STATEMENT OF WILLIAM C. MACLEOD

BEFORE THE

COMMITTEE ON

AGRICULTURE, NUTRITION, AND FORESTRY

UNITED STATES SENATE

JULY 27, 1999

ON BEHALF OF THE GROCERY MANUFACTURERS OF AMERICA

• •CEREAL INDUSTRY PURCHASES HAVE LITTLE EFFECT, IF ANY, ON GRAIN PRICES



• •PRICES FOR CEREAL ARE LOW; CEREAL IS A BARGAIN



• •INDUSTRY CONCENTRATION IS FALLING; COMPETITION IS INTENSE



• •CONSUMERS DEMAND VARIETY, INNOVATION AND NUTRITION

GMA is the world's largest association of food, beverage and consumer product companies. With U.S. sales of more than $450 billion, GMA members employ more than 2.5 million workers in all 50 states. The organization applies legal, scientific and political expertise from its member companies to vital food, nutrition and public policy issues affecting the industry. Led by a board of 42 Chief Executive Officers, GMA speaks for food and consumer product manufacturers at the state, federal and international levels on legislative and regulatory issues. The association also leads efforts to increase productivity, efficiency and growth in the food, beverage and consumer products industry.

EXECUTIVE SUMMARY

STATEMENT OF WILLIAM C. MACLEOD

CEREAL INDUSTRY PURCHASES HAVE LITTLE EFFECT, IF ANY, ON GRAIN PRICES

$ Only about two percent of the average annual U.S. wheat and corn crop is used for cereals.

$ By contrast, roughly half of American wheat is exported, and those markets have collapsed. In the early1990s, with wheat prices reaching record highs, as much as 55 percent of the crop was exported. In 1998/99, with depressed prices, exports are estimated at only 43 percent.

$ In two years, exports of corn dropped from 30 percent to 16 percent of production.

$ The agricultural export recession has helped push the U.S. trade deficit to record levels.

• For solutions to the problems farmers face, we should be looking for ways to open up and revitalize foreign markets for our crops. GMA has been working hard to accomplish these objectives and would be glad to lend its support to any worthy initiatives that this Committee may pursue.

CEREAL PRICES ARE LOW

Cereal prices have fallen throughout much of the 1990s, even when grain prices have increased.

Retailers often don=t pay list price. They buy a third of their volume of major brands at discounts from list prices. List price adjustments of a percentage point or two have little effect in this market.

Consumers often don=t pay shelf prices. They make about a third of their brand-name purchases with coupons or store-member discounts, achieving average savings of 30 percent and more.

Cereal is one of the least expensive breakfast foods available. The average cost of a bowl of cereal with milk is around 30 cents. Consumers pay about 50 cents for bacon and eggs at home and can spend more than a dollar on a bagel or a cup of coffee on the way to work.

Price brands have surged during the last decade. Dozens of firms produce private label, generic, and low-price cereals that now account for about 15 percent of the market. Their share has nearly tripled since 1986.

CONCENTRATION IS FALLING, COMPETITION IS INTENSE

Industry concentration is at an all-time low. Concentration has dropped nearly 40 percent since 1970. The decline continues today.

Price competition is intense. Market shares continue to shift from one producer to another.

Competition has been investigated again and again. Just last year, the Federal Trade Commission closed an examination of cereal competition that had been requested by two congressmen.

In 1995, a distinguished federal judge rejected an antitrust challenge to a cereal acquisition. She found the industry to be Ahighly competitive,@ and she found no evidence that profit levels reflected anticompetitive behavior. Separately, that same year, a California Superior Court summarily dismissed an antitrust lawsuit based on the same congressmen=s allegations.

In 1981, a Federal Trade Commission judge dismissed an antitrust complaint against cereal manufacturers. He found them to be Avigorously competitive.@ The full Commission dismissed the complaint, with prejudice, in 1982.

CONSUMERS DEMAND VARIETY, INNOVATION AND NUTRITION

The purchase of raw materials is just the beginning of a complex manufacturing, distribution and marketing effort to satisfy cereal consumers.

Consumption is moving from traditional, simple cereals to complex combinations of foods and flavors. Three of every four consumers switch brands every time they buy, with the average household purchasing 17 different brands. New introductions since 1980 account for a quarter of the cereal consumed today.

