Oligopoly in Cereal Industry

Running head: Oligopoly in Cereal Industry1

Oligopoly in Cereal Industry

December 2, 2013

Oligopoly in Cereal Industry 2

Abstract

They’re Great! This is a well-known slogan that is

synonymous with breakfast cereal. Ready-to-eat (RTE) breakfast

cereal is a global billion dollar industry that has been in

existence for over 100 years and is dominated by four main

company’s: Kellogg, General Mills, Post and Quaker that together

these oligopolies represent 85% of the market with Kellogg

leading the industry. But can it last? Today’s age of healthy

eating and ‘no-carbs please’ has caused a slow decline of

breakfast cereal consumption. This paper will look at the leader

of the cereal industry and its place in the market against its

competition and changes Kellogg will make to sustain its position

and continue to survive in this industry with today’s economy and

health crisis abroad.

Oligopoly

What makes an oligopoly? It is a market where a large

percentage of the industry is dominated by a few leading firms

which is comprised of a handful of competitors that are

responsible for the bulk of industry output. These firms have the

ability to set pricing and production strategy, and enjoy the


potential for economic profits in both the short run and the long

run. (Hirschey) The top cereal makers dominating today’s market

are Kellogg Co., General Mills Inc., Quaker Oats (PepsiCo, Inc.)

and Post (Ralcorp Inc.) with Kellogg and General Mills constantly

fighting for the top spot. These firms offer a common product of

RTE breakfast cereal in a variety of flavors and ingredients and

have stretched across to other product lines in the food

industry.

Ready to eat cereal (RTE)

This ready-to-eat (RTE) cereal has fed the young and old

around the world usually as a breakfast meal but is also enjoyed

as a snack throughout the day because it is so convenient to

serve and consume. They are produced with ingredients for human

consumption and made to sustain shelf life and usually enjoyed

with milk. These breakfast cereals are made from corn, wheat,

oats, or rice with added flavor and other ingredients. (Fast)

This type of food was founded in the United States in the late

1800s and the Kellogg brand was founded by a Dr. John Harvey

Kellogg and his brother Keith aimed at creating a healthy food

for people to consume advocating vegetarian eating lifestyle


which cultivated a brand new market in the food industry. They

are manufactured today as they were from the beginning of its

creation except today’s cereals contain more additives than when

Kellogg first invented its first cornflakes. “The original

breakfast cereal consisted of unsweetened flakes made from wheat

that had been baked, ground, and then mixed into dough. The dough

was then pressed between giant rollers and flaked off before

being cooked again.” (Fast) “Most RTE cereals may be grouped

into 12 general categories for discussion of their manufacturing

processes: 1) flaked cereals (corn flakes, wheat flakes, and rice

flakes), including extruded flakes, 2) gun-puffed whole grains,

3) extruded gun-puffed cereals, 4) shredded whole grains, 5)

extruded and other shredded cereals, 6) oven-puffed cereals, 7)

granola cereals, 8) extruded expanded cereals, 9) baked cereals,

10) compressed flake biscuits, 11) muesli-type products, and 12)

filled bite-size shredded wheat. Their processing typically

involves first cooking the grain with flavor materials and

sweeteners. Sometimes the more heat-stable nutritional fortifying

agents are added before cooking. Two general cooking methods are

employed in the industry—direct steam injection into the grain


mass in rotating batch vessels and continuous extrusion cooking.”

(Fast) By the 1960s this market was starting to take shape as an

oligopoly, it started to blossom from the 19th century to now,

and breakfast cereal is still served today in households,

schools, hotels, and even on airlines.

