Please see my notes, below. Just looking for an overview. Additional research will be required on my part to provide a good case study.
Notes:
Prepared by Emiko Tamura of Kegan Strategy November 27, 2002
Historically, the ready-to-eat (RTE) cereal industry has been one of the most profitable and concentrated industries United States. By the early 1970s, the three main players, Kellogg's, General Mills, and General Foods, were routinely reporting between 15 and 30 percent returns on assets.
Each year approximately 1 million tons of cereal is sold in the United States. Most RTE cereals are made from a similar combination of sugar, grains, flour, and other dehydrated food products. What differentiates RTE cereals from one another is advertising.
Because of the intense proliferation of cereal brands, the top 10 account for only 27.4 percent of sales. Kellogg's Frosted Flakes, the market leader, has only a 4.2 percent market share. All but one of the top 15 leading breakfast cereal brands in 2002 were Kellogg's and General Mills products.
Industry Characteristics:
RTE cereals are just one segment in the breakfast foods market. Other products, such as bagels, muffins, and breakfast bars, compete with cereal for consumers. As RTE cereal companies recognize the public's desire for more portable breakfast alternatives, they are responding with convenient products, such as cereal bars. In 1998, total cereal bar sales reached $275 million, and the market is growing at a rate of 10 percent per year. Kellogg's is the leader in this market with its Nutri-Grain bars and Rice Krispies Treats. In addition, Quaker Oats has a line of fruit and oatmeal cereal bars, which it created in 1998. According to Datamonitor's 2002 report on breakfast cereals in the United States, sales of RTE cereals are expected to decline from $8.2 billion in 2001 to $7.2 billion in 2006. In addition, the mix of cereals is expected to change, as children's cereals decline and cereals in what is termed in the industry the "family" segment increase—a reflection of baby boomers' health consciousness. Consumers in their early 20s to mid-30s already consume a more than expected share of organic and healthy cereals and are expected to maintain this habit as they age. This trend is encouraging, because A.C. Nielsen's research shows that increases in organic food sales in recent years are a reflection of increased purchases by dedicated consumers and not an expanding consumer base.
Manufacturing:
There are five basic methods for producing RTE breakfast cereals: granulating, flaking, shredding, puffing, and extruding. A typical cereal production line has a capacity of 25 million pounds per year (about 1 percent of total annual domestic production). Cereal plants must have the capacity to produce 75 million pounds annually to achieve minimum efficient scale. A plant this size requires an investment of approximately $100 million.
Because the production process for cereals does not differ widely, a single plant can produce a variety of cereal brands.
Cereal is manufactured at, or shipped to, regional distribution centers, which transport products one way and ship empty trucks on the return trip. Logistics costs account for an estimated 2 to 14 percent of the cost of goods sold in the consumer goods industry.
Product Differentiation:
Consumers tend to be heavily influenced by advertising, the main tool used by competitors to differentiate their products. The RTE market-advertising ratio has been as high as 19 percent of revenues. In 2000, it fell to 13 percent, which is still high compared with the rest of the food products industry, which averages just 6 percent of sales. Because of intense competition in the RTE industry, new products require high market entry and advertising costs. It takes an average of between two and four years and $5 million to $10 million in research and development costs alone to introduce a new product. But despite these high costs, most new products do not gain large market share. Between 1980 and 1993, no more than 50 percent of new brands survived. In addition, fewer than 10 percent of new products ever achieve market share of more than 1 percent.
Most RTE cereal companies have internal marketing teams that work with outsourced advertising agencies. The marketing team is responsible for the strategic direction of the product, pricing decisions, and coupons and other promotions. The team also manages the company's relationship with the advertising agency. Because of enormous advertising expenditures, some RTE companies choose different advertising agencies for different brands.
In 2002, children's cereals accounted for 46 percent of RTE cereal sales. To expand this lucrative market, companies have stepped up marketing directed at children. Though children do not generally have direct buying power, they are known to heavily influence purchase decisions.
In addition to media advertising, the RTE industry is the second largest category of couponing. One of the most common types of coupons is the buy-one-get-one-free coupon. More than 25 percent of cereal purchased is bought with coupons. Typically, when a manufacturer runs a coupon offer, it will experience market share gains of 2 to 3 percent during the coupon-offering period. In recent years, RTE cereal companies have flooded the market with coupons, resulting in a less-than-2-percent redemption rate. Coupons cost cereal manufacturers approximately 14.5 percent of sales in 2000.
Major Market Players:
The four primary players in the RTE cereal industry accounted for 90 percent of market share at the beginning of 2002. The two largest, Kellogg and General Mills, accounted for 66 percent of the market. Because the industry is dominated by so few players, these companies historically have been able to earn returns on assets of between 15 and 30 percent. This is twice the return of the food industry's average. Although the products may be difficult to differentiate, the significant players in the RTE market have unique strategies.
