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Global compass

China | Still a Mecca for the tobacco industry

06 Jan 2008. Asia, and China in particular, is increasingly becoming the only area of the world that the industry can look on with any degree of optimism.

In 2006, the Chinese tobacco industry produced 2.02 trillion cigarettes, 3.5 per cent up on the previous year. 2.03 trillion sticks were sold, up by 3.9 per cent on 2005 and more than 30 per cent of global cigarette sales. And this has all been achieved despite cautiously increasing awareness of the health risks and the falling numbers of manufacturers and brands.

But of course one reason for the current success of the industry has been the rationalisation drive of recent years that has seen economies of scale boost profits through the roof. Between January and June 2007, China’s tobacco industry registered more than RMB 200 billion (US$ 27 billion) in pre-tax profits, up by 26 per cent on the 2006 figure. With such gargantuan resources tucked away in the bank, the industry is aiming to invest in quality, increase exports and expand production steadily over the coming decade. Annual production in excess of 2.3 trillion sticks is forecast for as early as 2011.

In 2007, China’s industry regulator, the State Tobacco Monopoly Administration (STMA), accelerated the restructuring of the industry through mergers and regrouping, and cross-provincial mergers were a particular feature of 2007. The number of cigarette factories (which stood at 185 in 2001) was cut from 47 in mid 2006 to just 31 in 2007. The number of brands (1,800 in 2001) declined from 325 at the end of 2005 to just 224 by 2007. The ultimate plan is to have three tobacco centres in northern, central and south-western China.

One of the methods that the STMA has used to achieve such swingeing reductions in numbers of producers and brands has been to get provincial-level tobacco industry corporations to reorganise all their subordinate cigarette-making enterprises through merger or acquisition. The STMA has also succeeded in stripping county-level tobacco companies (more than 1,500 of them thus far) of their independent corporate status, which has greatly streamlined the nationwide marketing system. An additional result of all these measures has been the slashing of costs, with the cost rate of sales declining by 2.4 per cent to 32.6 per cent in the first six months of 2007, and the cost rate of operation, management and accounting falling by 1.3 per cent to 7.9 per cent in the same period.

Quality improvement is also being targeted. In 2005 and 2006, the STMA invested more than RMB 6 billion (US$ 810 million) in the establishment of a large number of leaf tobacco production and supply bases across China, improving the production conditions for growers. In addition, the professional training of growers has been improved and technical support extended to them.

Late in 2006, the STMA made the decision to apply the ISO 9000 management system to the industry. The administration plans to spend the next two to three years enabling all China’s manufacturing and commercial tobacco enterprises to apply the system, with special attention being paid to quality.


Ten is the target


The quest continues to establish ten large-scale tobacco enterprises, producing just ten major brands, which STMA hopes will ultimately have the financial clout to rival the Marlboros and Camels of the world. The country currently has 14 brands of which in excess of 25 billion sticks are produced annually (see table). These 14 brands occupy about 30 per cent of the total market and, backed by huge investment in marketing and quality, are continuing to consolidate their positions. In June this year, Furongwang and Baisha received the accolade of 43rd and 47th most valuable Chinese brands, their individual values having risen by about US$ 0.5 billion in the past year to stand at well over US$ 2 billion.

The leading cigarette manufacturer in China continues to be Yuxi Hongta with a national market share of 6.4 per cent in 2006, down slightly from 6.5 per cent in 2005, but still representing annual sales of almost 130 billion sticks of its flagships brands, Hongmei and Mount Hongtashan. Even the company in ninth position, Anyang Cigarette Factory, can now boast sales in excess of 50 billion sticks, its sole brand being the immensely popular Hongqiqu. The Shanghai Tobacco Group has been the most successful company in recent times, boosting its market share from 5.5 per cent to 5.8 per cent between 2005 and 2006, mainly on the strength of its Double Happiness, Peony and Zhongnanhai brands. The increase in Shanghai’s share represents a whopping annual volume increase of about 6 billion sticks.

