The 1993 year-end statistics showed that industry sales Roth had slowed to under 2%, while private labels had topped 5% market share by sales and 9% by volume for the first time. Price Increases by the Big Three had widened the gap between branded and private label products. The competitors had traditionally avoided destructive head-to-head competition, but this mutual restraint appeared to be crumbling. Each of the firms faced major decisions going forward about whether to break with the industry lock-step moves and how to deal with the threat of private labels.
History of the RET Breakfast Cereal Industry 2 The ready-to-eat breakfast cereal industry got its start in 1894, when Dry. John Kellogg and his brother W. K. Kellogg invented wheat cereal flakes in an attempt to make whole grains appealing to the vegetarian clients of the Seventh-Day Adventist sanitarium Dry. Kellogg ran In Battle Creek, Michigan, W. K. Went on to Invent the corn flake and to found the Kellogg Company, still the number one producer of ready-to- eat cereals in the world a hundred years later. Also in 1894, Henry D.
Perky, founder of Perry’s Shredded Wheat Company, promoted his cereal at the 1894 World’s Fair in Boston with the claim that, “From the most abject physical wreck, I have succeeded, y the use of naturally organized 1 James B. Trace, “The Nervous Faces Around Kellogg Breakfast Table,” Businesslike, July 18, 1994. 2 A comprehensive account of the history of the U. S. RET cereal industry can be found in Frederick M. Scorcher, The Breakfast Cereal Industry,” in The Structure of American Industry (6 Macmillan, 1982). The De. ), W. Adams, De. (New York: 3 Car De Silva, “The cereal crunch; antitrust suits focuses on something consumers have known for years: cereal prices are sky high, “Newsman, February 24, 1993. Professor Kenneth S. Sorts prepared this case as the basis for class discussion rather Han to illustrate either effective or ineffective handling of an administrative situation. Copyright 1995 by the President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685 or write Harvard Business School Publishing, Boston, MA 02163.
No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means-?electronic, mechanical, photocopying, recording, or otherwise -?without the permission of Harvard Business School. Http://Dacca. Shared. Com/doc/Attempts/preview. HTML 2013/8/25 95-191 The Ready-to-Eat Breakfast Cereal Industry in 1994 (A) food, in reorganizing my body into perfectly healthy condition. ” 4 1928, and his shredded wheat became their flagship brand. In 1898, a patient of Dry. Kellogg, C. W.
Post, introduced Post’s Grape Nuts, which early advertisements claimed could tighten loose teeth and cure appendicitis. By 1994, Philip Morris had acquired both the Post and Nabisco lines of RET cereals. The Quaker Oats Company diversified from its strong position in hot cereals into the RET market with the introduction of puffed rice and puffed wheat cereals at the 1904 World’s Fair in SST. Louis. Thus, by Just after the turn of the century, the predecessors of the Kellogg, Quaker, and Philip Morris cereal lines, which collectively accounted for 59% of 1993 RET sales by volume, had already been established.
Sales of RET cereals grew steadily throughout the 20th century, with a compound average annual volume growth rate of three percent between 1950 and 1993. Vitamin fortification, which first appeared during the second World War, presenting, which gained wide popularity in the sass, and the surge of interest in granola and natural cereals in the sass and ass fueled this growth. By 1993, the U. S. Market consumed 2. 82 billion pounds of cereal, grossing nearly $8 billion in sales for breakfast cereal manufacturers.
The RET cereal industry had historically been one of the most concentrated of all U. S. Industries, and firm market shares showed great persistence (see Exhibit 1). The largest cereal manufacturers were extremely profitable, routinely posting ROAST for their cereal divisions in the 15-30% range. However, the profitability of the industry attracted no significant entry, and the industry continued to become more concentrated. As a result, in 1972 the Federal Trade Commission filed a major antitrust suit against Kellogg, General Mills, and General Foods (then the maker of the Post line).
The FTC argued that the leading RET cereal manufacturers had Jointly monopolized the RET cereal market. The FTC case was based on the fact that the industry was concentrated and highly profitable, and not on specific actions that the firms might have undertaken to achieve this. Nonetheless, it became clear that the FTC believed that the firms had effectively raised industry profitability by restraining competition, and that the incumbent firms had taken specific steps to deter entry by new firms.
