An overview of oligopoly, treatments on Game theory, Nash equilibrium, Bertrand Price Competition and Barriers to Entry will be used to analyze the industry and the strategic concern determinations as they relate to the industry
Analysis of the Ready-to-eat Breakfast Cereals Industry
Connor ( 1999 ) described the ready-to-eat breakfast cereal industry as a capital intensive industry necessitating immense capital investings in production workss. To a big extent, this has contributed to Barriers to Entry in the industry. This industry market construction though holding rather a few figure of providers, is dominated by four major companies which are Kellogg Company, General Mills, Quaker Oats and Kraft. Harmonizing to Nevo ( 2000 ) these companies have systematically continued to post high net incomes in comparing with the other nutrient industries.
A cardinal characteristic characteristic of this industry is merchandise distinction.
Brand specific knowhow is seemingly present since established houses are sometimes unable to double each other s trade name. The being of this nevertheless, does non forestall them from bring forthing, advancing and administering successful new trade names. Existing trade names differ in such potentially relevant dimensions as sugariness, protein content, form, grain base, vitamin content, fibre content and crunchiness ( Schmalnesee, 1978 )
Connor ( 1999 ) has argued that competition in this industry does non affect the usage of monetary value war and hence non a competitory scheme. Different researches conducted on the industry have shown that there is a degree of collusion amongst the top houses though non openly done. This premise was made popular by a instance of anticompetitive ailment by the U.S. Federal Trade Commission against the top three makers Kellogg, general Mills & A ; Post in the 1970s ( Aviv Nevo, 2000 ) Because of the absence of monetary value wars in the industry, the usage of other non-price schemes to derive competitory advantage are employed by houses in this industry. The consistence of zero monetary value wars over the old ages, nevertheless was broken when in the late 1890ss, a monetary value decrease by Kraft led the other large three Kellogg Company, General Mills and Quaker oats to react by besides cut downing their monetary values as suggested by ( Nevo, 2000 ) . This pricing scheme by Kraft significantly affected the overall industry monetary value coercing its rivals to cut down their monetary values every bit good.
Innovation through the launch of new merchandises and aggressive media advertisement are schemes employed by houses in the ready-to-eat cereals industry to vie for market portion. This is a major factor lending to the consistent high net incomes in the industry. The consequence of Connor s ( 1999 ) research revealed that the competition in the breakfast cereals industry tends towards the choreographed oinks of televised wrestle than a cutthroat dual to the decease and that the ultimate arm, steep monetary value cuts, is seldom bare.
Harmonizing to Connor ( 1999 ) , media advertisement and new merchandise debuts are closely related. New merchandise debuts are one of the chief mechanisms for set uping rapid monetary value additions in the breakfast cereals industry. His research revealed that all the new cereals introduced by the large four companies between 1981 and 1987 in the first twelvemonth of gross revenues, were priced 12 % above the company ‘s bing trade names mean monetary values.
Connor ( 1999 ) in his research further showed that the extraordinary fond regard of consumers to branded cereals ( or at least to the boxes they come in ) has made entry by private-label merchandises highly hard. This high grade of trade name trueness in the industry has significantly posed a menace to any house sing entry into the industry. Constantly, the more a house s trade name is recognised, the higher the sale of a freshly introduced cereal will be.
The cereal industry has oligopolistic inclinations and features and will be classified as one. An overview on oligopoly below high spots the characteristic nature of oligopoly.
Overview of Oligopoly
Lipsey + Chrystal ( 1999 ) defined oligopoly as the theory of imperfect competition among the few. The industry is characterised by a few houses selling differentiated merchandises. Because there are merely few houses, each house realises that its rival may react to any move it makes and takes that into history because each house s determination affects the other houses in the industry.
Earl and Wakeley ( 2005 ) described houses in the Imperfect competition as holding differentiated merchandises which are close replacements. These differentiated merchandises are supported to a great extent by advertisement. Ad tends to carry consumers to patronize a peculiar trade name over other trade names of the other rivals. Ad is used as a important arm to make trade name trueness in the industry as consumers are assumed to be extremely nomadic. The being of strong trade name trueness makes entry hard because consumers are likely to hold strong penchants for the already bing trade names.
This implies that the behavior of oligopolists are strategic with each house taking expressed history of the impact of their determinations on rivals and the expected reactions from them ( Lipsey + Chrystal, 1999, page 176 ) . Besanko et Al ( 2004 ) besides defined oligopoly as a market in which the actions of single houses materially affect the industry monetary value degree.
