Kellogg to Hike Cereal Prices; Rivals Likely to Follow

Increases Expected to Shore Up Marketing Budgets

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NEW YORK ( -- You'll be paying more for your cereal this fall, and that will allow Kellogg and rivals to keep fueling their ad budgets.
In a move expected to be followed by its rivals, Kellogg plans to raise its cereal prices 2% and decrease the size of its product packages.
In a move expected to be followed by its rivals, Kellogg plans to raise its cereal prices 2% and decrease the size of its product packages.
Price hikes
The Battle Creek, Mich., giant is the latest in a string of marketers to fly in the face of the last decade of discounting trends and instead ratchet up prices, and its rivals in the $6 billion ready-to-eat-cereal category are expected to follow suit.

Joining Kraft Foods, Campbell Soup Co. and Hershey Co., among others, the leading cereal player will raise prices 2% across a number of its brands and decrease package sizes beginning in September as it seeks to maintain profitability as commodity costs soar. The move is expected to help Kellogg (and competitors General Mills and Kraft Foods' Post) avoid axing marketing budgets.

Profit-margin targets
"When you have to hit profit-margin targets and there is no pricing power, marketing has tended historically to be the offset," said Andrew Lazar, an analyst at Lehman Bros. "But if companies can take pricing it's a good sign that they won't be skimping on the marketing side."

In fact, marketing will be even more crucial in the coming days as companies that raise prices look to "ensure consumers that the product is really worth it," said Allen Adamson, managing director of Landor Associates, New York. Mr. Adamson said price increases across the board are far riskier than strategies such as Kellogg's, which take into consideration specific brands' value equation (how highly a brand is valued divided by the price) and recognize that "stronger brands can absorb price increases better."

Kellogg tested the price increases in April when it shrunk its 19 oz. box of Rice Krispies to an 18 oz. box without a price change and saw no decrease in sales. Now, similar downsizings will follow on at least seven other items. Kellogg CEO Jim Jenness, speaking at Kellogg's second-quarter-earnings conference last week, said the pricing actions, as well as others taken on some of Kellogg's frozen brands, will help generate operating-profit leverage as "we manage through this extraordinary cost-inflation period." Mr. Jenness noted during the call that the company still plans to deliver the earnings it promised to Wall Street this year despite $180 million in cost inflation.

Fuel and commodity prices
General Mills, which declined to comment on its pricing plans, is likewise facing what it expects will be $145 million more in fuel and commodities expenses in 2007. If, in fact, it hopes to follow through on plans to raise ad spending 8% over the next year (TNS Media Intelligence/CMR reports it spent $529.9 million in 2005), pricing will likely have to come into play.

"I know General Mills will follow, they've all been licking their chops to take pricing but would never make a move before Kellogg," said one East Coast retail executive.

General Mills, the one-time cereal leader who now trails Kellogg by nearly five share points, learned the hard way not to make the first move. Mills lost a crucial share point to Kellogg after a move in January 2005 after it decreased its trade spending and, effectively, raised promotional prices of its cereals across the board. Instead of following suit, Kellogg actually put more toward trade spending and knocked General Mills out of crucial feature displays and retail ads.

General Mills
"Mills' particular process and approach didn't work last time," Lehman Bros.' Mr. Lazar said, but he assumes it will look to follow Kellogg's move with a more tactical price-increase strategy of its own. "The window is at least cracked open now."

According to a spokeswoman, Kellogg cereals cost 5% less per ounce than the category average. Historically, industry observers suggest, General Mills has been able to garner a higher price per unit because of its stellar innovation, which meant that its lineup was harder for private-label competitors to copy. Recently, though, Kellogg has picked up the pace of innovation and, with that, raised its prices. Now, they're going higher still.
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