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Cigarette industry Essay

Introduction The cigarette industry is highly controversial. While facing increasing regulations worldwide, it persistently presents large profits for its main players, posing an interesting paradox. Since the sass’s the worldwide consumption of cigarettes has been increasing, yet at a slower rate in the recent decades (Appendix 1), reflecting the negative growth in sales among developed nations (Gauguin et al. , 2003). Concerned about public health, governments worldwide have been fighting consumption since the sass’s through increasing taxation and tightening regulations. Rumination, and only 27 countries have tax rates higher than 75% of the retail price. After the widespread policies of banning smoking from public spaces and having health warnings on the packages, EX. countries are soon expected to follow Australia in adopting plain packaging. The comparison of two fundamentally different market environments in Italy and Saudi Arabia yields vital information on the challenges the cigarette industry faces and the strategic orientation its main players should take.

The results of this analysis will be applied in the last part in order to formulate a comprehensive strategy recommendation for a particular company operating in Saudi Arabia. 2. Evaluating the market attractiveness in Italy and Saudi Arabia 2. 1 . General market characteristics Appendix

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2 summaries important general market characteristics of Italy and Saudi Arabia. It is worthwhile highlighting that despite Italy being the more populated, more developed and richer country, the population in Saudi Arabia is younger and faster growing and annual income per capita too is increasing at a faster pace.

In addition, Appendix 2 reveals that smoking prevalence is increasing in Saudi Arabia, however, unevenly distributed between men and women. Moreover, the relative price f cigarettes to average household income which should have a significant impact on the consumption of cigarettes (Guiding, 2003) differs dramatically in both countries. In fact, real prices of cigarettes in the Middle East have almost halved, whereas in the EX. they increased by 9,2% (Appendix 3). 2. 2. Five forces analysis Italy and Saudi Arabia Internal Rivalry With Heralded indices of 3307 for Italy and 3700 for Saudi Arabia, both markets are highly concentrated oligopolies dominated by the same four companies (Graphic 1). MIMI is – with over half of each market’s sales – the leader in volume shares, followed y BAT with less than half of Mi’s shares. Interestingly, JETS and TIGHT occupy positions 3 and 4 in Italy but switch roles in Saudi Arabia.

Due too production ban in Saudi Arabia and take-oversee in Italy, there are no local brands in either market. Graphic 1: Source: Remuneration International 2012 In the multi-stage scenario, the saturation of the markets discourages from price wars since there is no further volume to be generated, instead companies in this highly concentrated industry engage in careful cooperative pricing to exploit current demand without destroying profits (Italian Antitrust Authority, 2003).

Table 1: MI stands for Philip Morris International BAT stands for British American Tobacco TIT stands for Japan Tobacco International 4 ITS stands for Imperial Tobacco Group Table 2: The most striking difference regarding internal rivalry in the two countries is the adverse development of industry growth. Despite still being the bigger market (graph), Italy decreases at a rate of 1,4% annually. The cigarette industry in Saudi Arabia on the contrary grew by 28% in five years and forecasts of 38% volume growth until 201 5 suggest its role as rising star (Remuneration International 2012).

Increasing price-elasticity, especially in Europe, countervails historically high brand loyalty of Italians and could leave internal competition more fierce than before (Gallus et al. , 2006). Combined with increasing smoking restrictions as well as marketing regulations, this could, in the future, endanger cooperative pricing in favor of cutting prices in order to steal less loyal customers from competitors in a shrinking overall market. Therefore, despite minor differences, internal competition in both markets can presently be considered low, however with the prospect of a attention increase in Italy due to the described developments.

Entrants Threat of entry, determined by attractiveness to enter the market and barriers to doing so, is substantially different between the two countries. While Italy’s high taxation (57% of retail price), its downward sloping demand for cigarettes, strict smoking restrictions and regulations on marketing, as well as the increasingly old population shed doubt on the market’s long-term attractiveness (WHO, 2010), Saudi Arabia can score with the opposite development and an attractive target population characterized by low average age, increasing incomes and less general health wariness (Remuneration International 2012).

