GLOBAL VALUE CHAIN

Production ** Distribution**Marketing**Sales**Major Players**Developments

PRODUCTION

Tobacco

Tobacco, Nicotiana tabacum, is an annual leafy plant that is native to the Western hemisphere. Two main varieties of the tobacco plant are burley and bright-leaf. Nicotine, the substance responsible for the addictive quality of cigarettes, is found naturally in tobacco. The amount of nicotine in a given tobacco plant depends on any number of factors, including: growing conditions, species of tobacco, and method of curing. Curing is the essentially the process of drying the tobacco leaf. Once they are harvested, the leaves go through a multi-step ripening and drying process to prepare it for blending, and eventually, final cigarette production. There are several different ways that tobacco leaves are cured, including: flue-cured, air-cured, and fire-cured. At this point the tobacco is blended. Blending uses different kinds of tobacco leaves and processing by-products to create the specific recipe of the cigarette being produced. This is important because it allows for consistency in the product, when environmental conditions can affect the taste of the tobacco leaf alone.  Cigarette Manufacturing The tobacco is then brought to the factories. Cigarette manufacturing is a fast-paced, high volume process. Cigarette rolling machines produce anywhere from 8,000 to 14,000 cigarettes per minute. The cured and blended tobacco is placed on long rolls of cigarette paper, where they are then rolled into long rods, essentially over-sized cigarettes. The rods are then cut into cigarette-sized sections and filters are inserted. While the process is highly automated, human supervision is a part of every step in this process. Workers inspect tobacco leaves, the blending process, and the final product for quality control.

US Cigarette Production, Export, and Domestic Consumption—1990-2004

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DISTRIBUTION

After the final product has been made and packaged, it is shipped out and distributed to wholesalers. The wholesalers, in turn, sell the products to any number of retail stores, including convenience stores, supermarkets, and drug stores. The share of retail sales by kind of store is shown below.

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MARKETING

Marketing is perhaps the most important and most valuable link in the cigarette global value chain. For a century, cigarette manufacturers have spent immense amounts of effort and money on marketing their products as cool, acceptable, and safe. It is in advertising that a particular brand establishes their brand image. This is particularly important because cigarettes are among the top commodities in brand loyalty. Every smoker has their preferred brand of cigarettes, and they will more often than not always purchase that particular brand. Marlboro (Phillip Morris) is a brand that has found great success. Its campaigns with the Marlboro Man, showing desert scenery and an open, expansive atmosphere, appeal to the rugged cowboy inside of men. Men want to be tough, and the Marlboro ads say, “if you smoke Marlboros, you will be tough.”

With growing anti-smoking sentiments, particularly in the U.S., marketers have to adjust their marketing plans to adhere to social norms and government regulations. Television and radio spots for cigarettes are no longer allowed. Since 1989, product placement in movies has been non-existent. 2001 saw drastic changes in the remaining places that cigarette ads can be found. While overall spending in advertising and promotions was up, at $11.2 billion, advertising in newspapers, billboards, magazines and point-of-sale were all down. The only category in which there was a significant increase was retail value-added (which includes such promotions as “buy one get one free”.) Retail value-added marketing accounted for $4.76 billion of marketing expenditures in 2001.

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SALES

That retail value-added marketing is such an important part of the marketing of cigarettes is indicative of the importance of sales in the supply chain process. Of course, sales are important in every industry, but the cigarette industry has a particularly interesting situation. The nature of the product is polarizing. You either smoke, or you don’t smoke. Smokers, and only smokers, are going to buy cigarettes no matter what. So it is important for the cigarette companies to lure customers with the most obvious incentive: cheaper prices. Retail value-added has proven to be a relatively effective marketing tactic in that respect. However, overall consumption figures in the US paint a different picture.

The obvious decline in cigarette consumption in the US has, of course, affected sales numbers. In 2005, the volume of cigarettes sold was the lowest it’s been since 1951 at 378 billion. Since the 1998 Master Settlement Agreement, sales in the US have dropped 21%. Clearly influenced by the sizable government and advocacy groups campaigns that have been in action since the Surgeon General announced the link between smoking and lung cancer. The story is different in Japan and China, where cigarette consumption has been steadily increasing since 1960. Only in the past few years do we see consumption in Japan dip.

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MAJOR PLAYERS

China National Tobacco Co.: CNTC has an essential monopoly in the tobacco industry in China. It produces over 900 brands of cigarettes, and with a customer base of 350 million smokers, it’s no wonder CNTC holds a 33% market share in the world. Their monopoly is promoted and managed by the State Tobacco Monopoly Administration (STMA). CNTC has control over all aspects of the supply chain, but it outsources its orders to smaller factories, which fill them and then return orders to CNTC’s distribution chain. CNTC then sells their cigarettes retail distributors. The finals sales then get taxed by STMA.

Altria Group, Inc.: Philip Morris USA, a subsidiary of Altria, is the largest tobacco company by sales in the world. Philip Morris owns such popular brands as Marlboro, Parliament, and Virginia Slims. Headquarters in Richmond, Virginia, Philip Morris has plants in Virginia, Kentucky, and North Carolina. Not surprisingly, Altria, and particularly its tobacco subsidiary, is incredibly persuasive among lawmakers. To date, Altria Group has spent over $100,000,000 on lobbying.

British American Tobacco Group PLC: With such brands as Dunhill and Benson & Hedges, BAT has a global reach. It has international and local brands all across the world. In response to increased worldwide restrictions on cigarette advertising, BAT has taken to innovating their marketing efforts, foraying into the worlds of music and sports. BAT sponsors the London Symphony Orchestra. In 1996 they sponsored the Cricket World Cup and attained wide brand exposure for its Wills brand, particularly in India. BAT also had its own Formula One racing team to promote its Lucky Strike brand until 2005, when a European Union directive was issued to prevent tobacco company sponsorship.

Source: Euromonitor, 2000.

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DEVELOPMENTS

Private Label vs. Brand Names: Marlboro Monday

In order to undercut cigarette prices, companies in the 1980’s began to sell generic brands for 40 to 70 cents less than the branded cigarettes. Private labels found success in all types of product categories, and cigarettes were no exception. Due to the recession of the early 90’s, brand name cigarette prices continuing to rise, and the fact that private label cigarettes were essentially no different in quality to brand name cigarettes, the private labels gained a 30% market share in the US in 1993.

Philip Morris, which owns the most popular brand of cigarette in the world, Marlboro, became tired of the generic brands cutting into their profits. So, on April 2, 1992, Philip Morris CEO Michael Miles cut the price of Marlboro cigarettes by 20% to compete with the private labels. This led many of the other major US cigarette manufacturers to do the same. The cigarette industry being such a lucrative, powerful, and high profile industry, other companies followed suit. By the next Monday, now known as “Marlboro Monday”, the Dow Jones dipped 68.5 points. In the next quarter, Philip Morris posted terrible numbers, and it seemed as if Miles’ decision was ill advised. Still, within a year, Philip Morris had surpassed its previous high in market share. Philip Morris was back on top.

“Fire Safe” Cigarettes

Across the country, 800 people die per year in fires caused by smoldering cigarettes. In 2004, New York passed a safety standard that prompted US cigarette manufacturers to develop a cigarette that self-extinguish, greatly reducing this risk of cigarettes igniting. Reduced ignition propensity (RIP) versions are achieved by banding the cigarette paper, and are far less likely to burn completely than their non-RIP counterparts. Industry research further shows that there was no difference in sales because of this change in design.

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