Breakfast Cereal 1

Description

One of my favorite things to eat is breakfast cereal. I have been a cereal eater since I was

a kid and have chosen to do my paper on the breakfast cereal industry. The NAICS code is

311320. The SIC code is 2043 Cereal Breakfast Foods. The SIC gives a description of

establishments as primarily engaged in manufacturing cereal breakfast foods and related

preparations, except breakfast bars. Cereal breakfast foods include: coffee substitutes made

grain, hulled corn, farina, granola (except bars and clusters), hominy grits, infant cereal foods,

oatmeal, rolled oats, rice breakfast foods and wheat flakes.

History

Breakfast cereal is one of the most popular forms of breakfast in the United States. Just

about all of us have had and enjoyed a bowl of cereal in the morning. The breakfast cereal

industry is very profitable and has been around a long time. In 2007, the market value for the

industry was $11.2 billion (Datamonitor, 2007). The breakfast cereal was first invented in 1863

by Dr. James Caleb Jackson who made the granula. The granula was a hard wheat that had to

soak overnight before it could be eaten. Later the popular Corn Flakes was invented and today

there are many varieties of cereal to choose from.

There were a number of individuals who made various forms of cereal as a diet for its

patients of the Sanitarium in Battle Creek, Michigan. The cereals that were made however were

not for mass market. Not until 1906 was there a patent for cereal, and Corn Flakes were mass

marketed by The Kellogg Company. The Kellogg Company, however, was not the first

company to mass market cereal. The first was The Shredded Wheat Company, which sold

shredded wheat. The Shredded Wheat Company was sold later to what is now known as
 Breakfast Cereal 2

Nabisco. Although there were a few companies producing breakfast cereal for consumers, The

Kellogg Company was the largest and most productive.

Corn Flakes were very popular in American households. Soon after, there were a number

of breakfast cereal companies who were producing a number of different cereals for consumers.

In the early 1900’s, there were over 100 companies producing breakfast cereal. The Kellogg

Company had an initially monopoly, but soon the industry transformed from to a monopolistic

competition. Many of the breakfast cereal business went out of business, and by 1947, only 55

firms remained in the market (Price, 2000). Today only 45 firms make up the breakfast cereal

market.

There are two types of breakfast cereals in this market; the hot breakfast cereal and the

ready-to-eat breakfast cereal. According to Datamonitor 2007, the ready-to-eat breakfast cereal

dominates market share with an 88% share of the market value.

Governmental/Environmental Factors

The primary supplier to the breakfast cereal market is farmers. Farmers supply wheat,

corn, oats, rice, eggs and a number of other ingredients that are used to produce breakfast cereals.

The government plays a major role in both the quality of the product along with the packaging of

the product.

Looking at the quality of the cereal produced, the Federal Department of Agriculture

plays a major role in what foods can be legally produced in the United States. The Federal

Department of Agriculture is an agency within the Public Health Service, which is a part of the

Department of Health and Human Services. The Federal Department of Agriculture has a

number of different functions, one of which is to ensure that the food we eat is safe and
 Breakfast Cereal 3

nutritious. There are two major sections in the requirements of food law: health safeguards and

economic safeguards.

Health safeguards are set up to make sure that certain pesticides, poisons and chemical

substances are not included in the food. They also insure that food comes from non-diseased

animals along with a few other regulations to insure that the food is safe to eat.

Economic safeguards are set up to ensure that the food is not damaged or inferior.

Economic safeguards also ensure that food labels are correct on packaging and to make sure that

food containers are not made or formed to be misleading (USDA Website).

Although the Federal Department of Agriculture plays a major role in the production and

distribution of cereal, it is not the only government office that is involved in the breakfast cereal

industry. The breakfast cereal industry is also subject to the antitrust laws that are established by

the Federal Trade Commission.

The Federal Trade Commission deals with economic issues of Americans, including

consumer protection and competition jurisdiction. There are many rules and regulation set forth

by this organization to help govern the breakfast cereal industry. When there is a proposed

violation of the antitrust laws or higher than normal pricing on cereal, the Federal Trade

Commission applies the laws.

In 1996, the Federal Trade Commission negotiated a settlement to keep cereal prices

competitive. General Mills had acquired Ralcorp, the producer of the Chex brand cereal. With

the acquisition of Ralcorp, General Mills now had 31 percent of the breakfast cereal market. If

the Federal Trade Commission did not take action, this acquisition would have restricted the

entry of new private label cereal products. The restricting of new private label cereal products
 Breakfast Cereal 4

would dramatically reduce the competition in the breakfast cereal market. This would have

resulted in higher prices for Chex brand cereals (Federal Trade Commission, 1996).

