's turned out to be a difference maker -- a wise move that's ultimately led to market-bashing performance.

It's a humbling lesson to remember as we prognosticate about the "good" and "bad" decisions public companies make. Often times, it is only in hindsight that we can really know what was wise, and what was foolish.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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