Selling groceries is a grinding, low-margin business — except for Whole Foods (WFM). The world’s largest natural and organic grocer is a financial powerhouse with a market capitalization matching that of Kroger (KR) which is eight times its size by revenue. Keeping the magic alive as Whole Foods (No. 232 on the Fortune 500) expands aggressively is partly the task of Walter Robb, 59, who shares the CEO job with founder John Mackey. Robb started a 1,000-square-foot natural and organic food market in 1977, not long after graduating from Stanford, then built a grocery business and sold it to Whole Foods in 1991. He talked recently with Geoff Colvin about making the chain more competitive on price, the power of its culture, flying Southwest Airlines in the middle seat, and much else. Edited excerpts:
Until just a few years ago, Whole Foods was widely regarded as a niche business. It’s now challenging the largest mainstream grocers. What has been most important in broadening its appeal?
Recognition of the connection between health and diet, which the media has picked up, which science has backed up, and which people’s own experiences have demonstrated. It’s that, set against the backdrop of a health care crisis in this country with a $3 trillion annual spend and no way out other than people taking responsibility for their diets. I also like to think that we create a great experience for our customers.
Traditional grocers are stocking more and more organic and natural foods. What prevents them from taking over some of your business?
This has been happening for a number of years, and we’re continuing to gain market share. Our market capitalization today is larger than most of those companies put together, which is just a symbol of the size of the opportunity. The fact that they’re carrying these products suggests that this is a real growing market. We learn from competitors, we grow from competitors. It makes us better retailers. I love it. I embrace it.
You have a long-term program of narrowing the price difference between Whole Foods and some of your large competitors. What’s the strategic thinking behind that?
That’s the way to build long-term market share for Whole Foods. I mean, the only impediment you hear is that it’s more expensive, right? Which is less true than it used to be, and if we can get through the price thing, then we can talk about what we want to talk about, which is the quality of the food. There is a difference. You have seen crises where this has surfaced, and more of these are going to surface, I can tell you. If we can be relevant on price, we can get to the quality conversation that we really want to have.
Most of your major competitors have customer loyalty programs. Whole Foods doesn’t. Why not?
Those first-generation loyalty programs are a little stiff for me. They generate reams of data that don’t look like they actually translate into much, at least for us. But I think in this next generation of personalizing the relationship with your customer, we may well look at something like that in a different form.
My image of the Whole Foods customer is someone with a graduate degree, driving a Prius, with the radio on NPR. Accurate or off-base?
Well, they’re there. But the company is now 33 years old, and what has been significant in our success has been the broadening of our customer base. We have three generations of customers now: the boomers, the Xers, and the millennials, and our fastest-growing customer is the millennial who grew up in Whole Foods with their parents.
Affluent consumers cut back their spending in the recession in a way they hadn’t done in previous recessions. How well are they coming back from that?
After the Lehman Brothers shutdown, the market just froze in a way we haven’t seen in my 30-plus years in business. What I see now is that they’ve adapted, and they’re much more resilient. They have strategies. Of course the economy’s on much more solid footing right now. In the end, when you start thinking about the things that matter, the quality of your life and the quality of your health are really preeminent, and people have decided that’s an investment worth making.
A big part of Whole Foods’ financial success has been earning returns on capital that are much higher than mainstream grocers’. What has been the key to making that happen?
Focus. We are an EVA [economic value added] company, which is to say we calculate the cost of capital in generating those returns. We’ve put a real focus on return on invested capital the past few years and have been able to improve our returns significantly. We now build a store at lower cost and have more of a disciplined focus on coming out of the box in a strong fashion. We have the highest sales per square foot in the supermarket industry, and that makes a huge difference. When you have $900 a square foot in sales, that helps to generate returns.
An important element in the growth of Whole Foods has been management’s relationship to the employees. What has been the most important aspect of that?
Whole Foods is built on the idea that we want to encourage the creativity and intelligence of every one of our team members. If I could draw back the curtain, what you would see is a very strong culture of empowerment, and that is the secret of Whole Foods. We have these 78,000 fantastic team members who have a little room to run, and that is the strength of the company — the culture, which is the living, breathing heart of the company.
You have a policy that restricts the cash compensation of top executives to no more than 19 times the average salary in the company. What’s the effect of that?
The effect is keeping the faith. When people see in America that chief executives make 500 times the average wage — I’m not judging what other people do, but for the Whole Foods culture, we are at 19 times. When I walk around and talk with team members, I have the same benefits. I fly Southwest Airlines (LUV). I’m in the middle seat. And my pay is reasonable relative to theirs. It makes sense to them. So when you say we’re going somewhere, and we’re going together, they can believe that. It’s credible.
What’s your employee turnover?
Our voluntary turnover last year was 9%.
What’s the industry average?
A hundred percent plus. And when folks get to the team leader level, which is the department manager, ours is less than 3% and has been for some years.
You have a gain-sharing program in which teams are given some data and some incentives. How does it work?
Everybody in Whole Foods, including John and me, belong to a team. That’s the first thing, the basic human desire to belong and be part of something larger than yourself. In Whole Foods, labor is a fixed cost, not a variable cost as it is in other operators. If a team can generate revenue that exceeds a budgeted margin between the revenue and labor cost, they share in the gain. Every 30 days it’s in their paycheck. If they build sales or save costs, the productivity they create is shared with them. We’re doing it together. On the average in the company last year it was over $1 an hour in their paychecks from gain sharing, which they created through their own efforts.
What innovations have come out of this?
A customer who had a blind 7-year-old son said her son wanted to be able to shop Whole Foods. So a marketing team leader in Thousand Oaks, Calif., created Braille tags in three departments so this customer’s son could shop. Now those tags have been picked up by the Braille Institute in Boston and are being spread around. She did it on her own — didn’t ask permission, just did it. That’s the type of thing that builds the company culture.
It’s a competitive advantage for the company.
Peter Drucker said famously many years ago that culture eats strategy for lunch. If you can empower people so they are creating innovation on a constant basis, the company’s moving much faster. In the 21st century, distributed intelligence and distributed decision-making is the way to proceed because you’re going to go faster. Anything we do in retail can be copied right away — take a picture, send it, boom! The enduring competitive advantage is team members imbued with a sense of mission who are carrying the company forward. That is a sustainable competitive advantage.
The Leadership series: This is the latest interview with a top executive by Fortune senior editor-at-large Geoff Colvin. See video excerpts of this interview at fortune.com/leadership — plus find Colvin interviews with Charles Schwab, the team of Jeff Immelt (GE) and A.G. Lafley (P&G), former New York City schools chancellor Joel Klein, Pimco’s Mohamed El-Erian, Humana CEO Michael McCallister, and many more.
This story is from the May 20, 2013 issue of Fortune.