NDP' EW M. NOV AI(OWc

/?eprint ed ./i·olJl /),,;n', /-"t ",d alld (/11 ';1'111//1/"1/1, ,, S,III;/(I1;(/I/. \-'01. <) . No.5, Pages :145·252 (McII ' 1<)8<)) Copy righ t©. IAMFES. P.O. Box 701 , Ames . IA 50010

Structural Change in the U.S. Food Distribution System: Implications for Dairy Processors

and Their Markets

hy

Larry G, Hamm , Ass(lciall! Professor M ichig(/n S/(III! U nil'(,!,sitv

Papl!l' presl!nled 10 Ihe Uuiled Dairy Induslry Ass(!ciOliol1, Seplemher 14 , 19HR in Rosel1lonl, /IIil1ois .

I n trod uction

Dairy plant ownership changes are occurring at nei:l r dizzying speed, Bea trice se ll s its fluid operat ions to Borden. Knud se n is no longe r w ith us and Kraft is now the second lei:lding food serv ice distributor. These are all trends and factors in what economists have come to ca ll industrial market structure, This paper attempts to look at the curren t st ructure of di:liry processing indust ries, To help focus the discussion , dairy markets are c lass i fied within specific stra­tegic groups or market channel segments. The paper con­cl udes by enumerati ng some possible impl ications of struc­tural and mi:lrket channe l change for the various U,S, dairy industries,

Why is Market Structure Important'!

Economists define market structure as the significant fei:l tures of a market which affec t the behav ior of firms sup­plying that market ( I , p. 17), Economists are mos t fond of talking about compe titi ve markets. The struct ure of com­petitive markets is such that there are sufficient numbers of suppliers in a market so that no suppl y ing firm has or perceives that it has any effect on the market's outcome, Economic theory has also deve loped a second market mode l ca lled monopo ly . Monopoly is charac terized by the concept that a single suppl y ing Finn has economic power to rest rict market output and thereby increase prices. Both the com­petitive and the monopoly market models g ive de finitive market so lutions to economi sts' questions of how much will be produced and at what price. For the Illost part, neither of these ideal istic models reflect rea l world marketing situ­ations ,

A school or economic Iheory evolved to develop a fra mework for analyzi ng markeling sys lcms characteri zed by induslries wi th several dominant firms each having some powa over the market but yet not having sufricient power to

control the marke t as do monopol ists. That branch of eco­nomic theory became known as Industrii:ll Organization (10) theory and its formulation is summarized in Figure I ,

[n its most basic form, the 10 model starts w ith sti:lnd i:l rd supply and demand fi:lctors making up the basic conditions wi thin which markets opera te , The bas ic conditions help define market structure . Figure I li sts some of the most basic structural vClriab les. The 10 theory postulCltes that these structural conditions define firm 's market actions and con-

r I I I I I I I I I I I I I I

I I I I I I I I I I I I L

•

-. ~

--

BAStC CONDITIONS

SUPPLY DEMAND

Raw materials Price elasticity Technology Rate of growth Product durability Substitutes Value/welg ht Marketing type Business attitudes Purchase method Unionization Cyclical and seasonal

character

MARKET STRUCTURE

Number of sellers and buyers Product diHerentiation

Barriers to entry Cost Structures

Vertical integration Conglomerateness

+ CONDUCT

PriciMg behavior Product strategy

Research and in novation Advertising

Legal tactics

+ PERFORMANCE

Production and allocatlve efficiency Progress

Full employment Equity

Figure I. II 1110(/1'1 01' ;I/dllx/r;al (lrgo ll; :ol;ol/ (li/a/rs;x.

f-*

-

-, I I I I I I

Ih l/HI' . roo/) rl NI) (NI '1IIONMI:NIAL SANJrArtONIMA Y Il) ~ <j 245

duct. Pricing, advertising. promotions. R&D beh<lvior, elc.

are all consequences of a markels struclure. For exam ple. in a perfectly competitive market individual firms have no

choice but to se ll their products at the going market rate. This

is because their sa les Hre insignificant and their products are

viewed by consumers as being no differenl from Ihal of Ihe

other firm s in the market. Modern market struc ture is such

that each industry mu st be studied to undersland how it will

act and reac t ove r time. The com posite behavior of all firms

in the industry leads to economic performance (Figure I). Economists' performance is substantially different from

performance. viewed by finns' owners/managers. Therefore it is usually not in MBA curriculum. However, the 10 formu­

lation in Figure I has two powerful charact eri st ics. First, it

is predicl ive. The arrows that connect basic supply and

demand cond ition s 10 markel structure Ihrough conduct to

performance provide a method for speculating (albeit in­

formed) about the likely behavior of a given industry.

Second. the model is dynamic. In any time period the aClions

of the industry will feed back (the dotted lines in Figure I) on

to the other elements of the model. This allows the analyst

10 predici the future. These two characterislics have resulted in thi s basic formulation being the cen ter of ll1uch of the

recenl Harvard Business School formulation of a strategic

planning theory (II). This formulation can be used to

anCllyze economic power. It is thi s orientation which is useel

in the paper.

Dairy Processing Industry Stnlt'ture

Til(' Nlllilher olScI/a.1 Perhaps the basic market structure variable is the nUIll­

ber of se llers (processors. manufacturers. etc.) firm s within the mHrke\. Economists normall y measu re this va riable by H 4-firm concentration rati o (CR-4J. A CR-4 is the percentage of the industry's sa les that are controlled by the 4 larges t

TABLE I. NUll/her n!lllllis IIl1d I If(' flerc('1I1 olsel('( '{('d iJ/( lusflin'

.,Iu'til/WI/IS «()/lfm//ed 1)\' III(' /illlr lurg('Sl./inlls: II.)(J7. IV77 ((lid

/'.182 .