One characteristic of the market in the past couple of years has been internationalisation in terms of both manufacturing and sales. Philip Morris, Gallaher and Imperial all have joint-venture manufacturing in China, Philip Morris partnering the China National Tobacco Corporation (CNTC), the supervisory body for all Chinese tobacco companies, Gallaher teaming up with Shanghai Tobacco and Imperial working with Yuxi Hongta. BAT has yet to set up production in China, but can boast the highest market share of all the multinationals at 0.5 per cent in 2006.

Philip Morris and JTI combined could only muster 0.2 per cent. However, sales of foreign products are on a steady rise, largely as a result of the decision taken by the STMA in 2004 to stop issuing special tobacco retailing licences, allowing retailers with ordinary licences to sell imported brands. Since that date, the market share for imported cigarettes in China has risen from under 1 per cent to 1.6 per cent.


Getting more international


The market for cigarette components is also becoming more international, a recent example being the decision by Schweizer-Mauduit International to form a 50–50 joint venture with CNTC for the production of tobacco-related papers and porous plug wrap in Guangdong province. The move is a direct result of the country’s need for high-quality products to support the STMA’s campaign for lower tar delivery levels for all China’s cigarettes.

Internationalisation can also be seen in increased emphasis on exports. In March 2007, the STMA decided to implement reform of the country’s import-export system, with the result that the China National Tobacco Import-Export (Group) Company became the China National Tobacco International Co Ltd. This newly-coined organisation is expected to concentrate more of its resources on the establishment of marketing enterprises and networks overseas to boost exports, rather than “the mere operation of export”. Recent statistics show that such efforts are beginning to bear fruit. Although relatively static at around 15 billion sticks per year up to 2005, export volumes now appear to be on the up. According to data released by Chinese customs, cigarette exports through ports in Guangdong alone reached 8 billion sticks in 2006 with a value of US$ 120 million, 43 per cent and 12.5 per cent respectively up on the 2005 figures.

Even Taiwan is now being targeted as a legitimate export market, with the Shanghai Tobacco Group having developed Golden Deer, a special brand to suit Taiwanese tastes. The brand comes in three varieties, 8 mg Yellow, 5 mg White and 10 mg Blue, and, according to the Shanghai company, “has been developed on the basis of repeated technical improvement and consultation with Taiwan”, a sign of recent rapprochement between the two Chinas.

Having ratified the Framework Convention on Tobacco control (FCTC) in 2005 as the 89th country to do so, regulation is of course playing a larger part in Chinese tobacco-related proceedings than it previously did. It is expected that, as a result of ratification, within five years’ time there will be a comprehensive ban on tobacco advertising, marketing and promotion, more stringent health warnings in place, increased taxation and smoke-free workplaces and public spaces. Some cite the government’s US$ 6 billion tobacco tax take as a reason why it will fight such legislation tooth-and-nail but, on the other side of the coin, it is estimated that smoking-related illness and absenteeism costs the economy more than US$ 5 billion per year, so the tax benefits must be put into perspective.


Promoting tobacco-free Olympics


The impending Olympic Games are probably doing more than anything to control tobacco use in China. In October 2007, all Beijing’s 70,000 taxis became smoke-free in an effort to promote a tobacco-free Olympics. The slogan to go with the campaign will be “Green taxi, smokeless cabs, health for all”, but, as almost all cab drivers and about 60 per cent of the Chinese male population smoke, it may well be difficult to enforce. It is expected that, before the Olympics, the ban will be extended to all forms of public transport.

An advertising ban has been in place in China since 1996, but companies have easily side-stepped the rules by sponsoring sporting events and using logos in the media without mentioning cigarettes. By such ruses, it is estimated that manufacturers managed to spend about US$ 212 million on advertising in 2006. Now, however, Xu Guihua, vice president of the China Tobacco Control Association, has made an official announcement that China will fulfil its FCTC obligation and completely ban advertising by 2011.

