Demand for ready-to-eat cereal and its implications for price competition, merger analysis and valuation of new brands

This dissertation estimates demand for different brands of ready-to-eat (RTE) cereal and examines the implications for price competition in the industry, merger analysis, and consumers' valuation of new brands. Demand is estimated using a random coefficients discrete choice model and brand level scanner data. This dissertation extends previous discrete choice models by further controlling for unobserved quality, examining different identifying assumptions, modeling consumer taste heterogeneity in a (partially) non-parametric way, and significantly reducing the computational burden. In the process, the method employed here is compared with the main alternative approach: a multi-level demand system.; The RTE cereal industry is characterized by high concentration, high price-cost margins, large advertising to sales ratios, and numerous introductions of new products. Previous researchers have concluded that the RTE cereal industry is a classic example of an industry with nearly collusive pricing behavior and intense non-price competition. Using the demand estimates, I empirically examine this conclusion. In particular, I am able empirically to separate these margins into three parts: (1) that which is due to product differentiation; (2) that which is due to multi-product firm pricing; and (3) that due to potential price collusion. The results suggest that given the demand for different brands of cereal, the first two effects explain most of the observed price-cost markups. I conclude that prices in the industry are consistent with non-collusive pricing behavior, despite the high price-cost margins.; Next, I improve on existing methods to analyze mergers by simulating the effects of actual and hypothetical mergers in the industry. The results suggest that recent mergers between the cereal lines of Post and Nabisco, and General Mills' acquisition of Chex, did not affect post-merger prices, and therefore the decision to allow them is supported. This conclusion is no longer true for two hypothetical mergers between Quaker Oats and either Kellogg or General Mills.; Finally, the demand estimates are used to address biases in the Consumer Price Index pointed out by an advisory committee to Congress. The results suggest that not adjusting for quality changes and introduction of new brands generates a bias in the Consumer Price Index for ready-to-eat cereal of 1.1 percentage points.