Tobacco Industry Analytic

The barriers to entry in the tobacco industry are initially low and it is easy for small local and regional companies to enter into the market, but the barriers to enter the market nationally are very high. The economies at scale in manufacturing, distribution costs, and marketing at the national level make it very difficult for start-up companies to enter into the national market. There are substantial costs in raising the capital needed to build manufacturing facilities that can mass-produce tobacco products at the national level. Also, the costs of packaging goods such as cigarettes, at a mass level can generate high costs. Brand identity can also pose a barrier to entry for new entrants. Advertising restrictions imposed on electronic media by the U. S. government make it hard for any new entrant to gain brand awareness and also make it difficult for current top players in the market to increase their brand awareness. While many companies once relied on brand incentives in order to increase customer loyalty, they agreed to no longer use these incentives in the Master Settlement Agreement (MSA) in 1998. Also with many already established brands such as Altria’s Marlboro Cigarettes brand already have a huge stake in the market place. They have generated a lot of brand loyalty and awareness making it difficult for a new company to generate enough brand awareness to enter the market. Suppliers In the tobacco industry farmers supply the tobacco to dealers and manufacturers. Many of the tobacco farmers in the U. S. are located in the Southeastern states such as North Carolina, South Carolina, Georgia, and Florida. Farmers usually sell their tobacco at public auctions to the highest bidders. A federal program that started with the Agricultural Adjustment Act of 1933 once protected tobacco farmer’s prices. The tobacco growers were guaranteed minimum prices in exchange for limiting their production through allotments and quotas. U. S. grown tobacco is generally more expensive than non-U. S. grown tobacco because of the U. S. governments price-support system. Then in 2004 the government allowed for buyouts of the quotas, thus eliminating the price support system. However, in recent news many tobacco farmers are protesting for the entire buyout of their quotas and equipment. They say that the U. S. tobacco growing industry is on the verge of disappearing and they blame the high taxes on cigarettes and cheap tobacco imports. Thus illustrating that the farmers have little bargaining power due to the government interaction. Buyers Buyers in the tobacco industry are greatly affected by the economy and the level of their disposable income. Whenever a buyer’s disposable income declines, they are more likely to purchase cheaper brands of tobacco, and if a buyer’s disposable income increases, then they are more likely to buy more expensive brands. Buyer power was displayed in 1993 whenever Phillip Morris USA Inc. slashed their prices on leading brands such as Marlboro by 20% to raise their share of the market, thus leading many other leading companies to also reduce the prices of their popular brands. After many companies lowered their prices, discount cigarette brands saw a drop in their percentage of the market. However, in 2003 premium cigarette brands raised prices, then allowing discount cigarette brands to gain more of a share in the market, but the discount brands share in the market has been declining ever since. Consumers in the United States are now increasingly becoming more concerned with health issues. Consumer health awareness has hurt the market for tobacco sellers and has also led to the increase for government regulation. Many companies are now going international to focus on the increasing demand for tobacco products abroad. They are focusing on developing countries where the population is increasing much faster than in the United States and many of these countries have less government regulation, which can help with advertising and prices. Countries that have less taxation on tobacco sales can lead to higher revenues and sales of tobacco products because the costs involved are less. Industry Competitors/Intensity of Rivalry Within the tobacco industry there are three main competitors that control 90% of the domestic market. These three main players are: Altria Group, Inc. (Domestically known as Phillip Morris USA); Reynolds American; and Carolina Group. Phillip Morris USA, the United State’s largest tobacco company since 1983, controlled 50. 3% of the market share in the year 2006. Phillip Morris USA’s leading brand Marlboro had a 40. 5% share of the market in 2006; thus, displaying the importance of brand identity in the tobacco industry. Phillip Morris USA also offers different brands such as their premium brands Virginia Slims and Parliament, while also targeting the discount market with its brand Basic. The United States second largest tobacco company is Reynolds American, which offers premium brands such as Kool, Winston, Salem, and Camel; and two different discount brands, Doral and Capri. Reynolds American controlled 29. % of the market in 2006 and is also the second largest moist smokeless tobacco producer in the United States. The third largest company in the United State is Carolina Group with their premium menthol brand cigarette Newport that controlled 9. 