Some industry observers argued that the Big Three had restrained competition among themselves by achieving effective unwritten agreements to limit in-pack premiums-?free toys or gifts included in the package-?to one brand at a time for each company and to refrain from trade dealing-? offering discounts to retailers for special treatment or special promotions. In addition, for many years after the appearance of the first vitamin-fortified cereals during World War II, the Big Three refrained from widespread fortification of their brands because it was believed not to be in the long run interests of the industry.
Each of these practices-?trade dealing, in-pack premiums, and vitamin-fortification-? was viewed as a potentially powerful tool for increasing a firm’s market share temporarily at the expense of its competitors. The Big Three feared that such tactics might be employed by one firm for its short-run advantage, but would be mimicked by the other firms, initiating a cycle of escalating costs that would wreck industry profitability. However, the Big Three successfully avoided these practices for many years. To explain the lack of entry into this industry, and that the firms had taken specific actions to make entry into this industry unprofitable for new firms. The FTC argued that the Big Three had prevented entry into the RET cereals industry by encouraging supermarkets and other retailers to adopt a shelf space plan that ensured that the Big Three’s products received the most valued center-aisle positions. This plan (some variant of which was adhered to by many grocers and supermarkets) offered a simple resolution to the struggle for shelf space: space was allocated in proportion to historical sales volume.
Newer, smaller companies could obtain good shelf space room grocers despite this plan, but doing so at the time of the FTC complaint typically required a discount to the grocer of ten percent off the normal wholesale price. 4 Frederick M. Scorcher, “The Breakfast Cereal Industry,” in The Structure of American Industry (6 De. ), W. Adams, De. (New York: Macmillan, 1982) The proliferation of new brands was argued also to have contributed to the lack of entry.
By introducing a multitude of new products, the FTC argued, incumbent firms may have filled all profitable niches in the cereal market, thereby preempting the introduction of cereals by potential competitors. Support for this argument was drawn from the natural cereals boom of the early sass. When demand for natural cereals surged unexpectedly, the Big Three were caught off guard and had not preemptively introduced brands in this segment. Entry by both small firms and large food manufacturers, including Pet and Pillsbury, ensued.
The FTC argued that this demonstrated that product proliferation, and not economies of scale, was responsible for the lack of entry into the industry. However, within five years of the filing of the antitrust complaint, incumbent firms had introduced their own natural engaging new entrant, Pet, had seen the market share for its Heartland brand fall to less than a quarter of one percent. The FTC suit plodded along for nearly ten years before the complaint was dropped in 1981, in the aftermath of the election of President Reagan.
Industry Environment in the sass Technology There were five basic methods used in the production of RET cereals. Of these, four-? granulation, flaking, shredding, and puffing-?had been in use since 1905. The extrusion process, in which dough was pressed through a die to form the desired shape before baking, found its first commercial application with the 1941 introduction of General Mills’ Cheerios. The production of a flake cereal began with the automated combination of the raw ingredients to produce the dough, which was then flaked by drum rollers.
The flakes continued on a conveyor through a continuous flake toaster and then tumbled through a rotating slurry enrobed. Slurry contained ingredients like salt, sugar, honey, and the vitamin and mineral fortification. Finally, the finished flakes were dried and moved on to the packaging lines. Production of puffed or extruded cereals followed the same process, except that instead of being leaked by rollers, the dough was pneumatically “puffed” through automated conical guns or forced through shaped dies prior to baking.
While the fundamentals of the process technology were relatively simple and well-understood by all firms, some processes-?particularly the extrusion processes used in many children’s cereals-? were quite complex and required substantial engineering expertise and production experience to master. Some plants produced cereal that was shipped in bulk to packaging lines closer to the points of final distribution, rather than combine consumer packaging and cereal production under one roof. Exhibit 2 shows the cost breakdown for a typical Big Three competitor in 1994.
A single cereal production line had a capacity of about 25 million pounds per year, or just under one percent of total annual domestic production. Because of economies resulting from feeding a single packaging line from multiple production lines, an RET cereal plant was estimated to require a capacity of 75 million pounds per year to achieve minimum efficient scale. A plant of this capacity that combined production and packaging together in one plant employed about 125 employees and required a capital investment in excess of $100 million.
Since the production process was relatively similar for all cereals and the main source of scale economies was in bagging, a single plant could produce many brands of cereal. For example, a new plant built by General Mills in 1992 produced Cheerios, Honey Nut Cheerios, Total, Whites, Cinnamon Toast Crunch, Raisin Nut Bran, Xix, Clusters, Total Raisin Bran and Oatmeal Raisin Crisp. The RET cereal industry as a whole spent about one percent of gross sales (or $80 million) on R&D in 1993, compared with the food industry average of 0. 7 percent.
