[Intl-tobacco] Central/Eastern Europe: Coming Tobacco Market Changes

[Robert Weissman]

>From Tobacco Journal International
April/May 2004
p.85

The eight central and east European (CEE) countries set to join the European
Union on 1 May 2004 - Czech Republic, Estonia, Hungary, Latvia, Lithuania,
Poland, Slovakia, Slovenia - are bracing themselves for major changes to
their tobacco industries.

Global market analyst, Euromonitor, forecasts that the implementation of EU
directives - governing issues such as tar levels and, crucially, levels of
cigarette taxation - are set to impact heavily on all countries, the latter
threatening to propel average unit prices of cigarettes out of the reach of
average-income consumers and accordingly swell the incidence of non-duty
paid cigarettes.

The eight countries together accounted for sales of nearly 138 billion
sticks of cigarettes in 2003, with Poland alone accounting for 52 per cent
of this total, according to Euromonitor's latest research. Poland, Hungary
and the Czech Republic are the largest cigarette markets amongst the
accession countries, by virtue of their size (they have the lowest
percentage of smoking prevalence within the region), whilst per capita sales
are highest in Slovenia, Hungary and Poland, at an average of 2,000 sticks
per annum.

The official percentage of smokers over the age of 15 varies between 22 to
35 per cent, with the exception of Slovakia, which stands at the top of the
table with a whopping 48 per cent. As a rough rule, the poorer the country,
the higher the incidence of smoking.

Given the already relatively high per capita levels and general market
rationalisation brought about by the influx of multinationals following the
collapse of communism, the majority of these countries are already mature
and, according to Euromonitor research, have seen declining volume sales
over the past five years, with only the Czech Republic and Slovakia
exhibiting any growth.

The average rate of period decline stood at 3 to 9 per cent for the
remaining countries, bar Poland, which saw the steepest decline, at almost
18 per cent between 1998 and 2002. Interestingly, Poland has been the
fastest to begin implementing the EU directives on cigarette taxation,
boasting the highest tax in the region by 2003, and reflecting fears that
the decline in sales is in large part attributable to the price hikes
already being implemented.

EU taxation a challenge

The new EU directives on cigarette taxation (last revised in 2002) have set
minimum excise tax incidence at 57 per cent of retail price and the tax
burden at E 1.28/pack of 20 (or E 60/1,000 sticks). For all the accession
countries, this is a drastically tall order. Of them all, only Slovakia and
Slovenia's tax incidence is over 50 per cent (still below the EU minimum),
and all the countries' tax burden is well below that stipulated by the EU.
Needless to say, the hikes in taxation, necessary to fall in line with these
directives, will result in massive increases in the average retail price of
cigarettes across the board, the effects of which have already been felt in
some.

Alarmingly, retail prices are set to increase by an average of around 50 to
100 per cent in the accession countries, with the Baltic countries hardest
hit (Latvia alone is set to see a six-fold increase in unit prices, with
Lithuania hot on its heels). In all bar possibly Slovenia and the Czech
Republic, these increases will outpace the expected increase in disposable
incomes and push the average unit price of cigarettes out of the reach of
the average-income smoker. Cigarettes are already far less affordable in
real terms in these countries, and the further hike is set to
precipitate a
chain of consequences which critics claim will be of benefit to neither
consumer nor government.

The first and most obvious result of a market of unaffordable cigarettes is
expected to be a continued decrease in duty-paid cigarettes (with a
significant shift to economy brands) and a tandem increase in contraband
sales, already high in this region. Poland's estimated contraband sales are
equivalent to 20 to 25 per cent of its duty-paid market, and with
neighbouring Ukraine boasting a tax burden eight times lower, this
proportion is set to increase dramatically as the demand for cheap
cigarettes rises.