7% of the market in 2006. For the cigarette industry unit volumes have declined and the price of cigarettes has increased,thus creating higher net revenue for companies. Many companies are u sing cost efficient strategies and are merging to help gain profits in the industry. For example, R. J. Reynolds and Brown & Williamson Tobacco merged and now have a higher share of the market. Tobacco consumption declined a lot from 1994 to 2004 and the decline has started to slow down in the past couple of years, the growth rate is still not what it once was. [pic] Figure 1 : Market share holders in 2006 Rivalry in the menthol sector of the tobacco industry has been a strong focus of the leading companies in recent years. Menthol cigarettes offer a chance for domestic growth opportunities and premium pricing in the tobacco industry. Carolina Group controls this sector with its leading brand Newport, while Reynolds American offers two brands, Kool and Salem, which have been in the market for a long time. With the potential growth in the menthol sector, the leading tobacco company Marlboro introduced their menthol brand with strong promotions to compete with already existing brands. Other potential areas of domestic growth in the tobacco industry include cigars, which are on the rise again; and snuff or smokeless, which is one the rise due to smoking restrictions in public places. By using the Porter’s Five Forces Framework I was able to discuss the five basic competitive forces within the tobacco industry. The level of difficulty for new entrants; the lack of bargaining power of suppliers; the bargaining power of buyers between different brands; the high level of potential substitutes; and the competition rivalry, as well as domestic growth areas; were all analyzed within the tobacco industry using the Porter’s Five Forces Framework. Dominant forces such as government regulation and health awareness influence change in the tobacco industry. The potential impact that theses forces could play on the tobacco industry could be harsh if companies don’t adjust and change with them. Strengths: Altria and R. J. Reynolds both display much strength within the tobacco industry. Both companies display high levels of brand identity and brand awareness with many different well-known brands. Altria has dominant control of the market with their diversified Marlboro brands of cigarettes that dominate the market, contributing a 40. 5% share in the market. R. J. Reynolds also has many well-known diversified brands such as Kool, Winston, Salem, and Camel that help to control 29. 8% of the market. Both companies can use their strong brand awareness to build customer value with existing and new products. B oth companies are aligned with their mission statements to provide for their customers and maintain levels of responsibility and integrity for their operations. Altria, for instance offers a wide array of information concerning health issues, tobacco laws, cigarette ingredients, and youth smoking prevention on their website. While R. J. Reynolds offers information to the public on legal and regulatory issues, maintaining responsible marketing, and also health issues related to their products that consumers can access on their website. Also, both companies produce mass amounts of tobacco products and in order to be the top two producers in the United State they must both have strong manufacturing infrastructures. Weaknesses: Both companies face the weakness of selling dangerous products to consumers. Tobacco products obviously involve a great deal of health risks and consumers have been made well aware of the risks involved in tobacco use. Both companies face liability issues and litigation for the sale of such a dangerous product, which can cost the companies a lot of money. These companies must place a great deal of concentration on defending themselves in numerous lawsuits that come about frequently due to the health liability issues. Recent cases involving the â€Å"light† cigarettes have been brought against Altria, these cigarettes have lighter amounts of nicotine and tar but still can be just as harmful as regular cigarettes. Also a lot of blame for such high health care costs in the United States is placed on these companies as well. Another weakness that Altria and R. J. Reynolds suffer from is their dependencies to rely solely on the sale of tobacco products in order for them to remain such profitable companies in the market place. Sales from 2000 to 2005 declined at around an average rate of 4% a year and a decline of about 1% in 2006. If sales continue to decline every year, this could lead to substantial effects on profits. With the cigarette consumption declining, companies such as Altria and R. J. Reynolds have began to look towards international markets with growth opportunities. With so much concentration on tobacco sales both companies also have the weakness of being so heavily invested in the success of the tobacco industry. These companies could face a great deal of losses if the tobacco industry keeps declining. Opportunities: Both Altria and