Russia: Big Tobacco Survives Economic Crisis (fwd)

[Robert Weissman <rob@essential.org>]

Tobacco in Russia: Smoke signals
March 17, 1999

The Economist Intelligence Unit via NewsEdge
Corporation : The cigarette market has long been
one of Russia's fizziest. But is it completely
crisis-proof? 

Russia's financial crisis seems to have claimed its
first scalp in the $6bn-per- year tobacco industry. RJ
Reynolds/RJR (US), producer of Camel and Winston
cigarette brands, has sold its international tobacco
operations to Japan Tobacco, and will hand over
control of its Russian factories and trademarks within
the next two months. Is this a sign of a downturn in
arguably Russia's most promising industry? 

RJR says the sale was on the cards long before the
Russian crisis erupted last August, but admits that
lower revenue inflows and lower profit margins in
post- August Russia aggravated cashflow problems
and accelerated the decision to unload its tobacco
business worldwide. This is not necessarily a
gloomy sign: industry observers point out that RJR's
departure heralds the entry of another giant, Japan
Tobacco, which through the purchase gains a
readymade foothold in Russia. Although not such a
well-known name, Japan Tobacco has two enormous
advantages -- huge cash reserves and a state
backer, which can help it wait out the crisis far better
than RJR, with impatient shareholders to please. 

Catch the consumer as he falls 

In the wake of the rouble devaluation, many foreign
businesses saw their plans for Russia go up in
smoke. But Western tobacco companies had an ace
up their sleeve. They simply cranked up production
of cheaper cigarettes at their local factories, cutting
down on imports and premium brands, and sat back
to relax. 

The companies have reason to be complacent.
Russians, who are prodigious smokers, are unlikely
to quit the habit because of the crisis. But after the
collapse of the rouble and the erosion of their
incomes, they are reluctantly having to switch to
cheaper homegrown smokes, and tobacco
companies, which very sensibly have invested in
production facilities in Russia, are in a position to
give the market exactly what it wants. 

According to industry officials, sales of premium
cigarette brands, most of which are imported, have
suffered in recent months; but cheaper locally
produced brands are seeing booming sales. A poll in
November by Friedman & Rose, a market- research
agency, found that 41% of consumers had altered
their brand preferences; expensive cigarettes were
among the first to lose their market. 

Belomorkanal, an old Soviet brand, has jumped from
sixth to second place in terms of sales; Marlboro
has slipped from fourth to sixth place. According to
RJR, its Pyotr I brand, launched especially for the
Russian market and plastered with authentic-looking
Russian icono graphy, now has 35% of the mid-price
segment of the market, compared with just 6%
before August. B.A.T (UK), its main rival for the
cost-conscious smoker, says its Yava Zolotaya
brand, launched three years ago, is also growing
fast. Liggett-Ducat, a subsidiary of the Brooke Group
(US), produces some of the cheapest brands and
actually overshot its sales target by 250% after the
collapse. It is now producing 5% more than it did last
year, company officials say. 

@FI: BS9310AC.EPS 

Playing catch-up 

All three firms are now making inroads on the
once-dominant market share of Philip Morris (US),
whose Marlboro cigarettes were one of the main
status symbols in post-Soviet Russia. Philip Morris
is reluctant to head too far downmarket, seeing
Marlboro and Parliament, an even more expensive
imported brand, as valuable long-term investments. 

This strategy may turn out to be wise. Although the
multinationals like reporting high volume sales
figures and growing market share, they do not like
the fact that dollar revenues are taking a hit. Axel
Gietz, vice- president of RJR in Russia, admits that
his company would rather sell expensive imported
cigarettes, and that his profit margins have plunged.
To offset revenue loss caused by consumer
downtrading, RJR has boosted production volumes;
the firm produced 4bn more sticks last year than in
1997. 

The tobacco industry is probably the only one in
Russia which has received huge investments without
even trying. Investors in other sectors can receive at
times substantial incentives, but tobacco
companies, being producers of excisable goods,
may not under Russian law receive tax breaks.
Nevertheless, tobacco companies are among the
biggest foreign investors in Russia, having racked up
a total of more than $1bn in investments since 1992: 

* RJR has spent $400m in buying three factories --
one each in St Petersburg, Krasnodar and Yelets, in
south-central Russia -- and claims to hold 20% of
the entire market. Its RJR Petro factory in St
Petersburg is its second-largest plant worldwide. 

* Philip Morris has invested $250m in factories in St
Petersburg and Krasnodar and, apart from Marlboro,
produces the mid-priced Apollo Soyuz and L&M. 

* B.A.T bought Yava Tabak in Moscow and the
Saratov Tobacco Factory in 1994, upgrading them at
a cost of $170m. Last year it announced further fresh
investments of almost $500m. 

* Liggett is building a $100m factory outside
Moscow. 

* Bulgartabak (Bulgaria) was one of the biggest firms
on the Soviet market; it has a plant near Tula, and is
planning to build another in Moscow. 