Cereal, one of the most nutritious foods available, is a key to good health. Low in fat, high in fiber, cereal is an important part of a heart-healthy diet.

STATEMENT OF WILLIAM C. MACLEOD⁽¹⁾

Only about two percent of the average annual U.S. wheat and corn crop is used for cereals. By contrast, roughly half of American wheat is exported, and those markets have collapsed. In 1992/1993 1,353.6 million bushels of U.S. wheat were exported, accounting for about 55% of U.S. wheat production.⁽²⁾ Wheat exports fell almost ten percent the following year, a decline that has continued through 1998/1999, when estimated exports hit 1,050.0 million bushels, accounting for only 43% of U.S. production. Since their peak, wheat exports have dropped over 20%. Corn exports fell by over 30% while production expanded 25% in just two years during this period. These drops alone are many times larger than the entire annual volume purchased by the cereal industry.

According to the Economic Research Service of the U.S. Department of Agriculture, wheat prices have suffered since 1997 "due to large crops, relatively weak export demand, and rising carryover stocks."⁽³⁾ The USDA predicts that 1999/2000 exports will increase, but that the average farm price will increase only slightly because the major exporting countries have large supplies which will force competition to remain strong."⁽⁴⁾ Economic turmoil of the type that hit Asia and Russia was bound to hurt the farmers.

We are encouraged that USDA is projecting increases in foreign demand,⁽⁵⁾ and we hope those estimates are conservative. For solutions to the problems farmers face, we should be looking for ways to open up and revitalize foreign markets for our crops. GMA and its members have been working hard to accomplish these objectives and would be glad to lend their support to any worthy initiatives that this Committee may pursue.

PRICES FOR CEREAL ARE LOW; CEREAL IS A BARGAIN

Cereal prices have fallen throughout much of the 1990s, even when grain prices have increased. Adjusted for inflation, consumer prices for cereal have consistently decreased throughout the decade. And these decreases are present even before we take into account the additional cost savings that are passed on to consumers through coupons and store-member discounts.

Retailers often do not pay manufacturers= list prices, but instead buy a significant amount of their volume of the major brands at price discounts from the manufacturers. List price adjustments of a percentage point or two have little effect in this market. In addition, consumers often do not pay retail shelf prices. Instead, about a third of consumers= brand-name purchases are made with either coupons or store-member discounts. These discounts directly provide the consumers with average savings of 30 percent or more.

Cereal is one of the least expensive breakfast foods available. The average cost of a bowl of cereal with milk is under 30 cents. Contrast that with what a consumer must pay for other breakfast items: about 50 cents for bacon and eggs at home, $1.35 for a cup of coffee at a popular chain, $1.50 for a bagel, and $1.65 for a popular egg/muffin sandwich. These are prices you will pay here in Washington, D.C. if you go shopping today. In fact, these are the prices I paid when I went shopping just last week. I bought eight boxes of cereal, shopping the way most consumers shop--using my Safeway card for some purchases, taking a coupon from a shelf dispenser for others, and taking advantage of everyday low prices for the rest. Overall, I paid 20 cents a serving for the cereal I bought. Adding 4 ounces of milk, I can have a bowl of cereal and milk for 27 cents.

My shopping covered just branded products. I could have bought a bag of Quaker cereal and saved more. I could have used the $3.50 in cereal coupons that I received at the checkout counter for additional purchases. I could have bought Safeway=s private label. Dozens of firms produce private label, generic, and low-price cereals that now account for about 15 percent of the market. Consumers have many choices.

INDUSTRY CONCENTRATION IS FALLING, AND COMPETITION IS INTENSE

Industry concentration has dropped by over a third since 1970, and the decline continues today. In State of New York v. Kraft General Foods, Inc.,⁽⁶⁾ Judge Kimba Wood, a respected antitrust practitioner before she became a judge, found that A[b]etween 1970 and July 30, 1994, there has been a decline in concentration of about 27 percent.@⁽⁷⁾ This decreased concentration is reflected in a drop in the Herfindahl-Hirschman Index (HHI) from 2955 in 1970 to 2215 by 1992.⁽⁸⁾ Since then, the level of concentration has dropped below 1900, ⁽⁹⁾ a level not seen since such statistics have been recorded.