R. J. Reynolds have the opportunity to expand the ir companies internationally to target new customers in areas that provide potential for growth in sales. With the help of countries with rising personal incomes, high per capita cigarette consumption, and less government regulation in foreign countries Altria is taking action to expand their horizons abroad. An article from Wall Street Journal by Vanessa O’Connell describes how Altria is using spin off, Phillip Morris International to focus on international markets such as Pakistan, where smoking consumption is up 42% since 2001; Ukraine, where smoking consumption is up 36%; and Argentina, where smoking consumption is up 18%. She also explains how China offers 50 million more tobacco buyers than in the United States, thus showing that China offers great potential market opportunities. R. J. Reynolds is also focusing on the global market with creation of R. J. Reynolds Global Products. R. J. Reynolds is participating in joint ventures in European countries and Japan, collaborating with other companies to produce American-like brand cigarettes in foreign markets. They have also been establishing a business presence in Puerto Rico and the Caribbean and are supplying cigarettes to the U. S. military outlets and U. S. Duty Free sectors. R. J. Reynolds also manufactures cigarettes to be sold by other companies in foreign countries. Both companies are taking advantage of the potential growth in international markets. Another opportunity that both companies are focusing on is the opportunities of marketing new tobacco products to consumers. With more consumers looking for alternatives to smoking Altria has been f ocusing on developing its smokeless tobacco product line. With snuff being providing potential growth in the market, Altria is exploring the moist snuff or chew market as well as a new product called Snus. Altria is currently test marketing its Marlboro Snus products and its Marlboro moist smokeless tobacco in certain areas of the United States. They are also using the strong brand identity of Marlboro to help their new products enter into the market. R. J. Reynolds is also developing new products that have potential market opportunities. Reynolds is developing new exotic brands of Camel cigarettes and also trying to capitalize on smokeless tobacco opportunities with their brand of Camel Snus. Both brands are using their already existent brand awareness to help romote new products in the market. Threats: Companies in the tobacco industry such as Altria and R. J. Reynolds have a negative public perception because of providing such dangerous products and must deal with this perception accordingly in order to remain in the market. With the threat of being seen so negatively in the public eye companies must provide support in educating consumers about the dangerous health risks involved wi th smoking. Government regulation also poses a threat to both companies. In the 1998, the Master Settlement Agreement between tobacco companies and the government came to an agreement that tobacco companies would have to pay $250 billion over a 25 year span to help reimburse healthcare systems for to higher costs due to many patients with tobacco use related illnesses. The threat of government regulation poses high cost threats dealing with litigation and taxes. Both companies have been affected by the high taxes placed on the sale of tobacco products, thus causing them to have to raise prices, which could have a negative effect on sales. Also the threat of changes in the legal atmosphere pose a problem on companies. As new laws are adopted both companies must adapt to stay profitable, such as the new public smoking laws that threatens both these companies that rely on cigarette sales. The threat of Altria’s and R. J. Reynolds’ consumer base growing old and dying off from tobacco related illness and America’s new focus on healthy living styles display how these companies are affected by the benefits of substitutes for smoking and quitting smoking. There has also been a huge decline in the number of smokers in the United State over the past 40 years, which has cut the consumer base in half. With the number of smokers in the domestic market declining both companies also face the threat of marketing restrictions in the United States. Tobacco products cannot easily be marketed to consumer in the United States, which threatens the growth of tobacco products. Both Altria and R. J. Reynolds are aware of the threats that they face and that can explain why they are developing new products and moving towards international markets. The SWOT Analysis displayed how strengths such as brand identity have played a huge role in the success of both Altria and R. J. Reynolds. Altria leads the market with its well-known brand Marlboro and is taking on opportunities with new products and international markets. While R. J. Reynolds has a smaller share in the market they are also trying to grow by focusing on the same opportunities. Both companies also face many of the same weaknesses and threats, that being in the tobacco industry pose, such as government regulation and health awareness. They are taking action to deal with them by exploring new opportunities.