Why Has the Cereal Breakfast Been Such a Profitable Business?

1. WHY HAS THE CEREAL BREAKFAST BEEN SUCH A PROFITABLE BUSINESS?

Historically the RTE industry has been characterized by a state of high concentration and limited competition, in which only three dominant producers - Kellogg, General Mills, and Philip Morris (the Big Three) had three quarters of the market share from the 1950's till 1993. Collusion in pricing, trade dealings, in-pack promotions, and on decisions for new product introductions lead to the FTC filing an anti-trust suit.

The Big Three have consistently increased the prices of cereals - between 1990-93 they increased prices to 15.9% nearly 3 times the increase in overall food prices.

The cereal industry has been very profitable not only due to this oligopoly situation but also because of the many barriers to entry to new entrants. The Big Three were responsible for the following undertakings:

* Encouraging grocers and supermarkets to adopt a shelf space plan that ensured that the Big Three's products would have the most valued center-aisled positions - in proportion to historical sales volume;

* Continuous introduction of new products, by creation of new brands or by the extension of an existing one;

* Filling of virtually all market niches in the RTE market;

* Ownership of their own distribution systems and delivered cereal directly to most supermarkets and grocers;

* High investment for new entrants - an RTE plant with a capacity of 75 million pounds per year (to achieve minimum efficient scale) would cost $100 million;

* Collusion on trade dealing and in-pack promotions;

2. WHY HAVE PRIVATE LABELS BEEN ABLE TO ENTER THIS INDUSTRY SUCCESSFULLY? HOW DO THE COST STRUCTURES OF PRIVATE LABEL AND BRANDED CEREAL MANUFACTURERS DIFFER?

Private labels have had a successful entry for the following reasons:

* Substantial lower price - private label cereals averaged 40% less than the Big Three average of price per pound at retail.

* Better margins for retailer - 15% margins, compared to 12% margins dos branded cereals;

* Distribution channels - growing non-supermarket sales of food - private labels relied on supercenters and third-party distributors. Supercenters provided more flexible shelf spaces and orders were sent directly to the distributor's warehouse (less distribution costs for private labels);