History

Created by eccentric health reformers more than a hundred years ago, the strangely shaped bits of flavored grain have become a staple of the American diet, eaten by more than 80 million Americans every day. Defined by Webster's Dictionary as any edible grain, cereal was responsible for the rise of human civilization. "When neolithic farmers figured out how to cultivate wheat, millet, oats and other wild grasses some 10,000 years ago, they created the first steady food supply humankind had ever known. Thereafter, the Greeks thrived on a grain based concoction known as sitos, cooked cereal flavored with olive oil and perhaps a dash of lamb gravy. The Romans, whose cereal, or festivals in honor of the goddess of agriculture Ceres, gave us the word cereal, conquered the world on stomachs filled with puls, and gruel made from barley, millet, wheat or oats". Throughout world history cereal (and its contents) has been present, but it is in the American 20th century that the $8 billion industry was built. By 1915, many took breakfast out of a box of ready-to-eat, "cold", brand-name cereal. This was thanks in big part to John Harvey Kellogg and C.W. Post, who in the 1890's, launched the breakfast-food industry in Battle Creek, Michigan. As the industry evolved so did the domination of the big four cereal companies -- Kellogg, General Mills, Post, and Quaker.

Economic Analysis

The cereal industry is an oligopoly with four large companies and a few very small niche companies. The small niche companies hold very little market shares, approximately 13.6% in 1995, with the big four holding the other 86.4%. The big four manufacturers are Kellogg, General Mills, Post, and Quaker Oats. Price competition is almost nonexistent between these companies and no company has any clear dominance over any of the others. Due to the oligopolistic nature of the industry they earn large profit margins, a net profit average of 6.7% in 1993.T Great barriers to entry and the inelastic nature of cereal allow this oligopoly to exist and numerous government attempts to end it have failed. With the exception of Kellogg, the other big three are diversified with other food products and are first beginning to divest some of them in the past ten years. This diversity allows the companies in the industry to have "deeper pockets" and gives them to ability to use aggressive strategies in order gain or maintain market shares. However, Kellogg has also proven their strength which is held by remaining focused. Since the cereal industry is an $8 billion industry, every tactic that can gain even a 1% increase in market share is a substantial amount of money for the company that gains it.

Rivalry

As discussed previously, the cereal is a highly consolidated market. In 1970, four companies dominated an extraordinary 90% of the ready to eat cereal market. While the dominance of the big four has dropped some in recent years, the market is still highly consolidated. While there are only a few major players, these companies have individual brands which compete for very small shares of the market. Kellogg's Frosted Flakes leads all individual cereals with a 4.2% market share. This is followed by General Mills Cherrios at 3.7%, Kellogg's Corn Flakes 2.9%, and Kellogg' s Raison Bran at 2.8%. There is high competition backed be enormous advertising budgets that make rivalry very intense.

Buyer Power

The bargaining power of the buyers can have a significant impact on any industry if the consumers can determine prices or quality. Consumers do not have a profound impact on the cereal industry for a variety of reasons. First of all, there are only a few major players in the industry. Due to this fact, a company is not dependant on what a few customers want to see changed. Similarly, consumers do not purchase large quantities of cereal at one time. Cereal shopping is generally done weekly with purchases normally including only a few boxes. Buyers can switch companies to purchase from, however, the companies are still in control due to the small number of companies to select from. A potential threat to the cereal industry is the power of the grocery stores. Cereal manufacturers need to occupy shelf space in order to sell their product. The grocery stores ultimately have the ability to decide who gets shelf space. However, the cereal industry is an eight billio n dollar business. In order for the grocery stores to make money, they need to shelve breakfast products. With so few companies to choose from, their power is limited.

Supplier Power

Another potential threat to the cereal industry is the power of suppliers. Suppliers find that they are able to find the most power in a variety of scenarios. First, suppliers find power when there are few substitutes to their product. For most cereals, the main ingredients include sugar, food grains, flour, and other dehydrated food products. All of these ingredients are present in a variety of foods and are unable to control buyers of their products. A second form of power derives from suppliers ability to get along without the buyer. All of these products are bought for a variety of reasons, but due to the large size of the cereal industry it is a lucrative buyer for these products. Another lack of supplier power derives from the potential of suppliers to integrate. In this example, a sugar or grain supplier may attempt to move into the cereal industry. However, the trend developed in this paper is that this is very difficult to due. On the same note, the suppliers do have some power as it is unlikely that the cereal companies are going to enter the extremely large grain and sugar industries. Another potential power comes from the sugar industry as the United States imports the product. Other inputs into the sale of cereal come from advertising and packaging. Packaging is an industry in which the companies are able to change between suppliers. Conversely, the advertising agencies have a solid grip on the industry. Advertising is the largest source of marketing for the cereal companies. This allows them to have better control and set pricing for the ads.

