Embracing the future

| December 1, 2016

Alliance One is keeping up with a rapidly changing tobacco industry.

By Goerge Gay

Pieter Sikkel

Pieter Sikkel, the president and CEO of Alliance One International, says that he can remember the first fax machine being delivered to the office where he was working in South Korea. And well he might. For those of us who were used to operating within the confines of the postal system, the office fax machine was a thing of wonder because it brought about a massive positive change to the way that we were able to send and receive documents.

Change is inevitable and Alliance One, which was born of change, seems now to have it in its DNA. The company emerged in 2005 from the merger of two major leaf dealers, Dimon Incorporated, which itself had previously absorbed a number of leaf companies, and Standard Commercial. The merger, if not inevitable, was certainly essential if the leaf suppliers were to keep abreast of the changing needs of tobacco manufacturers, which had also grown bigger through consolidations. The leaf supply business, Sikkel said, was becoming less specialized, more a business delivering a bulk product, albeit one with high standards; and that required scale. “And that is the business we are in today,” he added. “Quality is still key, but it is about the delivery of a quality product from bigger facilities in fewer markets, with full traceability and compliance. Without a certain degree of scale, it is very difficult to make the investments that are needed in order to provide that product.”

So consolidation has allowed Alliance One to make the required investments and adapt to an evolving industry, and Sikkel is confident that the ongoing changes the company is making will “enhance shareholder return on the consolidation.”

So why the optimism now? After all, it has been more than 11 years since Dimon and Standard brought together their combined 200 years of leaf experience. What has changed? Well just about everything. Alliance One has been able to redirect part of its focus by investing in areas that it could not have invested in in the past, partly because they did not exist. Crucially, it is no longer only a leaf supplier. “We’re in value-added products,” said Sikkel. “We have a cut-rag business here in the U.S. and in Jordan. We’re in the supply of tobacco for reduced-risk products, we’ve invested in e-liquids and cartomizer filling, and all the different modes and forms of nicotine consumption. So I strongly believe that there is success to come.”

Sikkel seems genuinely excited about the future, about where vapor products are headed and what will come next. He sees the emergence of a multi-faceted consumer who might have a cigarette in the morning, who might vape mango-flavored e-liquid during the day and who might try a heat-not-burn product in the evening. “It’s very interesting and it’s very exciting, and it produces a lot of opportunities when you open your mind to thinking where this is going to go in the future,” he said. “That’s what makes coming into the office every day quite exciting—trying to think what we can do next. This industry and our consumers are changing so quickly; how can we be sure we will be able to be part of that in the future?”

Growing the slice

Hang on though; since the world is witnessing a decline in the use of combustible tobacco products, the question arises as to whether Alliance One can maintain its current level of business, let alone grow it, by taking advantage of market changes that are occurring, in the main, rather slowly. Opportunities and potential make a less-than-nourishing gruel on which to nurture a brave new future. But Sikkel has a ready answer to this question because he sees growth potential also in Alliance One’s traditional business, whose sales currently account for only about 5 percent of the cost of the tobacco currently used in global cigarette manufacture. “Do we think overall global leaf requirements will decline: yes,” he said. “Do we think we can continue to grow in a declining leaf-requirement situation: yes.”

The way he puts it is that Alliance One can continue to grow in the space that it occupies, but that is a space that is going to change and that change is going to require new ways of thinking and new skills. And no doubt he is right. Although the leaf supply industry can look rather conservative from the outside, change has been driving it for some time. For instance, the focus in recent years has been on reducing the number of countries of origin: concentrating on those that offer the scale and efficiencies needed, while being able to keep abreast of the compliance issues that meet the changing expectations of customers, regulators and society in general

Of course, such a change has its risks, especially when mixed with other changes that have occurred and are occurring, and with built-in weaknesses in the supply chain, such as those associated with political uncertainties in some of the countries in which tobacco is grown. It is well known that tobacco manufacturers have reduced their inventories and that leaf suppliers are not in the business of holding large quantities of uncommitted stocks, and over the past few years in particular there have been significant weather-related issues that have reduced crops. Tobacco is hardy and will always produce a crop, but volumes can be reduced significantly by wet weather. The most recent El Nino event caused significant damage to tobacco crops in the U.S., and the most recent Brazilian crop was down by more than 30 percent because of heavy rainfall during the growing season. And now the industry is looking at an Indonesian crop that, again because of high rainfall, is down by probably 40 percent, with sun-cured tobaccos particularly badly hit.

