The Private Label Threat From 1991 to 1994, sales of private label cereal grew 50% to nearly $500 million, or 9.2% of all cereal sales by volume.15 Private labels' share of the RTE cereal industry was projected to pass 15% by 2000. For grocery products as a whole, private label products accounted for 19% of unit sales and were anticipated to grow to 30% by 2000.17" Despite the inroads made by private label cereals in the 19903, not everyone was convinced that they presented a serious threat to the profitability of the branded manufacturers. A General Mills spokesperson said, "As the price of [RTE] cereals creeps up over time, I would think there would be opportunity for those companies in certain areas. But I don't think we would see them as a threat to any of our particular brands."18 Low price was the primary appeal of private label cereals. Private label cereals averaged $1.90 per pound at retail, 40% less than the Big Three average of ab0ut $3.20 per pound. Private labels did little advertising and made few attempts to differentiate their products in other ways. What little advertising they did undertake was devoted to raising awareness of their price advantage relative to branded cereals. Private label manufacturer MaltD-Meal, for example, ran magazine ads showing a $2.03 bag of Malt-O-Meal's Sugar Puffs next to a $3.16 b0x of Sugar Crisp. The caption read: \"You may not be able to tell the difference in your bowl, but we're sure you'll be able to tell the difference at the cash register.\" 19 Private label cereals offered lower prices to the consumer, but were also perceived to offer better margins to the retailer, which contributed to a willingness of grocers to promote private labels enthusiastically. Private labels typically offered grocers 15% margins, compared to 12% margins for branded cereals. \"Private label offers a good markup for us and savings for the consumer,\" said one grocer. "It doesn't take a genius to tell which products to put the signs next to?\" However, one trade journal argued that \"many retailers may not understand the fully burdened cost of private label. That is, how the costs of warehousing, merchandising, shrinkage and other issues affect private label profitability, compared with national brands." Industry analyst Bob McCann added, "I'm not entirely sure that what seems obvious is the right answer\";21 The high prices and ubiquitous coupons of branded cereals were blamed by many for the market share gains of private labels. lOne industry observer said, \"coupons have been a major eroding factor. Without them, shoppers feel like they are overpaying. Private label is an alternative if there is no coupon and no sales price.\"-2 The heavy use of coupons had more generally diminished brand loyalty by encouraging price-sensitive brand-switching. Brand loyalty was seen to have been further eroded by failed extensions of popular brands. One industry conSultant argued that, \"these brand extensions come out, and if they die, it tends to diminish the idea that these products are superior.\"23 Production and marketing of private label cereals changed dramatically in the early 19903. For years private label suffered from poor quality and limited product variety. Black and white label generic brands found only short-lived success in the 19805, and private label manufacturers discovered that even value-conscious consumers demanded a level of quality near that of a branded product. Increases in technological competence among private label manufacturers led to private label cereals that rivaled the branded products for quality. Still, the manufacturing costs per pound for a private label could be as much as 10-20% lower than for a Big Three firm because of their focus on simpler cereals with less labor intensive processes and fewer expensive fruits and nuts. Some private labels did away with the cereal box and sold cereals in clear plastic bags, reducing packaging costs by up to 25%. Private labels relied on wholesalers and third-party distributors-which received approximately a 10% margin on the wholesale price paid by the retailer--for distribution of their products. These distributors did little more than deliver the product to stores and did not provide the on-site presence of the Big Three's