Economics in the Frozen Food Industry Term Paper

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Capitalism is predicated on the principles of "Creative Destruction" where the loss of one item or industry, leads to the creation of another more beneficial product or industry. This principle has both destroyed and given rise to numerous industries throughout the world. For example, in the early 1900's, farming gave way to the industrialization of American made goods. Producers went from the farm lands to the assembly line of manufacturers. Entire industries, including the automobile, rail; oil and gas industries were born and created. Today, we are seeing a shift from producing tangible products to producing intangible services and technology. Industries often change for the better. The low-calorie frozen, microwavable food industry is no different in this regard. Shifts and changes in consumer preferences and industry dynamics necessitate a shift within the overall industry. In assignment 1, the industry was predicated on perfect competition with price competition and products that were easily substituted for each other. Now, with assignment 2, the market is imperfect which allows for more product differentiation and pricing power. Given that the market structure has changed, I believe the result is due to product differentiation, and exit of market participants.

In assignment 1, the market was characterized by a perfectly competitive environment. In this environment, competitors do not have a product or pricing advantage relative to peers in the industry. The product is mainly a commodity that easily substituted for in the event of higher prices. For example, there is very little differentiation between wheat bread. Producers of wheat bread therefore cannot raise prices because there product is not differentiated. If a producer attempts to raise prices, consumers will simply elect to purchase the wheat bread of competitors who have the same product at a lower price. The same concept applies to the frozen food industry. Many frozen foods can be substituted for cheaper alternatives. A price rise will therefore correspond to a decrease in quantity supplied. This was indicated in assignment 1, with the industry having a price elasticity of -1.19. This means that if there is an increase of one percent in the price of the product, the quantity demanded will change in the opposite direction by 1.19%. Since the price elasticity is less than -1, this shows that the quantity demanded is elastic. In addition, it was noted that the calculated cross-price elasticity was 0.68. This indicates that if competitors increase the price of their product by one percent, it will result in the increase of the quantity demanded of our product by 0.68%. Since the cross-price elasticity is greater than -1, this shows inelastic behavior of the product demanded to the price of competitors. A positive cross-price such as 0.68 indicates that this product is a substitute. Therefore, this industry is characterized by a very low degree of pricing power coupled with the ability to easily substitute products for each other.

Now, in assignment 2, the recent selling environment has been altered to one that is imperfect. The likely factors causing this change are product differentiation and market participants exiting the market. The preferences of consumers have now shifted to healthier brands and products. This allows firms to therefore differentiate relative to peers. The two leading participants in this industry are Nestle and Conagra. Both have relative large market share in a fragmented industry. Together, both account for roughly 23% of the low calorie frozen food market. The industry however still remains fragmented with nearly 345 producers in America alone. Nestle and ConAgra both have product offerings throughout the value chain. Offerings in the low end attempt to take advantage of the economies of scale that both companies possess. As large entities both companies are better able to compete on a low cost basis. Due to their ability to mass produce their products they can therefore lower the per- unit cost of each of its product offerings. This has allowed the company to lower prices while still remaining profitable. On the high end, both companies differentiated their products giving them more pricing power than their peers. For example, Nestle with its lean cuisine and lean pockets brands has created a brand that consumers respond to. These brands resonate for consumers due to their overall healthy perception. As consumers have shifted their purchasing behavior to healthier options both Nestle has shifted its overall product mix to emphasize health.

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It is therefore able to utilize its brand recognition and perception of health to change premium prices. As more consumers choose Nestle and ConAgra over competitors, they become brand loyal. Nestle in its most recent annual report, has shown improving gross margins each year, due in part to its choice of healthier options. Below are the gross margins of Nestle's frozen food segment taking directly from their respective annual reports.

2014

2013

2012

2011

56.1

54.8

55.1

53.2

ConAgra has experienced a similar trend with its Health Choice line of frozen food products. ConAgra differentiates through the use of higher quality ingredients and larger serving sizes. The larger sizes combined with the consumers shift towards healthy options has created an ability for ConAgra to charge premium prices as well. Because of their large size both companies are also able to negotiate better terms with suppliers in the industry. As mentioned earlier, both companies are privileged to have economies of scale due to their large size. As a result, they can purchase products in bulk and negotiate favorable terms with suppliers. These suppliers, in many instances, are force to purchase from them because they purchase is large quantities. As a result suppliers are dependent on them and are therefore more likely to provide better terms.

The second factor that is influencing is the overall maturity of the frozen food industry. Growth in the industry has risen generally in line with overall worldwide GDP. Worldwide GDP typically has grown at a rate of 2% to 3% a year. The industry typically has grown in the low single digits as well. Typically, during the mature phase of a business cycle, firms compete to take market share. This is completely different from an industry that is burgeoning or growing. For example, the early PC market was growing so rapidly that all participants were able to enjoy a large piece of a growing economic pie. However, as the PC market became mature, suppliers competed based on price to take customers from other competitors. Ultimately, companies exited the market, went bankrupt or merged together. The same is occurring within the frozen food industry. The industry is mature and available shelf space within the grocery store aisle is very limited. Therefore, those companies with the ability to differentiate or have a strong brand typically win. Those who do not have some form of competitive advantage will exit the industry altogether. As a result, those companies that remain will have the ability to raise prices to a limited extent. If market participants exit due to the low returns of the industry, the firm will then have the ability to steadily raise prices. However, the action of raising prices will inevitably invite new market entrants. The threat of new market entrants caps the ability of the firm to raise prices. Therefore, the firm should continue to differentiate. This is what is occurring in the frozen food industry. The industry still remains fragmented, but competitors are merging and differentiating their products to better compete in a slow growth industry.

As a result of these two industry changes, the previous supply and demand equations are not as compelling. When analyzing the TC, VC and MC of the industry, trends begin to emerge. Below is an overview of the equations for each cost function

Total Cost Equation

160000000+(Q*100)+(0.0063212)*Q^2

Variable Cost Equation

100Q + 0.0063212Q2

Marginal Cost Equation

100 + 0.0126424Q

Quantity

10000

15000

20000

25000

30000

TC

$160,106,321.20

$160,658,030.00

$161,632,120.00

$162,922,270.00

$164,528,480.00

$166,450,750.00

$168,689,080.00

VC

$106,321.20

$658,030.00

$1,632,120.00

$2,922,270.00

$4,528,480.00

$6,450,750.00

$8,689,080.00

MC

$112.64

$163.21

$226.42

$289.64

$352.85

$416.06

$479.27

Percentage Change TC

0%

1%

1%

1%

1%

1%

Percentage Change VC

79%

55%

42%

35%

Percentage Change MC

45%

39%

28%

22%

18%

15%

The total cost component of the frozen food industry rises very slowly over time. Variable costs however, are much more volatile when more products are produced. This is expected as more materials, labor, overhead, and ingredients are needed to create the product. In this instance, variable costs rise exponentially as quantity is increased. For example an increase in quantity from 1000 units to 5000 units results in 519% increase in variable cost. However, these increases occur at a diminishing rate. In this example, the next 5000 unites produced results in only a.....

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