Substitutes

As the prices of cereal continued to rise throughout the 1970's and 1980's many consumers began to look for substitutes. Products such as Pop Tarts and breakfast bars began to enter the market and consumers now had more to choose from. Another deciding factor in the creation substitutes came from consumers looking for a healthier diet and more rounded breakfast. Hot cereals entered the market.

Potential Competitors

The lack of potential competitors is what gives the present cereal companies so much power. With the lack of supplier power it is easy for an entrepreneurial company to innovate and create a brand of cereal. However, there are a variety of barriers to entry in the industry which make it near impossible to enter this potentially profitable market. The billion dollar cereal companies can take advantage of absolute cost advantages and economies of scale. A major portion of this stems from the advertising section of the industry. In 1993 more than 1.3 million advertisements for cereal aired on American television at a cost of 762 million dollars per day. This advertising budget was second only to the auto manufacturers. Companies such as Post are able to draw from the seven billion dollar Phillip Morris parent company. While a new company can probably develop a new cereal, it is very difficult to compete with these large advertising budgets. Another major barrier to entry comes from brand recognition. Consumers have grown up with the names of Kellogg, Post, and General Mills. The different cereals under these companies also pose significant name recognition. Cartoon characters such as Tony The Tiger, the Trix rabbit, Lucky (of Lucky Charms), Count Chocula, Snap Crackle and Pop, and Toucan Sam name just a few. Children are quick to recognize and relate to these characters. Potential competitors find it nearly impossible to compete with such characters that have ingrained their presence in the minds of consumers.

Technological Environment

The technological environment also poses a barrier to entry. The major players have spent years developing new products through research and development. This wide array of products makes it difficult to innovate a new brand of cereal. Technology such as keeping cereal crispy in milk also poses a barrier to new entrants.

Macro-Economic Environment

The macroeconomic environment is presently an opportunity for the cereal industry. The American economy has been growing for the past two years. Inflation has remained relatively steady while the national unemployment rate has fallen to 5.4%. For the cereal companies this means that the average person has more purchasing power and consumers are better able to afford paying four dollars for a box of cereal. However, the national economy poses the dilemma of a double edged sword. The economy goes through periods of change throughout its cycle. If the economy takes a downturn and America faces a depression, consumers are not as willing to put forth the money to purchase goods they may feel are overpriced. Two other important macroeconomic figures include the Consumer Price Index and the rate of inflation. In 1980, inflation was 13.5% followed by 10.32% in 1981. This indicates that the price for products in the United States was rising rapidly and the dollar no longer stretched as far. The early nineties are considerably more stable with inflation at 5.4% in 1990 and falling to 2.92% by 1996. This allows people to purchase more for their dollar. Similar to this is the CPI. The CPI is the average price for a bundle of goods compared to prices in 1982. The CPI in 1990 was 124.2 and increased to 134.1 by 1993. This means that the average cost for products is rising compared to what they cost in 1982. Again, this means that people are unable to purchase as much with their dollar.

Social Environment - Demographics

Demographics and the social environment play a vital role in any industry. Presently, 49% of Americans consume a bowl of cereal for breakfast while 30% eat toast, 28% eat eggs, 28% have coffee, 17% have hot cereal, and less than 10% have pancakes, sausage, bagels or french toast. With 49% of Americans eating cereal, it is easy to note that the social environment has a significant influence. Other demographic aspects can be observed. The median income for all households has increased from $31,341 in 1970 to $32,264 (This is in constant 1993 dollars). This suggests that incomes have not increased in proportion to the price of cereal. Total expenditures for cereal and bakery products per home increased from $312 in 1989 to $429 in 1994 indicating that consumers are spending more for breakfast (U.S. Bureau of Labor Statistics). Another factor which has increased the need for a quick breakfast is the fact that many households now have two working parents. Even tho ugh the average family size has fallen from 3.67 in 1960 to 3.19 in 1995, parents need to find a quick alternative for breakfast so that they can get kids to day care or school and still get to work on time. Time constraints only increase when evaluating families with only one parent.

Political and Legal Environment

In a consolidated industry such as this, companies often face a substantial amount of scrutiny from the legal environment. Often times this stems from the demands of consumers which were stated previously. The cereal industry came under examination in 1970 as the industry saw the big four manufacturers go from a 68% market share in 1940 to a staggering 90% in 1970. Critics charged the industry with cooperating their strategies and creating a shared monopoly. The Federal Trade Commission immediately began to investigate the alleged cooperation. However, the cereal industry has been able to block the allegations. In the 1970s, they delayed handing over information about profits and other "classified" information. The case continued to drag into the 1980s and the FTC found two significant barriers to breaking up the industry. First, the cereal manufacturers had great relationships with members of Congress that helped block potential legislation. Secondly, the mass advertising budgets of the companies pose a barrier. Breaking up the cereal industry meant that the hundreds of millions of dollars spent on advertising each year was in jeopardy. Due to these factors, the FTC eventually discontinued the case against the manufacturers after spending over fifteen years and countless amounts of money to break them.

