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Topher's Breakfast Cereal Character Guide

Analysis of the Cereal Industry

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All of the information presented here was prepared by a student at St. Norbert College
in St. Pere, Wisconsin in the Spring of 1997. This analysis is only one part of a larger
report on Kellogg's. This report has been reprinted by permission of Matthew Roy, Ph.D.

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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.




Structure



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 [sic] 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.

[Editor's note: two major barriers to entry in the cereal industry are: (1) the distribution network (greater than $600 million for a nationwide network), and (2) advertising / branding.




Porter's Model



Rivalry

Porter's Model 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 [sic]. 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.

Report Continued on Page Two


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