The strategic behavior of oligopolists is attributed to the extremely competitory nature of the industry. For these houses to do strategic determinations that can give them comparative advantage, they make usage of oligopoly theoretical accounts and game theory ( Besanko et al, 2004 ) .
Game Theory and Bertrand Price Competition
Besanko et Al ( 2004 ) defined Game theory as the subdivision of Economicss that trades with the analysis of optimum determination devising when all determination shapers are presumed to be rational and each is trying to expect the actions and reactions of its rivals ( Besanko et al, 2004, page 36 )
Game theory is a strategic concern determination doing tool in countries such as pricing and capacity enlargement.
Bertrand Price competition Model
Besanko et Al ( 2004 ) has described Bertrand competition as a theoretical account of competition in which each house selects a monetary value to maximise its net income given the monetary value that it anticipates its rival will choose. Each steadfast views its rival s monetary value as fixed and believes that its ain pricing patterns will non impact the pricing of the rival. In an oligopolistic industry with differentiated merchandises, monetary value competition is normally mild. When merchandises are differentiated, a house will non lose all of its concern to rivals that embark on a monetary value cut. This is majorly attributed to competition being based on a assortment of merchandise parametric quantities such as its quality, handiness and advertisement.
The US ready-to-eat- breakfast cereal industry like all oligopolistic industries is extremely competitory. The scheme of each house will be to maximise net incomes and end products given its challengers scheme.
To utilize game theory to analyze what pick is best for a house at any given point, two companies will be used ; Kellogg Company and General Mills as they are one of the top four and are each other s rivals.
Game theory and Nash equilibrium will be used to analyze the best scheme for net income maximization given that each house sets a monetary value for its cereals.
A Nash Equilibrium is the scheme combination where each participant is making its best given the schemes of its rival.
An premise is made that each house sets a monetary value that maximises its net income and that a monetary value cut by either of them to accomplish a larger market portion will impact their net incomes given the strong influence of trade name trueness. The effects of each house s actions are described in the game matrix below ;
$ 120, $ 120
$ 110, $ 100
$ 100, $ 110
$ 90, $ 90
Co-operate Do non Co-operate
Make non Co-operate
In the game above, the scheme ( Co-operate, Co-operate ) is both a Nash equilibrium and a dominant scheme because each house maximises net income at this point. It is a Nash equilibrium because with the pay-off of ( $ 120, $ 120 ) no house will one-sidedly desire to divert knowing that it will accomplish a lower pay-off by making so. Furthermore, co-operate scheme is a dominant scheme because no affair what the other house chooses, to co-operate will ever give a higher pay-off.
Barriers to Entry
Harmonizing to Earl and Wakeley ( 2005 ) , barriers to entry be when possible rivals find there are obstructions which hinder their proposed entry into an otherwise attractive industry. Typical barriers to entry include: officeholders having all beginnings of indispensable natural stuffs ; officeholders patents ; economic systems of graduated table supplying officeholders with a cost advantage ; and officeholders past outgo on advertisement ( which gives them a higher profile in the heads of purchasers relative to fledglings ) . The of import point to observe about barriers to entry is that they protect all of the industry s incumbent houses from the menace posed by competition from exterior of the industry
Equally fierce as competitions are and as extremely competitory as the oligopolistic industry may be in nature, Lipsey + Chrystal ( 1999 ) stated that there are finding factors that make a few big houses dominate in the industry. Harmonizing to Lipsey + Chrystal ( 1999 ) , some of these factors are natural or structural, and some are firm-created or strategic. These same factors are hindrances to houses seeking entry into an oligopolistic industry.
The natural/structural barriers as it applies to the cereal industry include economic systems of graduated table, cost of debut of new trade names and economic systems of range, and selling advantages of tenure, while firm-created/strategic barriers include capacity enlargement.