The superior scope of actions possible to companies operating in this market makes entry into the Saudi Arabian cigarette market more desirable in the long run. However, there are comparably high structural barriers to entry in both markets. Cigarette companies generally require high volumes to operate on efficient scales (van Limit, 2002). Highly automatic production processes require fairly heavy upfront costs and the trend away from auctioning towards direct contracting with farmers favors established relationships of incumbent firms with particular farmers (Hull 002: Tobacco in Transition).

The limited possibilities of marketing new products are particularly for the Italian market as can be seen from Yokes, an Italian cigarette company successfully operating in Korea that fails to properly penetrate its local market (Yokes, 2012). Saudi Arabia, in contrast, potentially faces a more serious 5 threat of entry by the Chinese Honing Group, the biggest cigarette company in volume terms which is trying to enter the Middle Eastern market (Hadley, 2011).

Being one of the largest manufacturers globally, it is most likely to overcome many of he mentioned barriers due to the already established infrastructure and the internal capital market to subsidize heavy marketing. Overall, the superior attractiveness of the Saudi Arabian market combined with the relatively easier entry leaves threat by entry higher than in Italy. Supplier Power Regarding threat by suppliers, such as farmers, situations in Italy and Saudi Arabia differ largely.

Due to the fact that cigarette companies operating in Saudi Arabia import their cigarettes, there are no direct influences of suppliers on the Saudi Arabian cigarette market in particular. Since Italy, however, does still produce cigarettes (World Tobacco, 2008), it faces potential threats by suppliers. The supply side of the cigarette industry is characterized by low concentration, which makes coordination against the few cigarette giants difficult.

Farmers are lacking possibilities to differentiate their products and instead of threatening with forward integration they are increasingly confronted with backwards integration by big cigarette companies. The before- mentioned shift from “auctioning” as the primary supply channel to direct contracting results in a decreased power of farmers. Around 80% of all transactions are negotiated directly between a cigarette company and particular farmers, determining price and quality criteria in advance and leaving farmers with all risks and little to no negotiation power (Hull 2002).

Furthermore, practices by tobacco Ones, such as Mi’s Good Agricultural Practices, which determine mandatory criteria for suppliers (e. G. No child labor) additionally diminish supplier power (MI, 2012). In general, it can be concluded that supplier power is negligible and neither an issue in Saudi Arabia nor significantly in Italy. Buyer Power The distribution channels of cigarettes are remarkably different in Italy and Saudi Arabia. In Saudi Arabia various channels coexist.

Supermarkets/hypermarkets and small grocery stores (mainly independent: e. G. Backslash) each sell around 40% of total cigarette volumes and leave the rest of the shares to various other players, such as tobacco specialists, bars, hotels and restaurants (Remuneration International 2012). Italy, in contrast, requires possession of a 6 license to sell cigarettes, which essentially leaves the market with a single distribution channel of privately-owned Tobacconist shops. This diminishes the market.

The fact that – unlike in Saudi Arabia cigarettes are essentially the only products sold by Tobacconists further decreases their power, because it creates a potential hold-up situation for the cigarette giants once the specific investment into being a Tobacconist has been made (Bespeak et al. , 2010). In Saudi Arabia, retailers have a slightly higher power over cigarette companies engaging in relationships with them for mutual understanding of each other’s strategies and to discover potential cooperation areas (BAT, 2012).

This “privilege” would be unimaginable for small Italian Tobacconists and could thus be interpreted as a means to tie powerful buyers to one’s own business and establishing relationship-specific investments on both sides (lock-in). To sum up, distribution is not a threat to industry profits in either country. Buyer power in Italy is very low, whereas in Saudi Arabia the distribution system and the presence of big retailers allows for some negotiating possibilities.

