Analyst Insight by Don Hedley, Contributing Analyst, Euromonitor International
Pricing strength has been, for some years now, the way in which the tobacco industry has managed to keep value sales and profits steaming ahead despite falling cigarette volumes in many key markets, notably in Europe, the US and Japan. A key element of pricing strength is the power of flagship brands and the year on year growth in the proportion of sales accounted for by brands in the premium price band – ‘premiumisation’. According to recent company results, this is still happening, however, recent research findings by Euromonitor International suggest a negative change in product mix which could signal a reversal of the trend, though whether a sea change or a fleeting squall in what is likely to be an increasingly tempestuous market remains to be seen.
Cigarette value, volume, pack price - proportion of countries where growth was recorded 2011-2012
Source: Euromonitor International
Tracking trends, and particularly financial trends based on global numbers is subject to distorting factors such as the size of the Chinese market and having to use a single currency for comparisons which introduces exchange rate anomalies which can obscure underlying trends. A better picture of what is happening to cigarette markets is by means of tracking market trends in individual countries. Euromonitor International tracks the global market by on-the-ground analysis in the 80 leading markets which account for over 90% of global cigarette sales. In 2012, the value in almost half ie 45% of those 80 cigarette markets fell. This was despite the fact that price paid per pack rose in 80% of the countries. The reason for the falls in market value despite the rise in average price paid was that, in 64% of the markets, fewer cigarettes were consumed.
This did not mean an overall fall in market value, though there was a definite hiatus in market value growth, as demonstrated in the chart. Euromonitor International monitors global movements in average-price-per-pack-paid by dividing market value by number of packs sold. The resulting average price paid therefore takes account both of tax driven and manufacturer driven price rises and also changes in product mix ie the proportion of premium priced cigarettes purchased. When analysing individual countries this is on the basis of local currencies while regional and global analysis is on the basis of US$ prices. This means that global and regional analysis can be influenced by exchange rate changes. That said, the broad trends are clear: the chart below shows global cigarette market values have considerably outgrown volumes over the past five years.
However, the chart also shows that, in 2012, the rate of average price growth and of value growth of the global cigarettes market slackened significantly. It may also be observed that, for the first time, in dollar terms at least, in 2012 illicit trade in cigarettes grew as fast in volume as the duty paid cigarette market did in value as well as obviously continuing to grow faster in volume than the legal market.
Source: Euromonitor International
The reason for the dip in price growth was partly due to exchange rate factors impacting dollar value changes in Western Europe but, particularly in EU there was evidence of weaker pricing due to factors such as recession and unemployment growth. The huge regional differences in average price paid per pack of cigarettes should also be mentioned - from some US$12 per pack in Australasia to US$1.60 per pack in Middle East and Africa and with far greater variations between individual countries. These differentials partly explain the continued rise in illicit trade – were prices paid by consumers for illicit cigarettes included in calculations of price per pack trends across markets, price paid per pack growth would not appear so robust.
Premiumisation is all about product mix. Product mix is a term used to refer to the proportion of premium-price brands to mid-price or low-price brands purchased by consumers in any given market. The big uncertainty however is always the consumer and the kind of price rise, in any given market, capable of halting profit momentum and destroying established pricing structures. The industry does not need reminding of the effect on Imperial Tobacco of the Spanish price war, the sole impact of which forced the company to issue a profit warning two years ago.
Flagship concept under threat?
So, is the major 2012 reduction in global cigarette market value growth described above, a temporary hiatus or a worrying trend for the industry? Pricing strength has, along with the related concept of ‘mix’, become the flagship concept of the tobacco industry, as demonstrated by its increased visibility and quantification in the financial reporting of the major companies. PMI quantified the contribution to net revenues of price increases in 2012 at a massive US$1.8 bn, a larger sum than that contributed by all the company’s sales of OTP, while JTI quantified price/product mix contribution as US$833 million in 2012/13 for its international business. This would suggest pricing strength is alive and well in the tobacco industry, however, a note of caution resides in another indicator. In 2011, according to the PMI 2012 annual report, volume/mix was favourable to net revenues (sales) to the tune of US$609 million , compared with unfavourable to the tune of US$12 million in 2012, suggesting significant down-trading in some markets.
For operating income, a favourable volume/mix of US422 million in 2011 became an unfavourable volume mix of US$233 million. These are major changes reported by the world’s biggest and most profitable international tobacco company which also holds the strongest portfolio of premium brands. Is this the shape of things to come? Is this the first precursor of a phase of ‘depremiumisation’ or a temporary glitch largely attributable to the down-trading EU smoker fearing for the economic future?
One key measure of the ‘premiumisation index’ is to take the world’s top 20 flagship brands, excluding the distorting effects of the leading brands from the Chinese market (Chinese brands account for 7 of the world’s 10 leading cigarette brands by volume) and analyse the share of these top 20 brands over the last three years. The calculation demonstrates that the flagship brands have continued to increase share of the global market (excluding China) from 37.1% in 2010 to 38.8% in 2012.
The premiumisation index - top 20 flagship brands of world cigarettes market 2010-12 (excluding China)
Source: Euromonitor International
So no need to panic about premiumisation just yet? Not entirely, because some of the best performing flagship brands are not strictly in the premium price ban and there have also been a number of examples of the leading companies deploying, for local market reasons, their premium brands in lower price bands, often by launching a cheaper extension to enable the brand to compete with cheaper. For example, in Spain, Marlboro Pocket Pack, was launched at a lower price platform than the Standard Marlboro Red brand straddling the premium/mid-price divide, offering cash- strapped Spanish smokers a mid-price alternative to a normally premium brand …. strategic de-premiumisation?