Tabinfo 2005
Tabinfo 2005


Finding the right balance

Downtrading, exploding smuggling volumes and proposed smoking bans all threaten the status quo in the UK. Manufacturers nevertheless reported satisfactory results for 2004, offsetting the volume decline by the creation of a healthy mix of premium, mid-price and low-price brands.

The message remains the same as in previous years – high taxes continue to put the UK tobacco market under pressure. Legal cigarette consumption in the UK has further declined to 72 billion pieces in 2004, down from 74 billion in 2003. If one deducts the volume of non-UK paid cigarettes, which reaches around 20 billion sticks per year, the results reveal where the decrease, in the main, is coming from, namely UK duty-paid cigarette sales. The latter declined from 53.5 billion in 2003 to 52 billion in 2004. The overall picture, nevertheless, looks a bit different when one includes the RYO segment. Parallel to declining cigarette sales, the consumption of RYO has risen from 2,830 tonnes in 2003 to 2,950 tonnes in 2004. For 2005 market analysts at Morgan Stanley expect the RYO market in the UK to account for 9 per cent of combined cigarette/RYO volumes.

Generally, the downtrading trend which had started a few years ago continued in 2004 as cigarette smokers increasingly and unsurprisingly have looked for cheaper alternatives.
According to independent market research company Retail Audits Ltd (RAL), ultra-low price cigarette brands (below £ 4.07 per pack of 20 cigarettes) for example accounted for 37.5 per cent of total UK duty-paid sales in 2004, while low-price brands (£ 4.19 to £4.36 for 20) reached 21.7 per cent, mid-price brands (£ 4.61) 10.1 per cent and premium brands (£ 4.72 for 20 and above) 30.7 per cent.

Within these price categories, domestic market leader Imperial Tobacco’s share of UK cigarette sales accounted for 35.9 per cent in the ultra-low price segment (for example Richmond), 78.8 per cent in the low-price segment (such as Lambert & Butler), 60.6 per cent in the mid-price segment (Superkings) and 25 per cent in the premium segment (Embassy).

The above mentioned shares of cigarette sales exclude all Philip Morris brands. However, Marlboro, Chesterfield, and Raffles are also distributed by Imperial Tobacco in the UK.
Sales volumes of Gallaher, the UK’s number two cigarette manufacturer, reportedly were distributed as follows: premium 37.1 per cent, mid-price 9.0 per cent and value 53.9 per cent.

In order to mitigate the effect of downtrading on its UK profits, Bristol-based Imperial on 10 January 2005 announced a price increase, raising its product prices by an average of 7 pence per pack of 20. Gallaher and BAT soon followed with a 3 to 9 pence per pack retail price increase. Given the fact that the large manufacturers increased prices at the end of June 2004 this increase came as a surprise. However, a move early in the year may give manufacturers the option of another price increase later in the year. This step may become necessary after the chancellor again increased tobacco duty on 16 March 2005 by 7 pence per 20 cigarettes.

Satisfying results

Despite all difficulties Imperial Tobacco said it had a good start into the year 2005, maintaining its leading domestic market positions in cigarettes and roll-your-own tobacco.
The UK company, whose flagship cigarette brand is Lambert & Butler, said its annual cigarette market share remained stable at 44.6 per cent.

The group reportedly also has been cashing in on the growing popularity in the UK of roll-your-own brands, with increasing demand for its Drum and Golden Virginia Tobacco. The market share in this segment increased to 65.9 per cent from 65.6 per cent last September.

Gallaher’s UK volumes declined by 0.4 per cent to 20.2 billion cigarettes in 2004. However, the group sustained its market share at 38.6 per cent for the first ten months of 2004. Nevertheless, volumes from July to December reportedly declined at a faster rate than the first half, as moderate downtrading from premium and mid-priced brands into cheaper brands continued. Of its largest UK cigarette brands, Mayfair increased its market share to 11.7 per cent (2003: 10.4 per cent) and Benson & Hedges’ rose to 9.5 per cent (2003: 9.3 per cent).

While domestic sales declined the company’s total volume sales rose by 6.5 per cent to 170.6 billion cigarettes in 2004, driven by market share gains in eastern Europe and certain continental European markets. Gallaher’s total turnover was up 5.6 per cent to £ 9.5 billion. The UK turnover also increased by 1.9 per cent to £ 3.68 billion due to price increases from government duties and own price increases.

The group has announced cuts of 250 jobs in a shake-up of its factories in the UK and Austria. A total of 70 jobs will go in the UK, largely at its Northern Ireland factory in Lisnafillan, though a plant at Cardiff could also be affected. The cutbacks are expected to be completed by the end of 2007. Analysts suggested the retrenchment could save the company about £ 10 million annually.

Despite being the world’s number two tobacco manufacturer British American Tobacco only has a small share in the UK market of 6.4 per cent. The company’s primary focus in the UK market has been on the low end, with its Royals brand accounting for around 75 per cent of its UK volumes. The share for Royals has recovered a little since the summer of 2003, when BAT repositioned its price in line with that of Gallaher’s Mayfair through not taking a manufacturer price increase. The company’s 555 brand, which was launched in 2002, was withdrawn from the market in the middle of 2004.