The level of risk that the industry is facing depends to some extent on whether recent weather patterns, which have seen back-to-back El Nino/La Nina events, are part of a short-term or long-term change, though in either case there is little that can be done to mitigate the effects of such events when they do occur. But other risks are man-made and can be avoided given the will to do so. One such risk is that pushed by the World Health Organization’s Framework Convention on Tobacco Control (FCTC), which would like to see all countries forsake tobacco growing. This, however, is proving to be a hard sell to countries that can see the benefits of growing and exporting tobacco, which extend beyond the often-vital foreign exchange earnings. So far, no country seems to have stopped growing tobacco on the basis of the FCTC’s recommendations. As Sikkel points out; in many countries, tobacco is the most lucrative cash crop that a farmer can produce, and in other countries it is one of the top three most lucrative cash crops. And it is produced by many hundreds of thousands of farmers—farmers who vote and who are important to society, and to governments that want to persuade people to stay on the land producing crops efficiently.

Sustainability

Of course, ranged against the risks that tobacco production faces is the strategy of sustainability, which is not, as is widely believed, a new strategy, but a newly expanded, constantly evolving strategy. Sustainability and compliance are largely based on the Integrated Production System (IPS), explains Sikkel, and the IPS has been in operation in Brazil for almost 100 years. Under the IPS model, farmers sign contracts with buyers who provide production support that ensures tobacco is grown efficiently and with as little negative impact on the environment as is possible, and who guarantee to buy the farmer’s total crop at grade-based prices that are, where possible (some governments, including that of Malawi, do not make provision for this), agreed before planting. For his part, the farmer agrees to certain conditions that include employing only voluntary and age-appropriate labor on fair wages—conditions that are carefully monitored and enforced by buyers.

So the big change that has taken place in recent years is that this system has been expanded to include countries other than Brazil. In both Malawi and Zimbabwe, for instance, 80 percent of the tobacco sold is now grown on the basis of contracts. And for Alliance One, this means that there has been a massive change to the way it is structured. Ten years ago, the company had almost no field technicians in Africa, but today almost half of its global workforce is in the field as field technicians, agronomists and researchers.

And what does the contract system mean for the farmer? This is more difficult to get to the bottom of, but, if you look on the bright side, this year contract tobacco prices in Malawi were on average 31 percent higher than were auction prices. But one has to set this against the fact that contract prices there have been either flat or down for the past five or six years, and auction prices have been massively down. Again, on the bright side, IPS grower income and profitability are said to have been increased significantly despite the flat prices because of the 20 percent increases in yields and quality, and the significant decrease in labor requirements that the IPS has brought about. There seems, however, to be an unwritten law that says that prices and IPS gains are in an either/or relationship: that farmers cannot benefit from both. And in theory at least this seems troublesome because while IPS gains are undoubtedly most helpful to everyone involved, being grade-based, they seem to be at the mercy of the weather, which, as is described above, has recently been unhelpful.

In part, sustainability is a matter of responsibilities that companies such as Alliance One owe to farmers and their communities, to customers, to governments and to their own ethical stances, but Sikkel sees it also as a matter of pride for the company and its employees. What Alliance One does today is very different to what it did in the past, he said. Today it is helping farmers improve yields and quality significantly, and it is monitoring farm conditions to ensure laborers are fairly treated. And it is supplying inputs and advice to help farmers produce food crops so as to ensure food security and another strand of income. “Who would have thought that we would have planted 55 million trees in Africa over the past five years,” said Sikkel. “So it’s a massive change, but, if you program it correctly, it doesn’t cause a massive increase in costs. We’ve found savings in other parts of the supply chain to take care of it. And our customers participate in it as well with financing, which helps us put in place things such as dams that make water more secure for many of the people we contract with.”