Market Structure

The NAIC code is for the breakfast cereal industry 311230.

In the 2002 report, there are 45 firms in the “Breakfast cereal manufacturing” industry

group (NAICS code 32123). The four largest firms supply 82.1 percent of the total value of

shipments in this industry. Furthermore, the eight largest firms are responsible for 92.1 percent

of total shipments. It implies that the 33 other firms produce only 7.9 percent of total output.

Thus, based upon the 4- and 8-firm concentration ratios, we conclude that this industry is

monopolistic competitive.

In monopolistic competition, it shares characteristics of both a monopoly and competitive

industry. There are many firms with similar products competing against each other. The

Herfindahl-Hirschman index further supports this conclusion. The HHI is equal to 2.999.6

which indicates that this market is highly concentrated.

The dynamics of this market structure has had a little change over time. In the 1997

report, there were 48 firms in the “Breakfast cereal manufacturing” industry group (NAICS code

311230). The four largest firms supplied 82.9 percent of the total value of shipments in this

industry. Furthermore, the eight largest firms were responsible for 93.5 percent of total

shipments. It implies that the 40 other firms produced only 6.5 percent of total output. Thus,

based upon the 4- and 8-firm concentration ratios, we conclude that this industry is an oligopoly.

The Herfindahl-Hirschman index further supports this conclusion. The HHI is equal to

2.445.9 which indicates that this market is highly concentrated and dominated by a few very
 Breakfast Cereal 5

large firms. Both CR and HHI indicate that the degree of concentration in this industry slightly

decreased in 2002 as compared to 1997.

According to the Datamonitor, 2007, there are 3 large corporations that dominate the

breakfast cereal market: General Mills, Kellogg’s and Altria. General Mills is the market leader

in terms of value, but in terms of market share, both General Mills and Kellogg have the same

market share at 29.8%. Kellogg’s market share has declined since 2004 where it had 32.2% of

the market. General Mills market share has also declined since 2004 where it had a 31.2%

market share. (See Appendix A)

The breakfast cereal industry has many substitutes. It all depends on the consumer’s

preferences and what they like to consume for breakfast. Substitutes can include fruits, bagels,

toasts, doughnuts, kolaches, yogurt and other items that consumer eat for breakfast.

According to Datamonitor 2007, however, threats are considered moderate as the benefits

of substitutes are negligible. With the breakfast cereal industry having a moderate threat level,

there are few barriers to entry. However, with strong brands and customer loyalty there are

fewer companies that are entering the industry.

If a company does want to enter the market, they need to understand government

regulations. The primary regulation deals with the packaging of the product. Nutrition labels,

best before date, weight, allergen and ingredient listing need to be included on the packaging. In

addition to government regulations, nutritional guidelines also need to be met (Datamonitor

2007).

What is found is a fierce competition within the industry. There are constant promotions;

toys included in boxes, give-a-ways, sport and event sponsorships and other promotions all

encouraging consumers to buy a specific cereal.

There has been a push in the United States for a healthier option, and cereal companies

have also joined in this push. Consider Kellogg’s latest cereal, Smart Start. The company is

marketing the product as a healthy cereal that helps to build a strong heart. In fact, all of the

major cereal companies have a whole website dedicated to healthier choices and eating right.

Nutrition labels are also included on packaging for consumers.

Industry Demand

The demand for breakfast cereal has increased dramatically from the 1940’s to the mid

1990’s. According to USDA’s Economic Research Service, Price writes that the consumption of

ready-to-eat breakfast cereals increased from 4.4 pounds to 14.8 pounds in 1994 (Price 2000).

In the mid 1990’s, the demand actually lessened. This was due to high cereal prices and the

increase in popularity of substitutes such as toast, breakfast bars, bagels, etc. During the 1990’s

the price cost margin also shrunk.

The price cost margin measures the total value of the shipments minus the costs of

materials, wages paid to production workers divided by the value of the shipments. It essentially

looks at the proportion of the total shipment value over the production costs (Price 2000). Prior

to 1996, the breakfast cereal industry had a higher price consumer margin than other food

industries. But at the same time demand for cereal went down, we also see a drop in the price

consumer margin (PCM) as well. The drop in PCM primarily happened because of the price cuts

in cereal and the lesser demand for breakfast cereal. The consumer price index also dropped 4.3

percent during this time frame as well.

The actual price for a box of breakfast cereal has increased over time as well. The price

of a box of cereal not only included the production costs, but also includes the costs to print

coupons and the heavy promotions around the product. Promotions include commercials,
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newspapers, magazines and give-a-ways that are included in the box. One of the largest costs for

breakfast cereal companies was the coupon used for promotion. The actual printing of the

coupon was not that expensive, but the face value of the coupon took away from the profit

margins of the breakfast cereal companies. Coupons were and are still used heavily to promote

breakfast cereals.

