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December, 2009

Market Watch:
Saturated German Cigarette Market
Sets Course

By Manfred Koerner

Saturated German Cigarette Market Price-Sensitivity Sets Course

Deck. Deck. Deck.

In a time of economic crisis consumers tend to economize on purchases rather than to spend lavishly. Cigarette smokers in Germany are not much of a different breed. Hence, the actual overall decline in the German cigarette market until September of this year. The market consists of four major product categories: manufactured cigarettes (industry brands plus dealers' own brands: DOBs), fine-cut tobacco for roll-your-own (RYO), eco-cigarillos, and pre-manufactured tobacco sticks.

First Nine Months' Results 2009
During the first nine months deliveries of RYOs and tobacco sticks from factory to trade gained in volume, due to low taxation and correspondingly low consumer prices. RYOs went up 7.7%, totalling the equivalent of some 19 bn cigarettes. Deliveries of tobacco sticks reached a volume of 631 mio pieces, representing a plus of 8.5%.

Manufactured cigarettes, in contrast, suffered some, while eco-cigarillos suffered heavy losses. Cigarette deliveries declined by 1.9% overall. Industry brands, however, were relatively better off than DOBs. While the former lost only 1.8% in volume, DOBs' losses accounted for 3.0%. Deliveries of Eco-cigarillos fell by a dramatic 15.1%, its volume totaled 2.19 bn pieces.

It needs no prophetic talent to predict that the consumption over the whole year will follow two mega-trends that influence the market. One is the fact that the German society is ever more health conscious and an ageing one. Older smokers tend to quit more often because of health reasons. Newcomers mainly from immigrants, who formerly filled the gap, are sparse with immigration gradually leveling out. This trend will make its mark on volumes. The other trend is marked by generally lower disposable incomes and fears of mass unemployment yet to come. This will affect the market structure to the effect that lower priced segments will gain over higher priced premium segments.

In Search of Profitability
Since 2003 cigarettes sales have been shrinking. This has driven competition among the major suppliers into high gear. Due to health politics the industry has been deprived of many of their former instruments for commercial communication. Hence, the marketing focus of the companies shifted ever more to price politics, resulting in brand extensions of premium labels to lower price ranges. As a lifeline against losses of individual market shares this exercise proved successful. The market share of low priced industry brands tripled during the last five years. At the same time the exercise was detrimental to brand value with brand cannibalism taking place and to margins and general profitability. Tobacco shops were particularly hard hit, some to the brink of economic extinction.

Such was the situation when market leader Philip Morris staged an autonomous non-tax-induced price hike early this year. BAT, Reemtsma/Imperial, and others followed suit, while manufacturers and traders of DOBs are still reluctant. Up to date smokers seem to generally accept that step, though a steep decline of deliveries in September bodes not well for the rest of this year. There are too many alternatives for the smoker to counter price hikes, whether to switch to lower priced products or smuggled cigarettes or even to stop smoking altogether.

2008 Flickers of Hope For Industry
Overall consumption on the German cigarette market accounted for 124 bn pieces in 2008, four billion less than the year before. This drop represented a minus of 2.7%. However, 2007 and 2006 suffered losses of even four percent each year. Sales of manufactured cigarettes (industry plus dealers' own brands) in 2008 accounted for 86.9 bn pieces, representing a minus of 2.4 bn pieces.

Industry brands fared better compared with DOBs. This despite the fact that DOBs represented a more economic buy than even low priced industry brands. Obviously smokers valued industry brands more. They lost only 1.8% in volume, while DOBs' sales dropped by 9.3%.

Sales in RYOs remained rather stable with only a slight increase of 1.3% year on year. Its volume is equivalent to 32.6 bn cigarettes. Included in this volume are cigarette equivalents from fine-cut pipe tobacco. Its sale vanished into smoke, however, when the Finance Ministry in mid 2008 equalized tax rates with those of genuine fine-cut for RYOs.

Eco-cigarillos and tobacco sticks were both hard hit. Ecos suffered a startling loss of 37.4% year on year, its volume totaling a mere 3.3 bn pieces sold. Sales of tobacco sticks reached a volume of 789 mn pieces, down 13.8% compared to 2007 sales.

Winners And Losers
There are four major cigarette manufacturers in Germany accounting jointly for nearly 90% of the whole market in terms of sales, i.e. Philip Morris (Munich), BAT (Hamburg), Reemtsma/Imperial (Hamburg), and JTI - Japan Tobacco International (Cologne). In contrast to the volatility of brand ranking the market positions of the individual tobacco companies have been relatively stable during the years.

Philip Morris held its longtime undisputed market leadership improving its share slightly to 36.9% in 2008. Losses in its best-selling Marlboro family were nearly compensated by the excellent performance of its L&M range.

Second ranking BAT suffered a minor loss in market share to reach an actual 23.8% of the market. The loss was mainly caused by a failure of its international value brand Pall Mall to uphold its above-average sales from 2007. And there was no compensation from its many other brands. In 2010 BAT has to hand over the Altadis brands Gauloises and Gitanes to rival Reemtsma/Imperial. Both labels account for 6% of BAT's sales. This poses a big challenge to the company. It will have to fight hard to compensate for this loss.

Reemtsma/Imperial recorded some smaller gains in its actual market share of 21.7%. However, the company is still trotting behind BAT, though with a narrowing distance between both of them. Reemtsma/Imperial's success is supported by the enduring strong performance of its leading John Player Special Red label.