Managing risk

This is all very good, but it seems to swing us back to the question of risk. An apparent additional risk taken on by leaf suppliers, especially in the light of the recent reversals that have been seen in vertical integration. Although tobacco manufacturers might help with the financing of specific projects, such as the provision of dams and boreholes, there is a lot more going on here than that. To an outsider, making the IPS a success seems to be a massive undertaking. Leaf suppliers have to be prepared to work with hundreds of thousands of farmers in some of the poorest countries in the world, and to try to create sustainable supply chains under some of the most difficult conditions in which agricultural crops are grown. And Sikkel seems to agree up to a point. “We clearly have taken on more risk in the supply chain over the past 10 years,” he said. “Whenever we’re contracting a year in advance of purchasing, processing and shipping a product, rather than buying to order from an auction floor, we are taking on more risk. And there is always going to be a question about what is going to be the right reward for the additional risk that we take. Clearly for ourselves and for our shareholders I would like to see additional reward for all of the risk that we take. And that is what we continue to work on with our customers, to make sure that we have the right balance there.”

There is occurring too a rebalancing of demand for certain types of tobacco, with flue-cured in the ascendancy while burley and to some extent oriental are on the wane. This merely reflects cigarette consumption, which is, generally speaking, weakening at a faster rate in countries where American-blend products are consumed than in those where Virginia-blend products are most popular.

What is more interesting perhaps is that increasing bans on additives in cigarettes are having little to no effect on the types of tobacco in demand, though they are having some effect on varietal demand. And according to Sikkel this is partly down to the fact that there has been an increase in the production of “natural” cigarettes around the globe. “I think that this is partly what has caused the increase in interest in African burley, for example, which is a lighter product,” he said. “It has flavor, but it is a little more gentle in the smoking and easier to use in a natural cigarette. I think a lot of our customers have made those sorts of adjustments and that is why, too, Brazilian burley is in lesser demand than it was in the past and probably U.S. burley will be in lesser demand in certain markets than it was in the past.”

One other area where little change has occurred is in respect of big-leaf processing. Threshing—or extracting stem from tobacco—and drying, have changed little, though Alliance One has invested heavily in ensuring that it has scaled-up processing capacity in those countries where production is being concentrated and in equipment for the removal of nontobacco material. The company has done a lot of work, too, on looking at how equipment functions to improve throughput and the yields it achieves from taking in farmers’ tobacco to dispatching packed cases.

It has invested heavily in racking in its stores, also, so as to avoid stacking tobacco in piles on the floor, which can lead to mold, fermentation and a loss of yields. Depending on the market, racking can help improve yields by 1–2 percent and the quality of the finished product, which are important improvements given that tobacco accounts for 80 percent of Alliance One’s costs.

Of course, the above does not take into account the biggest change to processing techniques of the past 20 years: the switch from natural drying to soft drying of oriental crops. This has reduced dramatically the complexity of putting oriental into a useable form for manufacturers. And though for tobacco suppliers it meant investing heavily in equipment for their oriental factories, it offered the advantage of hugely reduced labor and handling costs, and reduced the time taken for crops to be stabilized and shipped.

Finally, to take this story back to its beginnings; Sikkel is clearly still taken with the changing face of communications. “If you look at our website today you can see the stories of what we are doing and achieving around the world; how we are getting out the true message about what tobacco offers to communities around the world,” he said. “I think that is a significant change. In the past, we bought tobacco and we sold it, but we never talked about the process behind it. And I suppose we didn’t have that much to share on a global basis as we didn’t have the data to back up the results we were achieving. Today we’re much better at documenting things. We can prove what we do and we can use that data to communicate with anybody around the world, whether they are with environmental organizations, human rights organizations or other bodies. And we try to be very transparent in what we do. We try to be very open. Where we have issues, we say we have issues and this is what we are doing to try to improve things.”

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