Business Maverick

OP-ED

Up in smoke: Batsa’s cigarette pricing strategy has backfired, exposing its greedy, grubby underbelly

(Photo: Gallo Images / Ziyaad Douglas)

After two decades of limited competition and ever-increasing profits, things started unravelling for British American Tobacco SA in 2010 after a number of small, aggressive cigarette manufacturers entered the SA market. Previously, the company had been able to exploit its near-monopoly power to increase cigarette prices and therefore profits.

 

Corné van Walbeek is a Professor in the School of Economics at the University of Cape Town and Director of the Research Unit on the Economics of Excisable Products (Reep). Samantha Filby is a Research Officer at Reep.

Recently, Stop Tobacco Organisations and Products (Stop), an industry watchdog, published two reports (here and here) that describe British American Tobacco’s (BAT’s) efforts to undermine its competitors’ activities, mostly through dubious or illicit means.

The content of these reports has been summarised in an article that appeared in Daily Maverick. Among other things, the reports indicate that British American Tobacco South Africa (Batsa) and its UK-based parent company, BAT plc, have spent hundreds of millions of rands to fund a surveillance system that spied on — and disrupted — the activities of its competitors.

The ramifications of this scandal are potentially huge: not only are organisations like Stop placing pressure on authorities to punish BAT’s actions, but the average South African smoker is gaining insight into BAT’s “nefarious”, “colonial-like” practices which may have negative implications for the image of and demand for its brands. We believe that the situation BAT finds itself in is, largely, the result of its own actions.

In 1999, when Batsa was formed after the merger of Rothmans and the BAT-affiliated United Tobacco Company, the merged entity had a nearly 95% share of South Africa’s cigarette market. In 2019, it had a market share of 71.4% of the legal market. Its share of the total market, i.e. including the illicit market, is probably less than 50%. How is it that a company that was so dominant could fall so far?

One possible answer: corporate greed.

The story has a long run-up. During the 1970s and 1980s, Rembrandt, the South African subsidiary of Rothmans, was able to increase its market share by producing cigarettes that the market wanted and selling them at competitive prices. South Africa experienced high inflation during the 1970s and 1980s, but Rembrandt generally increased its prices by less than the inflation rate, which meant that its cigarettes became relatively cheaper.

There was a cosy relationship between Rembrandt and the apartheid government. In many years the excise taxes were not increased, and when they were, they were increased by less than the inflation rate. The combination of below-inflation tax increases and below-inflation net-of-tax price increases meant that the real cigarette retail price in 1990 was 40% lower than in the late 1960s.

Things changed in 1990. The ANC was unbanned, Nelson Mandela was released from prison and negotiations for a democratic dispensation began. The ANC made it clear that it would prioritise primary healthcare and disease prevention, and that it would have a strong tobacco-control policy. It, therefore, seemed unlikely that the cigarette market would continue to expand as it had done in previous decades.

In response to this threat, Rembrandt changed its strategy. Whereas previously it had gradually reduced the real price of cigarettes to attract more customers, it now embarked on a strategy to increase the retail price of its products substantially. While this may have caused it to lose those customers who could not afford the higher prices, this loss in volume was more than compensated for by an increase in the profit per cigarette. This strategy increased Rembrandt’s total revenue and total profit.

Crucially, it was only possible because of Rembrandt’s near-monopoly control of the South African cigarette market: holding about 85% of the total cigarette market at the time meant that it could raise its prices without much fear of being undermined by competitors.

When the ANC came into power in 1994, it substantially increased the excise tax on tobacco products. These increases were publicly castigated by Rembrandt as unfair and discriminatory. However, Rembrandt used these excise tax increases as a smokescreen to increase the retail price of cigarettes by much more than the excise tax increase. The result was that their profit per cigarette increased even more.

Since 1994, National Treasury has followed a clear and transparent principle in setting the excise tax level. It sets the excise tax in such a way that the total tax burden (i.e. the sum of excise tax and VAT, expressed as a percentage of the retail price) of the most popular-priced cigarette is 50%. This percentage was increased to 52% in 2002. What this meant is that if the tobacco industry increased the retail price, National Treasury would increase the excise tax in the subsequent budget cycle in order to keep to the targeted tax burden percentage.

