Number-Crunching a Bowl of Flakes

Put down the newspaper and take another look at that bowl of cereal in front of you. It looks like the simplest of breakfasts: corn flakes, milk and sliced peaches. But, as with life itself, that simple breakfast had a complex genesis.

Each component of the plainest of breakfasts--cereal, milk and fresh peach--has gone through a convoluted series of steps--and hands--in the food-processing chain before reaching the bowl.

And with each change of hands, the price has climbed. What started out as about 13 cents worth of raw material at the farm ended up costing about 50 cents.

That may not sound like a lot in this day of muesli, mineral water and mangoes, but it’s nearly a 300% markup between the farm and the kitchen--enough to make you wonder how prices are set.

What better product could there be to help learn that answer than the nation’s best-selling cereal, Kellogg’s Corn Flakes? So get ready, cereal eaters, it’s time for some number-crunching.

The Cornflakes

Here are the basics: You pay the supermarket about $2.20 for the 18-ounce box of Kellogg’s Corn Flakes. (The exact price varies, of course, depending on the store; recently, in the two largest supermarket chains in Washington, the box was selling for $2.19 at Giant and $2.25 at Safeway.) The stores, in turn, pay Kellogg $1.73 per box, of which the farmer gets about 10 cents, according to the U.S. Department of Agriculture.

Yes, we know, this is not a very detailed breakdown--but it’s a lot more than Kellogg, Giant and Safeway want us to know. Citing competition, all declined to detail their costs or pricing strategies.

For more detailed data then, we have to turn to other food industry experts. In this case, we sought out Nomi Ghez, a food analyst at the Wall Street investment firm of Goldman, Sachs & Co.

After studying Kellogg and other cereal companies, Ghez has devised a general cost formula for an average box of cereal, basing her percentage calculations on the cereal’s wholesale price of $1.73.

According to Ghez’s formula, the raw materials for corn flakes cost Kellogg about 14 cents (8% of the wholesale price). But wait a minute; the USDA says the farmer gets only 10 cents. Who gets the rest?

The grain-elevator operators and corn millers get some. After the farmer sells his corn, it has to be shipped to a grain elevator, where it waits to be shipped again to one of several corn mills in the Midwest. At the mill, the corn is cleaned, degerminated and cracked. The result--a flaky corn grit--is then sent to one of Kellogg’s five U.S. corn-flake plants, where it is again stored while waiting to be processed.

Processing the corn into flakes costs another 26 cents (15% of the wholesale price), while labor is six cents (3.5%). Add about eight more cents (4.5%) for freight and 12 cents (7%) for packaging, and already we are up to more than a third of the wholesale price.

What’s left? When it comes to cereal, you can’t forget advertising and marketing. After all, cereals are among the more heavily promoted products in the grocery store.

Advertising is heavier for newer brands, but even such old-time favorites as corn flakes must be touted to keep those corn-flake eaters loyal. Take another 21 cents of that box (or 12%) for advertising.

Even more money is spent on marketing and sales--31 cents (18%). The reason: With new cereals being introduced at a dizzying speed, Kellogg has to make sure that its very first cereal continues to hold a prime, easy-to-spot slot on supermarket shelves. To do that, the company constantly uses an active sales force and periodic special discounts to remind retailers of corn flakes’ popularity.

The large role that advertising and marketing play for brand-name cereals is obvious when shoppers compare the price of Kellogg’s Corn Flakes with a supermarket’s private label.

At Giant, for instance, the house brand 18-ounce box of corn flakes sells for $1.69--almost the exact cost of the Kellogg’s minus the 21 cents for advertising and the 31 cents for marketing.

But let’s get back to Kellogg’s box, where there’s 55 cents (32%) that remains unaccounted for.

According to Ghez, that money goes for warehousing, depreciation, general administration, research and development, taxes, interest, corporate overhead--and, of course, some profit. After all, Kellogg earned a $503 million profit in 1990--nearly a 10% return on sales of $5.2 billion.

Thanks to Ghez, tracking the trail of corn flakes from farm to store is not so painful--even for those who prefer to crunch cereal instead of numbers. So it’s time to move on to the supermarket, where another 47 cents is added to the price of corn flakes.

That’s about a 27% markup, although retail executives don’t like to use that term. They prefer to talk about the gross margin, which is calculated by dividing the difference between the retail and wholesale price by the retail price and comes out as a lower figure.

For those of you who don’t have calculators handy, we’ll figure out the gross margin of corn flakes for you: $2.20 minus $1.73 divided by $2.20 equals 21%. That margin is not far off the supermarket average of 22%.

Markup or gross margin--whatever you call it--just why do stores need to charge that much extra? Well, as Safeway and Giant officials note, the stores have their costs too.

There are shopping carts, bags, uniforms and store fixtures, warehouse and distribution expenses--including trucks and the fuel needed to run them. Then there are taxes, rent, utilities and, of course, payroll expenses.

In the Washington area, where labor costs are the fourth highest in the nation (behind Minneapolis-St. Paul, New York and San Francisco), payroll and benefit costs account for about one-sixth of the chain’s expenses.