Despite its attempt to enter the low-price category with Basic, Philip Morris’s business in the UK, which is licenced to Imperial Tobacco, still is a one brand story. Marlboro remains comfortably the third most valuable UK brand after Lambert & Butler and Benson & Hedges Gold.

One third counterfeit

As tobacco prices in the UK are among the highest in the world smuggling and counterfeited products, not surprisingly, represent a growing problem in the country. Investigators estimate a third of cigarettes smoked in Britain today are counterfeit – with 80 per cent of them now made in China.

Faced with growing international pressure the Chinese government is clamping down. Local security forces have shut down more than 2,800 clandestine bases in recent months but admit thousands more have begun operations. The cigarettes reportedly are crudely made with floor sweepings, sawdust and a toxic mix of chemicals.

Analysis of counterfeit cigarettes found “substantial contamination” in the tobacco from poisons such as cadmium and arsenic, according to a scientific study carried out for the government.

While customs agents have successfully disrupted the tobacco trade smuggled in from Europe, they still seem to be losing the battle of combating the Chinese counterfeit gangs who are becoming increasingly ruthless when it comes to protecting their illicit trade. The UK Treasury estimates it is losing £ 1.9 billion a year in duty from smuggled cigarettes.

Public smoking ban

The business environment has also become tougher on other fronts. More than 30 cities and towns in England reportedly are considering local bans on smoking in public places. Some are expected to follow the example of Liverpool and the Greater London authority, which have started parliamentary steps to enable them to implement a ban in 2006.

The UK government already had published its position on workplace smoking bans in its November 2004 ‘Choosing Health’ White Paper which foresees that by the end of 2007 all enclosed public places and workplaces, other than licenced premises, will be smokefree; and by the end of 2008, all restaurants, and pubs and bars preparing and serving food will be smoke-free. Other pubs and bars will be free to choose whether to allow smoking.
Scotland is meanwhile pressing ahead with its own plans for a complete ban on smoking in all public places, including all bars and restaurants. The Scottish ban could be implemented in spring 2006.

The Welsh Assembly has also voted to ban smoking in public places, but does not yet have the authority to pass a law that would implement this wish. Although a private member’s bill is currently being discussed in Westminster, it is not clear whether there will be time to pass the bill before parliament is dissolved for the election. Nonetheless, a separate ban in Wales does look possible in the next couple of years. Scotland accounts for around 10 per cent of the UK cigarette market, and Wales about 5 per cent.

Ireland introduced a ban on smoking in all public spaces, including bars and restaurants, at the end of March 2004.
Market analysts at Morgan Stanley believe a public place smoking ban would reduce UK consumption by 4 per cent.

Total UK smoking prevalence has been essentially stable in the last few years, at around 26 per cent of the total population. Smoking among schoolchildren, where patterns can be more volatile, appears to have reduced a little over the most recent period for which data is available.

Litigation risks

Litigation certainly does not pose the same risks in the UK as in the US given that the legal system in the UK is different. There are, for example, no class actions and the trial is by judge, not by jury. There are also no punitive damages, which means any damages awarded in any case would be a fraction of the amounts seen in the US.

However, a case which has attracted much attention in the UK is the McTear trial that started on 7 October 2003 in Edinburgh and in which Imperial is the defendant. Analysts assume that the case, a claim for a man who died from lung cancer, could set a precedent for claims against other British cigarette companies, which have so far avoided the flood of litigation that dogs their US rivals.

Compared to US dimensions, however, the McTear trial is taking place on a much smaller scale. Margaret McTear, the plaintiff’s widow, is suing Imperial for US$ 800,000, saying the company failed to warn her husband about the dangers of smoking cigarettes.
Final submissions in the case were completed on 20 February 2004, a decision is expected for 2005.

The case nevertheless has become more politically charged after a Rome court ruled on 9 March 2005 that the Italian arm of British American Tobacco must pay E 200,000 (US$ 267,500) in damages to the family of a lung cancer victim, the first such ruling in Italy. The appeals court ruled against BAT in a case arising from the death of Mario Stalteri in 1991. The court overturned an earlier ruling which had acquitted Ente Italiano Tabacchi (ETI), accused by Mr Stalteri’s family of failing to provide adequate warnings about the risks of smoking. BAT bought ETI in 2003 for E 2.3 billion. The sentence is likely to be seen as part of a growing anti-smoking drive in Italy, which in January introduced a law to ban smoking in indoor public places.

UK’s tobacco market has become a challenging business environment for manufacturers. Hard lessons had to be learnt from the consequences of ongoing and exorbitant tax increases. After several years of decline it seems the companies have found a way to react. The solution found may not necessarily stop the slow erosion of the market, but it might have taken out some of the speed. The present winning strategy seems to lie in finding the right mixture of premium, mid-price and low-price brands. And after all, one should not forget that although down-trading continues in the UK, the premium priced sector is still hugely significant. According to Michael Read, UK general manager at Imperial Tobacco Group, the two brands Embassy and Regal together generated more consumer expenditure than Coca-Cola in 2004.
Emily Paersch

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