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ever wonder why cereal costs so much?

The cornflake cartel: ever wonder why cereal costs so much?

Deborah Baldwin

Ever wonder why cereal costs so much? Government attorneys wondered too. Then they were sorry they asked.

Any sensible person would be at home — boiling grits. But life is short. So here I am in the cereal aisle at Safeway, engaged in one of America’s favorite indoor sports: brand surfing.

Even in today’s era of expanding consumer choice, the array is … extensive. Approximately 150 brands of cereal compete for space in today’s over-stuffed grocery stores, with some 40 new ones spiraling through the marketplace every year. Thanks to the miracle of modern merchandizing, they don’t fall into a vacuum. Rather, they are aimed at specific targets, or consumer subcultures. My group goes for “fruited complex,” which is not to be confused with adult health, or cereals also known in the trade as “functional benefit.”

The fruited complex selection for today’s discerning customer, I decide, is widly overpriced at $5.19 a pound and available only in dear 13.5-ounce boxes obviously aimed at my demographic group. It’s the right choice because I have a $1.50 coupon.

But not so fast. It seems Safeway has a competing muesli on sale at a mind-boggling 50 percent off. Unfortunately, my coupon for that brand is back home, crammed into a junk drawer with umpteen other cereal coupons whose aggregate worth probably tops my take-home pay.

As penance, I attempt a couple of unitprice comparisons. This involves much scuttling back and forth between the various rival mueslis, which are nowhere near one another: In the manner of old-fashioned auto dealerships, the manufacturers each get their own location (“Why, I don’t know,” a Safeway spokesperson offers). That’s not to mention the kind of higher math, thanks to adjustments made necessary by my coupon, that is beyond my graduate-school education.

All this is a little silly, of course: Cereal is cereal. Nearly every box contains the same basic raw materials: wheat, oats, sugar … preservatives. So I’m forced to fall back on the individual personalities of the various brands, which all seem packaged and pitched to reflect the curious human hunger for something that is both new and different yet intensely familiar. Indeed, in an effort to prove how very special each brand is, the cereal companies use their boxes as mini-billboards — making them so wide and thin they would topple over in a stiff breeze.

Clearly, many brilliant and creative minds have been put to work courting the fickle cereal shopper. So if this is the height of consumer-driven marketing, if this is American know-how at its entreprenurial best, if this is instant gratification in a box, how come I’m not having fun yet?

A Bowlful of Dollars

Not so very long ago, the inexplicably high cost of ready-to-eat (RTE) breakfast cereals was the subject of serious debate at the highest levels of government. In 1976 President Ford’s Council on Wage and Price Stability called for an investigation of possible cooperation among the big four cereal companies — Kellogg, General Mills, General Foods/Post and Quaker — to keep prices up. Several years earlier, Congress actually held cereal hearings. Before that, a blue-ribbon commission had investigated the history, marketing practices and profitability of the cereal industry.

In 1970 government researchers concluded that a mere four companies dominated 90 percent of the cereal market, up from 68 percent in 1940. Such “shared monopolies,” critics charged, opened the door for a subtle kind of price fixing based on the notion that if no one cuts prices, no one gets hurt. Economists at the Federal Trade Commission (FTC) also maintained that by dividing the market into smaller and smaller fragments and then flooding them with new brands, the cereal kingpins had crowded out smaller contenders. To help pay for all this, the FTC figured, the public was spending an extra 20 to 25 percent — or $150 to $250 million a year — for what was basically a group of heavily advertised boxed grains with funny names.

If cereal prices were high in 1970, they rose even higher in the ’80s, capitalizing on the breakfast needs of working moms and cholesterol-conscious dads — not to mention the questionable feeding habits of America’s littlest and least price-savvy consumers, who like to start their day with, say, one cup of Cocoa Bombs, a half cup of whole milk and 30 minutes of bad cartoons. Competition for market shares became furious, but it was hard for a parent to tell; in 1989, for example, all the major cereal makers raised their prices within two months of each other — evidence, say critics, of a kind of gentlemen’s agreement that has bonded the top dogs for decades.

