QUESTION
Marketing assignment
Three – dominated the industry. Together, these firms had a combined market share of more than 70%. However, they were threatened by slow industry sales growth and especially by the increasing market share of private labels. You will be asked to analyse the sources of value creation and value capture, together with potential threats to these.
Market shares and profitability
Traditionally, the RTE cereal industry was one of the most concentrated and profitable of all US industries. Despite this, the industry had attracted no significant entries, and the Big Three had remained dominant for several decades. Even their relative market shares had been quite stable, with Kellogg being the most dominant company, followed by General Mills and Philip Morris.
The Big Three had not been competing very forcefully among themselves. These limits to competition had taken the form of unwritten agreements to limit practices that could be profitable from an individual perspective but damaging from a “Big Three” perspective. For example, if one of the Big Three decreased their prices, it could have led to short-run sales increases at the expense of competitors, but this would have become ineffective once competitors replicated the strategy. Other potential practices they steered clear of included in-pack premiums in the form of free toys or gifts, which would have served to differentiate one of them over the others. For many decades, the Big Three managed to avoid competing with each other through prices or these kinds of practices. In fact, the industry was characterised by regular rounds of price increases, typically started by Kellogg and immediately followed by the other two. Cereal price inflation was typically higher than other consumer price inflation.
The industry was not characterised by significant “natural” barriers to entry (such as economies of scale), but the Big Three prevented entry by potential competitors through other measures. These measures included making agreements with supermarkets to limit the shelf space where the products of potential entrants could be displayed, as well as introducing a large variety of their own brands to limit the market niches through which potential competitors could enter the market.
Characteristics of the industry
From a technological perspective, the industry was not highly sophisticated. Economies of scale were not very significant, and it was relatively easy to start a new production plant for an existing product. Production plants had a low minimum efficient scale (the production volume at which average costs are minimum) relative to the market size. The minimum efficient scale was estimated at around 3% of the market. Therefore, there was no technological reason for a single plant (or a small number of plants) to dominate the industry. Because of this, entrenched companies did not have a significant advantage relative to new entrants in terms of learning economies.
The distribution of cereals was traditionally through food stores, although over time there was an increase in the importance of drug stores, convenience stores, and discount retailers. Displaying the cereals in the most accessible areas of the store was regarded as crucial. This “battle for shelf space” had traditionally been won by the Big Three. They managed to dominate the shelf space through long-term agreements with food stores and through the proliferation of brands, which left very little space for potential new entrants. However, in the new, increasingly important retail outlets, it was easier for potential new entrants to secure shelf space.
The industry was very advertising-intensive, both to market new brands and to secure loyalty for existing brands. Brand loyalty was regarded as an important reason why consumers tolerated high prices and above-general inflation. However, high and increasing prices were combined with the extensive use of coupons and other forms of trade promotions (such as “buy one, get one free” offers). In fact, over time, coupons had become ubiquitous, and many feared that this was encouraging consumers – who began to feel that they were overpaying without the coupons – to switch products.
Major firms tend to continually introduce new products, either through new brands or through the extension of existing brands. Developing a new brand required a significant investment of time and money, in the form of R&D and advertising expenditures. Partly because of this, many new brands failed, and over time, the market became very fragmented in terms of brands (although, as explained above, not in terms of firms). In the early 1990s, very few brands had a market share higher than a few percentage points.
The private label threat
Private labels are those where the manufacturing is done by a company, but the product is sold under another company’s name. Throughout the early 1990s, sales of private label cereal grew substantially, to around 5% in terms of sales and 9% in terms of volume.
The increasing success of private label brands was due to several factors. Most important was that low prices appealed to consumers. Secondly, private labels offered better margins to the retailers and, as a result, retailers were happy to favour them in the battle for shelf space. Private label brands could sustain these strategies because they did little advertising, and their manufacturing costs were 10–20% lower than those of a Big Three firm, thanks to the increasingly standardised technology and the focus on simpler cereal products, such as those without fruit. Distribution costs were also lower. For instance, some private labels sold cereals in plastic bags rather than boxes, making packaging cheaper.
The private label threat occurred in an environment of general uncertainty in the industry. Technological change, together with changes to consumer tastes and distribution, had disrupted the industry.
(Reference: Corts, K.S. 1997. The ready-to-eat breakfast cereal industry in 1994 (A). Harvard Business School. Case Study 9-795-191.)
Question 1
Evaluate the sources of value creation and value capture in the breakfast cereal industry. In your answer, aim to address the following questions:
a) How did the Big Three work together to capture value in the industry, and what were the enabling factors that allowed them to?
b) How much value did the Big Three capture compared to the food stores that bought from them?
Start writing here:
Question 2
a) Describe two changes in the early 1990s that made it easier for private labels to enter the market and capture value that was previously held by the Big Three.
b) How do you think the Big Three firms could have reacted to these threats? Provide at least two relevant suggestions.
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Answer
Case Study: The Ready-to-eat Breakfast Cereal Industry in 1994
Question #1
Part A
The Big Three had not been competing forcefully amongst themselves. They limited practices that would be beneficial for one company and not the other through unwritten agreements (Corts, 1997). Nonetheless, they stayed clear of other practices such as in-pack premiums in the form of free toys, which would have differentiated them. They avoided price competition amongst one another but engaged in regular rounds of price increases. The Big Three prevented market entry through measures such as making agreement with supermarkets to reduce shelf space for other players. Furthermore, they ensured mass production of their brands to limit market niche for potential competitors.
Part B
The Big Three captured a significantly higher value compared to the food stores that bought from them. They dominated the shelves of food stores with their brands to increase sales and prevent other players' entry into the market (Corts, 1997). They cemented their competitive position and used that advantage to increase the prices of their products. Low cost of production and high prices created a higher value for the Big Three.
Question #2
Part A
The changes included a shift in production technology and changes in the customer taste. The use of standardized technology enabled private labels to provide better margins for retailers. Thus, they won the battle of shelf space against the Big Three (Corts, 1997). The strategy was possible since they did not invest much in advertising compared to the Big Three. Besides, they had cheaper packaging services. Nonetheless, the private labels focused on simpler cereal products to satisfy the taste of customers.
Part B
- The Big Three firms could have reacted to the changes by adopting new production technology to reduce production cost, which would result in a subsequent reduction of prices of their brands in the market.
- They would have conducted market research on changing customer taste and tailor their products to satisfy the customer needs.
- Increase the margins for the retailers to keep the shelf space. The Big Three had increased the prices of their products to maximize profits. Thus, they ended up reducing the margins for the food stores.
References
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Corts, K.S. 1997. The ready-to-eat breakfast cereal industry in 1994 (A). Harvard Business School. Case Study 9-795-191.
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