However, this phenomenon has not been documented and the potential power of buyers in Saudi Arabia is cleverly turned into an advantage by the cigarette companies which not only try to benefit from relationships with retailers but also exploit the power of distribution channels in terms of marketing. Substitutes Both countries are characterized by large substitute consumption. Whereas in Italy the high cross-price elasticity between cigarettes and RYO tobacco makes this the primary alternative to cigarettes, RYO only plays a negligible role in Saudi Arabia.

Instead, Aisha tobacco is by far the dominant category in volume terms in Saudi Arabia (Remuneration International 2012). The unmatched popularity of Aisha Table 3: tobacco is based on its traditional unction and social acceptance as less harmful (Remuneration International 2012). Saudi start smoking Aisha at earlier age paving the way impressive growth rates such as 24% in only five years International 2012). The market is dominated by many small local companies and brand establishment is said to be difficult.

This 7 suggests that prospects of entry by big cigarette companies into this market do not suggest high profitability. Whereas RYO is actually luring away consumers from cigarette consumption in Italy, Aisha tobacco in Saudi Arabia is not a reason for smokers to quit and substitute cigarettes. Therefore, this particular substitute threat is to be taken seriously but it could even be converted into an opportunity for cigarette companies to learn and expand the overall market by attracting Aisha smokers.

Although occupying only about of the amount of cigarettes consumed annually, cigars’ substituting function has to be taken into account too due to two facts: their unprecedented growth of 53% in only five years and their inferior affection by regulation (Remuneration International, 2012). Increasing incomes and the tendency to demonstrate status with luxury accessories have given cigars as a humbly of wealth and power an impressive upswing.

Taken all together, the threat by substitutes can be estimated high in both countries. However, the opportunity offered by the Aisha market as well as the monopoly-like situation of tobacco in the ‘relaxation-market’ (alcohol is forbidden) partly offset this effect, leaving threat by substitutes in Saudi Arabia medium. 2. 3 Final evaluation In order to provide a more sophisticated industry evaluation, a regression analysis revealing the true drivers of cigarette consumption would have been necessary.

However, since its complexity would have surpassed the scope of this project and because we found other interesting empirical studies with validated results (Gauguin, 2003), we have focused on descriptive statistics as well as the five forces and SOOT analysis to compare the market attractiveness. Using the example of Italy and Saudi Arabia, we have highlighted the differences in the cigarette industry today among industrialized and developing countries.

The five forces and SOOT analysis generating solid cash flow for the cigarette industry, its prospects for the future are unclear or negative. Tougher regulation, increasing price sensitivity of consumers and the emergence of tobacco-related substitutes all put pressure on industry profits in Italy. Saudi Arabia, on the other hand, not only shows population growth, but also solidly increasing smoking prevalence.

Moreover, neither the risk awareness towards smoking, nor current regulations is as strict as in the Western world which leaves some flexibility for firms to work on increasing their sales in the future. 8 4. Strategy recommendation for British American Tobacco in Saudi Arabia In an industry where disruptive innovation is impossible and where prices are stable, achieving a competitive advantage is very difficult. Identifying the most critical challenges and opportunities is paramount in building a competitive edge based on the business areas firms do have an impact on.

The mid-term strategy recommendation for BAT, the second largest player in the Saudi Arabian market, outlined below is directed at dealing with the increasingly tough regulation, promoting change from Aisha tobacco to cigarettes and positioning particular cigarette brands to match the local customers’ needs. In order to identify areas in which competitive advantage can be built and sustained, we have analyses BAT’s value chain with all its “primary activities” and “supporting activities” (Porter, 1985).

Since logistics and operations are part of a complex global supply chain that has Just been reconfigured with a focus on maximizing operating efficiencies, it is not detailed in our analysis (Godsend et al. , 2010). However, we would like to emphasize that having a general cost advantage over competitors is crucial in gaining a competitive advantage in the first place as the theory of indifference curves ND trade-offs between price and quality suggests (Bespeak et al. , 2010).

Building on that superior cost structure, we recommend that BAT in Saudi Arabia focus on activities in the field of Human Resources as well as Marketing and Sales as this is where they can make a country-specific difference and gain a competitive edge. Securing highly driven people that are familiar with both the global cigarette business, but also know the specifics of the local market, is essential, yet is doesn’t represent a sustainable competitive advantage, since talented staff could be lured way by competitors.