These four firms produce their cereals using similar

ingredients and processes. The more popular product lines of

these cereal oligopolies include Kellogg’s Frosted Flakes, Fruit

Loops, Rice Crispies and Special K; General Mills’ Wheaties,

Cheerios, Chex, Lucky Charms, Trix and Count Chocula; Post’s

Fruity Pebbles, Grape Nuts, Raisin Bran, Honeycomb, and Honey

Bunches of Oats; and Quaker Oats’ Life and Captain Crunch. Along

with these products, Kellogg, General Mills and Quaker Oats have

already established an extension to other product lines. For

instance, Kellogg’s also produces Pop Tarts, Nutri-Grain and

Special K breakfast bars, frozen Eggo waffles and pancakes,

breakfast drinks, crackers and fruit flavor snacks. Not to be

left far behind General Mills also offers an eclectic list of

products such as frozen Pillsbury pastries and rolls, baking

products for cakes and pancakes, frozen fruit, vegetables and


pizza, salty snacks, soups, and yogurt. And Quaker Oats owns

Gatorade, a very popular sports drink that caught the eye of a

very popular soda firm. Despite the falling demand of consumers,

as long as these product lines continue to be demanded by

consumers, these oligopolies will continue to thrive.

Concentration Ratio

The four top firms in the cereal production market are

Kellogg, General Mills, Post and Quaker which account for

approximately 85% of the total cereal market. Both Post and

Quaker Oats have been purchased by other companies; Ralcorp

acquired Post from Kraft in 2008 and Pepsi acquired Quaker Oats

in 2001 to acquire their Gatorade non-soft drink product which

accounts for 80% of the sports drink market. Today Kellogg and

General Mills fight for the top spot and Post and Quaker Oat’s

continue to stay in the running with their popular cereal brands.

Reviewing these cereal makers history and current standings in

today’s market will explain why they make up today’s cereal

industry oligopoly.


Kellogg

Kellogg employs 31,000 employees and primarily produces RTE

products and it relies on agriculture resources such as corn

grits, wheat, oats, rice, cocoa, soybeans and some fruit to

produce these wonderful treats. These products are manufactured

in 18 countries and marketed in more than 180 countries. Kellogg

uses direct sales forces to sell to consumers and its main retail

customer are the Wal-Mart stores. According to MSN Money,

Kellogg Co. was said to have earned $326 million, or 90 cents per

share. Not including one-time items, it earned 95 cents per

share, which was above the 89 cents per share of last year’s

earnings. Wall Street expected an increase from last year’s 89

cents per share, their shares rose 1.5 percent to $63.25 in

premarket trading raising its stock more than 15 percent. (Choi)

Despite these earnings, recent reports state that Kellogg is

planning to cut its global workforce by 7 percent which equates

to about 2,170 jobs. Kellogg claims that this is necessary due to

falling sales for cereal products especially in the North

American market which they feel is due largely to the many option

that consumers have now for breakfast choices. “Kellogg says the


workforce reductions will take place by the end of 2017, along

with plant consolidations and other cost-cutting measures it's

dubbing Project K.” (Choi) Their latest product line extension is

the production of liquid breakfast drinks and salty snacks, like

Pringles chips. Kellogg’s current share price is 62.47.


General Mills

General Mills is the second leader in the market and is

Kellogg’s top contender. “General Mills, Inc. (General Mills) is

a manufacturer and marketer of branded consumer foods sold

through retail stores. The Company is also a supplier of branded

and unbranded food products to the foodservice and commercial

baking industries. The Company manufactures its products in 15

countries and markets them in more than 100 countries. The

Company's joint ventures manufacture and market products in more

than 130 countries and republics worldwide. General Mills

operates in three segments: U.S. Retail, International, and

Bakeries and Foodservice. In addition, the Company sells ready-

to-eat cereals through its Cereal Partners Worldwide (CPW) joint

venture.” (Forbes) Their increased sales of new products

overseas are reasons for their increased profits. “At its U.S.

retail segment, the largest by revenue, net sales rose 3.6% to

$2.58 billion, while operating profit improved 6.4%. The

international segment's sales jumped 22% and its operating profit

slipped 0.2%. Convenience stores and foodservice segment sales


slid 0.8% as operating profit increased 9.5%.” (Tadena) General

Mill’s current day share price is 50.12.


Quaker Oats

Quaker Oats was recently acquired by PepsiCo primarily for

Pepsi’s interest in their Gatorade product. Under the terms of

the deal, PepsiCo, offered 2.3 of its shares for each share of

Quaker, which valued Quaker at $97.46 a share based on PepsiCo's

share price of $42.38 and PepsiCo also is expected to assume

about $761 million of Quaker’s debt. Before the deal was

solidified Pepsi had a safety clause that would give Pepsi $420

million if Quaker broke the deal or sold to another company.