a ) Economies of Scale
Harmonizing to Besanko et Al ( 2004 ) production procedure for a specific merchandise exhibits economic systems of graduated table over a scope of end product when the norm cost beads over that scope. Economies of scale exist when the unit cost of production diminutions as the measure of end product additions. When production becomes standardised and extremely specialised, the construct of division of labor must be applied. Lipsey + Chrystal ( 1999 ) described division of labor as happening when the production of a merchandise is broken up into 100s of simple, insistent undertakings. They farther stated that the division of labor is, as Adam Smith observed long ago, dependant on the size of the market. If merely a few units of merchandises can be sold each twenty-four hours, there is no point in spliting its production into a figure of specialized undertakings. Lipsey + Chrystal ( 1999 ) further stated that larger houses have advantage in industries that have potencies for economic systems based on the division of labor because the larger the graduated table of production, the lower their mean costs of production. Economies of graduated table besides lead to minimal efficient graduated table. Harmonizing to Besanko et Al ( 2004 ) and Earl and Wakeley ( 2005 ) minimum efficient graduated table is the smallest degree of end product at which economic systems of graduated table can non be sustained farther. Minimum efficient graduated table can merely be achieved in the long tally. Based on this, it will be hard for a house sing entry to accomplish MES because of the dearly-won nature. The cereal industry is capital intensive and is dominated by a big few with the long old ages of being. As a scheme to discourage entry, the incumbent houses may make up one’s mind to increase the measure of end product to further drive down their costs and accomplish a higher rate of economic systems of graduated table. Because economic systems of graduated table are present in the industry, the officeholders mean cost of production will be lower than that of a new entrant who will hold troubles seeking to achieve MES which can merely be accomplishable in the long-run. Doing so will imply geting extra capacity and increasing production end product which will both be dearly-won and unprofitable as trade name trueness is highly high in this industry.
B ) Costss of Introducing A New Product and Economies of Scope
The cereal industry is categorised by the debut of new trade names. It will be hard for a house trying entry to retrieve such costs in a short period of clip bearing in head that it will necessitate to interrupt even before doing net incomes. Economies of range are associated with lower cost graduated tables derived from holding multiple production lines within a works. Harmonizing to Besanko et Al ( 2004 ) The ready-to-eat breakfast cereal industry provides a good illustration. For several decennaries, the industry has been dominated by a few houses including Kellogg, General Mills, General Foods and Quaker Oats, and at that place has been virtually no new entry since World War II. There are economic systems of range in bring forthing and selling cereals. Besank0 et Al ( 2004 ) further explained that for an entry to be successful in the ready-to-eat breakfast cereals industry, the fledgling will necessitate to present 6 to 12 successful trade names. This requires heavy capital and makes entry a hazardous proposition.
The debut of new trade names is associated with a high cost of advertisement. An incumbent house in the cereal industry can systematically use the usage of debut of new cereals to discourage farther entry by new houses. It will non be as expensive for the incumbent house to publicize its new cereal merchandise as it will be for a new entrant because of the high trade name trueness in the industry and the economic systems of range cost advantages.
C ) Marketing advantages of tenure
Umbrella stigmatization has been described as a state of affairs whereby a house sells different merchandises under the same trade name name ( Besanko et al, 2004 ) . Harmonizing to Besanko et Al ( 2004 ) , an incumbent house can work the umbrella consequence to countervail uncertainness about the quality of a new merchandise that is been introduced. The umbrella consequence may besides assist the bing house negociate the perpendicular concatenation. Retailers are more likely to give scarce repositing and shelf infinites to the house s new merchandises more than it would for a new entrant. Likewise, providers and distributers may be more willing to transact concerns with the incumbent houses more than the new entrant in the countries of recognition gross revenues and relationship-specific investings ( Besanko et al, 2004 ) . Incumbent houses in the cereals industry can utilize umbrella stigmatization as a scheme to discourage new entry or coerce new entrants out of the industry. Umbrella stigmatization besides has an consequence on consumers. The possibility of a freshly introduced trade names been widely accepted by consumers is higher for houses basking umbrella stigmatization than for new entrants. Umbrella stigmatization has the ability to cut down uncertainnesss associated with the debut of a new cereal trade name. Furthermore, the development of close relationships by an incumbent house with its perpendicular concatenation is another scheme for barriers to entry.
The incumbent house may make up one’s mind to ship on capacity enlargement. A new entrant will happen it hard to fit up its works size with the works size of bing houses and may incur losingss at entry. With the enlargement of capacity and increased gross revenues, the officeholder will go on to bask economic systems of graduated table thereby coercing new entrants who are unable to accomplish such low unit cost of production out of the industry as their mean cost of production may systematically be higher than the market monetary value of the cereal trade names and the monetary value.
The ready-to-eat breakfast cereal industry is an oligopolistic industry necessitating the houses to use non-pricing schemes to maximise net incomes and prolong competitory advantage.
Because the ready-to-eat breakfast cereal industry has natural barriers to entry, houses in this industry do non necessitate to make much in the country of strategic barrier to entry to forestall of or coerce new entrants out of the market. However, the changeless debut of new cereals is important to gaining higher net incomes.