[Intl-tobacco] Amazing Thailand

[Rob Weissman]

Tobacco Journal International (July '04).

Amazing Thailand

Six years after the Thai government decided in favour of a privatisation of
its state-owned tobacco business, nothing much has changed. Thailand remains
a rather traditional tobacco market.

Many have great stories to tell about experiences in Thailand. A fabulous
holiday on the beaches of Koh Samui. A great round of golf at Blue Canyon in
Puket. Shopping in Bangkok. Hill tribe hikes around Chiang Mai. And, not to
forget... that spectacular night out.

Sadly, there are not too many of these great experiences about the tobacco
industry in Thailand. One way or another there are few, or maybe no, success
stories when it comes to the cigarette business. Not for the internationals
who have been in the market since 1991 when the market was opened to
imports, and surprisingly, not even for the Thai Tobacco Monopoly (TTM).

With a population of over 60 million and average GDP growth rates of 9 per
cent in the 1990s, Thailand became a strategic priority for many of the
multinational FMCG players as Unilever, Nestle and Heineken, distributors as
Diethelm and Inchcape and even retailers as Watsons, Tesco and Makro. And
when in 1991 the market opened to cigarette imports, all the majors had high
expectations for this new opportunity.

Yet, as time went by, the tobacco giants were never able to implement
business models that delivered the same market shares and profit margins
they enjoyed in comparable markets elsewhere. Even BAT, with its wealth of
experience and track record of success in South East Asia, hopped from one
strategy to the next. And TTM, despite the large number of formal and
informal protections it enjoyed after 1991, appears not to have taken this
opportunity to build the internal strength to develop itself into a regional
tobacco powerhouse able to tap the opportunities that several other Thai
conglomerates have.

The multi-million dollar question is, is that all going to change as
Thailand emerges fast and furiously from the crippling financial crisis of
the late nineties?

Will the implementation of the ASEAN Free Trade Area duty reduction schedule
see an explosive growth in the market share of the international brands?
Will a Thailand Inc emerge under the guidance of the Prime Minister/multi
billionaire/telecom tycoon/aspiring Liverpool Soccer Club owner Thaksin
Shinawatra?

Will the sluggish state-owned enterprises become competitive,
market-oriented and efficient? Is the privatisation of TTM, which over the
years appeared like a traffic light, finally going to stay on green, or is
it again going to jump back to red just as everybody has the M&A teams ready
to go? One thing is certain; things are changing fast under the current
government.

And, as Mr Thaksin likely has another four years in the driver's seat,
Thailand should become an even more dominating, competitive economy in South
Asia. Not only will Mr Thaksin, who will soon be the elder statesman of
ASEAN, drive this free trade zone to Thailand's benefit, he will likely
develop another strong economic zone around the North Thai, South China,
Vietnam, Myanmar and Laos region.

Amazing market

Using the cigarette consumption per capita from comparable countries in Asia
as rule of thumb, Thailand with 40 million people over the age of 18 and a
normal male/female ratio of 0.98/1.02 should have a market size of well over
60 billion sticks and growing. Yet the duty paid market was only about 36
billion in 2002 and is projected to further erode to 31 billion this year -
a significant decline from its highest point in 1996 when the market was
close to 50 billion.

A comparison with other previously monopolised Asian markets that
liberalised towards imports around the same time offers some interesting
comparisons. While international brands were able to carve out combined
market shares from over 20 per cent in Korea to over 50 per cent in Taiwan,
the Thai success for now has barely reached 13 per cent, and that only
thanks to Philip Morris International which controls close to 90 per cent of
the import segment. It would appear that this lack of progress by the
internationals into the Thai market stems mainly from the continued
protection TTM enjoyed from a number of measures that reached beyond the
high import duties.

On the other hand, the competitive pressure from the internationals has been
a catalyst for the other previously protected enterprises to rise to the
challenge. Japan's JT transformed itself to a global player with dynamic low
tar brands and new technology, South Korea's KT&G built a substantial export
business to the Middle East and surrounding countries and developed a strong
low tar/nicotine portfolio of brands. Even Taiwan's TTL seems to have awoken
with the new Long Life variants, which arrested their market declines.