In 1996, Posts decided to lower the face value of coupons. It did this to cut the costs of

production and save money. Two months later, the other breakfast cereal companies followed

suite and also lowered the face value of coupons. The problem was, however, the manufactures

of the breakfast cereals could not require the retailers to pass along their price reductions. This is

because the retailers set the shelf price (Price 2000). Eighty four percent of breakfast cereals are

sold in supermarkets.

With the lowering of production costs through the lowering of coupons, Price (2000)

looked at data from the Information Resources Inc., to determine the influence of manufacturer

coupons and shelf prices on the prices consumers paid for cereals after 1996. The data included

over 50,000 consumers purchasing both branded and private-label breakfast cereals (See

Appendix B). It was shown that after the first month of Post’s reduction of coupons, the price of

branded cereal fell 3.5%. The prices continued to drop and even after 1 year, there was a drop of

10% of shelf prices from the previous year. This showed that the retailers passed on the

wholesaler’s price reductions to the consumers.

Looking at breakfast cereal on a global scale, ElAmin writes that sharp declines in world

cereal stocks could foreshadow future supply problems (ElAmin, 2006). He continues in his

article that declines are due to a slight decrease in global cereal output and a large growth in

demand. The breakfast cereal industry is also dependent on the grain industry. When an issue
 Breakfast Cereal 8

affects the output and supply in the grain industry, it in turn, affects the breakfast cereal industry.

In the United States, with smaller wheat crops outputs and an increase in demand for the grain

due to the increase in poultry consumption, prices are expected to rise in the breakfast cereal

market. ElAmin’s article gives a great example of the industry supply and what can happen to

prices when a shift happens. (See Appendix C)

Price Elasticity of Demand

The breakfast cereal industry is a relatively elastic in terms of demand. Breakfast cereal

is definitely a luxury versus a necessity. With there being so many different brands of cereals, if

the price of a box of cereal goes up, the consumer can just switch to another box or brand that

they perceive to be as good. In addition to other cereals, consumers can also choose to eat

something different for breakfast, such as toast, eggs, bagels or other breakfast foods.

In her article, Shoppers Scrimp as Food Prices Rise, Maestri writes how shoppers will go

to a different store to save money on cereal. If Wal-Mart is charging $5 for a box of cereal, a

consumer can go to a different store who may be charging a lesser amount for the same box of

cereal. The reason is that the retailers make the price for the cereal. The manufactures sell

cereal to retailers, who in turn sell it to consumers. The retailers can set the price for cereal to

any price they want, based upon their profit goals.

Stop & Shop is a popular supermarket on the east coast. It has a new promotion where it

wants to entice more shoppers to buy cereal from its stores as opposed to going elsewhere. Stop

& Shop has placed red signs on the cereal aisle where it has lowered the price of cereal. In the

case of Stop & Shop, they are hoping that a reduction in price will increase the demand for

breakfast cereal.
 Breakfast Cereal 9

The supermarkets follow the price elasticity of demand in the breakfast cereal market. A

rule of thumb is that the higher the price, the higher the total revenue if the demand is inelastic.

The lower the price of a good, the higher the revenues if the demand for that good is elastic.

Since the breakfast cereal market is elastic, consumers will benefit from lower prices (See

Appendix D).

Industry Supply

The numbers of breakfast cereal companies and manufacturing plants have shrunk since

its beginning in the early 1900’s. As mentioned earlier, by 1947, there were only 55companies

that produced breakfast cereal and today that number is down to 45. The manufacturing plants

have also shrunk, from over 100 in the 1900’s to 36 plants that produce the entire amount of

breakfast cereals (Price 2000). The major cost include the purchasing of ingredients, wage and

labor, energy costs for production, transportation and packaging of breakfast cereals, equipment,

overhead and advertising.

One of the determinants of supply that affects this industry is the grain market.

Whenever that is a significant change in the grain market, that change affects the breakfast cereal

market. In a recent article on cnnmoney.com, Worral writes on how poor harvest and increased

demand are sending wheat and corn prices to record highs, spiking food costs (See Appendix E).

Corn and wheat are predominate ingredients in breakfast cereals. If the manufactures have to

pay more for the costs of ingredients, they will need to find a way to offset costs. Many

manufactures try to pass the price on to consumers. But because the retailers set the prices of

breakfast cereal, it is up to the retailers to pass the price on to the consumers.

Technology has helped to improve the production of breakfast cereal. Manufactures are

now able to produce 40 to 60 million pounds of cereal annually as opposed to significant lower
 Breakfast Cereal 10

amounts produced at smaller plans. Manufactures have also reduced costs of shipping by

building additional plants so that the final product can be shipped a shorter distance (Price 2000).