Table: Profitability of Major Cereal Makers
|
Company
|
Market Share
|
Sales (in millions)
|
Gross Profit Margin
|
Return on Invested Capital
|
Return on Assets
|
|
General Mills
|
33%
|
$7,949
|
40.29%
|
4.8%
|
2.7%
|
|
Kellogg
|
33%
|
$8,853
|
51.75%
|
11.6%
|
6.4%
|
|
Kraft
|
15%
|
$33,875
|
44.91%
|
8.1%
|
5.3%
|
|
Quaker Oats
|
9%
|
$1,991
|
N/A
|
N/A
|
N/A
|
|
Private Label
|
8%
|
N/A
|
N/A
|
N/A
|
N/A
|
|
Industry Average
|
N/A
|
N/A
|
38.91%
|
9.2%
|
5.5%
|
a) The information provided reflects the companies as a whole; cereal operations cannot be identified separately.
b) Data on gross profit margins and returns on capital for Quaker Oats and private-label companies are unavailable.
c) "Industry Average" reflects major diversified food companies.
Source: Hoover's Online
Kellogg:
Kellogg has dominated the U.S. RTE cereal market for much of the past several decades. It specializes in children's cereals, such as Rice Krispies, Apple Jacks, and Froot Loops, as well as healthy cereals, such as Healthy Choice, Special K, and All-Bran. Kellogg's products have strong brand equity, and the company can use its brand name and its animated characters to enhance new products.
In 1995, though, the company's sales began to stagnate, losing ground to three major competitors. Then, in 2000, for the first time, Kellogg saw its total-dollar market share drop to competitor General Mills, according to Information Resources and Marketing, a Chicago-based research company.
In response to threats to its leadership position, Kellogg was forced to cut prices. In 1996, the company slashed prices by an average of 19 percent on 16 brands of cereal to counter price reductions made by Kraft Foods. In 2001, however, Kellogg changed its strategy, cutting under-performing products and eliminating the discounting program. These changes boosted Kellogg's RTE cereal total-dollar market share back above General Mills in the second quarter of 2002.
In the past, Kellogg has shifted resources into developing and launching new products and increasing advertising and promotions. In 1998, the company introduced Breakfast Mates, an RTE cereal that comes prepackaged with a bowl, spoon, and milk. The product is aimed at busy consumers who eat on the run. Then, in 2000, Kellogg's began to expand into products outside the RTE market through its purchase of Keebler for $3.6 billion in cash and the assumption of $800 million in debt, a move that reduced the company's reliance on cereals. Keebler accounts for approximately 30 percent of Kellogg's revenue. Since acquiring Keebler, Kellogg has been able to retire $1 billion of long-term debt.
Although Kellogg was slow to respond to the booming organic segment, in June 2000 it acquired natural cereal and convenience-foods maker Kashi Company. It also continues to introduce new products, including a line of RTE cereals in association with the Walt Disney Company and fortified extensions to existing products.
Table: Kellogg's Sales Data
|
Products
|
Sales (in millions)
|
Percent of Total Sales
|
|
Cereals
|
$4.914
|
55%
|
|
Snacks
|
$2,263
|
26%
|
|
Other
|
$1,676
|
19%
|
Source: Hoover's Online
General Mills:
General Mills is another leader in the RTE cereal industry. The company is more diversified than Kellogg, with several lines of snack foods.
Table: General Mills's Sales Data
|
Products
|
Sales (in millions)
|
% of Total Sales
|
|
Cereals
|
$1,866
|
23%
|
|
Snacks
|
$772
|
9%
|
|
Baking Products
|
$786
|
10%
|
|
Meals
|
$1,161
|
15%
|
|
Bakeries and Food Service
|
$1,028
|
13%
|
|
International
|
$778
|
10%
|
|
Pillsbury
|
778
|
10%
|
|
Yogurt and Health
|
$815
|
10%
|
Source: Hoover's Online
The General Mills product line of RTE cereals includes Cheerios, Wheaties, Total, and Chex. The company uses strong cereal brands to create line extensions, such as Frosted Cheerios and Honey Frosted Wheaties. Line extensions serve two strategic purposes: First, they enable the company to charge higher prices for new products, because consumers are interested in the special flavors and varieties; and second, they reduce the likelihood of price discounters offering similar products, because the line extensions focus on niche markets. In addition, product extensions have lower introduction costs than a new product launch because the consumer has some familiarity with the brand. For this reason, product extensions have a higher success rate than new product introductions.