TTM, however, has not become more consumer-focused and innovative, with
their leading Krong Thip and Falling Rain brands very much like they were
before the market liberalised. Same design, soft pack, and among the highest
tar/nicotine scores of 20.0+/1.4+ in Asia, except for kretek. And, the most
recent TTM initiative 'Wonder' is not exactly a wonder of marketing, even
though it did pick up volume due to its price positioning. One could wonder
where the volume came from.

Amazing RYO strength

But how are the relative low market development and its fast decline
explained? Thailand does not have a widespread culture of tobacco chewing or
bidi smoking. There is non-duty paid product in the market, but TTM
estimates that only to be around 7 per cent of the total market (it is
suggested that it could be higher including counterfeit). Anti-smoking
campaigners, led by Dr Hatai Chitanondh, are successful compared to most of
the rest of Asia, but that cannot explain a market development of two thirds
of its theoretical potential.

The answer to this enigma has been overlooked by some tobacco companies.
Thailand has one of the largest roll-your-own markets in the world.
Estimates based on leaf consumption and manufacturers' data are that on an
factory-manufactured cigarette (FMC) equivalent basis, the roll-your-own
segment in Thailand is around 40 billion sticks. Add this volume to the 38
billion duty paid volume and non-duty paid consumption, and Thailand's
market size is no longer that amazing.

A significant part of the roll-your-own is unbranded, sold by weight in the
wet markets around the country. However, there is also an estimated 15
billion stick equivalent market of branded RYO, made by a number of Thai
manufacturers who make a very decent living out of it, despite the low price
but thanks to the special excise treatment the segment is given if local
tobaccos are used.

Did the multinationals miss a trick here? Maybe. One could argue that had
the multinationals entered this segment, which is not controlled by the
monopoly law, and carved out a nice, profitable business, the rules of the
game would have been changed by one or more of the government departments
who also fall under the ownership of TTM, the ministry of finance. Maybe.
But they did not try. In fact, one of the senior managers of a multinational
company was not even aware of the opportunity, claiming the RYO market to be
5 billion at best.

But why then did TTM not build a RYO business? FMC volumes falling from over
45 billion sticks to below 30 billion should be a good enough reason, if
only to hold on to their consumers, as they were being forced to downtrade
to cheaper smokes owing to the financial crisis. TTM has the equipment, the
infrastructure and with close to 4,000 employees in the Bangkok facility,
they hardly had to recruit workers to handle the additional business.

What is the future of the branded RYO segment? One can safely assume the
segment is there to stay. By logic, one could expect smokers who traded down
from FMC to RYO in 1997 as their income took a hit, to start trading up
again as their income starts growing again behind the current economic
miracle which is putting a lot of money into the hands of the rural
population. This will cause the RYO segment to contract. However, current
smokers of unbranded RYO will more than compensate for the branded volume
lost as they also see more money in their pocket and aspire to better,
branded, products. Maybe TTM should reconsider their recent withdrawal from
RYO.

Amazing TTM

When, in 1998, as part of the economic restructuring programme, the Thai
government agreed with the IMF to put the tobacco monopoly on the list of
state-owned enterprises to be privatised, few held their breath. At least
nobody who had any knowledge of the Thai political landscape.

The combination of Thailand's strong national pride, TTM'S importance to the
treasury, a significant number of powerful groups with vested interest and
an enormous amount of other political and economic headaches, made the
agreement hardly worth IMF's ink. Nevertheless, the M&A teams flew into
Bangkok, the invitations were issued to visit headquarters and factories and
friendship and help were offered.

Six years on, nothing much has changed, at least as far as privatisation is
concerned. Except for Mr Thaksin saying that TTM would not be privatised in
2003, and only a 50/50 chance for 2004, but then certainly not in the form
of a majority sale to a foreign company.

But beyond the privatisation a lot has changed. The FMC market has dropped
by 24 per cent, TTM has lost nearly 30 per cent of its sales volume and PMI
has opened a brand new factory in the Philippines to supply ASEAN.
Furthermore, BAT and JTI have moved production for Thailand out of Malaysia
to Singapore and the Philippines and import duties from ASEAN countries,
except Malaysia, have dropped to 5 per cent.

When Suchon Watanapongvanich was appointed managing director of TTM, he
already pointed out that TTM would become much more vulnerable to imports
when the AFTA duty reduction fully kicked in. And that is now the case. The
drop from 60 per cent import duty to 5 per cent in itself is impressive. But
with the excise calculation method, effectively a multiplier on CIF plus
import duty, the reduction of total tax burden is so significant that the
imported premium brands can finally make an acceptable margin and it is now
worth driving into TTM's heartland with mid-priced brands.