Between 1994 and 2010, this system worked very well for Rembrandt, and, since 1999, Batsa. Twice a year, in March/April and again in August, the company would increase the retail price of cigarettes, by a rate usually well above the inflation rate. The price of cigarettes, in inflation-adjusted (i.e. real) terms, simply went up and up. Consumption dropped by between 2% and 5% each year, but the decrease in consumption was more than compensated for by the increase in the profit per cigarette.

In 2010, the total real net-of-tax turnover of the tobacco industry was more than 30% greater than it was in 1994, despite the fact that the total number of cigarettes smoked had fallen by 37%. The creation of Batsa in 1999, following the merger of Rothmans and United Tobacco, further entrenched the dominance of the company by bringing its market share up to 95%.

In the early 2000s, some competitors — among them, Apollo Tobacco, Mastermind Tobacco, Masters Tobacco, and Philip Morris — entered the South African cigarette market, though these entrants did not pose an existential threat to Batsa. Philip Morris marketed its Marlboro brand as a popular-price brand, rather than a discount brand, and did not undercut Batsa’s prices. Mastermind Tobacco posed a temporary threat to Batsa’s market share by producing significantly cheaper cigarettes, but they were closed down in 2006. The other companies were simply too small to pose a significant threat.

After almost two decades of limited competition and ever-increasing profits, things started unravelling for Batsa in 2010. The very large profits earned by Batsa attracted a number of small, aggressive cigarette manufacturers into the South African market. The new entrants were primarily competing in the low-price segment, selling at prices substantially lower than the economy brands sold by Batsa. Some of these manufacturers were legal, some were not.

The presence of low-price cigarettes dramatically changed the cigarette market. Previously, Batsa had been able to exploit their near-monopoly power to increase cigarette prices and therefore profits, but this was no longer possible after 2010. In effect, Batsa sowed the seeds of its own destruction. Had they been more modest in their pricing strategy, they would not have created the incentive for competitors to enter the market. These competitors mercilessly eroded their market share after 2010.

Batsa’s primary response to these low-price competitors is to argue that they are competitive because they are not paying taxes. There is certainly some truth in that. Evidence collected by our colleagues at the Research Unit on the Economics of Excisable Products (Reep) indicates that a substantial proportion of cigarettes produced by Batsa’s competitors are sold at prices so low that it is impossible that the full tax amount has been paid. It did not help Batsa’s situation that the South African Revenue Services was incapacitated from about 2014 onwards, further enabling non-tax-paid cigarettes to undermine Batsa’s market share.

However, Batsa is no saint. As research compiled in the Tobacco Control Data Initiative website shows, both small national companies and large international firms like BAT contribute to the illicit tobacco trade.

Despite attempts to portray itself as a pillar of virtue in a sea of vice, Batsa’s use of spies, lies and bribes to claw back some of its market share reveals its greedy, grubby underbelly. It will be tough to come back from this. DM

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  • The tenor and direction of this article greatly disturbs me; far more worrying ought to be the extent that criminal gangs have subverted governance and the ANC (and through Male & Shivambu also the EFF.)

    That big tobacco has sought to protect it’s interests, is, I agree, problematic – but nothing like as problematic as the obtuse.

  • Our cigarettes are very cheap compared to rest of world.

    End of the day there is a logical cost by reference to tobacco and production cost and that logical cost is impossible for a small producer no matter how efficient to compete against. The small guy will have far less in fancy head office and massive sales & marketing, but the cost per packet cannot be significantly different.

    Nobody can stay in business selling at less than marginal cost of production.

    Cheap cigarettes in SA are certainly not paying their taxes. That is what happens when government gets involved in pricing by way of producer taxes.

    The EXACT same thing is happening in carbonated soft drinks and sugar taxes.

    The same happens when VAT rates become too high: too much incentive for crooks.