Vertical Integration of Whole Foods - Case Study Example

Vertical Integration Contents Introduction 3 Vertical Integration of Whole Foods 4 Market Structure of Whole Foods 5 Economies of Scale and Extentof the Market 5 Economies of Scale 6 Number of Firms 6 Asset Specificity 7 Firm Specific Knowledge 7 Uncertainty 7 Scope of Opportunism 7 Monitoring Costs 8 Complexity of Production 8 Coordination and Innovation 8 Differentiation 8 Production and Transaction Cost 8 Further Scope 10 Conclusion 11 Reference List 12 Appendix 14 Introduction Whole Foods Market Inc. is an American multinational retailing concern. The company engages in selling natural and organic food products. The company was founded in 1980 by John Mackey and the headquarters are located in Austin, Texas, U.S. It operates in the health food and grocery store industry. Since its inception, the concern has been able to greatly expand scale and scope of its business operations and currently operates in more than 365 locations around the world. The food products sold by the company are natural and include minimum hydrogenated fats. Artificial sweeteners, preservatives, colours and flavours are not added in products sold by the concern (Harper, et al., 2006). Whole Foods Market Inc. had first expanded its business in Dallas and Houston. It had acquired the Whole Foods Company in 1988. In 1989, the company opened a store in Palo Alto, California. From 1990, the concern experienced rapid growth in business by acquiring Wellspring Grocery, Bread & Circus, Mrs. Gooch’s Natural Foods Markets, Bread of Life, Fresh Fields, Florida Bread of Life stores, Vino stores and Nature’s Heartland. In the period following 2001, the company expanded its business in Manhattan, Atlanta, Ontario, Georgia and Minnesota (Whole Foods Market, 2014). In 2007, stores of the company were opened in Honolulu and Hawaii. This paper will try to analyze the rationality of vertical integration process of Whole Food Markets Inc. The evaluation will be made on the basis of characteristic features of the market. Vertical integration explains the proportion of supply chain owned by a company itself. In general, supply chain of a company can be segregated in separate segments. Each segment manufactures a separate part of the final product. All semi-finished products combine to form the final output. Through this process, a company lowers manufacturing cost and maximizes its operating efficiency (Lin, Parlakuiirk and Swaminathan, 2009). Market structure defines features of a market where a company conducts its business. The numbers of sellers, buyers, nature of pricing, business optimality decisions are few factors on the basis of which market structure is determined. Monopolistic Competition, Perfect Competition, Oligopoly and Monopoly are major types of market structure. Vertical Integration of Whole Foods Whole Foods currently conducts its operations through a decentralized buying system. The concern does not follow a particular supply chain pattern. Instead of following a single pattern of supply chain, the company employs local businesses for acquiring specific merchandise. All major functions of the company are controlled through a multidivisional administrative system. Through this structure, Whole Foods shares several partnership relations with local vendors. Hence, each store of the company selects its own preferred distributor, but products delivered are as per the standards of Whole Foods. A product sold from a company store adheres to norms of Fair Trade Agreement and non-gmo commitment (Whole Foods Market, 2014). So, product offerings of the company are supplied at regional stages. When a new vendor desires to sell products of a company, it registers itself in regional office of the concern. The product demand and quality standards of the new vendor are determined in the regional office. Thus, from the above analysis it can be claimed that the level of vertical integration in Whole Foods Market Inc, is relatively low at present. The company aims to increase its commercial profit primarily through horizontal integration. Currently, the organization is composed of seventeen different firms. In 2007, the concern acquired Wild Oats Market, one of its potential market rivals. As demand for organic and natural food products has increased over time, the company has expanded business through acquisition (Clarke, 2013). The economy is almost stagnant after the recession in 2008 and growing demand of natural and organic foods can decline at any point of time. So, through greater vertical integration, Whole Foods Company must try to lower the average cost of its manufacturing. Rather, the company’s cost would soon increase in the long run owing to USDA certification. As American Dietetic Association has raised questions about the value of organic food, need for such certification has significantly risen (Stuckey and White, 1993). It is highly rational for Whole Foods Market Inc. to extend the degree of backward or upstream vertical integration in supply chain. By increasing upstream backward integration, Whole Foods Market Inc. can successfully improve security of its organic food supply through efficient forecasting. The company can gain higher trust from other trading organizations. At the same time, Whole Foods can communicate about attributes of its food products to consumers in a more proficient