No. or l"dusl")' Firms

B ullcr 6 1

Narur;tl and Processed Cheese .) 75

Condensed and Evaporated Mi Ik 1.12

Ice Crealll 4K2

Fluid Milk K.~4

1902 Pcrc..;111 No,ol

FirJll:--

29 12-'1

()()()

166

22 :'i()7

15 1.51 6

I')n I ')() 7

Pern.'lli NIJ, of Perce lll

Finlls .'I() )10 14

-15

179

27 71.1

17 21 Source: U.S. Department or COlllme rce . IV82 C ('II .\I/.' oIMu lll//il£'-

11/1'i'S Ouin' Pl'odl/('/s II/dl/sln' S(,l'i('s anti COIlCellll'Ulinli RU lins ill

MUIlI//i"ll/l'illg.

246 /)AII<Y. roo/) ,\N/) !;iV\ INON:HI-NII\/. SrlNII.YIlON 'o'I /\ Y I'IX')

firms in that industry. It is designed to measure the degree of

economic power held by the industry's leading firms. The higher its value. the greater the autonomy that indi v idual

firms have in determining competitive factors such as price prod uct advertising. promotion. etc.

T able I has tl\e most recent st<l tisti cs avail,lble on the full

array of dairy industr ies classified by the Bureau of the Cen­sus. These CRA's are taken from the 19S2 Census of Manu­

facturing published in 19R6 (14). Unfortunately. these me the only systematic structural dala avai lable. Generally speaking. when measured on a national m,lrket basis. the

dairy industries me among the least concentrated food proc­essing industries. Table I also indiultes lhat conce ntral ion

h,IS generally been st ati c or slightl y decreasing for nemly all

dairy product categories between the years 1967 and Il)R2.

By 10 standards. thi s tends to be phenomenal given the

dramalic reciuction in the number of dairy finn s in the

industry ancithe static market growth through 1982 for dairy

products. Most past 10 st udies show that concen trati on

increases in industries with slow growth and declining numbers.

One possible exp lanation for the relati vely low eco­

nomic concentration in the dairy industries is the Cact Ihat 1110st dairy products are standardized products. Standardiza­

tion has been re inforced by generic advert ising activiti es of

the dairy industry. The cheese category provides an example

of why product differenti,tlion is such an importanl structur,iI

variable. In 1l)82 the Bureau or Census ca lcul<l ted concen­

tration ratios for natural cheese (except cottage cheese) and processed cheese and related products. The I l)S2 C R-4 rm natural cheese was 3 1 but il was 64 for processed cheese. Processed cheeses are v,tlue-a(lded products Wl lich have had

brand su pport over the years. There are other reasons wily Ihe Il)S2 Bureau of Census

CR-4's may be l1lisic;lding . The numbers do nOI capture the growth in dairy product catcgories ( 13. p. I (7) . In 1l)841hat

number nearly doublecilO k06 and by 1l)87 there were 1132 new dairy product introductions . Much of Ihi s act ivil Y W,IS

generated in the brand-oriented produci ca tego ries such ,IS

yogurl. froze n novelties. etc.

Merger and acquisition activily is perhaps the greatesl

challenge to Table I . The U.S . Department of Agriculture

estimates that in In.'i. there were 20 dairy processing mergers (1:1 . p.:2I). In I l)S6. there were l) and during tile first Iwlf of 11187 there were 12. In 1986.1 wo of the seve n lead ing

firms making acqu isitions in all of the food industry were

cl airy companies: Kraft and Borden. Kraft and De,m Food~ Company made Ihat lisl in 19k.'i. Grill1ted not all of theil'

acquisitions were dairy processing firms bUI some. like the

Borden aClJuisition of Beatrice fluid milk operations. werc

quite large . The ll)k7 Census of Manufac turing w ill ce r­

tainly refl ec t the probable increases in conce ntralion due to

tllis merger and ;Icq ui.silion "ctivity. Another rC,I Son lhat Ihe slali stic s in Tahle I mil)' under

e.s till1 ;\le the degree ofconct' ntration in the dairy sect or is Ih'" Illany d,liry nwrkeh <Ire local or occupy Ill,lrkel niches. Thi s

is e.spec ially true of fluid milk markets. So " Ithough the fOllr largest firms in the U .S. in ll)k2 only controlled I V i( of Ihe

nuid milk ~a l e.s . in spec ifiC m,l rkct arc<lS Ihe lOp fOUl' firms

may cOniTol as much as 90% of the sales. The realigning of plant ownership and control as the result of mergers and ac­quisitions, bankruptcies, and divestitures is still not com­plete. However. all indications seem to point to significant local and regional fluid market concentration. A compre­hensive look at the economic power concentration in local fluid markets is a high priority. A related phenomenon is that concentration might be much higher in specific market niches. For example, mozzarella cheese may be processed by many processors. but relatively few dominate the fast food pizza market. Or examine the yogurt market where a recent trade publication estimates that the top three yogurt marketers sold 60.7% of the industry output (4).

We do not have an accurate picture of dairy industry concentration. Eventhough the national markets look com­petitive many local markets and niche markets exhibit sub­stantial market power. Betler estimates must be developed.

Illdus/rr Verr;colll1legro/ioll

Vertical integration has al ways been a part of the indus­try. Producer-handlers, " jug stores". etc. are examples of forward integration. However, backward integration into fluid milk processing by retail food chains has been the most impol1ant form of vertical integration. The largest food retail chains had sufficient volume to justify building their own fluid milk processing plants. The generic nature offluid milk. homogenization and the one-way package permined food chain integration.

By integrating backwards, food chains combine two profit centers (the profits from selling the retail item and the profit from processing a product) into one operation. When integrating chains were able to price their private label milk at substantially lower prices than their competitors, other re­tailers were forced to establish private label relationships with nearby processors.

