Russia Will Continue to Feature Prominently in the Portfolios of Tobacco Multinationals (Part I)

Source from:  Tobacco Reporter  12/09/2013

The Russian people's love of cigarettes is legendary. Since the fall of communism, cigarette production and consumption in the Russian Federation have steadily increased. But in recent years, the Russian government has started cracking down on tobacco. It has been raising taxes, restricting advertising and banning smoking in ever more public places. What does the future hold for the cigarette industry in this lucrative but rapidly changing market?

It is difficult to exaggerate the significance of Russia to tobacco companies. The largest country by land mass is the world's second-largest market for cigarettes by volume, behind only China, and it's the third-largest cigarette manufacturer (tied with Japan), after the U.S. and China, according to Euromonitor International.

Nearly half of the country's 44 million smokers consume a pack or more a day. Overall, Russians smoke between 290 billion and 330 billion cigarettes a year, on par with the U.S.—which has double the population and about the same number of smokers.

Russia is also more diverse than other tobacco markets, with hundreds of cigarette brands competing on kiosk shelves across the country. At present, there are about 300 brand families, which together with different types of formats and tar delivery levels exceed 1,000 versions, according to Igor Moiseev, chair-man of the Pogar Tobacco Factory and the Association of Russian Tobacco Manufacturers, Tabakprom.

The large number of offerings can mostly be attributed to competition between the multinationals who dominate the market. For example, the biggest driver of Japan Tobacco International's (JTI) business in Russia is its Winston brand, according to Alexander Kryvosheyev, JTI's vice president of corporate affairs for the CIS+ region. "Its market share in Russia has doubled in the past seven years and continues to grow," he says. "Winston, together with Peter I and former Gallaher brand LD, are among the top five most popular tobacco brands in the country."

The players

Cigarette production capacity in Russia doubled after the dis-solution of the Soviet Union, and the market share of the mul-tinationals has increased from nothing prior to 1990 to about 90 percent, in terms of volume, today. "A lot of state Soviet facto-ries were privatized by local management, and some of the best production facilities were sold to multinational companies at a relatively low value," says Alexander Khakhalev, a country man-ager and global business relationships manager with Alliance One International. "Labor was cheap, the market was growing and was able to consume more—all of this led to sharp increases in production figures.

"In addition to that, since the mid-'90s and until a few years ago, the price of a legal cigarette pack (cheap, mid-price or pre-mium) was one of the lowest in the world, backed up by market-ing and advertising campaigns," he says. "These factors drove local consumption increases, as well as cross-border trade." Also, in the late '90s, the multinationals began to use Russia as a manufacturing base for the export market, i.e., shifting some production from Western Europe to their Russian facilities. Wayne Merrett, general manager of Russia and Belarus for Imperial Tobacco (ITG), says that, prior to the global economic crisis in 2008, the growth in the Russian tobacco market was driven largely by the increases in consumers' disposable incomes.

Because of the multinational's rapid growth in Russia, the independent producers' market shares began to decrease dra-matically by the turn of the century, falling from 100 percent in 1990 to 42 percent in 2001 to only 7 percent by 2009, according to the Russian Statistics Bureau (RSB). In all, five companies control nearly 98 percent of the market today, and only one of those is an independent, according to Tabakprom.

All of the major multinational tobacco companies operate in the country, with all of them investing in facilities, brands, mar-keting and distribution. Analysts estimate that, as of August, JTI, under its parent company, Japan Tobacco (JT), garners 16–18 percent of its global profit in Russia, followed by Philip Morris International (PMI) at 9 percent, British American Tobacco (BAT) at 8 percent and ITG at 5 percent. Korea Tobacco & Ginseng (KT&G) is also a player in Russia with about a 1 percent share of the retail market.

Russian manufacturers produce just over 410 billion sticks combined annually, according to the Russian Tobacco Media Group (Rustabak). JTI produced 145.6 billion sticks in 2012, fol-lowed by PMI with 99.1 billion, BAT with 80.6 billion and ITG with 40.3 billion. The independent manufacturers produced 44.6 billion sticks, with Donskoy Tabak, the largest of the indepen-dents, producing 31.8 billion of that total, according to the RSB.

PMI was the first multinational to enter the Russian market  when it signed a production agreement with the Soviets in the mid-1970s, according to PMI's website. RJR International (now part of JTI) acquired the Uritsky Tobacco Factory in 1992. Then, in 1993, PMI acquired a controlling interest in the Krasnodartabakprom factory, which became PMI's first large-scale Russian production facility; it now operates two factories in Russia. BAT entered the market in 1994 and currently has two cigarette factories. And in 2007, JT acquired all outstanding shares of Gallaher Group, propelling JTI to No. 1 in Russia with 37 percent of the market.

Imperial got its foothold in the Russian market with its Reemtsma acquisition in 2002 and was strengthened by its Altadis acquisition in 2008. Altadis had acquired Balkan Star in late 2004.   KT&G entered the Russian market in 2003 with its Esse brand, according to S.J. Lee, a spokesperson for KT&G.Independent Russian manufacturers include Donskoy Tabak, Baltic Tobacco Factory, Pogar Cigarette & Cigar Factory, Usman Tobacco Factory and two small factories in Morshansk, according to Moiseev. "If we talk about manu-facturing volume in pieces, the independent manufactur-ers occupy about 11 percent of the market," says Moiseev.

"As to market share in finances, they occupy about 5 per-cent. Independent manufacturers are represented in the low- and mid-range product segments." Donskoy Tabak occupies  7.74 percent of the market as of 2012, according to Moiseev. The share of the other manufacturers accounts for less than  3.5 percent of the market combined. Enditem