PRICE CUTS: THEY'RE GRRREAT!
AUGUST 8, 1996
After years of rising prices, the major cereal manufacturers have entered in a price war. The NewsHour's economic correspondent Paul Solman explains the economic forces driving down the cost of breakfast.
Browse the NewsHour's business coverage.
PAUL SOLMAN: Packaged cereal: an $8 and a half billion a year industry, now a staple which serves breakfast for about 40 percent of us, cereal began a century ago as a health fad. The father of cereal, religious nutritionist Dr. John Kellogg, whose health tips included dressing in white and, as he lectured patients at his world famous spa, avoiding meat, spices, coffee, and above all, constipation. His cures: exercise, some stuff you don’t want to know about, and high fiber cereal; granola, and soon after, corn flakes.
The spa immediately spawned competition as one of its patients left to create his own health food company. C.W. Post, a suspenders salesman, made his fortune with Grape Nuts. Kellogg and Post were such bitter rivals they appeared together only once, next to President Taft in 1911, Kellogg, of course, in white. And their hundred years’ war has continued to this day.
Kellogg’s and Post, now a part of Philip Morris, are still two of the major players in an industry that includes General Mills, Quaker Oats, Rawl Corp., and a host of store brands. Over the century, the industry has introduced more than a thousand new products and adds to that number every year. The struggle for shelf space and attention is ferocious. Cereal makers pay stores to stock new items, give stores special discounts if they agree to feature shelf talkers and end-of-aisle displays.
(COMMERCIAL WITH TONY THE TIGER)
PAUL SOLMAN: The battlefield broadened with the coming of television. For the first time, cereal makers could train their sights directly on children.
(LUCKY CHARMS COMMERCIAL)
PAUL SOLMAN: Kid-vid marketing may be a far cry from cereal’s health pitch of a century ago but it hasn’t hurt prices any. Since 1983, they’ve risen at twice the rate of inflation and the TV ads continue to hook the kids, this summer with the tie-in to the Olympics.
MOTHER: Today we had to drag him out of the aisle because he wanted Lucky Charms.
PAUL SOLMAN: Why did you want Lucky Charms?
LITTLE BOY: Because I wanted them. They’re Olympic.
PAUL SOLMAN: But though he complained bitterly, that boy didn’t get Lucky Charms, still 50 cents higher than the store brand equivalent, Magic Stars. In fact, cereal sales fell nearly 4 percent last year and many consumers at this Shaw’s Supermarket in Waltham, Massachusetts, were buying cheaper non-name brand cereals.
MOTHER: Sometimes I bought the store brand because I thought the others were too expensive. I think $4.50 to $5 a box is too high.
PAUL SOLMAN: It is in this context that Post announced in April that it was cutting price 20 percent on average. The sound bite it sent to TV stations was upbeat.
TIM CALLAHAN, Post Cereal: With this price rollback, we’re giving consumers what they want for breakfast. For example, this box of Post Honeycomb sells for $3.95 and will go to $2.99, almost $1 less than its current suggested retail price.
PAUL SOLMAN: In the next several months, Post gained sales at the expense of archrival Kellogg, and so, in June, Kellogg also cut prices, sounding as though they’d just thought of it.
ARNOLD LANGBO, CEO, Kellogg Company: The good news for consumers today is that the best to you each morning will now cost less for you each morning.
PAUL SOLMAN: General Mills has since followed suit, and on June 26th, Quaker Oats also cut prices. To get some insight into all of this, we asked marketing professor Ron Curhan of Boston University to join us at the supermarket and explain what’s going on.
PAUL SOLMAN: First question: Why a price war in cereals?
RON CURHAN, Boston University: Well, there has been a good decade for cereals. The category has grown at about 5 percent a year for a decade.
PAUL SOLMAN: That is the industry. You mean cereals--
PROF. RON CURHAN: Yes.
PAUL SOLMAN: --as a category of product?
PROF. RON CURHAN: Yes, cereals in general. And you notice that we have a very extensive array here of cereals. And you have a tremendous variety here of cereals. So whether it was oat brand in the 80's or more and more healthful foods at various times, the category has grown, and as it has grown, the manufacturers have been able to raise their prices, which they have done.
Actually over the years you get to a position where it’s ripe for some price cutting, and it’s no surprise that the company with the third largest share took the lead in price cutting. And, of course, then the others have to follow. And now what you have is you have the private label brands accounting for as much as 10 percent of the market.
PAUL SOLMAN: Five years ago what were they, or ten?
