In early 2016, Finnish cigarette smokers prepared themselves for the usual, annual price increase when buying their favourite brands. Indeed, the yearly tax increases of cigarette products have lift up the prices for as long as many of them have persisted with the habit. Instead, unexpectedly, consumers of the far north were astonished to witness that despite the implemented tax increase, the cigarette shelves saw a special batch of lower priced products. How the prices got lowered, and why, remained unclear for many consumers, but what we can conclude from the rare turn is that Finland’s value-based taxation allows companies a certain room for tax planning which this year made ‘discounted’ products available for consumers, and that the industry is operating in an extreme environment seeking to take up all available measures to stay competitive.
Finland’s ad valorem system allows companies room for manoeuvre
The tobacco industry in Finland has been facing tough times already for several decades. While the value growth of cigarettes still looks promising with a CAGR of above 4% over the last 5 years, volumes have gone down steadily with a decline of more than 1% CAGR in the same period.
In Finland, campaigns against smoking and the government’s commitment to fight the industry show success when looking at the declining sales volumes. The frequent tax increases aim for a situation where an average citizen simply cannot afford to smoke anymore, the ultimate goal being a smoke-free society. In 2016 more pressure towards the industry is coming from the European Union. In its attempt to harmonize the union-wide legislation, the so called EU Tobacco Products Directive is being implemented this May. For the Finnish cigarette industry, the ban on flavoured cigarettes in particular will be a difficult transition to face given the fact that the total share of menthol cigarettes was nearly 24% in 2015.
Finland’s tax structure relies heavily on ad valorem, or value-based tax. The tax originates from a time when the country was seeking to protect its domestic production against imports. The tax is progressive in the sense that it increases along with the price of the brand. Hence, the ad valorem based regime is actually more vulnerable to industry pricing decisions than revenues generated by specific taxes. This is because industry price changes results in bigger changes in retail prices given the differentiated nature of the tax across price bands. Furthermore, the scope the tax structure gives for manufacturers to alter strategy in response intensifies along market concentration.
Discounted packs part of normal movement in Finland’s tobacco market
Finland’s cigarette shelves saw a range of cheaper and more expensive brands in early 2016 with some price reduction common across bands. For instance, the price of Smart by Imperial Tobacco declined by 30 cents and Marlboro, ranked second in volume sales, also cheapened by 20 cents from 6 euros to 5.80 Euros.
Companies are able to sell products with two pricing levels due to the fact that before tax increases, always scheduled in early year, companies have to the chance to hoard products into their storages in December and sell those products at the lower tax level during the following year. Finland is actually one of the few countries without legislation on the issue of advance stocking within the European Union. Hence, so called advance stocking is an annual phenomenon in the country and an acknowledged method for companies to avoid, or rather postpone, increasing taxes, hoping to also boost their volume sales.
Consumption volumes predicted to remain negative in 2016
However, the batch of discounted cigarettes on the market this year will probably have no real impact on the sales volumes which are rather set to continue to decline. A strong sense of health awareness among educated citizens is expected to grow even further and campaigns against smoking will be targeted increasingly to the younger generation. Actually for most Finns, increasing cigarette prices are acceptable as they symbolize the strong grip by the government over the ‘errant’ tendencies of its citizens. Over the next five years, cigarettes volumes are estimated to shrink by a further 2% CAGR. Instead of now looking at individual cases such as discounted products on the cigarette shelves, one wonders whether the more acute question is whether value-based taxation in a country without domestic production, along with the opportunity for stock manipulation, brings the intended tax revenue for the government’s pockets.