(FORTUNE Magazine) – BILLIONS OF DOLLARS are at stake in a breakfast brawl shaping up in Europe. Kellogg built the cereal market from scratch, starting in the British Isles in the 1920s and on the Continent in the 1950s. Now General Mills, in partnership with giant Nestle, which excels in almost every kind of food product but cereal, is trying to muscle in. Managers looking for ways to move swiftly into new global markets will find the battle instructive. Those who simply savor corporate combat should keep their heads down. This food fight could get messy.

Ready-to-eat cereal is one of the most profitable and competitive of all consumer businesses. Kellogg, the $5.2-billion-a-year maker of Corn Flakes, Rice Crispies, and Frosted Flakes, sells those ubiquitous brands in 130 countries. It has about half the European market and earns 35% of its profits outside the U.S. Unabashedly aiming for 20% of the market by the end of the decade is Cereal Partners Worldwide, or CPW, a joint venture of General Mills and Nestle, two of the world's best-managed companies. Cereal Partners is the food industry's first major joint venture designed to be a global business. Staffed and operating for less than a year, it has surmounted its first major hurdle. With the help of Nestle's power as a major supplier of food products, the venture has persuaded the Continent's powerful retailers to put its cereals on the shelves alongside Kellogg's. General Mills' Honey Nut Cheerios and Golden Grahams, which have broad family appeal in the U.S., are showing up in France, Spain, and Portugal. In France, the largest and toughest of these markets to enter, nine out of ten of the big chain stores, representing 80% of the market, have agreed to carry the brands. Says Charles Gaillard, chief executive of the joint venture and a former head of General Mills' domestic cereal business: ''Now I am extremely confident.'' Kellogg has retaliated with its version of a roundhouse punch. To counter the recent European appearance of Honey Nut Cheerios, the second-best-selling General Mills brand in the U.S., Kellogg has introduced a product called Honey Nut Loops. The two boxes look very similar, and it would take a cereal connoisseur to taste the difference. Next will come Kellogg's Golden Crackles, which bears a striking resemblance to Golden Grahams. Says Kellogg Chairman William LaMothe: ''We are vigorous competitors. We will be doing as much countering as we possibly can, anticipating what might be their logical moves.'' To Cereal Partners, Kellogg's strategy is unsporting. Says Mark Willes, president of General Mills and co-chairman of the joint venture: ''Everybody is better off if you compete with your own ideas, which is why we don't introduce a product that looks like Corn Flakes. I mean, why do that?'' In a business where rolling out a new product can cost $35 million for the marketing alone, counterpunching is an expensive way for Kellogg to defend its share. Gaillard can't resist a dig: ''They act like they think our product ideas are better than their own.'' KELLOGG'S LaMothe sees nothing to apologize for. Believing the best defense to be an in-your-face counteroffense, he is scrambling to block any easy openings for the joint venture's brands. But he also finds a positive aspect to the rough competition. Any new product, he says, can help accelerate industry growth in an emerging market. Product introductions and their fat marketing budgets generate excitement felt by both retailers and consumers, and that translates into larger sales. He expects Kellogg's tonnage to grow even if its brands lose share. With six plants in Europe and six of the top ten brands in most countries, Kellogg looks safely entrenched. Competition like this is nothing new in the mature U.S. cereal industry. Behind the jam-packed shelves of brightly colored boxes, the handful of producers hurl themselves at one another like pro wrestlers. If they can wrench free a point of a competitor's market share, that can be worth $75 million a year. Europe has long been a smaller, more fragmented market. The Brits eat lots of cereal -- 13.3 pounds per person per year, vs. 10.1 pounds in the U.S. -- but the Continentals prefer bread, cheese, eggs, and meat for breakfast. Cereal consumption has been low. In France, for instance, it is just 1.8 pounds per person. Although this is a business that uses cheap commodities as its raw materials, it is both capital and marketing intensive; you have to get the volume up before the margins begin to sparkle. Only in recent years has Kellogg begun to earn significant profits on the Continent.

Europeans are changing their eating and shopping habits. As the population ages, many consumers are becoming more concerned about health and nutrition, which is leading them away from heavy eggs-and-meat breakfasts to ready-to-eat cereal. Working women, growing in numbers, also appreciate the convenience. Thomas Russo of Gardner Investments in Lancaster, Pennsylvania, who follows international food companies, thinks Europeans are developing increasingly cosmopolitan tastes as they travel more. TWO OTHER major changes in Europe are boosting cereal sales. Supermarkets, with their rows and rows of shelves and colorful point-of-purchase displays, are springing up across Europe. So are new commercial television channels, where cereal makers can use the sales pitches that have been so successful in the U.S. Here is a nutritional product, say the ads, that can be prepared by a child in less than 30 seconds. Cleanup is quick and easy. Best of all, the cost of a meal runs to some 20 cents a serving. Already some countries are gobbling up 30% more of the stuff annually. If more Europeans accept the pitch, the market could quadruple to $6.5 billion by the year 2000, making cereal the fastest-growing food category. In late 1989, General Mills felt the time was right for a major move into Europe. The company had been on a roll since Chairman Bruce Atwater spun off the toy and fashion divisions in 1985 to focus on cereal, food, and restaurants. The six-year bar charts in the current annual report are a matching set of steep, rising staircases. Profits rose to $374 million in 1990 on sales of $6.4 billion, producing a stunning 48% return on equity, among the ten best returns on the Standard & Poor's 500. Though trailing Kellogg in U.S. market share 24.4% to 38.5%, General Mills has gained three percentage points in the past few years, primarily from Kellogg. The company managed to exploit reports that oats -- the main ingredient in Cheerios and Honey Nut Cheerios -- help reduce cholesterol. Still, taking on Kellogg in Europe was not the same as riding the oat bran craze. Atwater knew it would be extremely costly to set up a manufacturing base and massive sales force from scratch. The solution was a joint venture with an established European partner. Nestle, the world's largest food company, with $36.5 billion in annual sales and operations in more than 100 countries, seemed a great fit. In Europe it had everything General Mills lacked -- a famous name, a network of plants, a powerful distribution system -- except one thing that the American company could provide: strong cereal brands. Nestle had launched a few cereals in the mid-1980s, including Chocapic, a chocolate-based product, but none had made much of a hit with consumers. It didn't hurt that Atwater and Helmut Maucher, the Nestle chairman, knew each other: They both serve on the international council of J.P. Morgan. In late October 1989, Atwater called the German-born executive at the Nestle headquarters in Vevey, Switzerland, and broached the idea of a joint venture. Two days later he and Charles Gaillard boarded one of the two General Mills planes and flew to Switzerland to meet with Maucher and two of his top deputies. IN WHAT AMOUNTS to a case of corporate telepathy, senior Nestle managers at their annual retreat only a week before had talked about approaching General Mills to get some help in shaping up their own weak brands. Says Atwater, who champions speed as key to competitiveness: ''Within an hour we had the outline of what our arrangement would be . . . We started talking Europe, and it became immediately clear to us that we should extend this thing worldwide.''