Despite the reason for Pepsi’s interest in Quaker, it helped the

cereal company survive. Currently PepsiCo’s share price is 85.74.

Post

Post was founded in 1897 and is manufactured in the United

States and Canada through a flexible production platform


consisting of four owned primary facilities and sold through

several retail stores and mass merchandising companies. “Post

announced in September that it was buying Dakota Growers from

Viterra Inc. for $370 million in order to expand its food

offerings. It also acquired nutritional supplement maker Premier

Nutrition Corp. in August and the cereal, granola and snacks

business of Hearthside Food Solutions in May. Cereal maker Post

Holdings anticipates that its fiscal 2013 revenue will top Wall

Street's expectations. The St. Louis Company, whose brands

include Grape-Nuts and Honeycomb, foresees revenue between

approximately $1.03 billion and $1.04 billion.” Its current share

price is 46.79

Like any firm that produces a product, their prices are driven by

fixed and variable costs required to manufacturer, package and


distribute. They share common raw materials that are required for

their products and as those materials fluctuate in the economy so

does their price.

Price

Raw materials such as grains, corn, wheat, and cocoa are

common ingredients for these firms. The cost of production for

packaging, labor, transportation and energy as well as oil prices

and plastics would have an impact on prices as well. According to

the Wall Street Journal, Global cereal production, which includes

wheat and corn, is expected to be 8% higher over 2012’s level, at

2.49 billion tons. The U.S., the world’s largest corn producer,

is responsible for the bulk of the increase, expected to harvest

a record crop of 348 million tons—that’s 27% higher than the

previous year. U.S. corn supplies have been tight since the size

of last year’s harvest was hit by severe drought. But after high

acreage seeded with corn this spring and largely favorable summer

weather, the U.S. Department of Agriculture forecasts record U.S.

corn output this year. That should push corn prices lower.” (Rai)

These costs of production are short term cost drivers and

therefore, as price of raw materials and other factors of


production fluctuate up or down, so will the price of cereal for

consumers.

Long run cost drivers are the changing tastes of consumers

and the focus on healthier foods for children and adults. Foods

high in nutrients with less processing and less sugar, especially

gluten free products. In fact America has an awareness of

harmful effects of pesticide residues on breakfast cereal

products and is looking for more organic type products. These

consumer demands will drive the market and the cereal firms to

focus on what the consumer wants, i.e., organic, gluten-free,

sugar free products that taste good. (Wood) “There were more

than 230 natural or organic products introduced by various

companies in the US market in 2011.” (Wood) As these firms

continue to address the long run cost drivers they must also be

concerned with new competition into their market. Luckily, their

brand names are a barrier for entry by new cereal makers.

Barriers to Entry

The main Barriers to Entry in the cereal industry are

consumer loyalty to brands. According to Carnegie Consulting,

“Customers in the RTE cereal market historically have been shown


to have inelastic demand for established cereal brands. Children

are a major consumer of RTE cereal and after watching

advertisements for Rice Crispies or Lucky Charms, children are

not willing to settle for generic or off-brand cereals. In

addition, adults are willing to pay premiums for established

brands due to brand loyalty developed throughout their own

childhood.” (Carnegie Consulting) As consumers enjoy their

breakfast, little thought is given to how those products are

produced and the type of technology used to make it.


Technological Innovation

The importance of technology to the cereal industry is how

it is processed and packaged. According to Smithsonian magazine

“Ready-to-eat” cereal happens to be a prime contender for the

title of most manipulated food product. Its creation and rise

have been products of ever-devout American beliefs in the power

of technology and marketing, and of food to improve health.”

(Kummer) Technology also lends to economies of scale for

producers when new innovative technology allows firms to make

their products at a low cost, thus yielding higher profit margins

and a higher price per share.

Kellogg’s share price has seen an increase of 37 percent for

last two years and continues to hold the highest earnings per

share as compared to its competition.


