Sales of private label cereal grew 50% from 1991-1994 in the Ready-to-Eat breakfast cereal industry. Some of the factors that contributed to the entry of private label cereal manufacturers and their subsequent growth include – lower costs related to manufacturing, packaging, marketing, R&D compared to the Big 3 cereal companies, product quality approaching that of branded products, higher margins for grocers, lower priced products. Some observers blamed higher prices and elaborate expenditure on coupon printing, distribution, redemption and reimbursement of grocer’s handling fee for market share gains made by private label cereal products. The policy of “price up and spend back” seemed to hurt the Big 3 firms.
The RTE cereal industry was historically a highly concentrated industry (Herfindahl index of 2140.29). However, the industry’s internal rivalry was low because the Big 3 cereal companies pursued a strategy that restrained competition by avoiding practices that promote short-term benefits – trade dealing, in-pack premiums and vitamin fortification. The Big Three firms engaged in cooperative pricing and increased product prices in lockstep. They did not compete on price and invested heavily in R&D for new products while conducting extensive national advertising. The advertising decision could be partly influenced by a prisoner’s dilemma situation and also deterred potential entrants from the RTE cereal industry.
_STRATEGIC ADVANTAGE OF PRIVATE LABEL PRODUCERS OVER NEW BRAND PRODUCERS:_
Private label producers found it easier to make a breakthrough in this market due to several factors briefly mentioned above. Private label cereal products were considerably lower priced than their branded counterparts due to significantly lower costs achieved in manufacturing (focusing on simpler cereal products, less expensive ingredients), packaging (clear plastic bags rather than cereal boxes). Product differentiation was carried out only in terms of competitive pricing with little need for advertising and promotion.
Private label cereal products offered higher margins to grocers (15% versus 12% for branded products) thus enticing them to provide competitive shelf space. The incumbents did not perceive private label producers as a serious threat. In contrast, new brand producers would face several challenges if they chose to compete head-to-head with the incumbents on measures other than price. Challenges like high capital investment (manufacturing related), higher costs associated with advertising, marketing and R&D, high slotting allowances, multiple product line extension would make it difficult for new brand producers to enter the market.
Incumbents had privileged access to end consumers. Because of the policy of allocating space in proportion to historical sales volume, the entrants couldn’t procure prime space in supermarkets. In addition, allocating new shelf space for a brand cost more than $1 million dollars. The entrants would have to spend in excess of $100 million to set up a manufacturing and packaging plant and also incur considerable costs in advertising and marketing. Additionally, in order to establish a new brand could take time and R&D expenses close to $5-10 million. The incumbents’ sales force had established close relationships with the supermarkets thereby raising the barrier to entry for new firms. They also had a cost advantage because of both economies of scope and scale due to materials handling flexibility, scheduling advantages, production line capacity and R&D expenditures.
The Big 3 firms focused on introducing innovative products often making it increasingly difficult for entrants to compete right away. Since the market demand for cereal was elastic, the incumbents issued coupons as a way to price discriminate. Even though the incumbents used coupons to compete with each other, it also had the strategic effect of deterring entry from private labels, since price sensitive consumers tend to move to a lower priced branded product.
This also translates into higher costs for new brand entrants if they are forced to print, distribute, redeem coupons to compete effectively. The Big 3 had high advertising to sales ratios of 10-14%, also deterring entry, because average first year advertising cost for a new brand was over $20 million. We can conclude that total costs related to producing private label products are lower than new branded products. Private label products can offer greater margins to grocers and still sell at lower prices. They have a considerable competitive cost advantage over the new branded products.