The leveraged buyout craze sweeping the food retailing industry and the Jewell experience with Hillfarm Dairy have dramatically altered the vertical integration silUation. Safeway's sale of dairy plants around the country and the ciivestiture of the Southland dairy operations me two notable examples. Only the Kroger company currently maintains a commit­ment to fluid milk processing.

COllg If 111 I£' ro/ (' II(,S.\

The other structural characteristics of significance to the dairy processing sector is its degree of conglomerateness. A conglomerate is a multiple-product, multiple-market firm. The degree of conglomerate control within an industry is important because (among other things) it dilutes the power of ,IllY particular commodity within the hierarchy and the de­cision making processes in the conglomenlle. Table 2 illus­trates a few selected examples of the importance of dairy products in major well-known conglomerate food firms. These finns process brand name products known to most Americans. They are managed by brand managers with little or no understanding of milk or its product ion-promotion sys­tem. The situat ion becomes worse i I' conglomerate manag­ers are finance-oriented rat io-robots. For example. would a Borden's of old be marketing subst itute cheese"?

TABLE 2. Se/ec/f!dtiwd 111(11//{tclc//{rers and (heir r('/(I/;I 'f! sales ill dairy anri dair." rf!/o/f!d pmd/{CfS 1987.

Eslimalcd Percenl Firm Ycar TOial Sales Dairy Sales Dairy - - -

(million dollars)

Kraft. Inc. 1987 $9.876 $4,000 40.5

Borden. Inc. 1987 6.5t4 2.402 36.9

John Labatr. Ltd. 1987 4.150 900 21.7

Neslie. S.A. 1987 18,211 3,260 17.9

General Mills 1987 5.189 200 3.8 Pillsbury 1987 6,128 210 3.5

Dean Foods 1987 1.435 958 66.8 Souce: Estinlcnes are m(~by the author from Corporate Annual

Reports. Financial Newslellers and Dairy Trade Publications.

The Structure of Processors Markets; Strategic Distribution Channels

One of the key determinants of the market env ironment for dairy processors is the organization and operation of its customer (as opposed to its consumer) base. A recent addition to 10 theory is the concept of strategic groups. Strategic groups are markets organized along the I ines of the characteristics of the purchases of the firms within definable distribution channels (2). For the dairy industry, three strategic market channels are critical. They include the retail foods tore channel, the foodservice channel and the ingredi­ent market channel. Within each of these, subgroups can be ill1pol1alll for spec i fic industries like dairy. The important foodstore subgroups are the brand product segment and the retailer-private label product segment. Food service market channels have traditionally been divided between commer­cial and non-commercial outlets. The ingredient market is sometimes called the producer goods segment. It includes those firms which purchase food components to manufac­turer final products for either the retail or foodservice mar­kets.

Much of the discussion which follows is drawn from observations and hypotheses generated by the author. Many of these observ(\\ions could be empirically documented but have not been in order to keep the paper in bounds. The discussion takes place within the context of Figure I. Basic conditions such as business attitudes. the role of technology , changes in power relationships. growth in the size of the overall market. etc. are explored. This discussion sets in motion the dynamics sweeping the dairy industries.

CI/(/Ilges ;11 Foods/ore Segmell/

Figure 2 provides an overview of the foodstore segment of the U.S. food system. Often a distinction is made between chain stores and independents. For this paper, both ;.Ire con­sidered together. The recent merger wave among full-time general wholesalers has essentially tied many independents into procurement patterns similar to integrated chains. Also, in spite of the press accounts. specialty stores. like dairy still nnly make up about 6'Ic of food store sales.

0,1/11)' . F()OO ANI) FNI/lWN,"II-.N1AL SANIlAFlONIMA Y 19H9 247

• $ uoer m"' ''eI3 ·52 0 1 011. • C ,) n"o n.onCII Sf OtfU J2 • $ uoerQl leS J~

94 %

Figure 1. F{) ods i""!: s({l ('s fir seUO,.. I <JS() .

FiIlOIl Ci' Dril'(, 11 Simelurol ChungI'

Declallud loo dIl O'"

• Moal 1tt10 rl~ n mo rkOll SO 011.

• ROUIII Ol5kiHlo:s .5 • Pr o ouco :s 10'1I:S 2 • Oolt y " or o:s Z • Canoy ano nul

:SIO/ OS • Mr,collanoou,

1000 :s IOf'"

TOlal SIS oil .

A s w ith much o f the rest o frhe U.S . economy, financ ial

deregulation and it s resulting c reation of new f inanc ial in ­

struments has forced the food retailing inelustry away from

it s traditi onal management roo ts anel into the worl d of high

finance suspense. Food retailing has h istoricall y bee n a comlllun it y -based industry. Foodstore management came

up throu gh the rank s. The wa ve of merge rs and acquisiti ons

have af fec ted the food retail ing industry. Ameri can stores ,III have h(l(1 .som e varial ion o f finance -dri ven leve rage buyout

( LBO) ac tivit y. The ch arac teristi c of LBO ' s and hi gh

finance ga mesmanship necessary to finance them is to force

the management o f the food retailing sec tor away from ret ail

operillions and tow ard very short term per fo rman ce meas­

ures . Even those firms not in vol ved in LBO 's Iw ve been

,Iffec ted as firms like Kroger look over its shoulders toward

hos til e takeo vers. The result o f this has been a chUllling o f

food retailing asse ts as merged , bought-our and leveraged

conce rn s se ll o ff and repos iti on assets. Often the manufac­

turing ope ration s, i. e. milk operations of the merged or

bought out entity are some of the first asse ts to be sold off to

pay for the me rger and buy out.

When all the smoke cl ears, the U .S. foodstore market

w ill be domin ated by many local market situations charac ­

teri zed by very high market concentrati on leve ls. The re sult

will be rh,lI the sales represe nt atives o f food processors and

nlilnufac turers w ill have nlilny fe wer sales call s to make .

