Big Tobacco Gets Tough - new tactics after imposed marketing restrictions - Industry Overview - Statistical Data Included

Brandweek,  May 14, 2001  by Mike Beirne

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When the Master Settlement Agreement imposed marketing restrictions, Philip Morris and R.J. Reynolds back with tough tactics to squeeze their competitiors off shelves.

If you thought the 1998 Master Settlement Agreement succeeded in putting Big Tobacco in its place, think again. As part of the settlement, tobacco giants Philip Morris, R.J. Reynolds, Brown & Williamson, Liggett Group and Lorillard Tobacco agreed to pay $246 billion to 46 states suing the industry to recoup Medicaid costs. The cigarette companies also promised to adhere to a ban on outdoor advertising and curb youth-oriented marketing programs involving product placement, branded merchandise and multiple sponsor-ships.

While heralded as a huge victory by anti-smoking groups, the MSA has not stopped the tobacco industry from getting its message through to consumers. A recent report by the Federal Trade Commission indicated the Big Five tobacco giants spent a record $8.24 billion on advertising in 1999, $1.5 billion more than in 1998. Print advertising, the only remaining mass-media outlet for cigarettes, soared 37.8% to $428.3 million. Still, that was a mere 5% of the total spending in the category.

So where is the rest of the money going? A huge portion--more than $3.5 billion--is being pumped into retail outlets through price promotions and merchandising contracts. And that's where the tobacco giants are turning up the heat with aggressive--and some say bullying--tactics, to squeeze out rivals.

"The Big Two are more aggressive about dictating what goes on the store shelves," said a Southern operator of a tobacco outlet chain." Honestly we used to joke about the 'Philip Morris police.' The Philip Morris reps would come around and wreak havoc on anything that was wrong with the store, or if their market share wasn't what it should be, or if a competing brand had an extra sign or something. They would just have a fit."

Now, R.J. Reynolds is trying to flex its muscles in similar fashion. "I took our Reynolds rep outside recently and showed him the sign on our store," the operator said. "I told him when R.J. Reynolds' name is on that sign, then you can tell me what is and what is not going in here and how much I can sell it for."

If retailers are feeling the heat from tobacco companies, the reasons are pretty clear. Trying to compensate for huge MSA-dictated payments and a steady decline in cigarette consumption--analysts are projecting another 2% drop in 2001--manufacturers have introduced five price hikes in the last two years. As a result, average wholesale prices are up 74% in the $50 billion U.S. tobacco industry. Each price increase opened the door a little wider for discount cigarette brands, whose market share crept up to 3.7% last year, according to the Maxwell Report.

With the renewed pricing pressures, even category leader Marlboro is resorting to repeated discounts. "Marlboro never used to be on a reduced price for two months in a row," said one Midwest wholesaler." Now it's on two months, off one, on two months and off ... I don't think that hurts the strength of the brand because they can't advertise like they could before, and the only way to grab market share is with price."

Yet there's an even more intense battle taking place: on the shelves. In the aftermath of the MSA, Philip Morris and RJR have increased cash rewards to retailers who give top shelf placement and prominent signage to their brands. Contracts often include extra "buydowns," cash manufacturers pay retailers for passing reduced prices on to consumers.

The Big Two typically negotiate for 55% shelf placement. While the actual percentage varies per contract, Philip Morris requires participants in its Retail Leaders incentive program to give its products top-rack positioning. Similarly, RJR asks for No. 1 or No. 2 shelf position for its Retail Partners and, for certain levels of participation, no less than than 12 linear feet of display space for its core Winston, Camel and Doral brands. Window decals, signs over permanent displays and a dedicated area for flagging promotions are extras in both programs, earning retailers more bonus cash and benefits like coupon mailings to drive traffic to specific stores.

One Tennessee operator of tobacco outlets and c-stores, who dropped the Philip Morris contract two years ago because of "unreasonable" demands for compliance and signage, was gently coaxed back into the program by a recalcitrant PM. This year, he's allocating 35% to PM, 40% to RJR and 10% to B&W. But adding Philip Morris, he said, will force him to shrink his offerings of Lorillard and drop his contract with discounter Commonwealth.

Driving his and other retailers' decisions are incentives given for top brands like Marlboro, with its dominant 38% market share in the first quarter, per company figures. Those who don't receive some of the lucrative buydowns and promotions risk seeing consumers flock to participating stores where the brand is cheaper.

A similar phenomenon is occurring with RJR's Everyday Low Pricing program. EDLP stipulates that retailers stock a Reynolds deep discount brand, like Best Value or Monarch, and ensure that no other cigarette in the store will undercut its price. Doing so earns participants an extra dollar buydown on Doral, the branded savings smoke whose market share fell 0.5% to 6.2% last year thanks to cheaper, deep-discount brands, also dubbed "fourth-tier" cigarettes because they rank below private-label, branded savings and full-priced premium smokes.