Regulators want to block the merger, claiming it's bad for consumers, but industry experts disagree, citing healthy competition
The popular grocery chain Whole Foods Market (WFMI) charges handsomely for its all-natural and organic offerings—enough to be dubbed "whole paycheck" by many wags. Now, the U.S. Federal Trade Commission charges that Whole Foods would boost prices even higher, while reducing the quality and services at its stores, if it's allowed to acquire chief rival Wild Oats Markets (OATS).
But is that true? The FTC wants to block the $670 million deal announced in February on the grounds that it would prove anticompetitive and harm consumers. "Whole Foods and Wild Oats are each other's closest competitors in premium natural and organic supermarkets, and are engaged in intense head-to-head competition in markets across the country," Jeffrey Schmidt, director of the FTC's Bureau of Competition, said in a June 5 news release announcing the agency's lawsuit aimed at blocking the sale. "If Whole Foods is allowed to devour Wild Oats, it will mean higher prices, reduced quality, and fewer choices for consumers. That is a deal consumers should not be required to swallow."
Large Playing Field
However, what the FTC seems to be ignoring is that the market for natural and organic foods is growing rapidly with a plethora of new entrants, from giant retailer Wal-Mart Stores (WMT), to Kroger (KR), Safeway (SWY), SuperValu (SVU), Publix Super Markets, Costco Wholesale (COST), Meijer, and the fast-growing hip specialty retailer Trader Joe's.
Both Whole Foods and Wild Oats were quick to seize on that fact: "The FTC has failed to recognize the robust competition in the supermarket industry, which has grown more intense as competitors increase their offerings of natural, organic, and fresh products, renovate their stores and open stores with new banners and formats resembling Whole Foods Market," says John Mackey, chairman and CEO of Whole Foods. "Evidently the FTC does not appreciate the many benefits for consumers of the proposed merger, including our plan to invest capital in and improve many of the stores currently owned by Wild Oats."
A combined entity of Whole Foods and Wild Oats would control about 11% of the natural foods market, which is hardly a monopoly. Also, both retailers have built their reputations on the premise that they provide higher-quality produce and are committed to supporting local and small farms. It is these high standards that consumers have grown to depend on when it comes to organic foods, the fastest-growing area in the food industry. According to the Organic Trade Assn., sales of organic foods grew 22.1%, to reach $16.9 billion, in 2006. Together the combined company would squeeze better bargains from suppliers, which should ultimately lower prices in the aisles, analysts say.
Selling More Than Food
"There is so much competition from Wal-Mart and other grocery stores getting into the business that I don't see how these two could have a monopoly," says Peter Cohan, president of Peter S. Cohan & Associates, a management consulting and venture capital firm, who teaches management at Babson College. Additionally, Cohan argues that neither retailer would want to damage their reputation of working well with small farmers. "It just isn't in their interest to exploit the farmers and their smaller suppliers," he says (see BusinessWeek.com, 12/20/06, "Whole Foods and the Celebrity Farmer").
The government noted these qualities in its complaint. "Whole Foods' and Wild Oats' customers are buying something more than just the food product—they are seeking a shopping 'experience' where environment can matter as much as price," the FTC says. However, the agency worries that the transaction would curb direct competition and reduce product quality, service, and choice.
Whole Foods' shares fell 3%, to $40.48, June 5 on the NASDAQ. The stock is down sharply from a high this year of $51.90, which it reached after a 14% gain on Feb. 22, the day the Wild Oats deal was announced, and a 52-week high of $66.25 back in October. Wild Oats rose 1.5% to finish at $17.16 on June 5.
Not Without Precedent
Greg Mays, chairman and CEO of Wild Oats, based in Boulder, Colo., believes that the FTC's anxieties about market dominance are unfounded. "Our associates will benefit from greater opportunities working for a larger combined company, our shareholders will benefit from value creation, and our consumers will benefit from a stronger product offering and the capital investment to upgrade our stores," says Mays.
It is important to note that the FTC has historically been intolerant of mergers among food retailers. Starting in the 1960s, for instance, the antitrust agencies and the courts pursued a very aggressive antitrust policy and got the Supreme Court to block a 1960 merger between Von's Grocery and Shopping Bag Food Stores that would have given the merged firm a 7.5% share of the grocery retailing business in Los Angeles. And in 1971, the FTC charged Kroger of lessening competition in food retailing in the Dayton (Ohio) area, and required the company to divest itself of three discount food departments. Kroger sold the three food departments soon after.
"The FTC took the definition of a narrow channel of retailing and saw this as a merger of the two biggest competitors," says retail consultant Burt Flickinger III, managing director of Strategic Resource Group in New York. "Naturally, with Wild Oats being eliminated and no other major national gourmet chain left, there could possibly be a consumer concern."
Given this history, Whole Foods and Wild Oats have their work cut out for them. Flickinger points out that the companies will have to hire the best attorneys to fight the case. And if the FTC succeeds in stalling the merger, the companies would surely falter. Already both were looking to each other to help revive sales (see BusinessWeek.com, 4/12/07, "Organics: A Poor Harvest for Wal-Mart").
Fresh Direction Needed
Whole Foods, which started in Austin, Tex., 27 years ago, has 194 stores and annual sales of $5.6 billion. It is widely credited with having nurtured the growth of Americans' taste for organic and specialty foods, and it became a stock market darling as sales expanded at a double-digit pace in the early part of the decade. Lately, though Whole Foods' sales and profits have slowed as the big supermarket players expanded their organic, gourmet, and other upscale food offerings. In the second quarter ended Apr. 8, Whole Foods' net income fell 11%, to $46 million, from last year. In the same quarter, sales at stores open at least a year rose 6% in the period. At the same time, Wild Oats also was increasing its sales at a mere 3% to 5% clip. Since October, former CEO Perry Odak and other top executives have left, setting the stage for a buyout.
No wonder investors were already cheering this as a merger that would help reignite some of the financial fire in the companies. Wall Street also was hoping that the merger would lead to new managers who could take the company in a fresh direction: "Whole Foods has a wonderful culture and all that great stuff, but the founder has reached the limit in terms of what he can do and needs to find someone who can take it to the next level," says Cohan.
That level means a focus on extra-special items and avoiding the commodity-level natural goods Wal-Mart and Kroger now sell—even if it means consumers fork over a large chunk of their paychecks.