Those sa les call s w i ll be decidedl y less comfortable thall ill

the P(l st.

/? (' 10 i I e r-M (ll/llti lei II re r /11 1 el F(' lu I iO/ 1.111 ip s

The kind o f economic po wer gainecllhrough con solida­

tion ac ross market are a.~ af fect s the compet it ion bet ween

foodstore competit ors across and within markets . But ,\11 -o ther fo rm or concentration of eco nomic powe r is taking

place. Retail ers or their w ho lesaler represent ,lti ves are

rapidl y gaining power in their procurement rel,ltionship.s

w iLh suppl ie rs (5). A use ful way to think about a supenn,lr­

ke t is to think o f it as two squares. The inner squ,lre compri ses

the center sec t ions o f the grocery st ore and is w here the Illiljor

interac tion between food reta i lers and brand manu facturers

takes place. Dry groce ry . f rozen food ilnd HBA m,lnuf,lc tur­

ers battl e each othc r and retail er brands fo r ,I stati c or

declining linear foo ta ge. Along the edges o f thc 1,Irger

square representing the st ore it se lf arc the periphery depart­

ments : meal. produce. dairy, bakery , deli. sea food . et c.

24X /) r\II< Y. Ii )() /J AN!) lelVI IHONM I·.N I A I . \ ,\NIFA I/ONM ,\ Y I'IX ')

Generall y those periphery departments, are under th e direct

contro l of the retail er. M anu facturer brands are not usuall y

re presented in this retail shelf space .

T oday, a recent estimate indicates that approxi mate ly

50'1, o f a stores sal es are in the grocery depal1ment and 50'k o f th e sal es are in the per iphery departments ( 10. p. 2H) . In­

creasing ly, th e grocery shelf space has become exceedingly

competiti ve. The interbrand competition is fo ught via new

product illlrod uctio ns many o f w hich m e product o r line ex­

tensio ns. In 19R3, <m estimated 5956 new produc ts we re in­

troduced . B y 19X7 that num be r had ri sen to In, IR2 ( 13, p.

107). The powe r stru ggle ragi ng between retailers and

manufac turers is v isib le to the outside world as the contro ­

versy about "s lot charges" and " street m oney " become tr,Kle

pre ss headl ines. The increasing use of c<tl endar marketing

ag ree ments (CMA 's) and shelf-spacc "rental" fees are o ther

indications o f inc re as ing retail dominance ove r food manu­

facturers. Direc t product profitability ( DPP) prog rams w ill

be the w eapo ns of retailer cho ice in the comin g y ears.

A direct con sequence o f retail er po wer is th e desi re by

food reLailers to turn consumer directed fooel advertising and

co uponing ac ti v it y more towa rd interbnlncl price/promoti on

competiti on and ret ailer oriented push promoti on ac tiv i ty.

The ret ailer sec tor w ill do whate ver it can to di vert manufac ­

turers' promoti on do llars away from strat egic promotion and

lurn them toward lilCt ica l pro mot ion.

Therefo re, dea ling with fe wer ,md more econo m iC<llIy

powe rful retailers; manclg ing w ith mo re sophist ica ted COIll­

pUl er enhanccd inform,lIi on sys tems: i llld prodded by short­

term, finan ce -driven, non- retail ori ented management w ill

mean an inhospita b le env ironment for supplie rs in need o f

consumer access via food store s. The larges l manufac turers

have learned to deal with power w ith a bifold strat egy . They

only stri ve for first or second pos ition brands and they di ver­

sify into other strategic market channel" .

/1I1 1' lI sil/1'd /? ej;·igl'ro/('( I Cose C{)lIIpel ilio ll

There is a significant increased interest in th e refri ge r­

ated (dairy case) shelf sp<l ce in the food store segment. Thi s

trend i, dri ven by tw o forces . F irst, there is a demographi c

shift to ward mo re f resh-orient ed food as he,llth consc ious­

ness and c on venience dri ven consumers look r·or new prod ­

uct s. Demographi c growth are,IS al w ilYs attrel c t tremendous

;lInounts o f intere st fro m large cong lo merat e I·ood marketers.

Second. the wm in the grocery isles has spill ed ove r int o thc

dairy case. Food marke ting giant s looking ror pl ,lccs to

,I ppl y their llli1rketill g skill s honed in the p,lc ka ge goods

ind ustri es llil ve settl eel in on th e dairy C<lse . The d,lir)' ca.'ie

now has all the big playe rs inc lucling C OCil C ol a ( Mi ­

nutemaid). Proclor and G amble (Cit ru s Hill ). General Mills

(Yo pl ait) , in additi on to the well-known finns li ke K raft.

Borden. Beatrice. etc .

A few st'lti sti cs. hi ghlight the int ensification orlil e dairy

Cilse competition. Betwee n 1966 <Ind J9X7, the typical

supermarket do ubled in size. Ho wever. in 1966 the IY fli cal

c1airy case wa s ."i6 I inc; lr fce l. Today it rUlls 60 I inear fee l. So

at a t iJll t: 01 ' he ightened i nte rest in the da i ry case. the ,I V, I i !able

SP,ICC h;ls no t gro w n propo rti onall y. Thi s has Sl gnifiCi lnt iJ1l-

plications for many of the industry's medium sized dairy

processors and new entrants wanting to cash in on the

growing dairy industry demands.

Food Siore alld Food Sen'ice Compelilioll

A final trend in the food store strategic group is the

recent attempts by food retailers to regain ground lost to the

food service industry over the past ten years. The service

oriented activities within the periphery of the supermarket.

full service, del i 'so cheese centers. fresh orange juice squeez­

ing, take-out meals. salCld bars. etc. are all clltempts by the

food retailing industry to deal with competition from the

food service sector. The reason is obvious when one looks at

the latest USDA projection on grocery store sales. In 1987. US DA estimates the real growth in grocery stores sales to be

zero. The periphery departments for the most part use basic

standardized commodity ingredients and produce a non­

branded or retai ler identified product. Therefore. food manu­

facturers attempting to escape the center square of interbrand

and private label competition find it difficult to gain access

to these type of departments. Perhaps Kraft ' s recem acquisi­

tion of 19 food service wholesalers positions it to effectively

compete in th is food store arena.

