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Ensure that the combined word count for questions 1 and 2 does not exceed 500 words

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Ensure that the combined word count for questions 1 and 2 does not exceed 500 words. Read through the case study, titled “The ready-to-eat breakfast cereal industry in 1994”, and answer the questions that follow: The ready-to-eat breakfast cereal industry in 1994 This case analyses the ready-to-eat (RTE) breakfast cereal industry during the early 1990s. In 1994, three companies (Kellogg, General Mills, and Philip Morris) – also called the Big Three – dominated the industry. Together, these firms had a combined market share of more than 70%. However, they were threatened by slow industry sales growth and especially by the increasing market share of private labels. You will be asked to analyse the sources of value creation and value capture, together with potential threats to these. Market shares and profitability Traditionally, the RTE cereal industry was one of the most concentrated and profitable of all US industries. Despite this, the industry had attracted no significant entries, and the Big Three had remained dominant for several decades. Even their relative market shares had been quite stable, with Kellogg being the most dominant company, followed by General Mills and Philip Morris. The Big Three had not been competing very forcefully among themselves. These limits to competition had taken the form of unwritten agreements to limit practices that could be profitable from an individual perspective but damaging from a “Big Three” perspective. For example, if one of the Big Three decreased their prices, it could have led to short-run sales increases at the expense of competitors, but this would have become ineffective once competitors replicated the strategy. Other potential practices they steered clear of included in-pack premiums in the form of free toys or gifts, which would have served to differentiate one of them over the others. For many decades, the Big Three managed to avoid competing with each other through prices or these kinds of practices. In fact, the industry was characterised by regular rounds of price increases, typically started by Kellogg and immediately followed by the other two. Cereal price inflation was typically higher than other consumer price inflation. The industry was not characterised by significant “natural” barriers to entry (such as economies of scale), but the Big Three prevented entry by potential competitors through other measures. These measures included making agreements with supermarkets to limit the shelf space where the products of potential entrants could be displayed, as well as introducing a large variety of their own brands to limit the market niches through which potential competitors could enter the market. Characteristics of the industry From a technological perspective, the industry was not highly sophisticated. Economies of scale were not very significant, and it was relatively easy to start a new production plant for an existing product. Production plants had a low minimum efficient scale (the production volume at which average costs are minimum) relative to the market size. The minimum efficient scale was estimated at around 3% of the market. Therefore, there was no technological reason for a single plant (or a small number of plants) to dominate the industry. Because of this, entrenched companies did not have a significant advantage relative to new entrants in terms of learning economies. The distribution of cereals was traditionally through food stores, although over time there was an increase in the importance of drug stores, convenience stores, and discount retailers. Displaying the cereals in the most accessible areas of the store was regarded as crucial. This “battle for shelf space” had traditionally been won by the Big Three. They managed to dominate the shelf space through long- term agreements with food stores and through the proliferation of brands, which left very little space for potential new entrants. However, in the new, increasingly important retail outlets, it was easier for potential new entrants to secure shelf space. The industry was very advertising-intensive, both to market new brands and to secure loyalty for existing brands. Brand loyalty was regarded as an important reason why consumers tolerated high prices and above-general inflation. However, high and increasing prices were combined with the extensive use of coupons and other forms of trade promotions (such as “buy one, get one free” offers). In fact, over time, coupons had become ubiquitous, and many feared that this was encouraging consumers – who began to feel that they were overpaying without the coupons – to switch products. Major firms tend to continually introduce new products, either through new brands or through the extension of existing brands. Developing a new brand required a significant investment of time and money, in the form of R&D and advertising expenditures. Partly because of this, many new brands failed, and over time, the market became very fragmented in terms of brands (although, as explained above, not in terms of firms). In the early 1990s, very few brands had a market share higher than a few percentage points. The private label threat Private labels are those where the manufacturing is done by a company, but the product is sold under another company’s name. Throughout the early 1990s, sales of private label cereal grew substantially, to around 5% in terms of sales and 9% in terms of volume. The increasing success of private label brands was due to several factors. Most important was that low prices appealed to consumers. Secondly, private labels offered better margins to the retailers and, as a result, retailers were happy to favour them in the battle for shelf space. Private label brands could sustain these strategies because they did little advertising, and their manufacturing costs were 10– 20% lower than those of a Big Three firm, thanks to the increasingly standardised technology and the focus on simpler cereal products, such as those without fruit. Distribution costs were also lower. For instance, some private labels sold cereals in plastic bags rather than boxes, making packaging cheaper. The private label threat occurred in an environment of general uncertainty in the industry. Technological change, together with changes to consumer tastes and distribution, had disrupted the industry. (Reference: Corts, K.S. 1997. The ready-to-eat breakfast cereal industry in 1994 (A). Harvard Business School. Case Study 9-795-191.) Question 1 Evaluate the sources of value creation and value capture in the breakfast cereal industry. In your answer, aim to address the following questions: a) How did the Big Three work together to capture value in the industry, and what were the enabling factors that allowed them to? b) How much value did the Big Three capture compared to the food stores that bought from them? Start writing here: Question 2 a) Describe two changes in the early 1990s that made it easier for private labels to enter the market and capture value that was previously held by the Big Three. b) How do you think the Big Three firms could have reacted to these threats? Provide at least two relevant suggestions. Start writing here:

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