Lastly, fourth ranking JTI did quite well in 2008, recording a small gain in market share. It now holds 4% of total cigarette sales. The relaunch of its Winston Classic - which ranks 35th among the 50 leading industry brands - caused an increase in sales of that specific label of nearly 20%.

There are still some minor manufacturers operating on the German market. However, none of them holds a market share of at least one percent. The biggest among the minors is Luxembourg-based Heintz van Landewyck sharing 0.54% of overall cigarette sales. This company produces not only own labels but is also a major manufacturer of dealers' own brands.

Top Ten Brands
There are hundreds of different brands of manufactured cigarettes on offer in a broad variety of tastes, sizes, prices, and packaging. However, the number of original labels is shrinking. Ever more smaller and traditional brands are taken from the market because of lost attractiveness and profitability. Strongest gains have been made by new launches of international value brands in the low price segment, however at cost of the bread-and-butter premium segment. It suffered severe losses in volume, and so did profitability.

With over 11 bn pieces sold Philip Morris' Marlboro Red has a lone star place among the top ten best-selling brands. It is followed by Marlboro Gold with more than half of that volume. Next comes Reemtsma/Imperial's John Player Special Red with an amazing boost in sales by more than 15%, totaling well over 5 bn pieces. Fourth ranking is L&M Red, another Philip Morris brand, with a tremendous growth rate of over 31%. It is the last brand of the league selling over 5 bn pieces.

Ranks No 5 and No 6 are allocated to BAT's Pall Mall Filter and Lucky Strike Red, both accounting for sales of nearly 4 bn and 3.6 bn pieces respectively. Seventh place is held by Reemtsma/Imperial's West Red with well over 3 bn pieces sold, however, losing a dramatic 15.3% in volume. Ranks No 8 and No 9 are jointly held by BAT brands Gauloises Blondes Rot and HB Classic Blend, one recording sales of nearly 3 bn pieces and the other of over 2 bn pieces. The latter brand is loss-making over the last years in two digits percentages. Maybe the traditional label has come into ages as its devoted smokers did, and relaunches could not win over enough new smokers to uphold volume. Last of the league is Philip Morris' Marlboro MX4 Flavor with a volume of nearly 2 bn pieces sold, down some 6.9% year on year.

Legal And Illegal Sales
Generally there was no much change in sales channels. Smokers got their stuff mainly in food stores (37%), gas stations (27%), tobacco shops and kiosks (23%), and from vending machines (13%). The most spectacular changes in sales channels took place in the sector of vending machines in 2006. Then the machines had to be refitted to the requirements of the youth protection law. Being a costly affair outdoor vending machines underwent a strict cost/benefit analysis concerning their profitability. Many of them did not survive. Smokers, too, developed an ever-growing tendency to buy Big Packs. Their share on sales climbed to 34.4% in 2007. The newly introduced Maxi Packs with contents of 28 to 30 cigarettes reached since introduction a market share of 3,6%. Both, Big and Maxi Packs, are not sold through vending machines. All these different developments brought down the vending machines' share of sales from 22.1% in 2006 to 13.4% in 2008.

Most threatening to the tobacco business and all its stakeholders were, again, illegal sales of smuggled products. Experts estimate its volume round about 7 bn pieces. According to a continuing empirical study commissioned by the tobacco industry every fifth cigarette smoked in Germany had not been taxed by the German fisk, i.e. was either legally imported from neighboring countries with lower tobacco taxation or illegally bought from smugglers. Hot spots of smuggling were regions near the Polish and Czech border. In some of them the share of cigarettes not taxed in Germany amounted to well over 50% of total regional cigarette sales. Fake industry brands mainly from East Asia and imported via German ports like Hambug posed not only a commercial loss but also a health risk for smokers who bought that stuff. Those cigarettes were of dubious quality with many toxic ingredients in its blend. All major tobacco companies are working closely with national and international customs authorities to combat that kind of pest.

Sticking to The Rules
In accordance with international developments in anti-tobacco politics Germany is no longer "the land of the free" which it used to be over a long period. Ever more bans and restrictions have been passed by legislators to combat smoking and sometimes the smoker. Latest assault was the regulation that owners of bars, pubs, and restaurants should provide separate rooms for smoking and non-smoking guests. This proved to be a little too much. Public protests from consumers, the tobacco and the HORECA industry drew the attention of the lawmakers. Even the media took a more favorable view towards the cause of the smokers. In the Bavarian election liberals and free voters made considerable gains because of their commitment to soften the regulation. Germany's highest constitutional court judged the individual regulations by the Federal States as unconstitutional because of lack of uniformity and proportionality. Until now 11 of the 16 federal states have changed its legislation creating an exception for small bars and pubs serving no food from the rule of separation.

Brussels emits, again, dark smoke clouds out of its political stacks. In a draft directive the EU-Commission not only proposes a uniform regulation for smoke-free zones in the Union but promotes also the idea of plain packaging. This is somewhat puzzling because Brussels keeps already horror pictures of smokers' diseases in store to be placed on packs some day. The German Bundesrat, the political body of the federal states, rejected the Commission's move as being incompatible with German constitutional law and the principle of subsidiary and asking the government to refuse approval to this kind of proposal.

The tobacco industry is seeking a constructive dialogue and cooperation with the political community either on individual companies' level or through the German Cigarette Association (DZV - Deutscher Zigarettenverband). This is the successor organization of the former German Cigarette Manufacturers Association. It broke down some years ago after Philip Morris left it and was refunded soon after as a new lobbying body without membership of Philip Morris. It has meanwhile given up its former restraint in public appearances and presents the industry interests and positions with more force.

Tobacco International - December, 2009


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