Changes In The Food Service Segment

Food Sen'ice Suhsegmeilis

Some industry observers are postulating that the growth

in food service has essentially ended. The argument goes

that growth has ended because the basic demographic trend

driving it has slowed significantly. The assimilation of many

women into the work force resulted in a growth for food

service activities. It Clppears that the trend has stabilized.

Overall the food service sector (see Figure 3) may be over built and currently Illay have significant over capacity.

Many large food marketers who had been integrated in the food service segment are considering backing out of the segment. The number of commercial eating and drinking

places. in the U.S. peaked at 351,935 in I n3 and by 1985 (the latest statistics Clvailable) fell to 333. 994 ( 13, P 71). In

constant dollars. the value added per full-time equivalent

employee in eating and drinking places has stopped rising

( 13. p. 100). How Illuch longer will food service growth

continue to dominate food firm strategic planning') Non-commercial food service sector is often overlooked

in discussions about food service. As shown in Figure 3. it

now comprises a $46 billion market and makes up 26'/r- or segments sales. Demographics suggest that this will con­

tinue to grow and probably capture an increasing proportion

of food service sales. Servicing this portion of the food service strategic group has been unglamorous and it is

dominated by specification procurement of commodity type products. The dairy sector has had extensive involvement in the non-commercial market. However. competitive forces

may challenge the dairy industry.

Food Serl'ice - Food Store Compeliriol1 Rel'isiled

If slow growth and over-capacity force food service competition, what form will that competition take,) The cur­rent food m8rketing fad, "fresh prepmed foods" is one com­

petitive consequence. This trend is supposedly driven by demographic rebound caused by the women's ascension into

the work force. "Cocooning" is the food marketer' s new

buzzword. The logic goes that All-American yuppie couples

after a hard week of McDonald's breakfasts, salad bar lunch, and airline dinners least desire is to get dressed up on

Saturday night and go out for a restaurant meal. Therefore.

they will use their discretionary income to purchase a high

quality professionally prepared meal for consumption in their home with their family in front of their VCR and

fireplace. The home delivered and pick up fresh prepared

pizza market has been propelled by Ihe "cocooning" phe­nomenon. How long the phenomenon will continue is ques­

tionable. But is has established a significant interstrategic

group marketing battle between food retailers and commer­cial food operators.

Commercial {{lid NOll-Commercial Food Sen'ice Compeli­

I iOIl

The second manifestation of intensified competilion

and over building in the commercial food sector are the

recent moves by large commercial food service entities into

the non-commercial sector. For example. the Michigan State University Faculty Club now has its own private,

unadvertised, unmarked Burger King. McDonald Corpora­tion recently announced its first units in hospitals. Proctor

and Gamble sees the need for children to substitute calcium

fortified orange juice for milk in the school lunch program.

Again, perhaps Kraft's recent" moves are well planned.

The demographics of the U .S. population . the lack of

profitable expansion in commercial food service and the

power of the very largest food manufacturers and food

service distributors could likely make the non-commercial food service market the next competitive bClttleground.

The Mysterious Ingredient Market Strategic Group

Wlwi is Ille /I/gredielll Markee

The ingredient market is dominated by firms who pur­

chase intermediate or what economists often call producer

goods to further process into final consumer products. Little

is known about these firms by outsiders (professors. consult-

Comm.(cl:;a'L-___ ~

• ;::."II\jfanrs • ;::IUI looos • CA/orotlllS • LOOCiIr'lQ Olace, • ::l:olalr I'IO'U • ::l:'c:oarlon • DtinlClnQ .: .. ~eu

TOlal SI31 :l11l10'"

Figure :I. FOOd\('/Tic(' SIIII'S fir s('("/(Jr. 1986.

on(:oll1rno,(:I:.1

SIJ Oill;on • Hosoiltlll!ll 4"'0

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• Military • """olno • Tronsoorlaiion • Associollo,"" • Corr'ctlonal

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J)AIII)'. I-DO!) AN!) I-."NI lNONt'vI/,N"IAL. SA NrJA "IIONII'vtA Y Il)X<) 249

ants, etc.) because they do not purchase a lot of advertising, do not directly interface with final consumers or generate a lot of publicity outside of their own trade shows.

This snategic group has grown rapidly for severa l rea­son s. First, many major food manuFacturers have tried to iso late themselves from commodity markets. The most di­rec t way is to buy initially processed products from ingredi­ent suppliers (6). Second, food service expansion increased ingredient demand as food service buyers particularly those in the fast food segment demanded custom made products for their operations.

M ovement toward more ingredient buying by food manufacturers and food serv ice suppliers will probably grow. Ingredient buying isolates the firm s from commodity uncertainty by lett ing the ingredient supplier finns eliminate worries about adjusting market demands to avail,lble sup­plies. Purchas ing ingredients frees manufacturers and food service suppliers from inventory responsibility . M anyagri­culture based commodities are produced on a stock basis and must be supplied to the marketing system ou t of stored commodities. This exposes firms to price and inventory risk . Finally, ingred ient purchases give buyers greater flexibility in dealing with the commodity price and market dem,lnd changes. Simply put, purchasing ingredients is often the most cos t effective and least ri sky way of producing stan­dardized consumer and food service products.