The problems faced by cereal scientists had not changed much over the 100 year history f the cereal industry. Two basic problems persisted: it was difficult to keep cereal crispy in milk, and, in cereals like Raisin Bran, the flakes tended to become soggy in scientist, “It’s not easy to combine things with varying water activity characteristics. If you’re going to put berries in Cheerios or raisins in bran, you’ve got to monkey with the water activity. ” solution to this problem was to coat the fruit with a thin layer of fat to trap in the moisture, thus preventing the flakes from getting soggy in the box. A typical As with the process technology, the engineering expertise embodied in the product itself was generally neither complicated nor fast-changing; however, breakfast cereal R&D did generate proprietary new product developments. Post’s Blueberry Morning (new in 1994) was an example. The method by which the blueberries were preserved in this “combination of multi-grain flakes, oat clusters, wild blueberries and sliced almonds” was not widely known in the industry.
One industry consultant said of this introduction, “By coming out with something that’s truly new, Post has more flexibility in building brand image and fixing price points. ” In 1993, General Mills introduced Ripple Crisps, which featured a new kind of flake, with ridges that prevented milk absorption and preserved crispiness. Of course, many new products embodied no technological advances, but merely offered different shapes, colors, flavors, or fruit and nut combinations than existing brands offered.
Distribution Major RET cereal manufacturers owned national distribution systems; cereal was manufactured at or shipped to regional distribution centers, where it was picked up by the major supermarket chains and taken to their own distribution centers and stores. Wholesalers and food brokers provided this final link in the distribution recess for other outlets and smaller food stores in less well-developed markets. In food stores, which had traditionally comprised the bulk of their business, the fight for shelf space had long been important, as evidenced by the emphasis on the shelf space plan in the FTC complaint.
Between 1950 and the time of the FTC investigation supermarket carried nearly 200 SSW. As the number of RET cereal brands expanded, prime shelf space became even more important. In the sass, securing shelf space (a ‘slot’) for a new brand required payment to grocers of a ‘slotting allowance,’ which loud add as much as $1 million to the cost of nationally introducing a new brand. While large cereal firms were not exempt from this policy, they had more flexibility than new entrants in shuffling their allocation of space among brands, sometimes replacing a failed brand with a new introduction.
Major cereal manufacturers employed large sales staffs that worked closely with major supermarket chains and food stores to ensure the proper stocking, display and promotion of each firm’s brands. In the sass, as part of a larger food industry effort known as the “efficient customer response initiative” (ECRU), these firms increased their efforts to tailor distribution to the needs of each customer, making better use of scanner data to manage inventories, for example. In 1993 non-supermarket sales of food accounted for 5% of food sales and were expected to grow to 10% by 1996 and to 20% by 2000. A large portion of this increase came from expansion of the major national discount retailers into ‘superstructures’-?massive 125,000 square foot stores that combined a supermarket, a general discount retailer, and specialty retailers under one roof. In addition, more food was being sold through drug stores, nonviolence stores, and discount retailers like Wall-Mart. The division of shelf space in these outlets was significantly less entrenched than in supermarkets, allowing start-up value-oriented brands to obtain a market presence. In addition, these outlets did not require slotting allowances.
Exhibit 3 shows market shares by distribution channel for leading manufacturers of cereal. While the Big Three accounted for 75. 6% of sales in food stores, they had only a 41. 3% market share in mass merchandisers. 5 Elwood Caldwell, quoted in Bob Ferguson, “Cereal Science. (Special Report: Food Marketing Institute ’94),” Broadened, May 2, 1994. Advertising, Promotions, and Pricing The 1993 media expenditures for the RET breakfast cereal industry topped $800 million, accounting for over a quarter of all food industry advertising. The RET breakfast cereal industry had always been among the most advertising intensive of all industries, with an advertising/sales ratio as high as 18. 5% in the sass. By 1993, this ratio had fallen to 10. 2%, still high relative to most consumer products businesses. Exhibit 4 shows 1993 media advertising expenditures for each company and selected brands. Advertising was especially intense around the time of a new product introduction. Recent introductions of Kellogg Cinnamon Mini Buns and General Mills’ Triples and Basic 4 had averaged first-year advertising expenditures of $20 million.