manner. Therefore, there is a good scope for Whole Foods Market Inc. to improve the degree of its upstream vertical integration. The alternative motives of the organization relating to sales expansion and managerial efficiency can also be achieved through increased upstream vertical integration. Through this, Whole Foods Market Inc. can successfully reduce costs of intermediary vendor payments. Vertical integration can help to create “synergy” at certain points of time. Under this regime, worth of two integrated assets of a company will be more than that of their actual summation. For instance, Whole Foods can own a special biochemical company, which can enhance quality of natural food products. Through such facilities, the company can easily better product quality, thereby increasing sales by way of augmenting customers’ utility. The technology and human resource capability of the company can also improve with the help vertical integration. So, from the above analysis, it can be claimed that upstream vertical integration can effectively enhance overall brand value of Whole Food Market Inc. Market Structure of Whole Foods Whole Foods operates in a highly competitive market structure. The direct sellers of organic food products like, Trader Joe’s, are potential rivals of the company. Since aggregate demand in the organic food markets is rapidly increasing, number of new entrants within the industry is soaring. Some traditional grocers like, Kroger, Safeway and SuperValu, are also market competitors of Whole Foods. Moreover, giant retailing companies like, Wal-Mart, Costco and Sam’s Club, have also begun to sell organic food products across different marketplaces (Whole Foods Market, 2014). These companies are potential market rivals of Whole Foods Market Inc. By acquiring its direct competitor, Wild Oats, Whole Foods aimed to consolidate its market position through horizontal integration. Figure 1 shows that despite Wild Oats acquisition, sales of the company had significantly declined during the recession in 2008. Hence, in order to lead in the competitive market and increase revenue, Whole Foods Market Inc. must try to achieve higher supply chain consolidation through upstream vertical integration. The company, in general, sells self-standardized natural and organic food products in a monopolistically competitive market structure. The prices and special quality features of products sold by companies within the market are qualitatively different. Economies of Scale and Extent of the Market From the above analysis, it is clear that the process of vertical integration of Whole Foods is not optimal. It is highly rational for Whole Foods Market Inc. to analyze the extent up to which it needs to expand vertical integration within supply chain management. This analysis can be done through make or buy decision. Make or buy decision is the process through which a company makes decision regarding producing a product by way of in-house manufacturing or purchasing the same from an external supplier. However, decisions are made on the basis of cost and availability of manufacturing capacity. The following context of the paper will analyze “Make or Buy” decision making process for Whole Foods Market Inc. based on certain factors (Mclvor and Humphreys, 2000). Economies of Scale Economies of scale can be experienced by Whole Foods by way of its products market demand. From Figure 2 in the Appendix, it can be stated that an economy of scale is experienced when due to increased market demand, average cost of production reduces. Whole Foods should incorporate those products within the supply chain for experiencing high market demand. The food items facing low demand must be acquired by the company from external suppliers. For instance, meat, sea food and Allegro Coffee are popular customized organic food products offered by the company (Whole Foods Market, 2012). Whole Foods should completely own supplying facilities of these unique products owing to their high demand. On the other hand, it can procure those grocery items from external suppliers, which has low market demand. Number of Firms The make or buy decision also substantially depends on number of firms within the industry. If a company conducts business operations in a highly competitive market, then it needs to differentiate its services through increased research and development investments. Since Whole Foods operates in a competitive market, it should try to acquire more product supplying facilities for achieving higher competitive edge. The numbers of supplying firms also determines the make or buy decision. If the number of suppliers is high for a company, then their bargaining powers become low. Whole Foods accrues organic food products from 50 suppliers. Simmons Pet Food and Pitman Family Farms are some of its prominent suppliers (Whole Foods Market, 2014). The bargaining power of each supplier is high as they produce unique organic products. The company should try to own some of these rare supplying firms so as to gain competitive advantage within the industry. Asset Specificity The make or buy decision of a company significantly depends on its asset specificity. Asset specificity defines specific purpose of a particular resource in business. Expenditure made on such resources has low resale value. Whole Foods should aim to manufacture only those organic products, which can be prepared from owned