The recession- and health-food-weary ’90s haven’t exactly forced prices down. Despite a slowdown in the growth rate of cereal consumption, which leveled off at 12.3 pounds per capita in 1991, cereal company profits rose that year, “benefiting,” a U.S. Commerce Department analysis noted, “from both price increases and a steady decline in [the] cost of most ingredients.” In June 1992, Kellogg and General Mills both raised prices an average of 4 percent — the second such increase in nine months, the Wall Street Journal reported. A new round of price hikes was announced by Kellogg in January 1993, and General Mills soon followed. The only things rising faster than cereal prices, boasts one Wall Street analyst whose investment firm touts Kellogg stock, are prices for prescription drugs.

The cost of cereal may not seem like the most pressing issue of the day. But consumers have a right to be agitated when a box containing 14 cents’ worth of raw ingredients costs $2.20. New York State Attorney General Robert Abrams, for one, is so bent out of shape about it that he’s gone to court to stop the No. 3 cereal maker from gobbling up No. 6. Pointing out that the price of all food eaten at home has risen 37 percent in the past eight years while the price of RTE cereals has increased 71 percent, Abrams says, “These soaring price increases, far out of line with other food products, are a clear result of an over-concentrated industry…. The last thing this industry needs is less competition.”

But Abrams may be fighting an uphill battle. The FTC in fact spent nearly a decade trying to break up the three biggest cereal companies. Ultimately, this valiant effort failed, providing a cautionary tale of sorts about the limitations of government — and the free enterprise system — in an imperfect world.

Chex-Mate

To understand what the government was up against, it helps to know a little bit about how the cereal industry operates.

Cereal companies trace their colorful origins to the 19th century, when a fit of health consciousness, not unlike the one that afflicts America today, created a demand for wholesome food products, such as graham crackers. According to various, possibly apocryphal company histories, Kellogg got started when a couple of health nuts forced stale wheat berries through some rollers and then decided to bake the resulting flakes. Wheaties reportedly came about after a health clinician spilled bran gruel on a hot stove. The brains behind Nabisco? A peddler who was trying to sell wheat-shredding machines to housewives, if such a thing can be imagined, when he had a better idea: He shred the wheat himself, cut it in squares and baked the resulting “biscuits,” dubbing them you know what. And no one will be surprised to learn that bizarrely named Grape-Nuts were invented by a proponent of self-denial named C.W. Post who had some dried bread sticks on hand and thought to pass them through a coffee grinder. As the inventor of Postum, perhaps he intended to have people pour boiling water over the Grape-Nuts and throw the “grinds” away, as it’s hard to imagine why anyone would want to consume them with milk.

Normal grocery stores didn’t handle this stuff at first; it was sold through the mail or in pharmacies, the turn-of-the-century equivalent of health-food stores. And if the original recipes for breakfast cereal sound, well, down-to-earth, there was nothing humdrum about the way the flakes and berries were marketed. In 1899, Post poured a stunning $400,000 into advertising — the rough equivalent of $4.5 million today — according to a 1952 report buried deep in the files of the Food Marketing Institute, the supermarket industry’s well-heeled traded association. According to another account, the Kellogg Co. Kept itself busy during its first year of operation, 1906, by distributing four million free samples.

It didn’t take long for cereal baron wannabes to realize that since cereal ingredients cost practically nothing, the trick was to recycle revenues into bigger and better factory equipment — and heavier and hotter selling practices — in an effort to corner increasing shares of the market. Half the battle was in the advertising arena, the other half at the retail level. As the 1952 report noted so presciently, cereals “require tremendous shelf area. The battle for ‘eye-level position’ and the struggle for ‘adequate display’ and number of ‘front facings’ is certainly at white heat.”

