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Puffing Profits
Financial Express - 08 Nov 2007

How do you face taxing times in the Rs 15,000-crore branded cigarette industry in India? “Take a price hike to puff away your worries” seems to be the mantra for major players in this sector. And it seems to have worked well. For, tobacco-to-hotels and FMCG major ITC Ltd has reported that its cigarette sales rose 12% to Rs 15.7 billion in the second quarter of FY 08 and profit before tax and one- time gains or charges increased 9.8% to Rs 8.64 billion despite high incidence of taxes. Incidentally, ITC had raised cigarette prices by about 20% in the first quarter to offset a decline in sales volumes. Clearly, it is survival of the smartest in this overcrowded category.

With a market share of 75%, ITC currently leads the pack in the branded cigarette industry. Other major players include Godfrey Philips India Ltd, GTC Industries, VST Industries Ltd, Dalmia Consumer Care and Kothari Products Ltd. According to industry analysts, the Indian branded cigarette sector has registered a growth of 8% in the last two years.

“Despite high taxes, the industry is maintaining its growth rate. That's quite something to cheer the sector. Major players are now drawing up fresh game plans,” says an analyst based in Mumbai.

To sustain its leading edge in the highly competitive sector, ITC is now brewing a growth strategy, which includes expansion of manufacturing facilities and taking up innovative business processes. Says S Wanchoo, general manager, marketing, Tobacco Division, ITC Ltd, “Our focus on quality and innovation in responding to emerging consumer needs, across any category of product, not just cigarettes, will ensure that we maintain and improve our competitiveness on a continuous basis.”

According to industry sources, ITC is planning to kick off a Rs 300-crore expansion at its cigarette factory in Kolkata. Wanchoo is, however, reluctant to divulge further details about the company's expansion plans. “Currently, the Indian cigarette industry is operating at less than 50% of the installed capacity due to the high taxes on cigarettes vis-à-vis other forms of tobacco. Our manufacturing strategy is designed to remain quality-and cost-competitive, in step with the emerging demand and is being constantly reviewed,” he adds. At present, ITC has manufacturing facilities at four locations at Bengaluru, Munger, Saharanpur and Kolkata.

ITC Ltd, having diversified presence in hospitality, garments and biscuits, has reported a bottomline growth of 13.4% YoY at Rs 771 crore for the quarter ending September 30, 2007, and turnover growth of 14.2% at Rs 3,273 crore. How much did ITC's tobacco division contribute to the company’s overall business? “In the year ended March 31, 2007, cigarettes constituted 47.7% of the net turnover,” informs Wanchoo.

Meanwhile, ITC is chalking out an ambitious growth plan for all its diversified business interests. According to Y C Deveshwar, chairman of ITC Ltd, “As a group, we are going to invest Rs 20,000 crore in different businesses over the next five years.”

In a bid to consolidate its offerings in cigarettes, ITC is planning to create power brands in the highly competitive sector, inform industry sources. Currently, ITC's product portfolio includes 15 brands: Insignia, India Kings, Classic, Gold Flake, Silk Cut, Navy Cut, Scissors, Capstan, Berkeley, Bristol and Flake. According to Wanchoo, the company is following a portfolio approach to cater to all relevant consumer segments, be they geographical or price segments. “Our current portfolio of 15 brands is constantly reviewed for optimum consumer satisfaction,” he says.

It was in 2004 that the company disassociated its trademark ‘Wills’ from its cigarette portfolio and changed brand name ‘Wills’ to its old name Navy Cut. But now ITC's trademark ‘Wills’ is predominantly present in diverse categories such as personal care products and fashion retailing sector. What are ITC's long term plans for brand name ‘Wills’? Will ITC make ‘Wills’ its flagship brand across diverse categories? According to Wanchoo, the company adopts brand names that are relevant and best suited for the success of the individual products. “Thus we have Di Wills and Superia for shampoos and soaps, Spriha and Mangaldeep for agarbattis, John Players, Springwood and Wills Lifestyle for garments and Classmate for notebooks and Kitchens of India and Aashirvaad for ready-to-eat products,” he explains.