The industry does not require highly skilled workers to run the machines that produce the

breakfast cereal. Extensive training is required, but a person does not need an advanced to

degree to work at one of the manufacturing plants. Working for the large cereal companies does

require highly skilled workers. Many of the positions in the sales and marketing require

advanced business degrees in order to be hired.

The breakfast cereal industry does have unions and about 18% of the workers belong to

unions. College grad.com lists the prominent unions in the food industry as the United Food and

Commercial Workers; the International Brotherhood of Teamsters; and the Bakery,

Confectionery, Tobacco Workers and Grain Millers International Union (Collegegrad.com

2008). Unions in the food industry, like other industries, limit the access to labor and increase

the costs of production.

Conclusion

The breakfast cereal industry is an industry that is very profitable with over $11 billion

dollars in sales in 2007. The industry is dominated by 3 firms that have over a 76% market share

and sell their product primarily to supermarkets. But, there are over 45 firms in the breakfast

cereal industry. The 45 firms operate in a monopolistic competition.

The breakfast cereal industry is open to new entrants, as long as they understand the

government regulations regarding the nutritional value, product packaging and ingredients. Even

though the market is dominated by 3 firms, a company that has a specific population it wants to

target with cereal may be able to enter the market. For example, with the recent push toward

healthier eating and weight loss, companies that produced breakfast cereal for this population
 Breakfast Cereal 11

could potential do well. They would, however, have to find space shelf in the grocery aisles, as

space shelf is limited.

There has not been much growth in the breakfast cereal industry over the past 5 years, but

deceleration in the United States has been minor. There are many determinants of costs, but one

of the major determinants is the actual materials or ingredients used in the making of breakfast

cereals. The industry is dependent on farmers who produced wheat and corn. If something

happens to the crop, the prices of cereal are increased as manufactures have to pay more for corn

and wheat.

Substitutions for the breakfast cereal industry are abundant, with many choices of

breakfast items to choose from depending on the consumer’s choice. The industry has a bright

outlook and many different brands of cereal are constantly being introduced. There really is

nothing like a good bowl of cereal to start the day.

Appendix A

2004 Breakfast Cereal Market Share

Kellogg
General Mills
Kraft
Private Label
Other

Kellogg 32.2%
General Mils 31.2%
Kraft 17%
Private Label 7%
Other 12.6%

2007 Breakfast Cereal Market Share

General Mills
Kellogg
Altria Group, Inc
Other

General Mills 29.9%

Appendix B
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References

Clauson, A (1997). Economic factors holding down food prices increases. Food

Review, 2-4.

Datamonitor (2007). Breakfast cereal in the United States: Industry profile. Datamonitor.

Com. Retrieved April 10, 2008. www.datamonitor.com.

ElAdmin. A. (2006). Cereal price forecast to rise as demand soars. Foodnavigator-

.com. Retrieved April 10, 2008. http://www.foodnavigatousa.com/news

/ng.asp?n=69311-cereal-fao-ethanol.

Federal Trade Commission (1996). FTC negotiates settlement to keep cereal prices

competitive. Retrieved April 12, 2008. http://www.ftc.gov/opa/1996/12/genmills.shtm

Food Manufacturing Industry Information. CollegeGrad.com. Retrieved April 21, 2008.

http://www.collegegrad.com/industries/manuf05.shtml.

Ippolito, P.M. & Mathios, A.D. (1989). A study of the cereal market. Federal Trade

Commission, 1-158

Nevo, A. (2001). Measuring market power in the ready-to-eat cereal industry.

Econometrica, Vol. 69, 2, 307-342.

Price, G. (2000). Cereal sales soggy despite price cuts and reduced couponing.

Food Review, 23 21-28.

Reimer, J. (2004). Market conduct in the U.S. ready-to-eat cereal industry. Journal

Of Agricultural & Food Industrial Organization, 2, 1-29.

Spake, A. (2005). Utopia in a cereal bowl. U.S. News and World Report, 139, 46.
 Breakfast Cereal 15

Worrell, M. (2007). Grain price hikes squeeze food chain. CnnMoney.com. Retrieved

April 20, 2008 http://money.cnn.com/2007/12/11/smbusiness/grainprices.

fsb/index.htm.

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Appendix C

Industry Demand

As the price of breakfast cereal increase, the demand for cereal decreases.
 Breakfast Cereal 17

Appendix D

Price Elasticity of Demand

In this scenario, as the price of cereal decreases, the demand for cereal increases.
 Breakfast Cereal 18

Appendix E
Supply

In this diagram, as the demand increases, the quantity increases and the price increases as
well.