While Mr Thaksin has tasked TTM's management to increase EBITDA by 30 per
cent in five years, cut cost and push back foreign competition and
counterfeits, it does not appear TTM has been given the tools to do so.

TTM is still required to buy a too large local leaf quota, subsidise tobacco
farmers, employ too many people at too high wages, sell through a passive
distributor system and refrain from any form of marketing as Thailand has
one of the most restrictive advertising legislations in Asia.

Indeed TTM has lost a lot of its attraction to the multinationals, although
nobody would ignore the opportunity to buy an 85 per cent market share in a
country with 65 million people. But that opportunity is unlikely to
materialise.

If other Thai privatisations are used as guidance, TTM will indeed be
partially sold to the Thai public through a listing, as already mentioned by
the Prime Minister. However, the last thing he will want to do is to sell
his voters a 'dog', to use the Boston Consulting Group concept. And neither
is that necessary, as long TTM acts as a corporation rather than a
production monopoly, and Mr Thaksin expects no less, being a business
tycoon.

TTM certainly has a fair share of issues. More importantly, TTM has a number
of strengths, which should be leveraged to ensure the future Thai public
shareholders get a good return on their investment.

To mention several:

National pride. Thais in general are much more nationalistic than other
Asians and are therefore more loyal to Thai brands. 'Thai Rak Thai' - Thais
love Thais.

Local understanding. Thais will always be better at understanding Thai
consumers than foreigners, and there are first class Thai marketing
managers.

Market dominance. At 85 per cent TTM controls the market and while this may
erode over the years, TTM can act as market leader.

Distribution. TTM's numeric distribution is unparalleled. The system needs
to be re-engineered into an active and selling system, rather than what it
is now. Then it will be a virtually unbeatable competitive advantage to TTM.

Brand awareness. The very strict tobacco advertising laws make awareness
building a huge challenge for all brands. Krong Thip and Falling Rain's
awareness levels are already high and offer opportunities to leverage from.
In other markets there are examples enough for TTM to follow.

Local manufacturing. Being a large and in-market manufacturer should offer
cost advantages. The new factories in Chiang Mai and Saraburi will help.
Much more is needed and possible, but will also require help from the
government to achieve.

Higher margin products. A TTM brand in the premium segment would more than
double gross margin. Moving part of TTM's mind set from production to
consumer marketing, as other (ex-)monopolies have done, could allow Thai
consumers to buy a Thai premium brand.

Exports. Thailand has a very good reputation in ASEAN for being able to make
high quality products, ranging from FMCG to cars. Thailand has an abundance
of good tobacco and NTM suppliers. An export business does not come
overnight, but will require hard work by TTM itself, as distributors will
not do it. Again, other (ex-)monopolies have built large export businesses.
And if Red Bull can build an admirable consumer franchise around the world,
why can't the Thai tobacco monopoly?

As is evident from the above, the multinational cigarette manufacturers have
not achieved anything close to their expectations from when the market
opened. In fact it is unlikely that any one of them has made any money yet.
PMI has come out as top dog again with 89 per cent share of the
international segment nicely split between L&M and Marlboro. Neither BAT nor
JTI have been able to establish strong brand franchises. And, with the
strict advertising ban, it will prove very challenging to ever build a
significant market share behind their current strategy.

When PMI proposed to TTM that they should build and own a new factory
together, but PMI would manage it and include TTM's brands in their
distribution system, this was either a very long shot or a misreading of the
pride of the Thai people. It is assumed it was a long shot as PMI does not
necessarily need TTM, given the strength of its brands and ability to import
at 5 per cent duty. Unless it can control the 85 per cent market share and
gradually replace it with its own brands.

For BAT, JTI and all others that still aspire to have a Thai business it is
different. Doing what they have been doing for years is not going to get
them anywhere. Moving from distributor to distributor will only make things
worse. Maybe a fresh look at the market and their position towards TTM could
provide a glimmer of hope for a sustainable Thai business somewhere in the
future. Or maybe they should go down the route House of Prince has chosen
and focus their efforts on the tourists, to make sure they do not spend
their days on the beach trying and converting to Marlboro. Would that not be
amazing?

The Dalvey Group

The Dalvey Group are Asian consumer industry consultants based in Singapore.