Plans are also afoot to bring in landmark legislation banning the sale of tobacco to under-18s. A draft amendment to the existing law on the protection of minors would compel shopkeepers to display signs saying that they may not sell tobacco to minors. It does not, however, specify any penalties, saying only that the shopkeepers in question would be asked to “correct their mistakes” or “receive an administrative punishment”, so the temptation to make the sale and pocket the cash may yet be too great for many retailers.

The campaign to protect the nation’s youth, however, presses on regardless. Superstars, like actor Jackie Chan and Olympic gymnast Liu Xuan, have both been hired by the Chinese Association on Smoking and Health (CASH) to appear on large black-and-white billboards, some of which show a grim-faced Chan smashing giant cigarettes with his trademark kung-fu kicks.


Fighting counterfeit harder


The government itself is not, however, ready to push for any kind of blanket ban, citing how smokers rioted when the Soviet Union collapsed, because they were unable to get cigarettes, and surmising that the same kind of thing could happen in China. “As a developing country, China still needs the tobacco industry,” said Zhang Baozhen, deputy chief of the STMA.

The country is, however, stepping up its efforts to crack down on counterfeit products. In the first half of 2007, 4.12 billion fake cigarettes were seized, a rise of 20 per cent over the corresponding period in 2006. Law enforcement agencies raided 1,557 warehouses containing such products, arresting 2,995 people and prosecuting 1,160. It is estimated, however, that almost 70 billion counterfeit cigarettes are produced every year, so the lion’s share is still beating the system. Thanks to control efforts, however, that figure is predicted to fall to just over 50 billion by 2011.

The market is still dominated by high-tar brands, but low- and medium-tar varieties are slowly but surely gaining a foothold, and now account for more than 2.2 per cent of the market in 2007, having stood at just 1.2 per cent in 2004. The average tar level is now just 13.2 per cent, having scaled the heights of 25 per cent in the 1980s.

As far as grades are concerned, premium and mid-priced products (grades 1, 2 and 3 in China) are continuing to make significant gains. In the first half of 2007, grade 1 products accounted for 6 per cent of the market, an annual increase of 1.4 per cent, grade 2 accounted for 8 per cent (up 1.8 per cent), grade 3 for 20.3 per cent (up 3.5 per cent), grade 4 for 35 per cent (down 3.3 per cent) and grade 5 for 30.7 per cent (down 3.4 per cent). This is encouraging for grade 1 products, which were undergoing a slow, steady decline until 2006.

The number of women smoking continues to climb and now stands at about 4 per cent, which may sound small but was more or less 0 per cent just 15 years ago, and in a country the size of China, amounts to about 16 million. The incidence of male smoking is static at about 60 per cent, so it’s the Chinese women who form the world’s most potent demographic for cigarette manufacturers. If they only get the female incidence up to the western European norm of 20 per cent, that’s another 65 million potential smokers.

The bulk of smokers, however, are men of a “proletariat” background, who spend a vast chunk of their meagre wages on tobacco. Such men may earn just about RMB 550 (US$ 75) per month, and, if they smoke just 20 per day, will spend about one-third of that on cigarettes. Such consumers admit that a price hike would hurt their pocket but probably would not make them quit.

Cigars continue to make scanty progress in the value-conscious smoking nation, but headway is being made in the big cities with more western influence and a captive “yuppy” population. Cigar production is concentrated in the south-western province of Sichuan with 85 per cent of production originating from there, and, in May 2007, high-level decisions were made to turn Chongqing, a major city in the region, into a “model cigar market area in China”. This entails investing US$ 1.25 million in marketing, so that branch tobacco companies and retailers, accustomed only to pushing cigarettes, can be taught how to increase cigar sales and develop local markets.

Sichuan is also the scene of a Chinese tobacco distribution revolution, with the province’s capital, Chengdu, playing host to a modern cigarette supply and distribution centre, at a cost of US$ 50 million. The facility will be capable of storing three billion cigarettes and is expected to be completed by the end of 2007.

Tim Glogan