The deal had an inescapable logic. General Mills would provide the knowledge in cereal technology, including some of its proprietary manufacturing equipment, its stable of proven brands, and its knack for pitching these products to consumers. Nestle would provide the name on the box, access to retailers, and production capacity that could be converted to making General Mills' cereals. In no-nonsense Midwestern fashion, the two General Mills executives returned to Minnesota without so much as a glass of champagne in celebration. Nestle's marketing chief, Camillo Pagano, drafted the agreement over the weekend and faxed it Monday morning to Minnesota. Only 23 days passed from the initial meeting to the signing of the documents. FORTUNE estimates each company chipped in some $80 million. Neither side wanted to use investment bankers, though Atwater tacked on a standstill agreement to make sure that the deal was not a prelude to a Nestle takeover of General Mills. The joint venture will stay out of General Mills' North American markets, and should it be dissolved, Nestle is barred from selling cereal there for ten years. THE DEAL frightened one competitor clear out of the business. Ranks Hovis McDougall, a relatively small British cereal maker, had acquired Shreddies and Shredded Wheat from RJR Nabisco two years earlier to move up to No. 3 in Britain after Kellogg and Weetabix. The company's finance director told the Wall Street Journal, ''We know Kellogg will defend like mad, and General Mills and Nestle will attack.'' Ranks Hovis McDougall sold out to Cereal Partners for $167 million, giving the joint venture an instant 15% of the $1 billion British market. Executives at both Nestle and General Mills feel the joint venture could not have come together so quickly if the parent companies had not shared some basic values. Each is a strict meritocracy with an old-fashioned hard-work ethic and a low tolerance for failure. They expect the venture to be profitable in four to five years. Still, the proud parents want Cereal Partners to develop its own culture. They deliberately moved the headquarters out of Vevey to a leased office building in Morges, on a hillside overlooking Lake Geneva. The multilingual staffers conduct business in English and lunch together in a small dining room. To loosen everyone up, Gaillard organized a miniature golf tournament in the hallways -- something that never happens in Vevey, or in Minnesota. While Nestle's salesmen have been out pushing the brands into European stores, staffers from the General Mills side of the partnership have been using their own particular skills. In test kitchens back in Minnesota, they reformulated Chocapic, Nestle's relatively unsuccessful cereal, to give it a softer texture. Instead of a windmill-like figure on the box that was not particularly exciting to European children, marketing specialists created a hyperactive cartoon hound. The character will also appear in TV ads that will be generic enough so that various European languages can be dubbed into them at little extra cost. The cereal tested well with consumers. Sales data are not yet available, but Gaillard claims the gains are substantial. WHEN THE joint venture's managers look ahead, they like what they see. In Asia, Africa, and Latin America, Cereal Partners should have a tactical advantage over Kellogg because Nestle is a food powerhouse in those markets while Kellogg has only cereal. Furthermore, as part of an exclusive agreement to supply food for Euro Disneyland, which will open near Paris in 1993, Nestle got rights to use Walt Disney characters on its products throughout Europe and the Middle East. Don't be surprised to see these potent pitchmen crop up on the joint venture's cereal boxes. Meanwhile, Nestle has taken to joint ventures like a yuppie to golf. It has a deal with Coca-Cola in which the beverage giant distributes Nestle instant coffee and tea throughout the world. In a deal with Baxter International, Nestle is distributing food substitutes for hospital patients. For General Mills there remains a whispered risk. Nestle makes no secret that it prefers to own companies outright and that it intends to pursue a strategy of acquisitions, pursuing more big purchases like its recent acquisitions of American milk products producer Carnation ($3 billion) and Roundtree, the British food company ($4.5 billion). General Mills itself would make a nice addition to Nestle's group of high-margin food businesses. Says Nestle's Pagano, eager to put aside such speculation: ''We flirt, but we are not affianced.'' A price/earnings ratio of 21 gives General Mills a better defense than its standstill agreement. At a premium of 30 times earnings, a takeover today would cost around $12 billion, more than Nestle could easily afford. Still, the folks from Minneapolis should not forget that they are strolling arm in arm with a suave and hungry Continental. It pays to be cautious when you travel abroad.