Whole Foods' price problemWhole Foods faces similar problems. The grocery chain has long been a mecca for lovers of fine foods, including organic and gourmet products. But it's getting harder for Whole Foods to charge the premium prices that go with those products, says retail analyst George Whalin.
"Whole Foods doesn't have a product for which there is not a very good, viable alternative in a supermarket," he says.
The numbers bear this out. Although Whole Foods enjoyed double-digit sales growth during much of the past decade, sales have now slipped for six quarters in a row and were down 2.3% in last year's third quarter. In contrast, third-quarter sales were up 2.6% at, which shows that more consumers are turning to lower-priced chains. Third-quarter sales of perishables at were the strongest in 11 quarters.
Whole Foods is fighting back with "madness" sales and "Whole Deal" coupons.
But any hit to margins from offering discounts is being covered up by another change that does not bode well for the long term: Whole Foods is slowing down its growth. Newer stores weigh on profit margins because they take some time to ramp up to full speed. Opening fewer stores raises overall profit margin, but at the same time it robs the company of the growth that would lead investors to pay a higher price for the stock.
Morningstar analyst Michelle Chang also worries that this could harm employee morale, because workers will make less, as they are paid partly with stock options and other incentive-based pay. This in turn could hurt customer service, a key factor in Whole Foods' success.
Overexpansion and VegasMany of the companies that sold us the good life during the bubble days expanded too rapidly because they thought they could go on doing it forever. In this recession, that expansion is coming back to haunt them.
Whole Foods' showcase megastore in London, a product of those days of hubris, now loses $18 million a year. Starbucks has had to take big write-downs on a round of store closings.
MGM Mirage offers a particularly lavish example of expansion in the midst of recession. Last month, the casino company opened the doors of CityCenter, an $8.5 billion casino, hotel, retail and luxury condo extravaganza on 67 acres of the Las Vegas Strip.
Many Vegas experts are worried about the timing. The complex adds more than 4,000 hotel rooms at a time when casinos have had to cut room rates dramatically to keep their hotels at or above 90% occupancy. In the first nine months of 2009, MGM cut its average daily room rate to $111 from $154 the year before.
Lower room rates fill rooms, but they also attract visitors who spend a lot less on food, drinks and entertainment, which became some of the key revenue drivers back in the bubble days. More than half of MGM's net revenue comes from nongambling activities. Overall, MGM revenue was down 16% during the first nine months of last year compared with the year before. Noncasino revenue fell 21% to $3 billion, and casino revenue fell 12% to $1.9 billion.
MGM Mirage CEO Jim Murren told The Associated Press recently that the resort will help the Las Vegas economy in the long run. But throwing extra capacity into the mix while consumers are on a frugality kick will hold down room rates and the gambling take for quite a while -- key reasons Goldman Sachs analyst Steven Kent has a "hold" rating on MGM stock.
Holding the line on pricesSaks hasn't committed the sin of overexpansion. But it's been reluctant to offer less-expensive goods than other luxury chains do, says Jharonne Martis, the director of consumer research at Thomson Reuters. So it will likely continue to struggle against competitors that offer a taste of luxury at lower prices, like Nordstrom and Neiman Marcus, says Morningstar analyst Kimberly Picciola.
Saks says it has made substantial changes by introducing several lower-priced luxury items and negotiating new, exclusive and more-affordable lines with popular labels.
Luxury-home builder Toll Brothers is in the same boat as Saks, though in an entirely different market. Last year, the company sold homes with an average base price of $626,300, plus $163,000 per home in custom options. The company expects lower closing prices of $540,000 to $560,000 for 2010, but that wouldn't be enough to boost sales. Toll Brothers expects to sell significantly fewer homes this year compared with last year -- one reason Deutsche Bank analyst Nishu Sood has a "hold" rating and an $18 price target on the stock, which recently sold for $19.
So what could help these companies (and us) escape these frugal doldrums? For consumers to move out of frugality mode, retail analyst Whalin says, we need to see three things:
- Unemployment will have to fall to 7% to help restore consumer confidence. It recently stood at 10%, so there's a long way to go.
- Housing prices have to improve significantly so that fewer people owe more on their homes than they are worth.
- And third, consumers have to see a reversal in the current pattern of huge government spending, which has them worried about higher taxes.
None of this is likely to happen soon. "We won't get out of this in 2010," Whalin says.
At the time of publication, Michael Brush did not own or control shares of any company mentioned in this column.