Strategies

Competitive strategies within the mature stage of the industry life cycle include: low-cost, differentiation, and focusers. The cereal industry, which undoubtedly is in the mature stage, uses two of these strategies, low-cost and differentiation.

Low Cost Strategies

The companies pursue a low-cost strategy by the use of coupon reduction, streamline marketing, and economies of scale, all effective tools. Coupon reduction has been a strategy within the industry that very recently has been pursued. General Mills was the first to incorporate this strategy beginning in 1994. That year the company cut coupon promotion costs by $175 million. Since then Kellogg's, Post, and the others have followed suit attempting to reduce the cost of coupon promotions. The industry has also taken a turn toward streamline marketing. Streamline marketing refers to the companies marketing a variety of products together instead of marketing just a single product. This is done to cut marketing costs. For example, Post took a new advertising tack in May of 1996 with an estimated $10 million, anthem-like TV and print campaign that dials up the Post brand identity over that of Grape-Nuts, Shredded Wheat and 11 other adult cereals. Setting the tone and strategy for future ads, a 60-second TV spot entitled "Portraits" shows still photos of employees of the Kraft Foods unit as a voice over explains that consumer dissatisfaction prompted Post to cut prices on all its cereal. Post's estimated that their $175 million in ad spending may shrink too as little as $50 million. Likewise, Kellogg's has also used streamline marketing. Kellogg Co. is celebrating its 90th anniversary with a nostalgic promotion package that plays up the longtime equity of its top brands. The idea again is to promote Kellogg's name in general rather than focusing one specific brand. "There's so much equity in the Kellogg name, and so much history behind the brand," said Shireen Moore, VP-account services at Davidson Marketing, the Chicago shop where Kellogg had all its promo work done last year. "An anniversary gives you a chance to remind consumers of that". The cereal industry also attempts to produce low-cost strategy by using economies of scale. All the companies involved in this industry use capital intensive production methods rather than labor intensive method. This is proven by the decreasing amount of workers used and the increasing capital investments. This is also supported by the high levels of value added between raw materials and the final product. Industry averages for return on assets further reflect the strength of their production processes since they are far higher than most other manufacturing industries. The industry triples the value of the original materials by the time they reach the store shelf. Both of these statistics prove that this a very capital intensive industry.

Differentiation Strategy

The cereal industry without question uses the strategy of differentiation. The companies produce a range of name brands aimed at different market segments. There are brands for kids, teenagers, adults (parents), and the health conscious. Sometimes, by creating market segmentation it reduces the threat of entry. This strategy of pursuing a broad product line to deter entry is known as product proliferation. Within the cereal industry competition is based on the production of new kinds of cereal to satisfy or create new consumer desires. Currently there are over 75 brand names on the shelves today. Companies continuously search for new brands to attract various market segments. For example, Kellogg's is trying to energize its market share in introducing Cocoa Frosted Flakes with an anticipated $30 million ad push. TV advertising breaks April 1, 1997, with drops of freestanding insert coupons set for April and May. Likewise, Post has expanded their brand name cereals by recently introducing Cranberry Almond Crunch. The cereal industry has also tried to differentiate by pushing its value as a finger snack. While cereal accounts for a tiny segment of snacks, its consumption as a finger food has grown over the last 10 years, according to NPD Group, a company that tracks eating habits. And the snack market holds potential: Americans consumed an average of 200 snacks annually, compared to 300 or so breakfasts, the research firm reported.

Pricing Strategies

The industry has historically worked with only one pricing strategy, price discrimination. However, recently the industry has seen some of the key players begin to use price competition, previously an unused tactic, to gain an advantage.

Price Discrimination

A staple aspect of the cereal industry has been coupons. Coupons are designed to give consumers a lower price if they take the time to get and use the coupons. By using coupons the industry can charge a higher shelf price and the more price sensitive consumers will use the coupons. This allows the industry to receive higher profit margins on impulse buyers while still allowing the price concerned to not complain about high prices. This two tiered pricing system has been popular with consumers and is obviously favorable to the industry.

Price Slashing

Price competition has rarely been used in the industry to gain any competitive advantage, until recently. In an attempt to regain market share General Mills tried to slash prices in 1994 but met with little success and discontinued the strategy. Post tried the same strategy in 1996 in order to gain market share and compete with low cost generics. This time, the rest of the industry is taking notice and making plans to cut prices roughly 20% across the board. Consumers and government agencies have pressured for these price reductions and are finally going to get what they have asked for. For the industry, the price cuts will not be as painful as they sound since the average gross profit for the industry has been greater than 40% for the past 10 years. While the reduced price will reduce their profit margins, strategies to cut their costs (especially for advertising) will help offset any losses in profit.