The word “facings” is only one of several helpful terms I picked up in my research. Another one is “planograms,” or fancy, computer-generated projections of sales designed to persuade the besieged retailer to give the companies a good location. For example, if a cereal company has a big sale going, it tries to get “sit-down” space in the store — out in front or in some equally desirable spot designed specifically for specials. The end of the aisle guarantees sales, but not the dead space just in from the end, which is so often overlooked by dazed consumers that it’s known as the “coffin corner.” The best place to sell junky cereals is right below parental eye level, and the best way to do it, apparently, is by pasting Hollywood celebrities on the box (You’ve Seen the Movie. Now Eat the Cereal.) and then hawking the stuff like hell on Saturday morning TV.

Certain cereals, like Cheerios, are so popular that much money lies in the development of so-called line extensions (Honey Nut Cheerios). Then there’s the product that’s incorporated into a new kind of food altogether, say Trix yogurt, which is called a “brand franchise extension.” One way companies attempt to control yards of desirable shelf space is with “flanker” brands, oddball varieties that occupy the territory adjacent to name products and thus help keep rivals at bay. When these short-lived varieties sputter out of sight, new ones step in. “They are the sacrificial little ships,” explains cereal maven John Connor, an agricultural economist at Purdue University and author of Food Processing. “They may sink, but it’s worth it to protect the flagship.”

The laconic Safeway spokesperson couldn’t say how his chain decides how to stock its shelves, never mind how it prices its wares. But cereals reportedly are the second largest-selling “branded foods” after soft drinks and are believed to provide a disproportionate amount of revenue for retailers, whose after-tax profits are thin as a dime (a mere half percent of sales, according to government figures).

Companies like Kellogg don’t exactly hand out information about how and why they do what they do, but Connor, who believes the FTC may have been onto something, estimates that about 30 percent of the cost of a box of cereal gets eaten up by “selling expenses” — mainly coupons and other promotions, along with advertising — which apparently is typical of so-called value-added products. (Not much value in the ingredients, so we add it in the packaging and sales pitch.) All this spending presumably is made possible by the hefty profits on a typical box of cereal. There’s so much money, in fact, traveling between consumers’ wallets and Madison Avenue that the cereal industry is the envy of the food-processing world, where marketing genius is at least as important as developing a product the public really needs.

Cereal Killers

While the FTC’s probe of the cereal biz is invariably described as convoluted, it all boiled down to a couple of issues that still resonate among those of us who consider cereal one of the basic four food groups: Prices keep rising, seemingly in unison and without relation to costs, and the big guys occupy so much commercial space — from the airwaves to the grocery shelves — that it’s hard for upstarts to elbow in.

Today cereal moguls Kellogg and General Mills control nearly two-thirds of the $8-billion-a-year domestic cereal market, with Kellogg holding about 38 percent and General Mills about one-fourth. To protect their market shares — which are worth some $80 million per percentage point — each spends heavily on marketing. Kellogg, for example, spent $100 million in one quarter alone in 1991, according to Food Business magazine (and increased its sales 11.4 percent).

Scrambling to hold onto smaller but still-lucrative shares of the market are companies No. 3, 4, 5 and 6 (Kraft General Foods/Post, Quaker, Ralston Purina and Nabisco). Of the 40 new varieties of flakes, nuggets, crispies and puffs the Big Six trot out each year, 10 to 15 stick, at least temporarily. Increasing numbers are novelty, or licensed brands — cereals named “Ghostbusters,” “Ninja Turtles,” “Breakfast with Barbie” or whatever some creative genius guesses will strike the average pint-sized consumer’s fancy. Many of these licensed brands, incidentally, are made by Ralston Purina, which has enjoyed such success making both novelty and private label brands that in 1990 it quietly converted a cat-and-puppy-chow plant to cereals, according to news accounts. (Private labels are believed to be the single greatest threat to the Big Three’s hegemony. As Brand-week magazine recently reported, Ralston is in the store-brand business in a big way because “the more total shelf space they hold, the less likely their chances of getting squeezed out…”)