Ingredients Arc Chal1gil1g Their Il1l(1ge H istorica ll y, the ingred ient market has been c lose I y as­

soc iated with the 'additive' market dealing with coloring. stabilizers. spices, preservatives. etc. The impend ing bio­tec h breakthrough such as NutI'a-Sweet's Simplesse and Proctor and Gamble's Olestra may remove the last impedi­ment to further use of ingredients in food prod uct design and fabrication. "Add itives" h,lve had a pejorative impact on food demand . Increas ing additi ves will be viewed as pos i­ti ve if the additives reduce fat , cholesterol, calories or add ca lcium .

The dairy ingredients market has been largely domi­nated by the large fully integrated milk marketing coopera­tives and multinational dairy firms such as Borden and Nestle. The rapid growth of edible whey and whey proteins suggests that the dairy industry hilS been a critical player in the growing ingredient market. However. further empirical researc h is needed to full y understand thi s strat eg ic group.

Implications for The U.S. Dairy Processing Sector

In rev iew. the paper attempted to identify an analytical framework (Figure I) to bring order to the myriad of forces <lI work in dairy markets. Using thi s framework. the follow­ing are some likely structural and behavioral responses of var ious segments of the d,liry processing industry within the nex t fi ve years.

Fllfid Milf.:. Pmcessill,t:

The tluid milk processing sec tor with its assoc iated so ft produc t manu fac turing capaci ty w ill continue the trend it il;IS

2)0 /)AIIIV. FO()I) ANI) I:N lIlIONM/:IVIA L. SANIFX I/ON,:VI.·\ Y Il)Xl)

been on for the last 25 yeilrs. The recent consolidations have already made large formidable market share leaders in many important U.S. tluid milk markets. More mergers are ex­pected but those mergers will probably still continue to be driven by financial considerations. Current profit levels in the industry do not appear to justify purchases by big money outsiders.

The Pres ident ial election will have little effect on the current lack of antitrust en forcement. Changes to the Fedem l Court system brought about by eight years of Republican judicial appointments will mean fewer antitrust cases will be successful. Therefore, future fluid milk mergers will likely be among those firms already in the fluid milk business. Significant increases in economic power in local markets could continue.

The in tensification of dairy case shel f space competiti on combined with increased economic concentration spe lls se­rious trouble for regional fluid milk processors in the U.S. Many have survived on the profits from the slower moving soft-products (chip dips, sour cream. etc. ) and by gaining access to alternative distribution channels. As the large brand manufacturers fight for shelf space for yogull. "l ight" sou I' creams. etc. and P & G adds more orange ju ice products. the only hope for many of these spec ialized fluid processors is to go to alternative distribution channels. Reca ll Figure 3. The alternative markets like convenience stores. dairy storcs. gas stations are rather lim ited and expensive to service. Howe ver, a few firms lllany be able to survi ve using this strategy.

The COlllbinat ion of levcraged buyouts and the H ill farm plant disaster have shaken the resol ve of many of the inte­grated food chains to maintain their vertical int egra tion into tluid milk oper'lIions. However. there is no change in the pattern whereby retai l chains desire capti ve fluid milk sup­pliers within each of their geographic market reg ions. The Jewel-Hillfarm plant fiasco has howeve r convinced most chains that they Sl lOUlci adopt a strategy of ,tiw,I YS h,lvi ng backup suppliers available. Therefore . there may be lllore opportunities for very IMge fluid milk proces.'io rs to gclin access to grocery store chains. This can happen only if they are capable of handling the volume, service. and lllerch,tn­dising needs of increasingly power ful food retailers.

In the longe r run the adoption of reconstituted milk nwy allow significant product differentiation to develop in tluici milk markets. Standardiz,ltion and generic adverti sing have held down brand power in the fluid milk bu siness . Current and past debates of the reconstitution issue helVe not included discuss ion of the long terill market structural consequences of allowing the ,!Iteration of the identity of fluid milk. These conseLl uences may be as important as the redistributi ve as ­pects of reconstitution.

The fluid milk product s' probleills within til e comlller­ci,!I food service sec tor are well known ,I nd docuillented. The dairy industry has done fairly well inlhe non-comlller­cial food service secror. III fact. man y of our ~maller fluid milk processors survive by servic ing these accounh. The recent orange juice c,lse in a northern New Jersey schoo l district may be only the opening round in (\ cOllling intense

battle for the dairy industries' access to the non-commercial Foodservice business.

Cheese Perhaps nowhere will or is structural change occurring

as rapidly as it is in the cheese processing sector. Branded, packaged and value-added cheeses in the food retailing stra­tegic group will continue to be dominated by large brand companies. An important structural question will be whether the se brand manufacturers continue their historic position of being integrated backwards into milk proc urement. Many other brand manufacturers have already gone to the ingredi­ent market to eliminate commodity uncertainty. Given the finance-driven decision making of mode rn cong lomerates, this hitherto unim aginable development might take place. What will happen to Beatrice 's cheese division') Will the " bean counters" gain control of Kraft displacing the old line plan t manager power structure?

The private label sector of the food store strateg ic group is current ly handled by large specialized cheese processors some of which are integrated marketing cooperatives. There do not appear to be any significant forces push ing change in that segment of the cheese business.

The rapid growth in cheese consumption has attrac ted the retailers to featuring cheese at the expense of other protein items within the grocery store. The modern food grocery store may have cheese in the dairy case, in the deli case, in the meat case and in a cheese center. Kraft is perhaps the only firm positioned to sell in all of those locations. Also, g iven the increas ing power of retailers over suppliers, there is a real danger that trade oriented promotion activities by dairy producers will be changed from strategic promotion into tacti ca l promotion. This would allow retail ers use of producer dollars to lowertheir procurement prices for cheese. Reta il er, trade oriented promotion schemes for cheese must be fully explored in light of the dynamic structural bargain­ing power changes in the foodstore segment. III-conce ived trade promot ion can lower producer cheese returns overtime.