Exhaustive investigations, including a Federal Trade Commission proceeding during the 1970s and a federal trial in the 1990s have concluded that competition in the cereal industry is intense. In the 1995 New York case, the court rejected the antitrust challenge of Kraft=s acquisition of the Nabisco cereal line. Regarding the dimensions of competition, Judge Wood said that cereal manufacturers Acompete on the basis of price, quality, new product introductions, consumer promotions, trade promotions, and advertising.@⁽¹⁰⁾ The merger posed no threat to that competition.

Similar findings emerged from the earlier FTC proceeding.⁽¹¹⁾ After years of investigations and litigation, an administrative law judge found the industry vigorously competitive. The Commission dismissed the case with prejudice, finding that the staff had failed to establish any violation of Section 5 of the Federal Trade Commission Act.⁽¹²⁾ The FTC and Judge Wood have been vindicated by history, considering the course of real prices and concentration in the 1990s.

CONSUMERS DEMAND VARIETY, INNOVATION AND NUTRITION

Price is only one of the competitive factors in the cereal industry. Judge Wood found that when consumers decide to buy cereals, purchasing decisions are determined by a number of factors, including taste, nutrition, type of grain, sugar content, habit, price, and the availability of coupons.⁽¹³⁾ In fact, one study indicated that consumers ranked price as only the seventh most important factor in selecting cereal.⁽¹⁴⁾

Thus, the purchase of raw materials is just the beginning of a complex manufacturing, distribution and marketing effort to satisfy cereal consumers. Before a cereal is marketed companies invest heavily in research and development to produce a product that consumers will enjoy. Then plants and equipment must be dedicated to produce and package the volumes that serve a national market. The costs of distribution and marketing are major expenditures for the cereal companies. Inefficient distribution or inattention to the needs of retailers and consumers can spell quick trouble for a brand.

Research and development are critical to success in the cereal industry because variety in cereals is a strong motivator in consumers= purchasing decisions.⁽¹⁵⁾ As Judge Wood noted, cereal purchasers Ademand a particularly high level of variety and new products.@⁽¹⁶⁾ Their preference for variety manifests itself in their buying and eating practices: 77 percent of purchasers switch cereals every time they buy, and the average household buys 17 different brands of cereal during any given year.⁽¹⁷⁾ Furthermore, the average household now keeps five or six different cereals in the pantry.⁽¹⁸⁾

Cereal manufacturers respond to this consumer demand for variety by competing with one another through product improvements and the introduction of numerous new products. Industry observers note that innovation is the primary driver of growth in the cereal industry.⁽¹⁹⁾ Cereals introduced since 1980 account for more than 25 percent (measured by volume) of all cereal consumption; cereals introduced since 1990 account for at least 12.5 percent of cereal consumption. As Judge Wood found, the Acontinual introduction of new RTE cereal products is pro-competitive.@⁽²⁰⁾

Consumers also demand taste. Indeed, it is probably the most important factor for most cereal purchasers. In the same survey in which consumers ranked price as only the seventh-most important factor in the purchasing decision, taste was ranked as most important.⁽²¹⁾ Cereal firms respond to consumer demand for taste both by introducing new products and improving existing products. In 1994, for example, General Mills reformulated Cheerios and Wheaties, making them crispier and more distinctly grain-flavored;⁽²²⁾ during the same year, the company boosted fruit and nut levels by 25 percent in five of its adult cereals.⁽²³⁾

Finally, but equally important, consumers demand nutrition, and cereal manufacturers compete constantly through the introduction of healthier cereals. A Kellogg spokesman stated that Kellogg strives to meet consumer demand for a product that Atastes really good but delivers on nutrition as well.@⁽²⁴⁾ A current example of nutritional innovation is a substantial increase in the calcium that is added to many cereals. This innovation is a response to the recognition that many Americans, especially women, need to consume more calcium in their daily diets. And in a study published in the Journal of the American Medical Association,⁽²⁵⁾ Harvard researchers found that consumption of fiber was associated with lower incidences of heart disease and deaths from heart disease. Cereals, typically low in fat, were a major source of fiber in the study, leading the researchers to conclude that Americans should consider increasing their cereal consumption. The research adds to the large body of evidence that led the FDA to conclude that diets high in fiber are associated with a lower risk of heart disease.