Companies spend heavily on promotion because otherwise no one would ask for the new cereals, and retailers wouldn’t make room for them. Asked why he continued to carry a cereal that wasn’t doing well, one retailer told Advertising Age the company’s “massive marketing push” forced him to. My favorite example of this create-a-demand syndrome is a new Kellogg product called Rice Krispies Treats — that’s right, clusters of Rice Krispies already blended with marshmallows and margarine. Shortly after issuing coupons for this brilliant line extension (and why didn’t we think of it?), Kellogg took out full-page newspaper ads apologizing because there had been a run on Rice Krispies Treats and stores had exhausted their supplies — unexpected news that sent former skeptics like myself routing through the trash in search of misplaced coupons.

Manufacturers also spend heavily to promote their products to the retail industry. In 1990 food processors lavished about $2 on retail promotion (including such things as discounts and other incentives) for every $1 in direct consumer advertising, according to government analysts. Among the more controversial incentives are slotting allowances, or one-time fees paid to retailers as a way to get a new item on the shelf.

Theoretically, anyone can launch a new cereal, but not many companies have the kind of capital to compete with Kellogg, which once sank $30 million into the launch of a single kiddie “health” cereal, according to Advertising Age. (It was named Bigg Mixx, after a cartoon character with chicken feet, moose antlers, a pig’s tail and a wolf snout. He bombed.) Meanwhile the big guys can afford to gamble because their most popular brands boast fantastic profit margins. How fantastic? Often higher than 20 percent, or enough to make the name Kellogg synonymous with wealth. (One sign: With $6.4 billion in assets, the W.K. Kellogg Foundation is one of the top two foundations in the United States.)

Rather than lower prices, the cereal companies keep recycling revenues into selling, selling, selling — which in turn reinforces their clout at the retail level. To paraphrase food marketing professor Tom Pierson of Michigan State University, what better way to lobby for shelf space than to unleash a posse of frustrated consumers, waving their coupons in the air as they attempt to snag boxes of the latest heavily advertised brands?

Speaking of coupons, if the cereal-obsessed are willing to waste their Sunday mornings mining the newspaper for them, doesn’t that suggest that consumers are (a) utterly lacking in brand loyalty, and (b) highly sensitive to price — which would seem to argue for an end to the coupon war and a turn toward good old price-based competition? Not really, Pierson says, explaining — as tactfully as possible — that coupon hounds comprise a special subculture of consumers who, um, don’t attach much value to their time. By pandering to the peculiarly price-conscious with coupons, the cereal makers can pull these consumers away from low-priced store brands, while milking the rest of the consuming public for every penny.

Someone, after all, has to pay for all those promotions.

Snap, Crackle, Flop

The industry’s high profits, massive advertising, brand proliferation and heavy concentration formed the strands of the FTC’s probe.

It all got started when a staff attorney with a particular interest in shared monopolies, or oligopolies, put together a memo to his superiors recommending that the FTC take action against the four largest firms. The memo gathered dust for a while, but in late 1970 a few higherups thought. Why not? Let’s get started and see what happens.

Two years later, saying further research had yielded a “textbook example of the dangers of concentration and the evils of monopoly,” the FTC filed a formal complaint against the Big Four (subsequently reduced to Three).

The FTC began its case optimistically — some would say naively. The commission operates a bit like a courtroom, complete with expert witnesses and an administrative law judge, and the plan was to gather testimony and generate a decision in three or four years. Both sides lined up lawyers and economists, both started building a written record, and after it became clear that the companies weren’t going to settle, a formal trial finally got under way in 1976.

The staff had some specific remedies in mind. First, it wanted to break the big companies up — to literally force them to divest. Then it wanted to require them to license their brand names, giving any cereal maker the right to bid for contracts to manufacture such things as Cheerios. (That approach may sound un-American, says cereal industry critic John Connor, but it happens to be the way Fruit of the Loom makes underwear.)

In the end, the commission was so traumatized by its experience — more than 43,000 pages of testimony and exhibits piled up, another six years passed, and the big guys won — that it seems unlikely the staff will ever look at breakfast cereals again in quite the same way.