The ingred ient cheese market has been in formed and shaped by the pizza market and the needs of foodservice manufacturers. The concentration of sa les to the pizza market has become significant. Understanding the special­ized needs of ingredient product buyers and hav ing the money for specia li zed capital means that many cheese manufacturers are forec losed from the rapidly growing por­tion of the dairy sector.

The remaining part of the cheese business is a producer good-ingredient segment type of business. The pl ant tech­nologies requiring joint production of edible whey are now pervasive and will become even more so. As the ingredien t market continues to ga in a greater proportion of the demand for dairy based products. the fully integrated cheese-whey processor w ill survive. The structural fall-out 0 11 Northeast and Wisconsin cheese process ing firm s has ye t to happen. However, predicting the demise of the corner cheese factory in Wisconsin may be as difficult as predicting the demise of grade B milk in Wi sconsin .

BUller

Nothing mllch will happen to the structure of the butter market in either the food se rvice or food retailing sec tors. Packaging innovat ions for the foodservice market and the butter blends in the retail market were judged acceptable activity. There would be no reason to expect significant change in the butter market except one. Butter may be an endangered product unless research and development can neutralize the negative characteristics of butter products. If they are neutralized the basic flavor of butterfat is so positive that it will be the preferred ingredient for all market seg­ments. Without a change butter will continue in its smne unexc iting ex istel1ce.

Ice Cream The excitement of the super premiums and nove lty

growth has about run its course. Significant growth in ice cream will require the same technological breakthrough re­quired for butler. The new entrepreneurial firms entrance in the ice cream business will continue to get a lot more public­ity than sales. lee cream sales will again be dominated by the existing large sca le dairy processors who now control the business.

The rapid growth in frozen yoguI1 outlets could have significant impacts on ice cream sa les. Discussions with one of Michigan's lead ing ice cream shop operators verified empirically that their ice cream sa les were dramatica ll y lower in loca tions with competing frozen yogurt outlets. A major food retailer in Michigan, in an attempt to capture sa les from the foodserv ice strategic group plans to put frozen yogurt dispensers in all of their retail outlets. Although both ice cream and frozen yogurt are ingredient products, frozen yogurt is much more so. Frozen yogurt ingred ients are going to Michigan from California. This is another indication of increasing importance of ingredient suppliers in the st ructure of the dairy industry.

Cultured Products Growth in the cultured products will continue to be

dominated by the very large brand food processors now dominating many of those individual product ca tegories. Reformulated cultured and new dairy desserts have great potential in the U.S. Until a year ago, U.S. Market entry by European dairy processors seemed likely. The combination of the turnaround in the value of the dollar and the implem­entation of quota programs in the EC have quelled entry activity for the short run .

Any European entry into the U.S. cultured product mar­kets, will likely be done via j oi nt ventures with dominant marketing giants here ill the U.S., i .e., the Yoplait model.

Condensed and El'apoUlted Milk These are essentially stat ic and old line milk products

which will incur no more significant structural changes in their life time. Any movemenl toward reconstituted milk using powdered milk could reawaken some segments of these finns. Those powdered manufacturers who have the capacity to produce a full line of customer-specification

I)AINY. FOOl) ANI) r.N\'ftWNM t:Nt "AL SANIlA110NII'vlAY t<)Xl) 251

products will prosper with growth of the ingredient market. The large integrated producer cooperatives may continue to dominate this marker.

Summary and Conclusions

The combined effect of financial deregulation and non­existent antitrust enforcement have resulted in the greatest merger, acquisition and divestiture cycle in U.S. economic history. The U.S. dairy process ing and manufacturing indus­tri es have not escaped this structural upheaval. This merger mania has a Dr. Jeky ll and Mr. Hyde character about it. Much of the activity was generated by " financial churning" and is epitomized by the actions surrounding the Beatrice Company. Financial brokers were using , and are using companies to churn trading profits quickly without having to generate wealth the old fashioned way--through long-term growth and productivity improvement. The tlip side of the merger and acquisition activity is to allow powerful industry units to consolidate and enhance their relative market posi­ti ons in their respective indust ri es . The euphemistic phrase heard these days are that the large corporations are "return­ing to their roots". The consequences of the tremendous con­centration of economic power have yet to be visited upon U.S. consumers and the U.S . economy in general.

The illlplications are not clear however. The systelllatic application of economic power for long-term financial re­ward requires that the custodi ans of the industrial power understand the industries they are ill and have a long enough perspective and planning hori zon to harvest the rewards of market power. The current trend whereby the control of our industrial might by the so-called "bean counters" or fin,lIl ce oriented executives, may prevent economic power consoli­dation from being actualized. It is becoming increasingl y clear that the finance orienfed modern captains of industry have little understanding of what really goes on during sa les Celiis or on the shop noms. The dairy induslry and future of the processing sector is currently ti ed up within this di­lemma. For example, will the Borden's dairy people be abl e to ope rate Borden as a long-term dairy company or as part of ,1 financial conglomerate ') What will happen 10 Beatrice's cheese operations') Will the nex t round of finance driven shenanigans eliminate Kroger 's commitment 10 dairy proc­essing') These are the relevant questions to understanding whether we will conrinue to have a dairy industry as we know it. Will dairy products rewin their identity or become melted int o anonymous rat ios at some conglomerate's headquar­ters')

Perhaps the other significanl trend is tile rapid rise in til e ingred ient market nature of d~lirying products, As Illore and more firms go to designing and fabricating foods, tile dairy component of those foods becomes diluted and looses its identity . As this happens the consequences can be signifi­cant. The food manufacturer of the nex t decade Illay be abl e to switch protein sources at the drop of a har. How 10

maintain dairy's presence in ,I systelll evolving in thi s direction will be a significant challenge for dairy promolion organi zations.

