This document discusses entry deterrence in the ready-to-eat (RTE) breakfast cereal industry. It presents arguments that the major cereal companies avoided price competition and instead focused on entry deterrence, brand proliferation, and advertising to protect profits. The RTE cereal market was highly concentrated among a few large firms from the 1940s to the early 1970s, when no new producers gained significant market share. However, new natural cereal firms entered in the early 1970s as demand growth slowed and consumer tastes changed, opening an opportunity for new market entrants.

1. Entry deterrence in the RTE
breakfast cereal industry
-By Richard Schmalensee
(1978)
Presented By:
Rashi Saxena
MBA (Infrastructure)

2. Arguments about Industry conduct
Avoid price
competition
Entry
deterrence
& Profit
protection
New brand
introduction

3. RTE Cereal Market in U.S.
• Highly concentrated post-war
• Kellogg, General Mills, General Foods, and
Quaker Oats: 85% of sales
• Top six firms: 95% of sales
• 1940-early 1970s: no new producers of RTE
cereal attained significant market shares
• Early 1970s:
– Overall demand growth slackens
– New firms entered; national marketing of so-called
natural cereals

4. Timeline
1950-mid 1960s: Rapid and steady growth in RTE cereal sales
Early 1970s: Entry of new large firms in RTE cereal market
Apr 1972: U.S. FTC charges 4 U.S. RTE cereal manufactures of
“Brand Proliferation, Product Differentiation, Trademark
Promotion…resulting in high barriers to entry into the RTE cereal
market
Apr 1976-Jan 1978: Trial period
Feb 1976: Quaker Oats dismissed from the case

5. Some ‘facts’ taken as given…
• Entry Eligibility
• Brand-specific production knowhow
• Clear product differentiation
• Advertising sales ratio>10% (Glossary)
• Absolute capital costs~ $80-150 M (Glossary)

6. Assumptions
C(q): Cost of producing
• Increasing Returns at brand level and marketing a brand
– C(q) = F + v.q F, v: Positive constants
– Introductory advertising cost is independent of its
subsequent sales
– Intensity of advertising one brand vs. another
• Localized Rivalry
– “Variations in consumer taste give rise to product
differentiation”
– Brand patronizing also depends on distance proximity
– ‘Localized Oligopoly’
– Hence, marketing plans stress more on the actions of
only a few rivals

7. …continued
• Relative Immobility
– Economic space vs. Geographic space: If brands
differ only in their locations, then changes in
location are not costless
– Re-positioning costs: Cost of moving an old brand
to an arbitrary location vs. cost of introducing a
new brand

8. Static Theory of Entry Deterrence
• N brands Brand N Brand 1
• Distance between 2 Buyer
consecutive brands: 1/N
Brand… Brand 2
• Price charged: p
• Buyers patronize the Buyer Unit
Buyer
‘closest’ brand (≤N/2) circumference
• q(p,N) = a(p).b(N) Brand 6 Brand 3
• Total sales of product do
not fall as no. of brands Brand 5 Buyer Brand 4
increase
• ∏ (p,N) = A(p).b(N)-F A(p)= (p-v).a(p);
• ∏(p,Ń)=0  All brands p>v
are profitable if N<Ń

9. Another assumption…
• Established sellers collude to deter entry at
minimum cost to themselves
• Methods used to create barriers to entry:
– Increase no. of brands instead of using limit-
pricing policy
– Increase promotional outlays in the face of
threatened entry

10. Problems with Limit Pricing
• Entrants are more crowded after entry than are
established firms before entry
• Forgoing short-run profits to impose greater
costs on potential entrants  in collective
interest of established brands
• If entry still occurs, it is relatively immobile
• Now, profits can be generally raised by increasing
prices
• Limit pricing ceases to be an effective deterrent

11. Effect of Advertising
d(F) is an increasing
F: Expenditure by all
• q(p,N,F) = a(p).b(N).d(F) function
brands on advertising
• Advertising expands sales in direct proportion
to its market area
• Higher maintenance spending by established
brands would raise the level of introductory
spending an entrant must do to get noticed

12. When to crowd the Economic space?
• After • Before
– Threat to surround an – Entry deterring threat is
entrant with new brands that “brands will not be
– Mutually damaging moved if entry occurs”
warfare – Since repositioning
– Poor credibility brands is not costless,
– Higher credibility

13. Application to RTE Cereals Industry
• The assumptions of perfect collusion and static
market must be appropriately relaxed
• So, consider the 3 following questions:
– Could such a pattern of deterrence have arisen in the
absence of such coordination?
– How could the entry of new firms have been
deterred, even though established firms found it
profitable to launch new brands?
– Is the explanation advanced here for lack of entry
during 1950-60s consistent with the appearance of
new firms in this market in the early 1970s?

14. Question 1
• Price competition was suppressed and
possibly ‘cooperative’
• Rivalry was channeled into advertising
(probably non-cooperative) and new product
introductions (surely non-cooperative)
– Private label brands were discouraged
– Information exchanges through Nielson until 1972

15. Question 2
Two Reasons:
1. Differential expectations: At any point in the
segment’s growth, the expected value of a
new brands is less to potential entrants than
to established sellers. Ceteris paribus, existing
firms that have a modus vivendi with the
major rivals find new brand introduction
profitable.

16. 2. Minimum efficient firm size: A potential
entrant would need 3% of market share to
produce efficiently, while an existing firm can
do with 1%
The research task of potential entrants is
distinctly harder than those of established
sellers

17. Question 3
• After a rise in consumer interest in “health
foods”, the natural cereals’ market share had
increased steadily:
– 1972: all collective market share of all natural cereals
was 0.5%
– 1973: 4%
– 1974: 10%
• The shifts in consumer taste were poorly
anticipated by most of the established firms.
Hence, a substantially new market was up for
grabs!

18. Thank You