General Mills was quick to identify a consumer trend toward organic cereals and health foods in the mid-1990s, although it didn't launch its first actual organic cereal until 1999. From 1992 to 1997, as sales of organic cereal rose by 40 percent, opportunities for growth presented themselves to the company as the overall cereal market had seen a decrease in sales. The company thought early on that it could market existing brands, such as Cheerios, as healthy cereals. General Mills's advertising campaign emphasizing the health benefits of Cheerios resulted in a boost for the No. 2 brand. Capitalizing on this, General Mills launched extensions of its already popular Chex line. General Mills also used a medical study to promote the nutritional benefits of its kid-focused cereals. In February 2000, General Mills announced a national rollout of two new products: Harmony, a cereal specifically targeted at women, and Wheaties Energy Crunch, a new version of the Wheaties line.
In 2000 General Mills launched an organic cereal brand, Sunrise, and purchased Small Planet Foods, an organic foods manufacturer. In 2002 the company announced the launch of four more organic cereals under the brand name Cascadian Farms. This brand carries no General Mills identification and is aimed at organic grocers such as Whole Foods who refuse to carry products from the major cereal manufacturers. In July 2002 General Mills announced that it intended to have 80 new products on the shelves by the end of 2002, which would help them achieve their goal of increasing RTE cereal unit sales by 4 percent in 2003.
Quaker Oats:
Quaker Oaks, which was purchased by the international foods conglomerate Pepsico in August, 2001, is well known for its hot and RTE cereals. Although it trails the market leaders in RTE cereals, it dominates the hot cereal market with its Old Fashioned Oats and Quaker Instant Oatmeal. In addition, it has strong market leadership in granola bars and pancake mixes (the Aunt Jemima brand).
Quaker Oats's RTE cereal brands include Life, Cap'n Crunch, and Quaker 100% Natural. Quaker also introduced a variety of everyday-priced bagged cereals to compete with the low end of the market. Mother's brand is Quaker's entrant into the organic market.
The U.S. Food and Drug Administration's ruling on the health benefits of oats in the 1980s has helped the company's hot cereals steadily gain market share against the RTE cereals, a trend also attributable to the changing tastes of American consumers.
Kraft (Post):
Kraft Foods, formerly a subsidiary of the Philip Morris Company, was spun off in a 2001 initial public offering. Kraft's major brands include Kraft, Maxwell House, Oscar Mayer, Post, Nabisco, Philadelphia, and Jacobs, each of which brings in more than $1 billion in sales yearly. Philip Morris entered the RTE cereal industry with the acquisition of General Foods (Post) in 1985. Post's cereal portfolio includes Grape Nuts, Raisin Bran, Honey Comb, Fruity Pebbles, and Shredded Wheat.
In the 1990s, Kraft continued to launch new products. The majority of these focused on the growing health food market. Post has slowly increased its market share, but unlike other competitors in the RTE market, it is not the largest product line at Kraft. In recent years, Kraft has divested its lower margin products and breakfast foods, such as Lender's bagels and Log Cabin syrup.
Distribution:
More than two-thirds of cereal is distributed by standard and grocery store chains. Consolidation in the grocery store market has led to dominance among the top five grocers: Wal-Mart, Kroger, Safeway, Costco, and Albertson's. Of these, Wal-Mart accounts for more than 10 percent of RTE cereal sales in the United States. Overall, grocery store chains account for 9.4 percent of total retail sales. These large chains have positioned themselves to earn higher profit margins by purchasing products in bulk from food manufacturers. In addition, larger chains are more likely to develop private-label brands, which earn higher margins for the chain. For example, according to U.S. Monitor, branded cereals bring in 12 percent margins for grocers whereas private-label cereals generate 15 percent margins.
Table: Cereal Distribution
|
|
Sales (in millions of dollars)
|
Number of Outlets
|
Gross Margins
|
Return on Invested Capital
|
Return on Assets
|
|
Wal-Mart Stores, Inc.
|
$217,799
|
4,500+
|
22.89%
|
13.1%
|
8.3%
|
|
Kroger
|
$50,098
|
2,400
|
27.19%
|
9.8%
|
5.9%
|
|
Safeway
|
$34,301
|
1,770+
|
27.19%
|
10.4%
|
7.5%
|
|
Albertson's
|
$37,931
|
2,400+
|
31.54%
|
5.7%
|
4.1%
|
|
Industry Average
|
N/A
|
N/A
|
26.38%
|
5.5%
|
3.4%
|
Independent food stores account for 20 percent of cereal sales. Supermarket chains typically have lower prices than independent stores because of economies of scale. However, the price difference between the supermarket chain and the independent grocer is small. A leading national brand like Rice Krispies is priced similarly in all outlets, reflecting the competitive nature of the cereal industry.
Table: Cereal Prices
|
Family Cereals
|
Highest- Priced Brand
|
Lowest- Priced Brand
|
Private- Label Brand
|
|
Chain Supermarkets
|
$4.09
|
$2.49
|
$1.89
|
|
Independent Supermarkets
|
$4.09
|
$2.79
|
$1.99
|