252 /)AIHY, U)Of) liN/) I:NI /kON.'\I//-./V/>\/ )r\N/lri//ON:M ,t., Y IlJRl)

Finally, the rising power of major food retail and food servi ce buyers makes facti onali sm within dairy promotion ex tremely dangerous, Firms with procurement power will always attempt to play one supplier off against another. They will turn promotion ac tiviti es from strategic market building to tactical pri ce -oriented ac tivities. As dairy pro­mot ions necessarily respond to ri sing importance in the ingredient and food service markets, knowledge of the ex istence, and use of economic procurement power is criti­ca l. Without an understanding of real world procurement power, dairy promotion activities might have analogous results to the naive country cousin's first visit to the big city,

Se/ecled ReFerences

ol/d Backgml/I/d Maleria/

C<.1vCS . Richard. All1cri e<lIl tndu s[r),: S[ruc[lIrc. Cl)]lcluci. PcrfonnJIlCC,

Si x[h Edi[ion. PrcllIicc-Hall Ille .. Englewood Clill's. NJ. 1 0~7,

) Connor, John M. CI. al .. Thc Fooci Manurac[uril1g tndus[rics: S[rUCllirc.

SII'(licgics, Performance and Poli c ies. Lex ington Bool...s. Lc xillglOlI. MA. Il)X'i.

,1. Cook. Hugh L . C[ aI. , " The Dairy Suhscc[ors 01 A lllcri cJn Agr icu l[lIre:

Organi za [ion and Venicat Coord inati on", Nonh Cel1[ral RcgiollJt Rc­

search PuolicJ[ inll ~57, M adison. WI. Novc lllocr 107X,

4 D;riry Foods. "An U llfinisiled Maslcrpiccc", July 1 9X~, pp . . 12-,17.

5. Hall1ll1, L;IIT), G. ;lIld Gcra ld Grillilctl. "Evolving RC\;r[i o ll ships BC l wCC I1

["ood rvLlIlUlac[lIrcrs ;1I111 Rc'[ailcrs: Illlpli c;nilllls lor Food SYS[CIl1 01'­ganil.:.J.lion and PL'ri"()rlll;Ull'C" l-\1ll c ri carl Journal of Agricultural Eco-

110111ICS, VOl. 6'i. No, 'i, Decc'l11ocr I lJ:';,\, Pl'. IlIh'i-1117:?,

6. Hdllllll, Larry G, "RC[dilr;r-M,lIlui'''l'[llrCr Rcl;lIiollsilips in [il c Food

SCl' [or -- SOl11e OhSCn" l[i ollS Fnlill [ile U.S..'\." N,C. Pl'lljC( [ 117 ,

Working PdJXr No. (, ~ , M ;ldisoll . W I. Apr il IlJ~2.

7. iVI;lIlc hes lcr. A ldell C Fhl' Pllhlir Noh- ill rlt c Oll ilY /:" ("OIlOIJIY It:lly ({ml

/l O ll ' (J O I '('FIIJIII ' Il{\' 11I/( ' /Ti'JlC ill r/U' IHi//" HIIS;III...·ss. \Vcslv ic w Pre". Bouldcr. CO. I lJ ~.1.

X, Mdrion, Brul'c ;Inri N.C. 117 COl11l11il [CC. 1 lit' (}rg(/I/;:(/I;"I/ (/I/r! I'cr­

j()l'l/hll!(,(' (If//(' U .. \, /:out! .\ySICIll, L l, ... illgl oll I3u uks. Lex i 11,::.1 Oil , MA, Il)~(,.

9. Me'lIller, Will,ml F .. LilT)' G, Hdl11l11 ;}lld HuSil L. Cook. "Punlil' t)o ti c)

Tow;ll'lJ Mcrger' ill [ilc Dairy Pnll'ess ing Illdlls"')" Nnl'lh CCllIr;} I Rc­

g inll;} 1 Rc,c;lrl'il Puhli l';lIi OIl 2,1.1. ~'bdi'nll, WI. DCl'c'llloc' r Il)7(,.

10. Picr,oll . TIllllIl .IS R. and Jo hn W, A lk-II. "The Challging Fnnd M"rkc[­

pl~lce : E."'p' II11lillg ()pporlullilk~=, for Packaglllg" ( Fonhco lllin g" F(lnd

Indlhlr.\' 11l ~ lillllL'. f\tlichi ga ll S l ~ lll...' Ulli \'c rsil y . Sql( l~ lllhl' r I lYxX.

II Porler. Midlllci E. CflJIlj>('/ilirr 5;/1'I/11 'gy' Fl' l"iIll ;lllwS j ('" AlIlI!Y. (Jlg

111(/11,\ /1';(' \ (llId C(lIJ/I)('I;/or~ , 'I'll .. ' r rl'e Pre"". !\Ie,,' York , NY. It)XO.

12, ScllerL']'. F.M, I"dl/stl'io/ A'ltll'/.:, " .) !I'I(C'f/f/'(' owl r (ollolJli! P(,l'j(JrIJ/UIIlX.

""d Edi[i(\\1, t'l(\u,:h[(\n - ivlii'i'li\1 Co .. 8"s[(\\1, \'IA. IlJ~().

1,~, L:,S, Dcp<lJ'IJ11elll or /\gri culluJ'e. ECOIlOlllil' Rl>cardl Sl'I"\'jCl', Foud

rHcll'/"uill.'.!. NeTiell ', I VX7, l-\~J'inillllr~" F.l'l1Jlomic Report :'\llillher :;t)() ,

W;I, ilill"lllll, D.C SCI'[cllliln Il)XX.

1-1 . l i.S . Dl' Pilrtllll' 1ll (l r( 'olll nh.' rcc. Burc :ltlllrlhl...· ('L' lhlh 1()S2 ('CI/ \ /!\ (>(

:\folllf/ ;'I 'lItrc ' r s: ( 'fllI ('l'lIlJ'tllioll Natitls ill ,H ll lllf/;'dlfl'lllJ!- . ;\pri l 19l'\() .