Preaching to the converted 

Russia is a tobacco marketer's dream. One-third of
Russian women and two- thirds of men smoke,
making for a market of 260bn cigarettes per year.
Tobacco consumption is growing at a rate of more
than 5% per year; in developed markets like the US
and Western Europe, it is declining by about the
same annual amount. And best of all, unlike in the
US, where the tobacco industry is being forced to
cough up $368bn towards healthcare, concerns
about smoking-related health problems are muted in
Russia -- despite the fact that almost half of male
deaths are believed to be tobacco-related. 

Russian consumers, especially of the younger
generation, are extremely susceptible to the lure of
Western-style advertising, a trick the tobacco
industry has never hesitated to use. The companies,
with the support of cash- strapped media, are now
lobbying to be let back on television, from which they
were banished several years back. 

Cigarette advertising has always been cunning. In
1996 advertising campaigns for B.A.T's Yava
cigarettes cleverly exploited many Russians'
exasperation with the deluge of Western goods --
billboards loudly proclaimed: "Yava -- our answer to
America." The trick worked: within a year of its
launch, Yava had bagged 20% of the Moscow
tobacco market. 

Companies offered consumers low-priced cigarettes
with foreign sounding names such as Monte Carlo
and Magna, as well as cigarettes bearing Russian
names. Many well known -- and cheap -- Soviet
brands such as Pegas, Belomorkanal, Novosti and
Kosmos which have never been registered, are also
being manufactured by Western companies. Liggett
was the leader in this field, concentrating on
producing only old Soviet brands, albeit with some
efforts to improve quality. 

If incomes continue to fall, serious problems could
be around the corner even for the tobacco industry.
Russia's economy is expected to contract by at
least 5% in 1999, and this could bring even
mid-priced smokes into the danger zone. RJR has
already announced plans for major staff cuts this
year, and says the measure is necessary despite
the sale of its Russia facilities to Japan Tobacco.
B.A.T and Rothmans (UK), which both produce in
Russia, last year announced a $23bn global merger,
a move directly aimed at cutting costs in
international operations. 

And local production is not a complete safeguard
against economic crisis. Many components, notably
tobacco itself, are imported and while they carry
lower customs duty than cigarettes, they must be
paid for in hard currency. Revenues, meanwhile, are
in fast-depreciating roubles, and sensitivity to price
hikes is high -- as a recent Russian saying goes, a
packet of Marlboro cigarettes costs, and always will
cost, $1; when the price soared to Rb40-50 after
devaluation, it was taken as a terrible omen by
superstitious Russians. The price has since dropped
back to its traditional level, however. 

Nasty, but cheap 

Western cigarette brands could also soon run into
increased competition from domestic manufacturers,
which since the crisis have upped production by
almost one-quarter. Russian tobacco companies are
not noted for their high quality; around half their
output is papirosy like Belomorkanal, a strong slug
of black tobacco in a paper tube, favoured by older
smokers, and which retail for only Rb2-3 a packet. 

Alexey Sudorgin, technical director of the
Balkanskaya Zvezda tobacco plant in Yaroslavl,
says sales of his filterless Balkanskaya Zvezda and
Prima cigarettes have risen by 20% since August.
Prima is now Russia's top selling cigarette, with
almost half of the market in terms of unit sales; the
only thing stopping it being a real money-spinner is
that it is not a protected brand -- dozens of factories,
with varying standards of quality, produce it. 

Balkanskaya Zvezda and several other Russian
factories have been slowly upgrading equipment in
recent years; now, Balkanskaya Zvevda is in a
position to crank up output at its factory, which also
produces higher- margin filter cigarettes. 

But the Russian threat is fundamentally weak.
Although almost all Russian producers are under the
wing of Tabakprom, the tobacco-producers'
association, they are highly fragmented. Most are
purely regional, and lacking the marketing might of
the multinationals, they will find it almost impossible
to break into other regional markets. 

Sujata Rao, Moscow 

<<The Economist Intelligence Unit -- 03-10-99>> 


Foreign invasion
Russia's tobacco market, 1998 estimates; bn cigarettes
Local production

Foreign

RJR (US)          41
B.A.T (UK)         25
 Liggett (US)       14
 Reemtsma (Germany)    12
 Philip Morris (US)    11
 Rothmans (UK)       6
 Bulgartabak (Bulgaria)   2
Domestic
Tabakprom          90
Imports           50
Smuggled/counterfeit    12
Total market        263

Source: Business Russia.

Highs and lows

Typical Moscow kiosk prices, packet of 20 cigarettes; Rb

Parliament (Philip Morris)   30
Marlboro (Philip Morris)    25
Camel (RJR)          25
Chesterfield (Philip Morris)  15
L&M (Philip Morris)      15
Pall Mall (B.A.T)       14
Yava (B.A.T)          12
Pyotr I (RJR)         11
Apollo Soyuz (Philip Morris)  10
Belomorkanal (various)     3

Note. Rb23.3:$1.

Source: Business Russia.


[Copyright 1999, The Economist Intelligence Unit]