In the light of declining cigarette sales in many mature markets, and the only regional growth areas of the future being Asia and Middle East/Africa, the tobacco multinationals are left with only a handful of main routes to generate growth apart from innovation in cigarettes: M&A, expansion into other, non-combustible nicotine delivery formats or expansion into other non-tobacco industries altogether. The problem with M&A is the tobacco industry’s concentrations (the top four multinationals account for 45% of total world volumes), whilst other non-tobacco industry presence is thwarted by public antipathy to big tobacco (though is working for the Indian conglomerate ITC), leaving expansion into the so-called ‘reduced risk’, non-combustible product category currently the most buoyant.
Furious and sustained industry consolidation over the past few decades has left only four international tobacco companies – Philip Morris International (PMI), British American Tobacco (BAT), Japan Tobacco (JT) and Imperial Tobacco (IT). These four companies account for some 45% of the global market in volume terms, or around three-quarters of the market excluding China. However, most of the countries where these companies make most of their sales have declining cigarettes markets and volume growth has instead been generated via M&A. As a case in point, in 2010, the only one of the four to record volume growth was PMI, achieved via the new volume gained by the merger of its Philippines subsidiary with Fortune Tobacco.
The problem is the lack of available companies to acquire. There are some major national companies which have not been acquired: the private companies Altria and Reynolds in the US, the state companies in Egypt, Thailand, Algeria and a number of others but none of these are on the market. This is why the sudden availability of Donskoi in Russia is of particular interest. Russia is the second-largest market in the world and all the four global companies are probably right now involved in competing for it.
There will be other acquisitions and from time to time – it is even suggested that Imperial Tobacco, smallest of the big 4, might become the target of one of the other three, attracted by its strong positions in the UK, Spanish, French, German and Moroccan cigarettes markets. And, in addition, Imperial has OTP appeal as global leader in smoking tobacco and cigars.
There are two other companies in the global tobacco market which could prove of strategic interest to the four majors – Swedish Match and Scandinavian Tobacco Group (STG). Last year Swedish Match and STG exchanged various parts of their businesses to create Swedish Match as a global smokeless specialist and STG as a global cigars specialist.
There is also an x-factor in the M&A future and this is China. CNTC, the Chinese state tobacco company, has already given notice that it plans to cut the number of domestic cigarette brands to less than 20 by 2015 in a bid to compete with the international companies. In May 2011, STMA (which administers the CNTC) held a conference at which it was announced that Chunghwa, Zhongnanhai and Golden Deer were to be promoted as international brands while Red Double Happiness was to be promoted as a key regional brand. Earlier in the year there were reports of cooperation with and possibly even acquisition of Sekap of Greece although it now appears that Bommidala Enterprises of India will acquire a major stake in Sekap.
But perhaps CNTC is gearing up for something bigger: the company already sells, in China alone, volumes equivalent to the total sales of PMI, BAT, JT and IT combined and there has been speculation for some time that the Chinese state company might acquire an international company. It would make strategic sense: Chinese brands are made from Virginia blend tobacco while most global brands are American Blend (which includes Virginia and also Burley and oriental tobacco). The acquisition of a major American blend brand (eg Marlboro, Winston, Camel) would add a dimension to CNTC’s brand portfolio.
Of course there are other paths to growth for tobacco companies than acquisitions or organic growth. One path is to use the unmatched cash flow generation of tobacco to fund diversification into other FMCG areas. This is the strategy that ITC, the tobacco market leader in India, has been following for some years – expanding into areas such as foods and lifestyle products to become India’s biggest FMCG company. This is a strategy which was tried in the past but then rejected by Philip Morris (who famously owned Kraft in the 1980s), BAT (variously owning Saks Fifth Avenue and Marshall Field’s in the US and financial services groups in the 1980s), and Imperial in order to return to the core tobacco business.
The other big trend in NPD and innovation is the drive to offer ‘reduced risk’, non-combustible cigarette alternatives, such as traditional smokeless tobacco as well as more novel products such as Altria’s Tobacco Sticks and JT’s Zerostyle. Acquisition of such products (JTI’s recent minority stake in Ploom, a pocket-sized smoking device that heats tobacco, vaporizing nicotine without burning the materials or producing smoke, and its plans to commercialise the product outside the US) as well as the launch of smokeless tobacco initiatives by the majors themselves (for example BAT’s Nicoventures) all point in the direction of cigarette alternatives being the main area of new product development.
Looking ahead, the pace of new product development is likely to accelerate as the companies race to cement the qualities of their new brands in the consumer mind before price rises cause loyalty to waver. Another way in which NPD is a race against time is the trend towards flavour bans which, where adopted, remove a whole genre of products, particularly should menthol ever be included in flavour bans. Perhaps the most intriguing possibilities for the industry are tobacco-free brand extensions to major brands from BAT and PMI, offering products that provide the iconic appeal of the cigarette but none of the carcinogens should their investments in new nicotine delivery product technology bear fruit.