Is Whole Foods the Next Costco?

Daniel is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

At a glance, two recent retail success stories, Costco Wholesale (NASDAQ: COST) and Whole Foods Market (NASDAQ: WFM) don’t seem to have much in common. One sells everything from potato chips to flat-screen TV sets out of a no frills big box club store, and the other sells organic produce and gourmet foods from a fancy supermarket.

Yet the two retailers have a few things in common: rising revenues, share prices, and sales. Between November 2010 and May 2013, Costco’s revenues went from $72.38 billion to $104.89 billion. Whole Food’s revenues went from $9.37 billion in December 2010 to $12.52 billion in March 2013.

Whole Foods’ same store sales increased by 6.6% in the first quarter, and Costco reported that its same stores rose by 5% in May. The increases are pretty similar, aren’t they? What’s going on here? Why are these two retailers doing great while bigger players such as Wal-Mart are reporting anemic sales? Could some of the same factors be driving the two company’s sales?

What Whole Foods and Costco have in common

Whole Foods and Costco do share some characteristics that investors might not see. These characteristics are:

  • Both chains cater to upper middle class shoppers who like to get the most for their buck, but dislike traditional discounters. These shoppers also value their time. They go to Whole Foods and Costco because they know they won’t waste time there.
  • Both Whole Foods and Costco are likeable. People like both chains and enjoy shopping at them. We should not dismiss likeability as an asset; it has turned a wide variety of companies ranging from Volkswagen to Apple to Bank of Internet into great investments. Likeability is one of the best assets that a retailer can have because people will spend more money at a store they like.
  • Both retailers go out of their way to be liked and create an enjoyable shopping experience. Shopping at either store can be fun; shopping at Wal-Mart and traditional grocers is often a hassle.
  • The two chains target a similar kind of shopper -- an upper middle class professional with a good job or successful business and a steady income. This makes them practically recession proof. Unlike Family Dollar and Dollar General, they don’t have to worry if Congress decides to cut welfare benefits or raises the payroll tax. A person who can spend money on a Costco membership or Whole Foods organic produce is probably not shopping with food stamps.
  • Whole Foods and Costco are rule breakers that can attract large numbers of customers without having to resort to advertising and traditional costly retail gimmicks. Their reputation is what brings customers in, not the sales or the ads. In fact, neither company runs much advertising.

Okay, there’s a host of differences between the two chains, but you get the idea; they have very similar characteristics. Both chains are rule breakers that appeal to a new class of consumers that dislike traditional retailers and avoid them like the plague.

Both chains are also growing. Whole Foods plans to open 40 more stores in Canada and expand to 1,000 stores. Costco added 1.6 million new members in the first quarter of 2013.

Is there a ceiling to the growth?

Obviously, there’s a ceiling to this growth that both Whole Foods and Costco could run into sooner or later. They could over expand, and their stores could start stealing customers from their other locations. Over expansion can also lead to a drop in standards and likeability, which has happened to some big chains, including Wal-Mart.

So will Whole Foods’ share price rise to the levels Costco’s has hit in recent months? Based on the shared characteristics and growth, there’s a strong possibility it might. To be fair, Costco has sources of revenue that Whole Foods lacks, including gasoline sales, appliances and hardware, electronics, office products, and membership fees. That could make the difference, particularly in a prolonged recession.

Yet both chains have demonstrated an intriguing ability to attract and retain the loyalty of a class of very fickle customers. More importantly, that class of customers has a lot of disposable income and appears to be growing. That asset might be more important than any other in today’s retail marketplace.

The retail space is in the midst of the biggest paradigm shift since mail order took off at the turn of last century. Only those most forward-looking and capable companies will survive, and they'll handsomely reward those investors who understand the landscape. You can read about the 3 Companies Ready to Rule Retail in The Motley Fool's special report. Uncovering these top picks is free today; just click here to read more.

blog comments powered by Disqus