Interviews with former FTC attorneys and economists — some now gainfully employed as private consultants and lawyers in the lucrative antitrust field — yielded half-a-dozen views about the case. One theme that seemed to run throughout the various reminiscences, however, was this: The cereal case may have been argued on its merits, but it was shaped by changing political winds.

Controversial from the outset, the case defied conventional political labels. It was launched, after all, under President Nixon, after conservative and liberal legal experts alike had called for a reinvigorated FTC. By the time Ronald Reagan was elected, having campaigned on an anti-government platform, faith in government was crumbling, the Senate had lost some of its leading antitrust advocates, and the consumer movement was running out of steam. Meanwhile interest groups were increasingly well financed. After a series of politically potent constituencies, ranging from funeral directors and used car dealers to sponsors of Saturday morning kiddie TV, rose up in outrage over proposed consumer protection rules, Congress nearly shut the FTC down.

Many of these interest groups had spent the 1970s organizing not only constituencies but PACs. Among those active today: Kellogg’s Better Government Committee, which spent $86,200 in the last election cycle, and General Mill’s GM PAC, which spent $100,850.

As the case dragged on into the late ’70s, thanks in part to delays caused by the industry’s reluctance to fork over information about profits and other things it believed confidential, the political climate kept moving right. Eventually the Big Three persuaded Congress to take up legislation questioning the concept of shared monopolies as “a legitimate concern of the FTC,” as one news account put it at the time. They also lobbied Congress to pass legislation ordering the FTC to drop the case while the cereal makers quarreled with commission lawyers over the status of the administrative law judge, who had been forced to leave Washington for personal reasons after years of hearing the case and had been given a contract to finish it up as a consultant. (General Mills argued that this was a violation of civil service law. The judge was replaced.)

“I learned two political lessons at the FTC,” says Frederic Scherer, a Harvard professor and consultant to big business who was the FTC’s chief economist in the mid-’70s. “Never go up against the undertakers, because they see their [congressional] representative at least once a week, and never go up against a group [that benefits from] massive TV advertising … because you get really bad press.”

As Scherer and others recollect, the case was several years old when industry leader Kellogg woke up and realized it wasn’t in Battle Creek anymore, but Washington. The cereal mogul dismissed its prestigious establishment law firm and brought in a more politically astute firm headed by antitrust expert Fredrick Furth, who told the company “you’re fighting this in the wrong courtroom,” according to Scherer. He credits Furth with working to “get the [cereal workers’] union and management together in common cause.”

A “huge amount of face to face lobbying” on Capitol Hill ensued, Scherer says. Mirroring, perhaps, public disenchantment with big government, the media grew skeptical, coining the phrase “national nanny” to deride the commission’s involvement in such things as children’s TV advertising, a pet cause of Carter administration FTC chair Michael Pertschuk.

In fact, it was the “kidvid” proceeding — which attacked TV ads for toys and sugary children’s cereal as being manipulative — that eventually eclipsed the cereal case, bringing ferocious pressure on the FTC not only from cereal and toy makers, but the powerful broadcast industry, which depends on advertising to keep the airwaves humming during kiddie prime time.

Scherer says the FTC trial group knew that a proposal involving children’s advertising was in the works and knew the political fallout would provide the final blow to the cereal case by giving the cereal industry a vast array of political bedfellows. Group members wanted to lobby Pertschuk to wait till the cereal case was decided before taking the FTC into deeper political waters, he says, but sat still because it would be improper for them to talk directly to one of the commissioners while a case was still being heard.

Pertschuk remembers what happened next. The week before the 1980 election, Republican presidential candidate Ronald Reagan made an appearance in Battle Creek, where he promised cereal workers that, if elected, he would kill the case. Not to be outdone, Democratic vice presidential candidate Walter Mondale telegrammed the union the next day, saying the same thing.