large national salesforces. The Big Three had systematically and publicly refused to produce private label cereals. In fact, some Kellogg packages boasted, \"We don't make cereals for anyone else." While Ralston had at one point virtually monopolized the private label cereal market, by 1994 its market share of the private label cereals was estimated to have fallen to about 50%. After Ralston, the most established producer of private label cereals was Malt-O-Meal, which had been in the business since the 19703. Other, more recent entrants into the private label RTE business included Grist Mill (the nation's leading supplier of private label granola bars and pie crusts) and McKee Baking (the nation's leading snack cake manufacturer with its Little Debbie brand). led to numerous plant expansions, and by 1994 MaltCtMeal had spent over $121] million to expand and equip a massive B square foot stateoftheart production facility.25 A Turning Point The first sign that the cycle of increasing prices and promotions by the Big Three might be ending came in August, 1993, when Kellogg armounced its third price increase of the year, a 2.1% increase that would bring the year's total to 6.2%. General Mills announced that it had no immediate plans to increase prices, and MaltDMeal's CED proclaimed, "The era of price hikes is over. This is the first time the industry didn't move in lock step. We think the price increases of 'he 193-115 are history.\"2'51 In the coming months, Stephen Sanger and Charla Gaillard took their new posts as head of General Mills and the Big G cereal division, respectively. Sanger had been complaining for several months about the increasingly inefficient spiral of promotional spending plaguing the industry. With a newr management team in place, Big G was ready to make a bold move. In April 1994, General Mills announced it planned to cut $135 million out of its trade promotions and couponing budget, and simultaneously to reduce prices on its biggest brands [accounting for about 4U percent of sales] by an average of '11 percent. "The overall purpose is to improve the profit performance of Big G," Gaillard said}; Sanger explained 'd'tis action: The practice of pricing up and discounting back has become more and more inefficient for manufacturers and retailers, and burdensome for consumers. . Clearly, the money we were spending to print, distribute and handle those additional coupons was not benefiting consumers. The St] cents that the consumer saves by clipping a coupon can cost manufacturers as much as T5 cents. It just doesn't make sense.EB Sanger believed that he was speaking not only for General Mills but for all the cereal makers. He stated that, "This is a move that's goo-d for General Mills and good for our industry. I would guess other manufacturers see the same wastefulness in coupon and other price promotions."29 General Mills' announcement set off a feverish debate in the trade and financial situation. Brandweelr dramatized the situation: Kellogg, in classic high noon drama fashion, will hew to the price up and spend back line. . . . Still, [Sanger's] move to restore sanity generated enough shock value to create a cereal drama, a sudden 130 that results in a showdown between Kellogg and General Mills. 'The two big gladiators are in the ring. with all the other little players ringside, and everybody else in the category jammed into the rest of the arena,' said a cereal industry observer. In three to six months, one or the other' s going to have lost. It shouldn't take any longer than that for one or the other of them to cave, widt the others going the way of the winner?\" Exhibit 1 RTE Cereal Market Shares Volume Market Share 1950 1960 1970 1980 1990 1993 Kellogg 35.2 45.9 45.5 40.9 37.5 36.5 General Mills 22.3 19.5 19.7 19.9 24.4 24.3 Post 26.8 19.6 19.3 15.6 11.1 11.9 Quaker 5.5 3.6 7.8 8.6 7.8 7.4 Nabisco 6.6 6.0 4.8 4.9 4.4 3.1 Ralston 3.5 5.3 3.7 6.5 6.1 4.2 Private label 5.6 9.2 Sources: Thomas, Louis. Brand Capital and Industry Evolution. Harvard University dissertation, 1991. J.C. Maxwell, Jr. "Cold Cereal Industry in 1991." Wheat First Butcher & Singer, Inc., March 25, 1993. Adelman, L., et al. "Special Report - Cereal Industry." Dean Witter Reynolds, March 11, 1994. RTE Market Share by Volume 50.0 