PROF. RON CURHAN: 4 percent. Ten years ago 1 percent.
PAUL SOLMAN: Really?
PROF. RON CURHAN: And so with the growth of the private labels, the national manufacturers said, hey, we’ve got to compete more vigorously on price. And that’s one of the reasons for the price war.
PAUL SOLMAN: Now what’s been the key to competition until now?
PROF. RON CURHAN: The key to competition until now has been a lot of proliferation of different varieties. You came up with a new brand it seems as though every week, and if you look here and you ask yourself what were the brands that I knew when I was a kid--
PAUL SOLMAN: Yeah.
PROF. RON CURHAN: --you know, you’ll still find the Wheaties and you’ll still find Corn Flakes--
PAUL SOLMAN: But you can hardly see ‘em.
PROF. RON CURHAN: But you’re going to find an awful lot of additional brands, additional packages here on the shelf.
PAUL SOLMAN: Now how much of the price of something like this--I don’t know--this $4.29 for Just Right--how much of that price is the product and how much is other stuff?
PROF. RON CURHAN: It depends on how you charge in factory costs and depreciation and one thing or another, but when all is said and done, a $4 box probably costs $1.35 plus or minus to actually make at the factory level.
PAUL SOLMAN: And so the rest of it is marketing, promotion, advertising?
PROF. RON CURHAN: You’re not going to sell any of this and have the consumer even know that it exists without some marketing efforts. And yes, they’ll spend 80 cents, a dollar on marketing. It--the cereal department has a high marketing cost at the manufacture level compared to many other departments in the store.
PAUL SOLMAN: Well, I read somewhere that 30 to 40 percent of the price was marketing versus even other packaged food goods, maybe 20 percent, something like that.
PROF. RON CURHAN: Well, I think 20 percent for the rest of the store would be in the right range and 30 percent for cereals would also be in the right range.
PAUL SOLMAN: As a marketing professor, how do you respond to the charge that we heard from a number of people outside of today that there’s just tremendous waste in advertising, in promotion, and stuff like that?
PROF. RON CURHAN: Well, my response would be that the consumers are very intelligent people, and--you talked about a price war--the price war is in response to consumer resistance to the higher prices, and so the system tends to redress itself. And here we’re getting a new equilibrium based, I think, on the consumer’s pressures ultimately to drive it in that direction.
PAUL SOLMAN: Do you think that we’re beginning to see a sort of--I don’t know--a business-wide trend, or an economy-wide trend? I’m thinking of the fact that cigarettes went through this same process recently. Is this something that we’re going to see more and more of now, do you suppose?
PROF. RON CURHAN: Well, we’re certainly going to continue to see it. More and more I don’t know, but there is a concern amongst a large segment of the population for price when they purchase. They may go to a warehouse club. They may go to a discount store to buy a dress. There’s also a sector out there who are beginning to say deliver my order to home and paying 13 or 14 dollars extra an order just to have it sent home.
And so it’s really a very complex market, and that’s not a surprise; when you have over 100 million households, naturally we’re going to have some of one type and some of another, and stores tend to focus on a segment of the population, more than all segments of the population.
PAUL SOLMAN: Finally, quickly, who wins, who loses?
PROF. RON CURHAN: Well, clearly, the biggest winner is the customer. Because the customer comes in and now can buy the goods that are an important part of their table; they can buy them at a lesser price. From the point of the retailer, the retailer probably comes out a little less good in the sense that they tend to look for a gross margin percentage on each item. If it has a high price tag and they make 20 percent of $4, then they made 80 cents. If it’s selling for $3, they only make 60 cents. And the mentality of this industry still is to look for gross margin percentage.
PAUL SOLMAN: And what about the manufacturers, themselves?
PROF. RON CURHAN: The manufacturer is going to get a lot less out of this.
PAUL SOLMAN: So their stockholders, for example, are hurt? Their stock is down, I think, am I right?
PROF. RON CURHAN: The stock of Kellogg’s dropped, I forgot how many points, on the news of this just like with the Philip Morris situation with the cigarettes, the stocks dropped because it’s clear that they’re going to be able to extract less from the marketplace, at least in the short run.
Now, remember, they will in the long run have some savings because they are cutting advertising, I heard as much as $40 million in the quarter, and that’s a lot of advertising. And in addition, they are cutting their promotional activity; not only media, but the couponing we were talking about and the other things, so they will tend to try to protect their profit in this area. But they’re going to take a hit in the short run.
PAUL SOLMAN: Okay. Well, Professor, thank you very much.
PROF. RON CURHAN: You’re welcome.