Jan 29, 2000|
Fighting smokestack valuations
Cigarette smoking may be injurious to the consumer's health but cigarette sales have been very profitable for the industry. So far, that is.
A three horse race characterised by high entry barriers:
The industry is basically a three horse race between the Indian Tobacco Company (ITC), Godfrey Phillips and Vazir Sultan Tobacco (VST). These three companies account for 95% of the total domestic cigarette sales with the fourth player viz. GTC having wiped out its net worth. It is characterised by high entry barriers that exist in terms of:
Brands:To build up a new brand in cigarettes have proved a difficult task. Infact, there has been no successful launch of a new brand since the late 80s when VST launched 'Charms'. Repeated attempts by all the existing players have been failures and they've been restricted to launching variants of the existing brands.
Distribution network:An extensive distribution network is required for a high transaction good like cigarettes.
Capital:The minimum economic size for an international scale cigarette making facility is a 7500 million sticks per annum, which requires an overall investment of Rs 1 billion.
The cigarette market is divided into five major segments (see table).
The cigarette sales for all the three companies have on an average declined in volume terms by 5.5% in April-November 1999 vis-…-vis the corresponding period last year. As against 61.568 bn cigarette sticks sold in between April-November 1998 sales have come down to 58.176 bn.
The decline in cigarette sales seems to be a part of the continuing trend. The reasons are:
- a continuous increase in excise duties over the last few year's which has resulted in an increase in prices. Infact, excise duties amount to almost 50-55% of both ITC and Godfrey Phillips' turnover. The criticality of the excise cost is evident from the almost Rs.4 bn worth of investment proposals that have been made once the excise exemption for cigarettes manufactured in the north eastern states was announced.
- the fall of the mini segment which is the largest segment in terms of volume since the last budget increased the duty on this segment.
- Restrictions and bans on smoking on public places
- The gathering strength of the anti-smoking lobby.
If this were not enough, the industry faces another threat: the grey market of smuggled cigarettes. Since the grey market operators don't pay either the excise duty or the local luxury taxes, they can offer retailers larger margins, at times even five times the margins that players such as ITC gives. While it makes good business sense for retailers to buy from the grey market the problem gets compounded because consumers don't discriminate between the domestically manufactured product and the smuggled item.
All in all the industry seems to be fighting against the forthcoming smokestack valuations.
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