Ready To Eat Cereal
1) The Big Three firms, Kellogg, General Mills, and Philip Morris, formed practically an oligopoly in the RTE cereal market. Their price and cost levels moved in lockstep, following signals sent mostly by the biggest player, Kellogg, while their tactics could be used against outside competition, as suggested in the scenario below. Although RTE cereal is a basic food item and production technology stabilized for about half century, the industry had effective barriers to entry. The competition between incumbents was friendly while most of the inputs came from a perfectly competitive market, agriculture. Major customers, the food stores, were coopted in perpetuating barriers to entry in the form of shelf space “slotting”. The competition included traditional breakfast items, and, lately, toaster pastries and granola bars.
The RTE cereal has been a profitable business mainly because of friendly competition between the Big Three, barriers to entry, and defense against outside competition. Big Three’s cooperation allowed them to keep margins high by avoiding trade dealing, lower in-pack premium, and avoid vitamin fortification. Barriers to entry related to distribution and shelf space could increase a newcomer’s cost structure by about 10% each. Also, the Big Three practically covered all niches of the market with a proliferation of brands. An entrant producing RTE cereals like the Big Three could have similar cost structure and projected EBIT, around 15%-20%. This would be erased by expenses due to barriers to entry which amount to 20%, making the entrants unprofitable. The Big Three were able to counter even those entrants who could produce at lower cost or avoid barriers, A temporary price cut could situate the retail price of a Big Three’s product below production cost on an entrant. The negative effect on incumbents would be minimal given they had tens of brands with margins 5% to 15% to even out losses. A number of factors contributed to the oligopoly’s current crisis. First, the total achievable market was heading towards saturation. A growth rate by volume of about 3% per year since 1950 clearly surpassed population growth rates of 2% in the 1950s to 1% in the 1980s. Also, the proliferation and failure of new brands fragmented the market, covered all foreseeable niches, and degraded consumer brand loyalty. The current market size growth rate decline was offset by accelerating price growth rates, which had the undesirable side effect of increasing marketing costs. An outside factor was the increased non-supermarkets sales which led the growth of private labels as shelf related barrier did not exist anymore. The Big Three had 75.6% of sales in food stores, and only about 41% with mass merchandisers. The market share of RTE cereals sold by mass merchandisers was projected to increase 15% by 2000. Keeping proportions, this represents a market share loss of (75%-41%)*15%, or just above 5%, by 2000. The proliferation and failure of new brands led to fragmentation and eroded brand loyalty. For example Kellogg launched in the 1980s 30 new brands which ended up covering 13% of its market share in 1993, or 4.7% of the RTE cereal market, for about $375M in revenues. The R&D costs alone were estimated to $150M-$300M in 1980 currency while Kellogg’s resulting 1993 net income of 10.8% was about $40M, which represents 24.5M discounted at a 5% rate back to 1983,. It would take Kellogg some 15 years to recover R&D costs alone, practically rendering Kellogg’s endeavors unattractive. 2) The private labels have targeted customers who are price sensitive and not brand conscious. The Big 3 brands while working in lock-step approach had been raising prices (prices raised were 15.6% from 1990-1993), and hence when private labels came with low prices, this attracted consumers who were price sensitive. The Big 3 brands did not want to enter the private label market, as that would dilute their brand. Also, by entering...
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