Russian Experience

1.Think and say:

a) Do many people in Russia smoke? And in America? Why?

b) Do you smoke? What brand of cigarettes do you prefer: domestic or foreign? Why?

c) Do you feel that several foreign companies do their best to boost the quality and quantity of their cigarettes in Russia?

2. Read the text and say what you think about the expansion of the world tobacco giants (the “big four”) into Russia.

3. Analyse the situation in terms of the market structure and imperfect competition theory.

4. Retell the text as if you were 1) an executive of an American tobacco company, 2) a heavy smoker.

5. Role play a chat between cigarettes in the pack in the pocket of a businessman.

Russian Tobacco Manufacturers Lie Low

By early next century, British-American concerns will have captured the whole of Russia’s tobacco market.

The worried owner of the Izhevsk Tobacco Factory recently gave a call to Expert Magazine’s office, asking it to find a strategic investor for the enterprise or, better still, a buyer. One could understand the businessman’s agitation. The factory had recently slashed production, and it had practically no chance of staying in the market. Many regional tobacco factories are finding themselves in a similar plight as they are increasingly ousted by British-American corporations. The latter will have gained almost complete control over our cigarette market by the beginning of the next century.

The “big four” — Philip Morris, R.J.R., BAT, and Rothmans — have already invested $600 million in their Russian factories, and recently these companies’ top managers announced their intention to set aside enough money to boost the quality of their cigarette production. If they are currently turning out local brands of cigarettes and, for the time being, importing the bulk of Marlboro, Camel and the like, eventually the whole volume of imports will be replaced by domestic production. In 2002 in Russia the British-American tobacco giants are forecasted to produce about 260 billion cigarettes, or nearly as many as the market can take.

A Haven for Tobacco Manufacturers.

The expansion of the tobacco giants into Russia looks quite logical amid the unfolding crisis of their relations with the American authorities. The tobacco companies were ready to pay the U.S. federal government a lump sum of nearly $100 billion in exchange for terminating the legal actions brought against them by the “victims” of American cigarettes. But many American states on their own set about taking care of the nation’s health and adopted relevant anti-tobacco laws. It looks as if the giant cigarette manufacturers will now have to pay up over a long period of time on complaints lodged against them. Evidently, the “big four” can compensate for these enormous losses only by operating on a vast and dynamic market. In this respect, Russia is their best option.

The Russian tobacco market is one of the world’s largest, surpassed only by the Chinese, American and Japanese markets. Approximately 250 billion cigarettes are annually sold in Russia for a total of $6 billion, and consumption rises by two percent every year. Moreover, for the international tobacco companies cigarette production in Russia is an incredibly profitable business. According to the research agency Business Analytica Europe, $100 million invested in a Russian tobacco factory with an annual capacity of 30 billion cigarettes is paid back in full in two or three years, after which the factory will bring in a 40 percent net profit. In fact, the Russian authorities have created a tax haven for big tobacco manufacturers. Russian excise duties and taxes are several times lower than those in the United States and Germany; that is why a pack of Marlboro or Camel costs no more than $1.50 in Russia, rather than $3 as in Europe. This boosts demand in Russia.

According to R.J.R.’s director for external ties, Andre Benois, Russian excise duty and taxes make up some 12 percent of the retail price of a pack of good cigarettes; a similar tax rate exists only in Poland and several other emerging markets. The cost price of a pack of Marlboro type cigarettes, according to the estimates of Business Analytica Europe’s director, Asndrei Sterlin, is barely $0.15. It is therefore not surprising that unlike businesses in other sectors, the tobacco transnationals unanimously agree that Russia’s present excise-duty rates are optimal.

By the way, relatively low excise-duty rates suit not only the tobacco manufacturers, but also the authorities, because the low rates discourage smuggling. It may not be out of place here to recall that six years ago, Canada jacked up excise duties to such an extent that a pack of good cigarettes cost the smoker $5 to $6. As a result, smuggled cigarettes filled half of the market, and the local authorities had to back down. True, the Canadian government recently raised excise-duty rates once again, and the tobacco companies retaliated by refusing to sponsor national festivals and sports events.

Prima’s Days Are Counted.

Perhaps the most ambitious of the “big four” projects in Russia is that of R.J.R., which owns the Armavir, Yelets and St.Petersburg Tobacco Factories. The R.J.R. director for CIS and Baltic countries, Pierre Govard, announced that his company intended to increase cigarette production in Russia almost fivefold (from 37 billion to 185 billion cigarettes a year). For this purpose, $120 million has been allocated, mostly to renovate and boost the productive capacities of the R.J.R.-Petro Factory in St.Petersburg. When this investment program is completed, the St.Petersburg factory will be the largest one owned by the American company outside the United States. According to an announcement by Andre Benois, the main stake will be put on local brands of cigarettes — Peter I and its “mild” modifications. Their production in Russia last year exceeded 20 billion cigarettes and a substantial increase is planned for this year. The R.J.R.-Petro factory also intends to manufacture the international brands of cigarettes Monte Carlo and Magna.

R.J.R.’s main rival on the Russian market, BAT, has already retooled its Saratov Tobacco Factory, which produces Pall-Mall and is going to develop the production of BAT-Yava in Moscow. According to BAT Managing Director Ulrich Herter, $60 million will be made available for this purpose this year. After the renovation, output at BAT-Yava may increase to 30 billion cigarettes a year.

Finally, Philip Morris and Rothmans have decided to build a tobacco factory in the Leningrad Region. As Rothmans director for external ties Vladimir Yershov told Expert Magazine, his company’s new, $80 million factory had practically been built and would start making Dallas cigarettes this fall. Its present capacity is no more than six billion cigarettes a year, but will increase in the future.

Philip Morris, which already owns the Krasnodar Factory and St.Petersburg’s Philip Morris-Neva, will start construction of a new factory in June. According to Alik Tuigunov, director for external ties of Philip Morris’ Russian Division, about $300 million will be invested in the new factory, and its capacity will be 25 billion cigarettes a year. In addition to this project, Philip Morris will increase the output of Soyuz-Appolon, Bond Street, and Chesterfield cigarettes at affiliated Russian enterprises to 14 billion toward the end of this year.

Thus, American companies hope to put an end to smuggling and squeeze small producers out of business. Most of them will simply have to pull out of the market. According to the director of the Tabakprom Association, Vasily Terevtsov, of the 17 Russian tobacco factories that are still operating in the sector but have failed to find foreign investors, only half will survive over the next few years. These are the larger enterprises, such as Donskoi Tabak and Neva-tabak, which command their regional markets and have the local administration’s support. It seems that nothing can save their weaker brethren. In the course of last year, they slashed production by 15 percent on average, and analysts expect a similar cut this year. The main cause of this crisis at small factories is overproduction of nonfilter cigarettes of the Prima type. As the small factories’ 40 percent share of the market continues to dwindle, they see no way of finding investors who would undertake restructuring.

The British-American corporations’ ambitious plans have discouraged other international tobacco companies from investing in Russia. So the owner of the Izhevsk Tobacco Company, like may other owners of regional factories, is unlikely to find a buyer. According to James Brady, director for the CIS of the audit firm Deloitte & Touche, all foreign corporations that were keen to make large investments in Russia’s tobacco sector have long been operating here, and new ones are not expected to arrive in the near future.

(Moscow News, April 23-29, 1998.)

Key terms.

1. Imperfect competition.

2. Oligopoly.

3. Monopolistic competition.

4. Collusion.

5. Product differentiation.