TRENDS

Since the beginning of the cereal business, companies have relied on the domination of a market through tremendous marketing and promotion budgets supported with high-priced products. Barriers to entry through these promotional wars have made market share virtually unattainable for smaller companies. This environment has caused the evolution of four dominant firms in the breakfast industry: Kellogg, General Mills, Phillip Morris (Post), and Quaker Oats. For years these companies have literally swamped supermarkets with different cereal brands in search of profits. The substantial profit margins realized by the four firms has been criticized and questioned in the past. Particularly because of the fact that by 1983 branded cereal prices had increased at twice the rate of other foods, and profit margins were twice as large as the food industry's average. By the 1980's, however, a force emerged within this once secure industry that continues to be a threat to these companies' market share today. Generic and private-label brands have captured consumers' purchases because of significantly lower priced products that are comparable (in the eyes of an increasing number of consumers) in quality and taste.

Consumer Trends

Breakfast cereal consumers today have chosen to forego purchasing these higher-priced products, and private-label brands are becoming more popular (primarily because they are about $1.50 cheaper per box than the brand-name cereals). Industry leaders have become aware of this threat, and begun to pursue solutions to problems such as premium pricing (which has been a primary reason for the loss of market share over the past several years). For example, Kellogg's market share has decreased from 41% to 33% between 1988 and 1996. As a result, these four major companies have slowly engaged in a "price war" beginning with General Mills' initial price cuts in 1994. Kellogg and Post have reluctantly surrendered, and beginning to lower prices. These manufacturers have traditionally raised prices aggressively and promoted their products in the supermarkets with inefficient and ineffective couponing. Companies such as Post are accepting the fact that the most effective form of promotion is through competitive pricing and price slashing. Post has recently lowered 22 of its cereal brands an average of 20%, and changed its coupon strategy to a "universal coupon" for all of its products. The price competition in this industry, with Post taking the lead, has been referred to by many analysts as "Grape Nuts Friday", when Phillip Morris cut the cost of Marlboro's in 1993 and sparked an industry-wide break in cigarette prices. The difficult aspect of this strategy that these firms must now be prepared for is the power of grocers to decide whether or not to reflect these price cuts in their product prices. Kellogg and its major competitors will now need to persuade grocers to extend these lower price opportunities to individual customers. This steep price cutting trend, and the necessary strategies that come along with it, is one that is relatively new to these "cereal kings". After profitable years of premium pricing, Kellogg and its brand-name rivals are now focusing on ways to lower costs to make up for the lost profits that price reductions are presently causing. The most evident area that will be targeted is the gigantic advertising budget each of these companies have developed. More efficient marketing techniques will be pursued, and reductions in in-store promotions are likely. Kellogg has also resorted to cutting its work force by one-tenth this past year in order to drive costs down. Pricing leverage in the breakfast cereal industry has begun to reflect that of the rest of the food industry, and customer value is now becoming a reality and priority within this industry.

Trends in Product Development

Other strategies that these dominant firms are incorporating into their defensive plans are strategies that will help to limit the ability of private-label brands to tap into this lucrative market. Research and development has always been and important variable of the cereal industry. Company success has been influenced and driven by new product development. New cereal flavors, crunchier cereal, healthier cereal, and cartoon-affiliated cereal are just a few examples of avenues explored throughout the history of product development. Private-branded cereal companies, however, can effectively offer their lower-priced imitation brands to the market because of their comparable technology and speed. This has resulted in various co-branding ventures among the "big four" that has produced products such as Hershey's and General Mills' Reese's brand, and Kellogg's and Con Agra's Healthy Choice brand. Through these co-branding agreements these dominant companies are able to establish brand equity that is virtually impossible for private-branded labels to imitate. If researchers from both companies can actually achieve a state of (as John Bryne calls it) "co-evolution", then Kellogg and others will be able to cut the enormous costs of launching a new product. One difficulty with co-branding ventures, however, is the weariness of companies to proceed with such a strategy in fear of tarnishing or losing previously established brand equity. The time taken to introduce a product to the market may also be much longer when co-branding considering the need for cooperation and agreement between the two companies!

Growth Trends

As competitors in the cereal industry attempt to ensure success and growth in the future, strategies including global expansion and operating cost reductions will be pursued. Companies such as Kellogg (which is currently the global leader in new-market development) recognize the importance and potential of foreign markets. Consumers throughout the world are developing similar tastes and preferences due to technological and economical improvements, and this provides many opportunities for global market share. Lower costs are essential for successful global expansion and also domestic competition. As product pricing trends continue to lean toward competitively lower prices, companies in the cereal industry will strive to improve efficiency in areas such as manufacturing and advertising. The security provided by premium pricing is no longer present, and cost control is the key to future success!