The-Ready-to-Eat-Breakfast-Cereal-Industry-in-1994

HarvardBusinessSchool9-795-191Rev.February14,1997ProfessorKennethS.Cortspreparedthiscaseasthebasisforclassdiscussionratherthantoillustrateeithereffectiveorineffectivehandlingofanadministrativesituation.Copyright©1995bythePresidentandFellowsofHarvardCollege.Toordercopiesorrequestpermissiontoreproducematerials,call1-800-545-7685orwriteHarvardBusinessSchoolPublishing,Boston,MA02163.Nopartofthispublicationmaybereproduced,storedinaretrievalsystem,usedinaspreadsheet,ortransmittedinanyformorbyanymeans—electronic,mechanical,photocopying,recording,orotherwise—withoutthepermissionofHarvardBusinessSchool.1TheReady-to-EatBreakfastCerealIndustryin1994(A)AllisnotwellinthelandofTonytheTiger.1Inearly1994,theready-to-eat(RTE)breakfastcerealindustryhadreachedacriticalturningpointinitsevolution.Inanindustryhistoricallycharacterizedbystabilityandaboveaverageprofitability,slowingdemandgrowthandasurgeinprivatelabelsalesthreatenedtounderminethedominantpositionsoftheBigThree:Kellogg,GeneralMills,andPhilipMorris.The1993year-endstatisticsshowedthatindustrysalesgrowthhadslowedtounder2%,whileprivatelabelshadtopped5%marketsharebysalesand9%byvolumeforthefirsttime.PriceincreasesbytheBigThreehadwidenedthegapbetweenbrandedandprivatelabelproducts.Thecompetitorshadtraditionallyavoideddestructivehead-to-headcompetition,butthismutualrestraintappearedtobecrumbling.Eachofthefirmsfacedmajordecisionsgoingforwardaboutwhethertobreakwiththeindustry’slock-stepmovesandhowtodealwiththethreatofprivatelabels.HistoryoftheRTEBreakfastCerealIndustry2Theready-to-eatbreakfastcerealindustrygotitsstartin1894,whenDr.JohnKelloggandhisbrotherW.K.KellogginventedwheatcerealflakesinanattempttomakewholegrainsappealingtothevegetarianclientsoftheSeventh-DayAdventistsanitariumDr.KelloggraninBattleCreek,Michigan.3W.K.wentontoinventthecornflakeandtofoundtheKelloggCompany,stillthenumberoneproducerofready-to-eatcerealsintheworldahundredyearslater.Alsoin1894,HenryD.Perky,founderofPerky'sShreddedWheatCompany,promotedhiscerealatthe1894World'sFairinBostonwiththeclaimthat,Fromthemostabjectphysicalwreck,Ihavesucceeded,bytheuseofnaturallyorganized1JamesB.Treece,“TheNervousFacesAroundKellogg’sBreakfastTable,”BusinessWeek,July18,1994.2AcomprehensiveaccountofthehistoryoftheU.S.RTEcerealindustrycanbefoundinFrederickM.Scherer,“TheBreakfastCerealIndustry,”inTheStructureofAmericanIndustry(6thed.),W.Adams,ed.,(NewYork:Macmillan,1982).3CaradeSilva,“Thecerealcrunch;antitrustsuitsfocusesonsomethingconsumershaveknownforyears:cerealpricesareskyhigh,”Newsday,February24,1993.795-191TheReady-to-EatBreakfastCerealIndustryin1994(A)2food,inreorganizingmybodyintoperfectlyhealthycondition.4PerkysoldhiscompanytoNabiscoin1928,andhisshreddedwheatbecametheirflagshipbrand.In1898,apatientofDr.Kellogg's,C.W.Post,introducedPost'sGrapeNuts,whichearlyadvertisementsclaimedcouldtightenlooseteethandcureappendicitis.By1994,PhilipMorrishadacquiredboththePostandNabiscolinesofRTEcereals.TheQuakerOatsCompanydiversifiedfromitsstrongpositioninhotcerealsintotheRTEmarketwiththeintroductionofpuffedriceandpuffedwheatcerealsatthe1904World'sFairinSt.Louis.Thus,byjustaftertheturnofthecentury,thepredecessorsoftheKellogg,Quaker,andPhilipMorriscereallines,whichcollectivelyaccountedfor59%of1993RTEsalesbyvolume,hadalreadybeenestablished.SalesofRTEcerealsgrewsteadilythroughoutthe20thcentury,withacompoundaverageannualvolumegrowthrateofthreepercentbetween1950and1993.Vitaminfortification,whichfirstappearedduringthesecondWorldWar,presweetening,whichgainedwidepopularityinthe1950s,andthesurgeofinterestingranolaandnaturalcerealsinthe1970sand80sfueledthisgrowth.By1993,theU.S.marketconsumed2.82billionpoundsofcereal,grossingnearly$8billioninsalesforbreakfastcerealmanufacturers.TheRTEcerealindustryhadhistoricallybeenoneofthemostconcentratedofallU.S.industries,andfirmmarketsharesshowedgreatpersistence(seeExhibit1).Thelargestcerealmanufacturerswereextremelyprofitable,routinelypostingROAsfortheircerealdivisionsinthe15-30%range.However,theprofitabilityoftheindustryattractednosignificantentry,andtheindustrycontinuedtobecomemoreconcentrated.Asaresult,in1972theFederalTradeCommissionfiledamajorantitrustsuitagainstKellogg,GeneralMills,andGeneralFoods(thenthemakerofthePostline).TheFTCarguedthattheleadingRTEcerealmanufacturershadjointlymonopolizedtheRTEcerealmarket.TheFTCcasewasbasedonthefactthattheindustrywasconcentratedandhighlyprofitable,andnotonspecificactionsthatthefirmsmighthaveundertakentoachievethis.Nonetheless,itbecameclearthattheFTCbelievedthatthefirmshadeffectivelyraisedindustryprofitabilitybyrestrainingcompetition,andthattheincumbentfirmshadtakenspecificstepstodeterentrybynewfirms.SomeindustryobserversarguedthattheBigThreehadrestrainedcompetitionamongthemselvesbyachievingeffectiveunwrittenagreementstolimitin-packpremiums—freetoysorgiftsincludedinthepackage—toonebrandatatimeforeachcompanyandtorefrainfromtradedealing—offeringdiscountstoretailersforspecialtreatmentorspecialpromotions.Inaddition,formanyyearsaftertheappearanceofthefirstvitamin-fortif