TABEXPO

As the tobacco industry gears up for the next major congress and exhibition, TABINFO Asia, in Bangkok, Nov. 11-13, it’s a good time to remember why the Asia Pacific area warrants its own dedicated tobacco show. Despite many challenges, the region remains one of the world’s most promising cigarette markets. Even as the recent credit crunch has made consumers cautious, Asia Pacific’s fundamentals remain in place. In many markets, disposable incomes are at record highs, and the population will continue growing apace.

While it’s convenient to lump together various markets under a single heading, doing so also risks glossing over their considerable differences. Below, Tobacco Reporter examines the tobacco industry’s challenges and opportunities in four key Asian Pacific markets—Malaysia, Indonesia, Thailand and the Philippines.

Malaysia

Malaysia recently joined the rank of countries requiring cigarette manufacturers to print graphic health warnings on their products. Like their counterparts in Thailand, Brazil and Canada, Malaysian smokers will be treated to pictures of damaged lungs and other smoking-related diseases. Cigarettes without such warnings must be withdrawn from the market this year.

            Illicit trade remains a top concern. In November 2004, the government introduced tax stamps and security inks to help stem the loss in revenue from smuggled cigarettes, but with little success so far. According to the cigarette industry, illegal cigarettes made up 14.4 percent of the market in 2004. In June-August 2008, it was 24.5 percent.

            As elsewhere, illicit trade is driven by differences in cigarette prices among neighboring countries. Regionally, Malaysian cigarette prices are second only to those in Singapore. In July 2007, the government unexpectedly increased cigarette excise duty from MYR120 to MYR150 per 1,000 sticks—a jump of 20 percent. It was the first time in many years that an excise duty increased on tobacco products in between national budget announcements. Taxes went up again in 2008, and budget 2009 is expected to include an excise duty increase of between 9 percent and 10 percent.

            The government also plans to set minimum cigarette prices to deter smoking. These would be determined by taking into account all taxes imposed by the government and the profit made by the industry. The minimum price would be adjusted each time there is a change in taxes.

            The discussion about minimum prices gained momentum following a price war between the majors in late 2008, which focused on the value-for-money and extremely low-priced segments.

            The Malaysian tobacco industry also expects fallout from the Asean Free Trade Area agreement, which is scheduled to take effect in 2010. Local tobacco executives fear an influx of cheap imports from neighboring countries will impact Malaysian manufacturers and the livelihoods of those involved in the industry.

Philippines

The Philippine tobacco industry operates under a complex tax code that favors existing brands over newcomers. Implemented in 1997, the code comprises an unusual mixture of taxes and duties based on factors including price segments, retail pricing and the length of time a brand has been available in the market. “Old” brands (those on the market prior to 1996) are taxed at their net retail price as of October 1996, while newer brands are taxed at their current retail price.

            British American Tobacco, which entered the market in 1998, challenged the tax code in court but lost when the Supreme Court ruled in August that the section of the tax code levying higher taxes on “new” brands is constitutional. Unsurprisingly, companies who had brands on the market prior to 1997 support the code. Meanwhile, the World Bank and the International Monetary Fund have recommended that the Philippine government shift to a uniform tax rate to increase revenue collections.

            Some believe the Philippines’ unusual tax code discourages innovation. In 2008, Philip Morris and Fortune Tobacco Co. introduced five- and 10-stick packs, but British American Tobacco said it had put all product innovations on hold. The current tax law expires in 2011.

            Despite the recent economic slowdown, multinational tobacco companies continue to invest in the Philippines. Philip Morris International is in the process of expanding its leaf tobacco storage capacity. The company wants to transform Subic Freeport, a former U.S. naval base, into a leaf distribution hub for the Asia Pacific market. Leaf from countries such as Thailand and Indonesia will be shipped for processing to PMI cigarette factories in the Philippines, Malaysia, Indonesia and other Asian countries.

            The company says it chose Subic because it provides “reasonable advantages” in cost and efficiency over the various storage areas where leaf tobacco was previously kept.

Thailand

The Thai cigarette market continues to be dominated by the Thailand Tobacco Monopoly (TTM). Foreign companies together account for about 25 percent of the market, but their market share has been growing steadily despite a tax code that favors monopoly brands. Competition is expected to increase as tariffs continue to decline under the Asean Free Trade Area agreement. The number of smokers, meanwhile, has dropped by almost 40 percent over the past 20 years to about 10 million today.

            These factors, together with Thailand’s strict anti-tobacco policies, suggest a challenging time ahead for TTM, which sold 30.9 billion cigarettes in 2007. Thailand was one of the first countries to adopt graphic health warnings and enact a ban on the display of tobacco products in shops, although the World Health Organization has complained about patchy compliance and weak enforcement of the latter.

            In order to maintain profitability, TTM has been working to reduce production costs, distribute products more efficiently and expand related businesses. It is also said to be considering partnerships with multinationals. Privatization, however, is not in the cards. Following some half-hearted attempts at privatization, the government appears to have abandoned that path for the time being.

            TTM plans to build a new manufacturing plant outside the capital. The company’s existing Bangkok facility would become part of Benjakitti Park by 2011.

            The move followed an attempt to relocate TTM’s main production facilities from Bangkok to Chiang Mai under a contract with a Chinese firm. But the project was plagued by allegations of political interference and eventually abandoned.

            Over the years, Thailand has sparred with neighboring Philippines over the fiscal treatment of cigarette imports from that country.

Indonesia

With 2007 sales of 231 billion cigarettes, Indonesia is Southeast Asia’s largest tobacco market. It is also one of the most promising markets in terms of value. As JP Morgan points out, Indonesia’s cigarette prices are low relative to comparable consumables such as fast food. In 2007, for example, a pack of Marlboro cost IDR9,000 ($0.81), compared with IDR15,900 for a Big Mac. This, according to the bank, implies significant scope for price increases.

            Operating in Indonesia, however, comes with its own set of unique challenges. For starters, the white cigarette common in other parts of the world account for less than 10 percent of Indonesian cigarette sales. Indonesia, of course, is dominated by clove cigarettes, or kreteks, named for the crackling sound they make while burning.

            Philip Morris International is the only multinational to have entered Indonesia in a big way. In May 2005, the company acquired Sampoerna for $5 billion. One of the largest foreign investments in Indonesian history, the purchase was so big that Indonesia’s currency reportedly gained value as U.S. dollars from the transaction were converted into rupiahs.

            But there are rumors that other multinationals are also eying Indonesian kretek makers. JTI is said to be interested in Gudang Garam, for example, but this rumor remains unsubstantiated.

            Tobacco is one of Indonesia’s largest employers and taxpayers. Perhaps due to the industry’s clout, Indonesia is one of the few countries that have not signed up to the World Health Organization’s Framework Convention on Tobacco Control. While regulations remain reasonable compared with neighboring countries, the climate is nevertheless becoming more restricted. In November 2008, lawmakers were pushing a bill for deliberations by the House of Representatives that would curb tobacco advertising, promotions, sponsorships and sales.