Basic economic theory suggests that besides the mere size of operations and subsequent economies of scale, learning economies are another source for reducing the average costs of business (Bespeak et al. , 2010). As learning economies are deeply rooted in a firm’s Human Resources, we have selected this secondary activity as a focus area. BAT needs to exploit its learning economies and path-dependent knowledge by, for instance, transferring valuable experiences made in dealing with anti-smoking regulation in industrialized nations to Saudi Arabia.

The degree to which BAT can exploit its Human Resources and knowledge management presents an opportunity for building a sustainable competitive advantage. The second activity that allows BAT to sustainable differentiate its operations from competitors is Marketing and Sales. When applying the ROB, we could conclude that the actual resources needed to produce cigarettes do not vary greatly between the major players in the industry, however, the category where all firms differ is the brands they sell.

We advise BAT to (re)position three of their few immobile resources, TTS renowned brands (Dunghill, Lucky Strike and Earthman), in order to tackle the challenges and opportunities mentioned earlier. Thanks to the diverse brand portfolio of BAT, we can apply two of the three generic strategies “differentiation” and “cost leadership” described by Porter without being “stuck in the middle” (Porter, 1980).

Finally, while showing its dynamic capabilities, BAT needs to find the right balance between exploiting existing and developing new capabilities on both the product and resource level in order to master the challenges of the coming years (Heartfelt, 1984). Due to the perception of cigarettes as luxury products and the overall importance of prestige in the Saudi Arabian society, we recommend BAT to follow a “differentiation strategy’ for Dunghill and Lucky Strike.

More precisely, Dunghill should be promoted as the classy market brand and should increasingly target the untapped market for female smokers by featuring an extra light version with a feminine touch. In general, packaging needs to live up to the high standards of consumers and their tendencies towards luxury goods whereas particularly Saudi women are extremely conscious of heir attire and the aesthetics of the few visible accessories they can reveal (NY Times, 2006).

Being the first cigarette company to actively target the female market would present BAT with a first mover advantage which can build a competitive advantage over the next decades. Responding to socioeconomic trends (Remuneration International 2012), the brand Lucky Strike needs to be positioned as the young and Western cigarette brand for the Saudi Arabian generation Y with creative packaging and promotions which can be executed online or in trendy locations.

Targeting this customer group is crucial in two ways – future cigarette sales largely depend on this demographic and convincing young Arabs to smoke cigarettes instead of Aisha tobacco is a major milestone in fighting the most influential substitute. Anticipating increasing price sensitivity of demand and being able to fight potential entrants, we recommend a “cost leadership strategy’ for Earthman. This brand would offer “more for less”: selling in big packs at the same price as 18 sticks packs of the standard cigarette brands.

This strategy has already proven successful in the I-J and could help to lure some customers 10 onto smoking cigarettes instead of Aisha tobacco (Miller, 1993). Nevertheless, we would like to stress that price wars do not work in industries where tit-for-tat like pricing adjustments do nothing but destroy profit margins and customers don’t actually switch brands. In fact, rice cutting only works for entirely new customers as 5.

Conclusion Even though tobacco companies are among the most profitable businesses in the world, growth in cigarette sales is slowing down resulting in a probable increase of rivalry in the industry in the long run as well as pressure on profits. As our analysis suggests, the cigarette industry in Italy might have already seen its best times and might face increased rivalry in the coming decades. However, we also saw that the many opportunities a developing market such as Saudi Arabia offers are yet to be fully exploited by the big tobacco companies.

Applying basic economic theory and concepts such as Porter’s value chain and the ROB, we formulated a mid-term strategy recommendation for BAT in Saudi Arabia. We identified Human Resources and Marketing and Sales as key areas to build future competitive advantage. Exploiting the learning economies of its human resources next to a brand re)positioning targeting the major demographic trends will give BAT a competitive edge in the coming years.

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