[Intl-tobacco] Taxation Structure Hits Indian Cigarette Market (fwd)

[Robert Weissman]

Taxation Structure Hits Indian Cigarette Market
Source: Tobacco Journal International, Monday, 7/31/00

India=92s tobacco industry has been witnessing a 4 per cent decline in
cigarette sales down to 95 billion sticks in 1999. Steep duty hikes and
subsequent price increases have contributed to the slowdown. Apart from
this, restrictions on smoking in public places and a ban on sales at
railway stations have also had an adverse impact on cigarette sales. The
sharp increase of smuggled brands has become another area of concern.

With around 200 million smokers, India is one of the biggest tobacco
markets in the world ranking fourth in total tobacco consumption. However,
it differs significantly from the rest of the world in terms of product
configuration.  India=92s tobacco market is still characterised by a low
share of cigarettes, which accounts for only around 18 per cent of total
tobacco consumption. The lion=92s share of the country=92s tobacco market
still goes to traditional tobacco products, such as bidis, chewing and
non-smoking products.

In 1999 India=92s cigarette consumption reached 95 billion units, which is =
=96
when compared internationally =96 way below China=92s 1,700 billion sticks,
the EU=92s 750 billion sticks or the USA=92s 490 billion units. However,
cigarettes are India=92s primary generator of excise duty accounting for 87
per cent of total tobacco excise in 1998-1999. As in many other countries,
general conditions for the cigarette industry have also worsened in India.
With 95 billion units sold in 1999-2000, the country=92s cigarette sector
has suffered a 4 per cent decline over the previous year. Industry sources
attribute this development mainly to a continued increase in excise duty
over the last few budgets. Tax on micro cigarettes, for example, has been
increased by 83 per cent since 1997. A luxury tax of 15 to 20 per cent,
which was imposed on cigarettes in some states, is also considered to have
influenced this development negatively. As a consequence, Indian consumers
increasingly changed to lower priced tobacco products such as bidis.

Another factor, that might have contributed to the drop in cigarette sales
is seen in the high share of smuggled cigarettes, which is estimated to
reach 150 million cigarettes every year. Industry sources also cite the
growing prevalence of smoke-free offices as a reason for the decline, as
well as the ban on the sale of tobacco products at railway stations. A ban
on cigarette advertising, which has been introduced in seven states of the
country, is considered to have had an impact on cigarette sales too.

India=92s cigarette market is still dominated by local brands, although
international brands such as Benson and Hedges and State Express 555 have
started to be produced and distributed on a larger scale in the country.

India's main tobacco manufacturer is the Indian Tobacco Company (ITC)
which is partially owned by British American Tobacco and held a 66 per
cent market share by volume in 1999. Other main players are Vazir Sultan
Tobacco Ltd (VST), in which BAT holds a minority stake, Godfrey Philips,
linked to Philip Morris, and GTC. GPI and VST each had close to a 12.5 per
cent volume share in 1999 while GTC had 8.1 per cent market share in the
same period.

Strong brand equity, pricing power and presence across all segments have
enabled the country=92s leading tobacco manufacturer ITC to strengthen its
position, despite the tenacious market situation.

After recovering from a corruption scandal two years ago in which top
executives of the company had been involved, the appointment of a new
chairman and a restructuring plan seem to have brought back stability. ITC
posted a 17 per cent increase in net profits to US$ 130.3 million for the
nine-months period ending December 1999.

The company has also started to aggressively modernise its factories and
bring in faster and better equipment. In addition, it has expanded its
production capacity with the latest construction of a brand new factory
near Bangalore.

The new factory, commonly known as B-II, will be fully operational by the
end of 2000 and will have an ultimate production capacity of 200 million
sticks per day. ITC also plans to intensify its focus on filter-tipped,
upmarket brands rather than so-called "micro" cigarettes, which do not
give manufacturers the same profit margin. Filter cigarettes meanwhile
account for around 70 per cent of ITC production volume. The company=92s
main brands are Scissors, Wills and Gold Flake. In order to further
increase the quality of its products, the company has decided to switch
some of its brands to acetate filters =96 a move, that could also put other
manufacturers under pressure.

Diversification has also become a declared goal for the company, which
aims at changing its portfolio and reducing the cigarettes related
operations from a current 70 per cent to 50 per cent of its revenue by
2005.

However, the company is still eager to defend its position on the domestic
tobacco market. Fearing destabilisation of domestic companies, ITC had
called for a blanket ban on new direct foreign investments after the
country=92s government had considered allowing 100 per cent direct foreign
investment. The main reason for the concern was the move by US
manufacturer Philip Morris, which is waiting for clearance of the
company=92s 100 per cent subsidiary FTR Holdings. Philip Morris already own=
s
a 36 per cent stake in Godfrey Philips India (GPI). The US-based company,
however, is expected to make an entry into India via the food business.
The new food factory, which was rejected by the government a number of
times, will be built in Hyderabad and is 100 per cent PMI-owned.

GPI is the country=92s second cigarette manufacturer and especially strong
in India=92s Western and Northern markets. During the financial year of
1999, GPI had been able to marginally improve its market share from 12.5
per cent to 12.7 per cent. With the launch of its Four Square Gold brand
in the 74 mm mini kings category, GPI has hit ITC=92s highly flourishing
Wills Navy Cut brand, which was the only player in this segment before.
GPI has announced to further concentrate its activities on new brand

launches especially in the premium king-size segment. At present around 90
per cent of the company=92s revenues are generated by Four Square Gold, and
the company=92s two other main brands Red&White and Cavender.

VST Industry of Hyderabad, the third player on the domestic market,
recorded a sharp 8 per cent drop in volumes in the financial year 1999.
The main reason for this decline was the company=92s great presence in the
micro segment, which =96 as mentioned before =96 had witnessed steep duty
hikes in the last two budgets.  While the VST=92s volume share in the
cigarette business stood at 12.5 per cent in 1999, the company=92s value
share, however, was much lower at 7.4 per cent.

VST's main brands are Charminar and Charms. The latter brand, which had a
market share of 13 per cent in 1999, is according to the company supposed
to be being repositioned, targeting a 15 per cent market share by 2002. In
contrast to the market leader ITC, who is intensifying its effort in
diversification the new management of VST has devised a scheme to divest
its loss-making non-tobacco businesses such as natural products and
financial services.

India=92s cigarette manufacturers are sailing through rough waters. Given
the unique product configuration with a comparably small share of
cigarette sales, the country=92s cigarette companies have been additionally
hit by the current tax structure. General strategies =96 be it
diversification or divesting =96 may be different. However, cigarette
companies seem to share one common goal, namely the revision of the
current tax structure, which is seen as discriminatory to their business.
Whether they will succeed is difficult to foresee.