In 1993, you are an executive working for Puleva, a Spanish producer of dairy products, infant formula, and baby cereals. You have been tasked by the CEO to analyze possible entry into the United States ready-to-eat breakfast cereal business. Please analyze the breakfast cereal industry for your report to the CEO. Describe the structure of the industry during the 1980s and early 1990s, and how you project it to change moving forward.

In 1993, the United States ready-to-eat breakfast cereal industry was changing. For many years, the industry had been very stable, and profit margins had been quite high. The industry had long been dominated by three players:  Kellogg, General Mills, and Post. Together, those three firms had a market share of over 80% from 1950 through the late 1980s. The ROA for their cereal divisions were quite healthy, ranging from 15-30% throughout this period. For decades, the firm’s prices rose in lock-step with one another. When Kellogg raised prices, the other two major rivals tended to follow suit rather quickly. All competitors tended to avoid major discounting to retailers. The companies tended to promote their brands by inserting toys or special prizes in the packages. However, each firm only promoted one brand at a time with these special inserts. The three major firms had strong relationships with supermarket chains, where most of their products were sold. They had convinced the supermarkets to allocate shelf space to various cereal manufacturers based on historical sales volume. Supermarkets tended to demand a 10% discount for new companies wishing to secure shelf space without a historical sales track record. Over the years, the major cereal makers had also engaged in a great deal of brand and product proliferation. The companies had strong brands. Major brands included Corn Flakes, Frosted Flakes, Cheerios, Rice Krispies, and Grape Nuts. Often, new product introductions involved extensions of existing popular brands. With all the new brands introduced over the years, no more than 10% of the new product introductions achieved 1% market share. The average new brand introduction achieved 0.2% market share. The average new product introduction cost $5-10 million in product development, and it involved $20 million in advertising expenditure in the first year. As a whole, cereal makers accounted for roughly 25% of all food industry advertising. Advertising as a percentage of sales had been as high as 18% for the major cereal makers. As for manufacturing, the cost of building a plant of sufficient scale to achieve the most efficient production was $100 million. A plant of that size could produce enough cereal to achieve 3% market share (equivalent to 75 million pounds of cereal per year). As capacity of a plant exceeded 75 million mounds, productivity no longer increased. Thus, there was room in the industry for more than 30 production facilities of optimal scale. Plants always could produce multiple brands of cereal. Plants typically used raw materials such as flour, oats, sugar, honey, and salt to produce cereal. The engineering expertise to run a plant or develop new products was not at all highly advanced. However, firms did create proprietary product innovations from time to time; for instance, Post had introduced a “Blueberry Morning” brand that was widely regarded for high quality and good taste, largely due to the innovative way in which Post had preserved the blueberries. Many new product introductions, however, involved no substantial manufacturing or engineering innovation whatsoever. By 1993, though, industry revenue growth had slowed to 2% per year, and private label products now accounted for 9% of total industry volume – an all-time high. The top three cereal makers now held 72% share of the entire market. The quality of private label products had risen substantially since the 1970s, when such products had reputations for below average taste. By the early 1990s, Phillip Morris had entered the industry, through the acquisition of the Post brands (#3 in market share) and then in 1994, it purchased the Nabisco brands (#5 in market share). By the early to mid-1990s, the percentage of cereal sold in supermarkets had begun to decline, as more product was being sold in wholesale clubs such as Costco and mass merchandisers such as Wal-Mart. In recent years, coupons had become much more prevalent in the industry. The average value of redeemed coupons was now approaching $1.00. In August 1993, like it had for decades, Kellogg announced a price increase (2.1%), expecting the other major cereal makers to follow suit. This time, however, General Mills issued a press release, indicating that it would not raise prices at that time.