Wanchoo adds that plans are made for product categories and not for brands in isolation of the respective product. “The choice of a brand depends on its suitability for a particular product category that the company decides to enter,” says Wanchoo. There was a time when advertising for tobacco products was not a taboo. Remember ITC's classic advertising campaign ‘Wills—Made for Each Other’? After the government ban on cigarette advertising, ITC and other major players shifted their focus to below the line advertising. Like ITC’s Wills advertising campaign, Godfrey Philip’s huge billboards displayed the brand proposition of Four Square cigarettes for many years. But after the ban on all advertisements relating to tobacco-related products in May 2004, these king-sized hoardings just went up in smoke without leaving a trace.

What’s the impact of government's ban on tobacco advertising? Has it really affected tobacco majors? “I think it has no impact at all on ITC as the company's competitors too cannot advertise their brands,” says a Mumbai-based FMCG analyst. As a result of the ban, tobacco companies are now beefing up their point-of-sale ads and ground events to lure smokers across the country. “ When there is no ban on the sale of the products, why should there be a ban on advertising tobacco products?” asks a leading advertising practitioner in Mumbai.

The tobacco companies have been facing another challenge since April this year. The government has imposed a value-added tax (VAT) of 12.5% on cigarettes. What has been the direct impact of VAT on ITC's performance? The severe taxation and regulatory milieu for cigarettes in India remains a cause for concern, admits Wanchoo. “Despite lower volumes, the additional burden of indirect taxes during the last quarter aggregated Rs 411 crore, consequent to the staggering increase in such taxes of 29% per pack over the corresponding quarter of the previous year,” he adds.

According to analysts, such high rates of taxation at nearly 132% of the value of the product (ex-factory price net of taxes) will only drive consumers to switch to cheaper and inferior forms of tobacco, resulting in lower revenue collections by the exchequer. “This sharp increase in taxes has resulted in a drop in the cigarette industry volumes,” point out analysts.

From December 1 2007, cigarette majors will face yet another major challenge. They are required to print pictorial health warnings on tobacco product packs under the Cigarettes and Other Tobacco Products (Prohibition of Advertisement and Regulation of Trade and Commerce, Production, Supply and Distribution) Act, 2003 (COTPA). While these provisions of COPTA are proposed to be made effective from December 1 this year, the scope and implementation processes including the timeline need to be rationalised, point our analysts.

“We hope that the group of ministers, which has been set up to examine the issues arising from these provisions and make suitable recommendations, will take a pragmatic view keeping in mind the interests of the livelihood of 35 million people involved with the tobacco industry and India's status as the third largest tobacco producing country in the world,” says Wanchoo.


S Wanchoo heads the tobacco marketing division at ITC. A seasoned marketing professional, he has been with the company for 20 years. Wanchoo talks on:

Taxation

Cigarettes contribute more than 90% of the total tax revenue from the tobacco sector despite constituting only 14 % of the tobacco consumption in the country. However, discriminatory and high taxes on cigarettes continuously drive consumers to cheaper, revenue inefficient tobacco products.

Thus, fiscal legislation on tobacco has, unwittingly, led to sub-optimisation of the economic value per unit of tobacco consumption without in any way curbing tobacco consumption. Cigarettes are taxed the highest among all tobacco products @ 132% of the value of the product.

Contraband cigarettes

Smuggled cigarettes pose a major threat to the industry. Given the high taxes on cigarettes, smuggling provides an attractive tax arbitrage opportunity. Reports suggest that, currently, contraband cigarette sales cause a loss of Rs 1,500-Rs.2,000 crore per annum to the Indian government in terms of taxes and forex outflow. Since both imported and smuggled cigarettes do not use Indian tobacco, their influx serves to erode the demand for Indian cigarette tobacco, thereby negatively impacting farmers.

Illegal manufacturing

Some unscrupulous manufacturers in the small-scale industry have entered the market without government’s approval under Industrial Licensing Act. Some of these industries manufacture products illegally, thereby escaping the excise tax net. This not only leads to proliferation of inferior products, which do not conform to strict quality standards, but also affects the legitimate cigarette industry apart from resulting in a major loss of revenue to the exchequer.