The RET cereal industry was historically typified by regular rounds of price increases, usually initiated by Kellogg and followed by the other manufacturers of branded cereals. These price increases were often Justified to analysts as necessary to generate funds for promotions and advertising in a process known as “price up and spend back”. In edition to being among the most advertising intensive of industries, the RET cereal industry was the top issuer of coupons, and this reliance on coupons 8 was increasing.
In 1993, cereal manufacturers issued over 25 billion coupons (up 35% in two The associated costs of printing, distribution, redemption, and reimbursement of the grocers’ years). Handling fee amounted to $610 million in addition to the $800 million in media advertising expenditures. Coupons were so prevalent that even though only about 2% of coupons issued were redeemed, over a quarter of all cereal purchases were made with coupons. By 1994, the average value of redeemed coupons had climbed to 87 cents. 9 In addition to coupons, other forms of trade promotions were also becoming increasingly prevalent.
These included per-case discounts to retailers and cash payments for special in-store promotions and cooperative advertising. Among the most prevalent and costly trade promotions were buy-one-get-one-free offers, known in the industry by the acronym Bogs. By aggressive use of trade promotions, a single firm might achieve gains of 2-3% in market share by swaying the purchase decisions of the most price-sensitive consumers; however, neither coupons nor other arms of trade promotions were believed to stimulate total cereal demand very switching by the most fickle consumers.
The price-promotion spiral drove RET cereal prices up 15. 6% from 1990 to 1993, compared to a 5. 9% increase in overall food prices. Cereal prices regularly outpaced other consumer prices, and in a 1994 market research survey breakfast cereal was voted the “no-contest worst value product winner. ” One consumer surveyed responded, “cereal prices are an obscenity-?to take a genuinely basic food and make a luxury item out of it is an outrage, and not far from sinful. ” 10 New Product Introductions
In 1950, the six industry leaders offered only 26 brands of RET cereal, ND Kellogg Corn Flakes alone accounted for 16% of the market. However, the number of product introductions increased until the market became so fragmented that a brand that captured a single market share point was considered a major hit. High rates of new product introduction led to high rates of product failure. Exhibit 5 presents statistics on the success of the major firms’ new product introductions.
The two most highly touted product introductions of 1994 were “co-branded” cereals, a segment that was forecast to grow dramatically throughout the sass. Co-branded reels were produced and distributed by one of the Big Three, but relied on another company’s brand name for the product’s distinctiveness. Prominent 1994 introductions in this category were a line of multi-grain cereals from Kellogg, marketed as Healthy Choice from Kellogg, and General Mills’ Reece’s Peanut Butter Puffs. In other food categories, Healthy Choice was an established brand manufactured by Contra, the U.
S. ‘s second largest consumer foods company. Reece’s was the brand name for Hershey Foods’ peanut butter and chocolate candy. Industry observers suggested that the increasing speed to market and quality of riveter label products would drive an increase in the introductions of cobwebbed products: “Expect more co-branded deals, since the same labs that can knock off flakes or nuggets can do little 1 counter the added brand equity that, for example, the Healthy Choice brand to gives Kellogg. Several companies had recently attempted to extend the reach of the RET cereal category into snack foods. While Ralston Ache cereal had long been popular as a snack food and several of the firms offered granola or other cereal snack bars, General Mills tried to blur the category distinction even further with its introduction f Bingos in 1993. This was packaged and marketed as a cereal, but as a cereal that could be eaten with the fingers, or as “the perfect commuter snack. General Mills even redesigned the box so that it could accommodate a smacker’s hand more easily than the traditional narrow cereal box. Kellogg introduced of its own snack-oriented cereal, Rice Crispier Treats, in early 1994. Competition Kellogg Kellogg was the clear leader in the U. S. RET breakfast cereal industry with a 35. 2% market share in 1993. RET breakfast cereals accounted for over 80% of Kellogg 1994 ales, making it the most focused of the major RET cereal firms.
Kellogg also had a strong position in toaster pastries (Kellogg Pop-Tarts), frozen waffles (the Ego brand), and granola bars. Total U. S. Industry sales in these three categories exceeded $1. 5 billion in 1994, and these categories continued to grow faster than the RET cereal market. Kellogg had over 40 RET cereal brands in national distribution in 1994, and was particularly strong in relatively simple flaked cereals, including Corn Flakes, Frosted Flakes, Raisin Bran, Special K, and Complete Bran Flakes. U. S. Market shares