resources. If available capital and labour of the company cannot efficiently produce certain products, then it should acquire the same from external suppliers (Gottfredson, et al., 2013). Firm Specific Knowledge A company should manufacture those products about which it possesses adequate knowhow. Unsweetened vanilla flavoured almost milk, Tortillas brown rice, Hummus roasted garlic, Organic Crisp Bread and Rip’s Big Bowl: Banana Walnut Cereal are some of the exclusive products of Whole Foods (Whole Foods Market, 2014). The company personally manufactures these products because of having specific knowledge about the recipe. So, if the concern tries to augment product base and lower outsourcing of products, then it would surely gain higher competency in the market. Uncertainty Since emergence of globalization, extent of commercial market uncertainty has significantly enhanced. Multinational retailing companies like, Whole Foods, should create an adaptive business culture through which it would be able to capture upcoming positive and negative uncertainties within the market. The scope of its vertical integration should be influenced by uncertainty forecasting analysis. For instance, new rivals can enter in the retailing market, lowering demand share of Whole Foods Market Inc in future. The bargaining powers of company’s external suppliers will be higher under such circumstances. Thus, the company should identify strategic scopes of enhancing the degree of upstream supply chain consolidation (Gottfredson, et al., 2013). Scope of Opportunism The make or buy decision of Whole Foods should be determined by upcoming opportunities in the business world. If some prominent external supplier of the concern runs short of finance, then Whole Foods can acquire the firm and expand scope of its upstream vertical integration. Moreover, if demand for an outsourced product of Whole Foods is high, then the company must try to build internal productive resources whereby it can produce the product, thereby experiencing a lower production cost (Gottfredson, et al., 2013). Monitoring Costs Make or buy decision of Whole Foods should be determined on the basis of product monitoring cost. If cost of producing an organic food product internally is higher than the expenditure incurred for outsourcing it, then the company should not integrate corresponding supplying facility within its supply chain. If scope of vertical integration of the company widens through this process, then it would lower efficiency and increase manufacturing cost (Gottfredson, et al., 2013). Complexity of Production The product outsourcing decision of Whole Foods should be determined on grounds of production process complexity. Complex production process entails higher costs. So, Whole Foods should internally encourage complex production of a product, only if it experiences high market demand \ (Tondel and Woods, 2006). Coordination and Innovation Differentiation According to the theory of economics and business, product and process differentiation is the method through which a company makes its services or produce attractive in the market to the target clientele. However, it should be noted that differentiation is always encouraged by a firm with the essence of rare non-imitable factor endowments. Sales promotion, product features and technology are primary ways through which differentiation can be facilitated (Sloman and Garratt, 2010). Production and Transaction Cost The classical economists always consider long run analysis where all factors of production are highly variable in nature and firms experience constant returns to scale in manufacturing process. Nevertheless, it should be noted that under such circumstances, supply side facts add value to a firm’s competency. Modern economists emphasize on the value of transaction. According to classical economists, production cost can be lowered through efficiency of supply side factors. Modern economists emphasize on the worth of short run transaction costs of business firms. Trade partnership, contract negotiation, compliance monitoring, fulfilment of enforcement, bounded rationality and opportunism are all components included within short run transaction cost of a firm. In addition, continuum of various forms relating to mergers, tapering integration, long-term contracts, franchising and strategic alliances are also covered within the scope of transaction cost. The productive business capabilities of a firm usually increase over time along with rise in scale and scope of commercial activities. It is believed by the classical economists that a firm’s capability completely diffuses in the market in long run. This leads to specialization and vertical disintegration. Even so, it should be noted that degree of diffusion will depend on the learning abilities of a firm and market. Components of transaction cost are alternatives to vertical integration. Through upstream and downstream vertical integration, a company can lower its production cost in business and enhance commercial capabilities. Since components of transaction costs are alternative to vertical integration, increased vertical integration can lower a company’s transaction cost in business. If Whole Foods Market Inc. is able to own most of its upstream suppliers, then its production as well as transaction cost can be lowered. In order to procure organic food products, the concern