Cereal manufacturers seek to meet the needs of consumers on myriad levels, including taste, variety, nutrition, health and price. Those consumers who view price as the crucial factor in selecting cereals can have their demands answered by the numerous discounts the major brands offer and by the expanding price brand segment. Those consumers who demand taste and variety have dozens of products to choose from, and new offerings continually add to their choices. And for those consumers who seek healthier food, the 30 cent bowl of cereal is one of the best investments they can make.

CONCLUSION

We thank you for allowing us to tell the story of competition in breakfast cereals. We would be glad to answer any questions that you might have.

1. I am currently a senior partner in the law firm of Collier, Shannon, Rill & Scott. My career covers over twenty years of practice in the field of antitrust law, including eight years at the Federal Trade Commission and the Antitrust Division of the Department of Justice. From 1986 to 1990, I was the Director of the Bureau of Consumer Protection at the FTC. My practice today is devoted exclusively to antitrust and consumer protection, and my clients include the Grocery Manufacturers of America, on whose behalf I appear today. This testimony is based on my experience and on the research of Professor Timothy J. Muris, GMU Foundation Professor at the George Mason University School of Law, and former Director of both the Bureau of Competition and Bureau of Consumer Protection at the Federal Trade Commission.

2. Wheat Outlook (Econ. Research Serv., U.S. Dep=t of Agric.), July 1999. All export data are from this source.

3. 2/ Id. at 1.

4. 3/ See Id.

5. 4/ See Id.

6. See State of New York v. Kraft General Foods, Inc., 1995-1 Trade Cas. (CCH) ¶ 70,911, at 74,055 (S.D.N.Y. 1995) (hereinafter Kraft).

7. 6/ Kraft at 74,038.

8. 7/ See Id. at 74,046. The Herfindahl-Hirschman Index is now the principal tool used to assess market concentration. This index is calculated by summing the squares of the individual market shares of all firms in the market. This calculation provides a single number somewhere between a number approaching zero (an atomistic market) and 10,000 (a monopoly).

9. Source A.C. Nielsen.

10. 9/ Kraft at 74,051.

11. 10/ See Kellogg Co., 99 F.T.C. 8 (1982). The charges against Quaker Oats were dropped early in the proceedings.

12. 11/ See Id. at 269. Most recently, the Federal Trade Commission just closed an examination of cereal competition that had been requested three years ago by two congressmen, Charles E. Schumer (now Senator) of New York and Sam Gejdenson of Connecticut.

13. 12/ See Kraft at 74,039.

14. 13/ See Id.

15. 14/ See Betsy Spethmann, Cereal Chic, Brandweek, August 7, 1995, at 26 (research indicates Aconsumers= growing penchant for variety@).

16. 15/ Kraft at 74,038.

17. 16/ See Kraft at 74,039. See also Betsy Spethmann, Cereal Chic, at 26 (Aconsumers want a variety of tastes, and so they develop a list of 8-10 cereals they=ll buy; sort of a personal portfolio@).

18. 17/ See Fierce Cold Cereal Competition Continues, Food Institute Report, July 11, 1994, at 3.

19. 18/ See Eric Palmer, Beyond the Breakfast Bowl: New Cereal Products, Milling and Baking News, June 27, 1995, at 22 (Anew product introductions drive the ready-to-eat breakfast cereal category@); John C. Maxwell Jr., New Items Boost Cereals, Advertising Age, June 20, 1994, at 12 (attributing 5 percent increase in sales volume partially to new product introductions and line extensions); Betsy Spethmann, Cereal Chic, at 26 (A[n]ew brands that add flavors to the palette also can boost consumption [of RTE cereal]@).

20. 19/ Kraft at 74,055 (emphasis added). Judge Wood also recognized that brand proliferation made coordinated action more difficult. Id.

21. 20/ See Kraft at 74,039.

22. 21/ See PL Cereals, Cold and Hot, Post Continued Growth, Private Label, at 46; Eric Palmer, Beyond the Breakfast Bowl: New Cereal Products, at 22.

23. 22/ See Harry Berkowitz, General Mills Goes Against the Grain, Newsday, April 18, 1994, at CO2.

24. 23/ Eric Palmer, Beyond the Breakfast Bowl: New Cereal Products, at 22.

25. 24/ See Ernst L. Wynder, M.D., High Fiber Intake: Indicator of a Healthy Lifestyle, Journal of the American Medical Association, February 14, 1996, at 486.