Similarly for the Baltic countries, with Estonia and Latvia bordering
Russia, where the tax burden is lower many times over, a similar pattern is
set to emerge. Legitimate cross-border shopping and illegal smuggling and
bootlegging have already been the effects of price hikes on cigarettes in
existing EU countries. Even without porous borders, the UK, for example, has
witnessed a substantial increase in the incidence of smuggling over the past
five years, with estimated contraband growing at a sizeable 65 per cent
between 1998 and 2002.

Fear of increased contraband

With CEE's long and porous borders, coupled with the lack of manpower and
financial muscle to patrol, Euromonitor forecasts that the quantity of
non-duty paid cigarettes is set to increase, whilst duty-paid cigarettes
will continue their downward trend. Estonia alone is set to exhibit a volume
decline of just under seven per cent in duty paid cigarettes over the next
five years, with only Slovenia and Latvia exhibiting marginal growth. The
average rate of decline is set to stand at five per cent in volume terms
over the next five years.

Critics insist there will be no winners: government coffers will be reduced
rather than increased; public health campaigns (scant as they are in this
region) will be compromised, and the poorer households will be hardest hit.
A further bone of contention is the unduly hasty deadline set by the EU. The
new taxes will need to be phased in over the next five years, despite the
massive disparity in starting cigarette unit prices and living standards in
the accession countries compared to some of the existing EU countries which
were given extensions to their phasing-in deadlines, most notably Spain and
Greece.

Another EU directive already altering the shape of the CEE tobacco
market is
the EU tar maximum directive - which sets a maximum of 10 mg of tar per
cigarette, 1 mg nicotine and 10 mg carbon monoxide -, in effect in the EU
since the start of 2004. High tar cigarettes have already seen a dip in
sales over the past five years in this region, with most of the accession
countries registering a dip of over 20 per cent over the past five years,
with the more mature markets such as Poland registering drops of over 50 per
cent.

Trend towards lower-tar smokes

Euromonitor forecasts that the downward trend for high tar cigarettes is set
to accelerate as the accession countries implement the directives, with an
average decline of 30 to 60 per cent forecast over the next five years.
Hungary, for example, already set maximum tar content in cigarettes at
18 mg
at the end of 1998, down to 15 mg by the end of 2000, and is phasing in 12
mg by the end of 2006.

In the Czech Republic, though high tar sales have dipped by over a quarter
over the past five years, this segment still accounts for around 40 per cent
of total volume sales, prompting some manufacturers to refer to it as a high
strength hold out. Accordingly, sales of low tar and ultra low tar
cigarettes have seen triple digit growth over the past five years and these
segments will be the chief drivers of growth within the region as a
whole.

Taking into account the aforementioned factors, Euromonitor believes that
the entry of the CEE accession countries into the EU is likely to create an
increasingly competitive marketplace. BAT's commitment to compete with
Philip Morris for dominance of the world market, including CEE, where Philip
Morris has a near monopoly, is set to stimulate manufacturer activity.
Philip Morris enjoys a leading position in all the accession countries, bar
Hungary and Slovenia, where it is runner-up to BAT and Imperial Tobacco
respectively.

In the Czech Republic and Lithuania, this lead extends to over 80 per cent
of the market.

It is estimated that over US$ 1.5 billion was invested by Philip Morris in
eastern Europe alone between 1992 and 1997. In most countries, this was by
way of acquisitions of leading players, e.g. Tabak in the Czech Republic,
Zaklady Przemyslu Tytoniowego w Krakowie in Poland, and a majority hold in
Lithuania's Klapeida Tobacco Co.

Since then, the focus has been more on consolidation.  It will be
interesting to see the development of the strategies employed to deal with
the effects of EU legislation on its markets amongst the accession
countries, such as the shift to low and ultra low tar cigarettes, the
continued popularity of mid- and low-priced brands and the threat of
contraband. All in all, Euromonitor believes that the region will be an
interesting one to watch over the next few years as the effects of EU
tobacco legislation become apparent.

 -- Zora Milenkovich, manager global market research, Euromonitor
International