would entertain least possible business mergers and contracts. In general, production costs are related to a firm’s innovation. On the other hand, transaction cost is associated with a firm’s coordination activities. Hence, in this manner, it can be claimed that production and transaction cost in business are differentiated (Gottfredson, et al., 2013). Whole Foods Market Inc. can always make a choice between coordination and innovation. If the company aims to enhance market competency through innovation, then it would be indirectly pushing the transaction costs to employees. Higher productivity and knowhow of employees can improve the extent of product or process innovation. The employees can be rendered more efficient and productive by way of effectively generating motivation at workplace. If the company decides against pushing transaction cost to employees, then it needs to avail the alternative option of coordination, instead of innovation. Under that regime, commercial competency in the market is enhanced through strategic alliances, mergers and contracts (Gottfredson, et al., 2013). Further Scope Vertical Integration is an expensive, complex, risky and irreversible business strategy. So, Whole Foods Market Inc. should make decisions regarding vertical integration after analyzing transaction costs and risks. Figure 3 in the Appendix shows the primary criteria, which should be considered before practicing upstream or downstream vertical integration (Stuckey and White, 1993). As an alternative to vertical integration, quasi-integration strategies can be implemented by Whole Foods Market Inc. Such strategies comprise joint ventures, technology licences, franchising, strategic alliances and asset ownerships. Quasi-integration strategies involve lower cost and greater flexibility than simple vertical integration. Such strategies would help Whole Foods retain its corporate identity in the competitive market. Through special strategic alliances and joint ventures, the concern can build formal mutual profit maximizing trading relationships with potential rivals. Valuable goods, information and knowledge can be shared through such relationships (Earl and Wakeley, 2004). Through asset ownership, Whole Foods can own specific critical assets in the organic food industry and contract out remaining aspects to the outside market. It is the best process through which company can thwart opportunism associated with physical capital of external suppliers or market rivals. Whole Foods can also expand business through downstream franchising procedure. Under this regime, the company can expand without draining excessive business management resources and capital. This will allow Whole Foods to expand business across many markets through ownership of intangible assets and non-ownership of tangible resources. Apart from joint venture, strategic alliance, asset ownership and franchising, the company can also encourage innovation licensing in business. By purchasing unique product or process related formulae, the concern can enhance its business profit and brand value in the market. All these strategies are alternatives to vertical integration and can be practices for increasing command and control mechanism. Issues in joint venture, strategic alliance and licensing can be minimized by applying efficient business entrepreneurial skills and control mechanism. For instance, Whole Foods should keep proper control and performance records of its business franchisees over different marketplaces. Therefore, through quasi-integration strategies, Whole Foods Market Inc. can substantially increase profit and revenue in the long run (Coase, 2012). Conclusion The state of commercial affairs is extensively complex in the contemporary era. After trade liberalization, global economy has become integrated and degree of market competition has increased. With rise in per capita income levels and living standards, taste and preference patterns of consumers are seen to rapidly change. Consumers are highly conscious about matters relating to health and diet. Overtime, demand for organic food products is increasing across all economies. Nonetheless, with the essence of booming market demand, extent of market competition among retailing firms within this industry have also increased. Hence, companies like, Whole Foods, should try to expand business scale and scope so as to reap soaring market demand for such products. In order to park more loyal clientele, the company must consolidate its supply chain management and improve the level of communication. It would be correct to conclude from the paper that vertical integration of Whole Foods is still not optimal. In order to so, the company must own more supplying firms or expand the scope of upstream vertical integration. Even so, alternative strategies of quasi-integration, like, joint ventures and franchising, can also be considered by the concern. Such strategic moves would help to broaden customer base and improve revenue in the long run (Bresnahan and Levin, 2012). 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Whole Foods Market, 2014. Whole foods market. [online] Available at: [Accessed 19 May 2014]. Appendix Figure 1: Sales of Whole Foods Market Inc. (Source: WFM, 2014) Figure 2: Economies of Scale (Source: McAleese, 2004) Figure 3: Criteria Analysis for Vertical Integration (Source: Stuckey and White, 1993) Read More