As president, Reagan followed through. After the freshly installed administrative law judge ruled against the complaint, the staff sought an appeal, but a Reagan-appointed FTC official blocked the way. When Pertschuk — no longer chair — was unable to persuade the rest of the commission to intercede, the case died.

An attorney with Furth’s firm seemed surprised by the notion that politics played a part in the disposition of the case. “The proceeding was based on a bizarre theory of ‘shared monopoly,'” he said in a brief phone interview, adding, “We won on the law, on the facts.”

Former FTC economist Russell Parker believes the FTC would have won in a different political climate. “If you see a highly concentrated industry with sustained high profits,” he argues, “that should be sufficient evidence to look at its behavior to see if there is tacit or explicit collusion. That was the focus of the cereal case.”

Charles Mueller, who wrote the memo that got the case going and is now editor of Antitrust Law & Economics Review, similarly concedes that while this was an antitrust case without a smoking gun, there were sufficient grounds for pursuing it — all the way to the Supreme Court, which recently heard a similar case involving oligopolistic behavior in the tobacco industry. Oligopolies, he argues, are the “largest single problem in the economy,” and while cereal wasn’t exactly in the same realm as automobiles or steel in 1970, the case was “a workable size” and might have given the FTC a grip on the theory of shared monopolies.

Pertschuk also believes the case could have been won, pointing to the FTC’s recent success in ending anticompetitive behavior by two of the three manufacturers of infant formula, which together shared 90 percent of the market. In contrast to the cereal case, he says, “That’s a dramatic example of what the government can do.”

Once the cereal case died, Mueller believes, the industry saw “clear sailing,” and simply kept raising prices.

Mikey Says Buy It

From the point of view of New York State Attorney General Robert Abrams, the combination of high prices, high profits and massive selling expenditures within an industry indicates a distinct lack of “vigorous price competition.” And last fall, when General Mills made overtures about buying Nabisco cereals, he was among those who charged that the acquisition would further concentrate an industry already as concentrated as frozen orange juice. Critics stopped the acquisition, but Nabisco’s giant parent company, which had neglected its shredded wheat subsidiary in the wake of a disruptive leveraged buyout, was anxious to make a deal, and soon it attracted the interests of a second suitor: Post cereals (a division of Kraft, which is a division of General Foods, which is in turn a division of Philip Morris).

In January Post snapped up the shredded wheat division of RJR Nabisco for $450 million — “pocket change,” as analysts told Food Business. Now, instead of six cereal companies with control of 90 percent of the market, there are only five.

In a federal antitrust lawsuit filed in February, Abrams charged that the General Foods-Nabisco deal not only reduces the number of major players, but also highly concentrates an important segment of the market currently dominated by Post Grape-Nuts and Nabisco Shredded Wheat: adult health.

Do the industry’s various expert observers believe Abrams can win? That depends on whom you ask. His lawsuit is far less ambitious than the complaint filed by the FTC. At the same time, Americans have grown increasingly tolerant of mergers and acquisitions, which became as commonplace in the 1980s as inflated real estate.

Looked at a certain way, 11 years after the FTC case collapsed we have the cereal industry we’ve come to know and love: vast assortments of crunchy brands, lots of lively advertising and packaging, big-ticket coupons to woo the price-obsessed and major markups to cover the costs. Despite hot competition among the cereal moguls, which are taking their rivalry to Europe (Germany, meet Cap’n Crunch), the growing prominence of private labels and Kellogg’s recent call for a truce in the coupon wars, there’s little evidence that consumers are about to see major cuts in the cost of their favorite brands.

What about the continuing proliferation of new brands of flakes, puffs, nuggets and fruited complexes — a phenomenon those FTC economists thought was key to the Big Three’s monopoly of the marketplace? “If you’re asking me,” responds food marketing professor Tom Pierson philosophically, “we’ve gotten to something on the silly side. But when Kellogg’s came out with NutriGrain? I said ‘great.’ And that cranberry walnut stuff?” he adds. “I really like that.”

COPYRIGHT 1993 Common Cause Magazine

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