Elusive potential

| May 1, 2017

India’s promise to the cigarette industry is likely to remain where it has been for a long time—on the horizon.

By Shane McGuill

It is remarkable that a country whose people purchase billions of dollars of tobacco products every year is regarded as a sleeping giant by the cigarette industry. Indian consumers spend more than $20 billion annually on tobacco products (ranking the country 11th in the world), and the rolled manufactured cigarettes (RMC) market stood at 90 billion sticks in 2015, making it the world’s ninth largest. Yet in the context of a 1 billion-plus population, these figures are modest, attaching to the Indian market a seemingly perpetual sense of latent-but-never-quite-realized potential. Indeed, in many ways, the story of tobacco in India is characterized by changes that never arrive.

That is not to say that the consumption of tobacco in India is a marginal pursuit. However, tobacco use in India is significantly more diffuse than that in virtually any other world market. According to the Global Adult Tobacco Survey (GATS), one-third of the India population were daily users of tobacco in some form in 2010. Most of these—20 percent of the population—used chewing tobacco. The remainder was split between smokers of bidis and RMC, with the former having close to twice the level of use of the latter.

In the context of rising disposable income and improved logistics, a long-awaited shift in patterns of Indian tobacco use has been increased uptake of cigarettes. However, while the years between 2010 and 2016 have seen a dramatic shift in usage, it was not in the prevalence of cigarette smoking, which has remained stable. Instead, according to industry sources, on the back of increased restrictions and increased pricing, by 2015 bidi consumption overtook the use of chewing tobacco as India’s dominant mode of consumption.

The government of India intends to restrict the practice of selling cigarettes per stick, which accounts for 70 percent of cigarette consumption.

The driving force behind this shift as well as the lack of traction by RMC is India’s excise and tobacco-control regime, which is rapidly becoming one of the world’s most restrictive. In the past five years alone, India has sought to prohibit the smokeless tobacco category, introduced sweeping graphic health warning regulations and has increased excise taxes on tobacco products dramatically (though not always proportionately across categories). In the aggregate, legislative and excise tightening has benefited the hand-rolled bidi category with declines evident in smokeless tobacco consumption and elevated volume losses in RMC, the segment that dominates in other markets.

Excise evolution is especially problematic to the RMC segment because it has significantly increased the unaffordability of a product segment that has been striving to migrate lower-income consumers from competing tobacco products. The average Indian must work in excess of 2.5 hours at the average wage to purchase 20 cigarettes; in neighboring Pakistan, the equivalent figure is just over one hour, while Japanese and South Korean smokers on average earn quickly enough to afford a pack of 20 cigarettes every 15 minutes.

While the level of excise increases on the cigarette segment has varied year-on-year both in absolute terms and in terms of the balance of stick length segments by which the government levies taxation (13 percent net in 2015, 10 percent in 2016 and 12.5 percent in 2017), since 2012 excise has increased by more than 100 percent. In a fixed-price market, such as India, this goes in toto onto the pack price of lower-priced (usually shorter stick length) brands, with manufacturer margins absorbing some of the increases on premium (usually longer stick length) products. This level of unit price increase has not only acted as a barrier to migration into the category but also facilitated a shift out of it—into the illicit trade or back into the lower-priced bidi segment. The illicit tobacco trade has grown from 10 percent of the total market in 2001 to more than 20 percent in 2016. The price increases have also likely impeded increased uptake from demographics with limited disposable income, such as female smokers or adult smokers under 30.

A further effect of the excise evolution has been an increasing polarization in the market between stick lengths, with fewer consumers seeing the value in opting for products other than either 64 mm (downtraders) or 84 mm (those inclined to trade up). There has been some speculation recently that the government will seek to rationalize India’s excise regime on cigarettes, as recommended by the World Health Organization, away from stick length buckets.

Developments on the regulatory side have been scarcely less striking. India’s packaging legislation has progressed rapidly to stand now (after lengthy legal wrangling) at requiring full graphic warnings covering 85 percent of both the front and back of packs. Indian manufacturers briefly suspended production in 2016 in protest at the imposition of the measure. The federal government is also preparing to enforce nationwide public smoking restrictions. The impact of such restrictions will inevitably vary by region, but it is likely to be significant in major urban areas and will reduce consumption frequency, not least because of the effect on street stalls and kiosks where cigarettes are largely purchased and in the environs of which they are typically consumed.

In the medium to longer term, further regulatory action is probable. Around 70 percent of India’s RMC is purchased as single sticks because low-income consumers purchase as their daily revenue flows allow. The government has promised action to enforce a ban on these transactions, which are complicated by regular excise increases and which blunt the impact of health warnings. In the slightly longer term, India is a strong candidate for the introduction of standardized tobacco packaging.

Going nowhere: India’s tax regime continues to favor non-cigarette tobacco products.

The Indian RMC market continues to be dominated by domestic players, and in effect it is a duopoly with the conglomerate ITC (in which British American Tobacco holds a 29.74 percent stake) enjoying a retail volume share of 79 percent, followed by Godfrey Phillips India (GPI, which has a relationship with Philip Morris International) with 11 percent. Other domestic players, including VST Industries, share a further 8 percent of the market, with strong presences in certain regions of the country.

In general terms, the involvement of international tobacco manufacturers in the Indian market is limited by government restrictions on foreign direct investment (FDI), and these appear poised to amplify. FDI in cigarette manufacturing has been prohibited since 2010, while other forms of engagement, such as trading relationships and licensing, have been legal. It is under this rubric that GPI manufactures the Marlboro brand on behalf of Philip Morris International (PMI) with the product then distributed and marketed by a PMI-controlled sales operation. In March of 2017, it was widely reported that the Indian government is considering further restrictions on this type of arrangement (though not retroactively), which would have the effect of impairing future expansion by international companies in the Indian tobacco market.

With respect to the manufacturers’ retail partners, newsagent tobacconists and kiosks remain the leading distribution channel for cigarettes, accounting for around 70 percent of volume sales. There is a high density of these outlets, which are embedded in communities and typically benefit from a cohort of loyal consumers living locally. Given restrictions on the advertising of tobacco products to consumers through other media channels, point-of-sale display advertising represents the core marketing and promotional platform for manufacturers. The dominant players concentrate on creating branded material for kiosks and tobacconists, for which operators are compensated.

This type of material primarily takes the form of paper hoardings at point of sale, along with display cabinets and logo-specific hoardings displayed on the front and side of stores. Furthermore, manufacturers also pay to decorate stores with specific brand colors to attract consumers in India’s major urban areas.

Packaging and advertising regulation of the type in force in India tends to mitigate against frantic new product development, but innovation is nonetheless visible, particularly at the premium end of the market. Products incorporating features such as flow filters and packaging innovations have been launched in recent years. Capsule products have also begun appearing, notably across price points. Flavor in general remains niche, accounting for around 1 percent of the market, but is expected to grow in coming years as a range of menthol and other flavor variants, such as Marlboro Kretek, continue to hit the marketplace.

Looking ahead, consumer expenditure on tobacco in India is forecast to increase by more than 50 percent to $32 billion by 2021, as the influence of taxation in all product segments is felt. However, as enhanced regulations, such as pack warnings, public smoking restrictions and potentially even an increase in the legal smoking age, continue to bite, it is difficult to see considerable growth in the RMC segment. Euromonitor International currently forecasts a compound annual growth rate volume decline of about 3 percent in cigarettes between now and 2021, with value evolution also on an only marginally more moderated downward trend. In the same period, India’s per-smoker consumption of cigarettes (already one of the lowest in the world) will decrease further. In essence, another half decade of unrealized possibility.

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