Putting It Together: Place: Distribution Channels

Let’s return to our earlier example of Whole Foods’ and Trader Joe’s distribution strategies now
that we understand much more about marketing channels and supply chains. Whole Foods and
Trader Joe’s use very different approaches to source their products, place stores, and get the
products to the stores. Both companies have developed these strategies because of their missions
and their focus on delivering value to target customers. Is one of the distribution strategies better
than the other, or are they both using successful but different strategies?

Marketing Channels

Both companies use the retail channel and deal directly with suppliers.

In the case of fruits and vegetables, Whole Foods has buying relationships with local farmers
(producers) who supply the store with seasonal produce. Thus, if one farmer is unable to produce
a sufficient amount of yellow corn or heirloom tomatoes, the shortfall can be made up by another
farmer. Although challenging to perfect, these short supply chains are agile and difficult for other
big retailers to duplicate.
Trader Joe’s also buys directly from producers. It offers manufacturers detailed specifications for
new products along with the price it will pay, but then it leaves it up to the vendors to create
innovative high-quality items. In return, Trader Joe’s expects a high level of secrecy from its
suppliers, even going so far as to force them to not publicly acknowledge their business
relationship. Trader Joe’s does this because it doesn’t want other vendors, customers, or
competitors to know where it gets its products. In most cases vendors agree to this cloak of
secrecy because they are typically producing a lower-cost version of a product for Trader Joe’s
than for their other customers, and they do not want to create pricing pressure with other
customers by disclosing this.

Sourcing
Whole Foods emphasizes the quality of its products, requiring that stores must not stock products
with artificial flavors, preservatives, colors, sweeteners, or hydrogenated oils.[1] Due to this focus
on quality, customers pay a premium for Whole Foods’ one-of-a-kind produce selection and
quality. Because of its high prices, Whole Foods has been dubbed “Whole Paycheck.”
Nonetheless, loyal customers are happy to pay them. Whole Foods does not compete with other
grocers on price and has no intention of ever competing in that arena. And since many of its
products cannot be found anywhere else, Whole Foods exerts enormous leverage in terms of its
pricing power. Furthermore, Whole Foods filters its product offerings and only carries pure,
unadulterated foods. This is a strong differentiator, which adds value from the customer’s
perspective. Historically, Whole Foods has been able to sell this high-quality merchandise at a
price that provides strong profits, in spite of the higher costs.

Trader Joe’s manages its supply chain by relying on its successful private-label brands. Eighty
percent of Trader Joe’s products are developed either in-house or are created by suppliers
exclusively for Trader Joe’s; average stores carry only 16 percent local products. This strategy
allows Trader Joe’s to differentiate from its competitors and reduce its marketing costs,
and selling its own in-house brands reduces the number of SKUs in its stores. This collapses the
number of supplier relationships and leads to a more efficient and controllable supply chain.[2]

Distribution Networks and Inventory Management

As Whole Foods has increased the number of retail centers it operates, it has suffered growing
pains in efficiently managing distribution of products to its stores. The chain is growing at such a
fast rate that it struggles to keep up with demand for products and keep shelves stocked. The
single biggest reason for inefficiency is Whole Foods’ almost completely decentralized back end.
It has twelve geographic divisions, a national headquarters in Austin, regional distribution
centers, bakery facilities, kitchens, seafood processing facilities, meat and produce procurement
centers, and a specialty-coffee/tea procurement operation.[3] Each geographic division has its own
office, regional president, and oversees its own store network. Many outsiders scoff at its supply
chain and consider it amateurish and lacking in professionalism. But with the ample margins that
Whole Foods commands for its products, it doesn’t face immediate pressure to
improve efficiencies.
The stores operate under minimal governance and are given maximum freedom to source a
product mix that is appropriate for their location. Whole Foods stores operate under the premise
that they need these freedoms to meet the unique buying needs of its local customers. The only
governing rule put in place by the corporate office is that stores must not stock products with
artificial flavors, preservatives, colors, sweeteners, or hydrogenated oils. A down side to this
local purchasing policy is that consistency is compromised across the chain. Every retail location
carries a variety of products that distinguishes it from other stores in the same chain. Not
surprisingly, it is difficult to achieve economies of scale.

Trader Joe’s manages its distribution networks by minimizing the number of hands that touch the
product, thereby reducing costs and making products quickly available to their customers. You’ll
recall that Trader Joe’s orders directly from the manufacturer. The manufacturer, in turn, is
responsible for bringing the product to a Trader Joe’s distribution center. At the distribution
center, trucks leave on daily resupply trips to local stores. Because of the average store’s small
size, there is little room for excess inventory, and orders from distribution centers need to be
incredibly accurate.

Trader Joe’s primary success factor has been its inventory-sourcing and pricing model: it limits
its stock to specialty products that it can sell at very low prices. This is accomplished by
purchasing large quantities of specialty goods (that do not interest conventional supermarkets),
thereby securing low prices. Customers are able to purchase unique products that
guarantee value. This strategy also means that customers buy more because Trader Joe’s sells
twice as much per square foot compared to other supermarkets. It achieves these quantities by
focusing on a smaller range of products—typically carrying around 2,000 SKUs, whereas the
typical grocery store carries upwards of 30,000.[4] This small figure is likely exacerbated by the
size of the store (one-third the square footage of an average supermarket) and cramped aisles.

The Results
Whole Foods’ stock price has declined sharply since February 2015, while Trader Joe’s
continues to thrive. Lower-cost competitors like Wal-mart and Kroger’s saw Whole Foods’ high
prices and margins and have been able to add high-quality organic products to their offerings at a
lower price because of supply chain and distribution efficiencies. In other words, Whole Foods’
sourcing strategy, once thought to be a sustainable competitive advantage, can in fact be
replicated more efficiently by competitors. The press coverage of some of the challenges is
highlighted below: