“Why so many cereals?" - The economics of competition

Category: Economics

Tags: cerealchoiceconsumerdifferentiationeconomics

Entities: Apple Cinnamon CheeriosCheeriosCornflakesGeneral MillsJerry HmanQuaker Oats

Summary

• Historical Context
• During World War II, there were only three types of cereal: Cheerios, Cornflakes, and Quaker Oats.
• By 1970, the number of breakfast cereals increased to over 150, including generic versions.
• Product Differentiation
• Cereal companies faced profit challenges due to generic products mimicking their offerings.
• General Mills introduced Apple Cinnamon Cheerios in 1989, which faced inelastic demand and allowed for higher pricing.
• The introduction of Apple Cinnamon Cheerios raised consumer surplus by over $75 million annually.
• Economic Implications
• Product differentiation is generally seen as positive, as it drives variety and consumer choice.
• However, there is a concern about choice overload, where too many options can lead to decision paralysis.
• Only five firms currently produce the majority of the 5,000 types of cereal available.

Transcript

00:00

There was essentially three types of cereal in World War II. Cheerios, cornflakes, and Quaker oats.

That was it. Okay.

Uh but by 1970, there was more than 150 breakfast cereals to choose from. Uh including

00:16

ones that are very similar like apple cinnamon Cheerios. Okay.

By 1970s, so ba but basically I'm sorry, let me back up. I said this wrong.

1953 type cereals. By 1970, there 150 cereals.

But it wasn't differentiation. It was that stores had

00:32

realized they could make generic versions. So they made odeos which were Cheerios a different name but they were Cheerios and then they could just sell them.

They could sell them at epsilon above marginal cost and make money. So essentially the cereal companies were not making profits anymore because

00:48

generic products have been introduced to essentially mimic what they were making. So they product differentiated.

In 1989 General Mills introduced Apple Cinnamon Cheerios. It's less old than you think.

Okay, it's before you guys, but well after me. Apple cinnamon Cheerios.

Now, when apple cinnamon and Cheerios came

01:04

in, they were delicious objectively. Okay, and there was no good substitute.

So, they suddenly face fairly inelastic demand. So, they could raise prices above marginal costs.

So, General Mills,

01:19

while getting competed to death on regular Cheerios, could suddenly have a highly profitable apple cinnamon Cheerio line. and they patented the apple cinnamon formula.

So for a while there wasn't competition. Now there's generic apple cinnamon materials but they weren't for the first few years.

01:36

Okay. So by product differentiating they ended this death cycle of betron competition.

Is that good or bad? Let's come back to welfare.

Yeah. Oh just checking your nails question answer

01:52

rather. Uh is that good or bad?

Yeah. Well, is it good or bad?

Depends very much on your model. We think it's probably good because of the principle I've talked about reveal preference,

02:07

which is if people didn't want apple cinnamon cereals, they wouldn't buy them. So, you've created a new in product differentiating, you've created a new product that consumers want.

Indeed, my colleague, very famous economist name Jerry Hman, actually estimated that the

02:23

introduction of Apple Cinnamon Cheerios raised consumer surplus by more than $75 million a year because they had this new thing they wanted. Now, on the other hand, they were paying a monopoly price for

02:38

it. So, we are better off in a world with apple cinnamon Cheerios than without it.

But we're still not as good off, not not as well off if they weren't if there wasn't more competition providing apple cinnamon Cheerios. So it doesn't mean in other words in

02:55

economists we talk about the we talked about the first fundamental welfare theorem, the best we can do. We also talk about the second best which is well the best we can do given constraints we live under.

So having apple cinnamon chur the best we could do. It's the second best.

We are better off having apple cinnamon

03:10

than not. But the first best will be apple cinnamon materials with a regulated price at the perfectly competitive price or at least above it enough to invent new products.

So indeed today only five firms make most cereals. Five firms.

There are 5,000 types of

03:28

cereal. 5,000.

So that raises another interesting issue. So overall economistic product differentiation is good.

We think essentially it's driving variety. People like variety.

If they didn't, they wouldn't buy it. That's good.

03:43

But there's starting to be an interesting question in industrial organization of the problem of choice overload, which is in some sense, are we actually do we have too many choices? In economics, we assume more choice is good.

That's our fundamental assumption.

03:59

But what if now you just get to the you get to the supermarket, you look at that, you're like, it I'm going to have toast. Okay?

Because you're like, I just can't decide. There's so much.

Well, you could get to the point we're actually worse off from that much product differentiation.