45.0 40.0 35.0 - Kellogg 30.0 - General Mills Post 25.0 Quaker 20.0 - Nabisco 15.0 - Ralston 10.0 - 5.0 0.0 1940 1950 1960 1970 1980 1990 2000Exhibit 2 Cost Breakdown per Pound for Typical Big Three Cereal Firm Raw materials $0.42 Packaging .19 Labor and indirect manufacturing .52 Distribution .14 Advertising and sales .75 Depreciation, overhead .40 EBIT .40 Wholesale price $2.82 Retailer margin .38 Retail price $3.20 Source: Industry sources and casewriter estimates. Exhibit 3 1993 Volume Market Share by Channel Food Stores Drug Stores Mass Merchandisers Kellogg 36.3% 39.0% 18.7% General Mills 24.3 34.9 16.6 Philip Morris: Post 11.9 6.9 5.6 Nabisco 3.1 1.8 0.4 Quaker Oats 7.4 2.1 14.3 Ralston Purina 4.2 8.9 2.5 Malt-O-Meal 1.7 0.3 3.3 Mckee Baking 0.0 0.6 28.1 Other branded 2.0 0.0 0.0 Private label 9.2 5.2 11.9 Total Cold Cereal 100.0 100.0 100.0 Total industry sales: $7,954 million Total industry volume: 2,820 million poundsExhibit 7 Selected Financial Results 1993 1993 1992 1992 1991 1991 $ millions % sales $ millions % sales $ millions % sales Kellogg Sales $6,293.9 $6,227.4 $5,801.2 COGS 2.989.0 47.5 2,987.7 48.0 2,828.7 48.8 SGA 2.237.5 35.6 2,140.1 34.4 1,930.0 33.3 Operating income 1,067.4 17.0 1,099.6 17.7 1,042.5 18.0 Interest 33.3 29.2 58.3 Taxes 353.4 387.6 378.2 Accounting changes 0.0 -251.6 0.0 Net income 680.7 10.8 431.2 606.0 10.4 Total assets 4,237.1 4,015.0 3,925.8 Long-term debt 521.6 314.9 15.2 Shareholder's equity 1,713.4 1,945.2 2,159.8 General Mills Sales 8,516.9 8,134.6 7,777.8 COGS 4,458.2 52.3 4,297.6 52.8 4,123.2 53.0 SGA 2.755.5 32.4 2.578.2 31.7 2.516.3 32.4 Other 450.7 341.2 245.6 Operating income 852.5 10.0 917.6 11.3 392 7 11.5 Interest 99.2 73.6 58.2 Taxes 283.6 337.9 338.9 Net income 469.7 5.5 506.1 6.2 495.6 6.4 Total assets 5,198.3 4,650.8 ,305.0 Long-term debt 1,417.2 1,268.3 920.5 Shareholder's equity 1,151.2 1,218.5 1,370.9 Philip Morris Sales 60,901 59,131 56,458 COGS 26,771 44.0 26,082 44.1 25,612 45.4 Excise taxes 10.280 9.036 8,394 SGA 15.694 25.8 13,433 22.7 13,331 23.6 Other 569 521 499 Operating income 7,587 12.5 10,059 17.0 8,622 15.3 Interest 1,391 1,451 1,651 Taxes 2,628 3.669 3.044 Accounting changes -477 0 -921 Net income 3.091 5.1 4.939 8.4 3,006 5.3 Total assets 51,205 50,014 47,384 Long-term debt 15,221 14,583 14,213 Shareholder's equity 11.627 12.563 12 512 Quaker Oats Sales 5,955.0 5,730.6 5,576.4 COGS 2.926.2 49.1 2.870.0 50.1 2,831.1 50.8 SGA 2,425.6 40.7 2,302.3 40.2 2,244.3 40.2 Other 134.8 35.6 12.1 Operating income 168.4 7.9 622.7 9.1 488.9 B.B Interest 89.7 55.1 67.4 Taxes 147.2 180.8 173.9 Accounting changes 0.0 115.5 0.0 Net income 231.5 3.9 171.3 3.0 247.6 4.4 Total assets 3.043.3 2,815.9 3,039.9 Long-term debt 759.5 632.6 688.7 Shareholder's equity 445.8 551.1 842.1 Ralston Purina Sales 7,902.2 7,752.4 7,375.8 COGS 4,322.0 54.7 4,223.1 54.5 3,974.3 53.9 SGA 2,755.3 34.9 2,716.2 35.0 2,513.8 34.1 Other 6.4 69.6 31.2 Operating income 818.5 10.4 743.5 9.6 856.5 11.6 Interest 238.1 242.9 208.7 Taxes 239.1 221.4 255.9 Accounting changes -218.7 34.0 Net income 122.6 1.6 313.2 4.0 391.9 5.3 Total assets 5,071.9 5,150.5 4,632.1 Long-term debt 2.054.5 2,111.3 2,071.3 Shareholder's equity 469.8 655.2 783.8Exhibit 8 Selected Financial Results by Segment 1993 1992 1991 $ millions $ millions $ millions Kellogg-United States Sales $3,783.9 $3,564.9 $3,411.0 Operating Profit 452.2 458.4 388.3 Identifiable Assets 2,340.4 2,064.4 1,859.6 General Mills-Consumer Foods Sales 5,553.9 5,397.2 5,233.8 Operating Profit 653.1 772.6 744.3 Identifiable Assets 2,820.8 2,576.4 2,481.2 Philip Morris -Food Sales 30,372 29,048 28,178 Operating Profit 2,608 2,769 2,016 Identifiable Assets 33,253 32,672 31,622 Quaker Oats -U.S. and Canadian Grocery Products Sales 4,252.7 3,930.3 3,842.3 Operating Profit 430.9 447.0 435.0 Identifiable Assets 1,999.4 1,877.3 1,997.9 Ralston Purina -Pet and Human Foods Sales 2,534.8 2,550.6 2,517.4 Operating Profit 413.3 387.7 434.5 Identifiable Assets 873.9 877.2 838.8Cost Structure Comparison Big Three Average Private Label private label calculations Raw materials 0.42 S Packaging 0.19 $ manufacuting 0.52 S Distribution 0.14 S LI .we Advertising and sales 0.75 Depreciation, overhead 0.40 EBIT 0.40 Wholesale price 2.82 Retailer margin 0.38 Retail Price 3.20