Date Adj Close* O pen High Low Close Volum eNov 2011 45.73 48.21 48.98 48.2 48.75 1,201,900Nov 2013 62.47 61.83 62.51 61.55 62.47 5,072,500

45.73

62.47

0

10

20

30

40

50

60

70

Nov 2011 Nov 2013

Kellogg Share Price

Adj Close*

What’s expected for these firms in the next 12 months? Cold

cereal, an option that's been around for over 100 years, has been

falling out of favor over the past two decades, however,

according to CNBC’s Wood, “the analysts forecast the Breakfast

Cereals market in the US to grow at a CAGR of 2.14 percent over

the period 2012-2016. One of the key factors contributing to this

market growth is the increase in a health-conscious population.

The Breakfast Cereals market in the US has also been witnessing

the increasing demand for natural and organic breakfast cereals.


However, the declining birth rates could pose a challenge to the

growth of this market.” (CNBC)

BusinessWeek’s recent report about how these oligopolies are

affected by today’s consumer changes and demands “Kellogg (K),

owner of Special K, Frosted Flakes, Raisin Bran, and other

varieties, reported a 3.3 percent drop in “morning foods” revenue

during the recent quarter, and the company recently moved to

close its Kashi brand headquarters outside San Diego and lay off

at least 70 workers at a Tennessee cereal plant. General Mills

(GIS), maker of Cheerios, Wheaties, and Lucky Charms, saw similar

results as its cereal revenue slumped by almost 2 percent in the

12-month period that ended in May. The appetite for Honey Bunches

of Oats, a Post Holdings (POST) brand, has dropped by 9 percent

in the past year, and the company is in the process of closing a

140-worker cereal plant in Modesto, Calif.” (Stock)

http://investing.businessweek.com/research/stocks/snapshot/snapshot.asp?ticker=POST

http://investing.businessweek.com/research/stocks/snapshot/snapshot.asp?ticker=GIS

http://m.bizjournals.com/memphis/news/2013/08/01/kellogg-laying-off-70-local-employees.html

http://www.utsandiego.com/news/2013/mar/11/kashi-kellogg-michigan-moving-lajolla/

http://investing.businessweek.com/research/stocks/snapshot/snapshot.asp?ticker=K


Conclusion

Could this be the end of these wonderful breakfast cereals?

Like any industry that needs refreshing. These firms continue to

look for ways to increase their market shares and one way is

product line extensions. “The packaged-food giants are responding

with a flurry of new breakfast drinks, bars, and healthier cereal

options. Kellogg now has Special K Protein and just launched a

line of hot cereals that feature quinoa and packets of

cranberries. It is also working on Special K “cracker crisps,”

which seem like a cross between a bran flake and a potato chip.”

(Stock) Kellogg recognizes that in today’s fast past world

consumers do not always have time to poor a cup of cereal and

settle for on-the-go grabs, such as Kellogg’s portable Pop-Tarts,

which today are in high demand (Stock)

Only time will tell if the cereal industry will continue to

grow or decline, however, Food and Agricultural Organization

reports, “with the world cereal harvest forecast to surge to a

record 2,460 million tons in 2013, cereal prices could ease, with

markets becoming calmer and latest indications from point to a

more comfortable world cereal supply-and-demand balance in the


new 2013/14 marketing season and after a relatively tight

situation and high prices in 2012/13, "good production prospects

and a likely replenishment in world stocks could pave the way for

calmer markets and some easing of prices in the new season.”

(Winstanley)

One thing is for certain even with consumer tastes and

demand fluctuations, Kellogg, General Mills, Post and Quaker Oats

are still making cereal today and are extending product lines to

increase market shares, looking for ways to cut costs of

production and continue looking for new ideas to continue their

domination of the cereal market and growth in the food industry.

References

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to top street. Bloomberg

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from http://money.msn.com/investing/breakfast-cereals-

americans-no-longer-love- 247wallstreet.aspx?cp-

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slide. MSN Money.

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date=20131104&feed=AP&id=17066429

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http://money.msn.com/business-news


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http://online.wsj.com/article/ SB975872896745048674.html

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Oligopoly in Cereal Industry

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