Last week, Jana Partners announced that it has taken a 9% stake in Whole Foods Market, Inc. (NASDAQ:WFM). Among the changes Jana hopes to enact is:
…pursuing opportunities to improve performance by advancing its brand development and by addressing core operating deficiencies in areas including customer loyalty and analytics.
Through technological, customer focused solutions, Whole Foods can recapture market share and differentiate itself once again in the supermarket space.
When Whole Foods Market was founded in 1980, it was one of only a handful of natural food supermarkets in the United States. Over the next three decades, Whole Foods opened new geographic markets nationwide through expansion and strategic acquisitions. By the first decade of the 2000’s, Whole Foods helped ignite a national shift in consumption, as a first of its kind and best in class purveyor of natural and organic foods. By focusing not only on the customer experience in its physical stores, but also shinning a spotlight on the differentiation in the higher standard of products it sourced, WFM was able to redefine how people thought about food origination.
Whole Foods was first measured by the American Customer Satisfaction Index (ACSI) in 2007. With a below industry average score of 73, it was much closer in customer satisfaction to Wal-Mart’s (NYSE:WMT) supermarket offering (71) than to the industry leader Publix (OTC:PUSH) (83). This was perhaps due to customers still adjusting to value proposition that allowed Whole Foods to charge premium prices. However, over the next four years Whole Foods recorded an unprecedented four straight annual increases in their ACSI Score. From 1/2008 to 1/2013 Whole Foods saw its sales increase 53% while consistently maintaining 34% gross margins, far higher than the 21% average gross margins of its competitors. WFM’s strong customer satisfaction allowed it to exhibit pricing power and led to the traditional fundamental improvements that increased its stock a phenomenal +123% over that timeframe (vs S&P 500 -2.9%).
A well-established underpinning of microeconomic theory is that consumers will spend their money on the goods that bring them the most utility. With customer satisfaction as a proxy for utility, this is a concept well founded in classical economic theory and well proven in academic studies from sources ranging from Dr. Claes Fornell (considered the father of customer satisfaction) to the world renown consulting firm McKinsey and Company. WFM’s stock price has been particularly sensitive to customer satisfaction changes as shown in the graph below.
It is easy to see the very strong relationship between the changes in WFM’s ACSI score and the performance of the stock in the subsequent year. However, one cannot simply look at the stock price of WFM in a vacuum and draw the conclusion that changes in WFM’s customer satisfaction were predictive of future stock performance.
The way that customer satisfaction as a metric ultimately gets disseminated to the market at large, is through revenue and earnings surprises. As the ACSI collects customer data about their satisfaction and, by extension, their future buying behavior, those increases or decreases should make their way to the top line of the company within 1 – 3 quarters
(depending on a product’s buying cycle). We expect strong/increasing customer satisfaction companies to have revenue surprises at a greater than market rate and therefore outperform the market in the subsequent year. Here to, the relationship between WFM’s satisfaction score and stock performance is very strong as seen in the table below.
Please note that the ACSI change listed for any above year took place at the beginning of that time period, and thus the relative return of WFM to the S&P 500 is what took place in the 12 months after the satisfaction measurement. In 6 of the 7 one year periods following the release of WFM’s annual ACSI score, the stock either over or underperformed the S&P 500 in the correct direction as indicated by satisfaction changes at the periods beginning (one of the periods listed above had an ACSI score that did not change and was not counted as correct or incorrect).
In the table, the only notable deviation from expectation is the 2015-2016 period where an increase in satisfaction was met by a huge underperformance vs the market. It is however important to note, that while WFM underperformed on an annual basis, there was a mid-year shift where it changed from over-to-underperforming. At the time, each company was only being measured annually by the ACSI and thus was susceptible to timing issues. As we can see, ACSI dropped enormously during the next period and therefore, had WFM been remeasured mid-year, the change in satisfaction might have been apparent sooner. Moving forward ACSI is changing its data collection process so that each company will be measured on a monthly basis, diminishing the probability of mistiming these huge movements.
So, the question remains, what changed about people’s satisfaction with Whole Foods and how can a Jana led intervention get them back to the top? It is likely that originally, customers were satisfied by the broad array of organic options and the availability of sophisticated prepared foods which Whole Foods was the first of its kind to bring to most geographic markets. This gave WFM a relative monopoly in the space, lending them the power to charge premium prices without angering their customer base, regardless of any continued innovation and focus on the customer experience. However, as is the case with most successful innovations, competition such as Trader Joe’s, Fairway, Wegman’s and Kroger (NYSE:KR) began to copy the Whole Foods model. Giving their stores a similar look and feel and offering an ever growing variety of natural and organic products. Whole Foods can no longer differentiate itself on a superior quality of their product offering and therefore needs to refocus on technologically led, customer focused improvements to the shopping experience in the physical store itself and the way that customers interact with the brand.
Jana Partners, with their strong reputation as an activist firm and their historical success in dealing with food service companies such as ConAgra Brands, Inc. (Ticker: CAG) looks to be on track to have Whole Foods looking fresh once again.
Originally posted at Seeking Alpha.
Josh Blechman is the Director of Operations and Capital Markets at ACSI Funds.
