A Period of Adjustment

Source from:  worldtobacco.co.uk 26 July 2007 07/27/2007

Germany's cigarette market in recent years has provided a classic illustration of the truth that faced by higher prices, consumers will try most things - except give up smoking. In the four years to late 2006 there were five German government-imposed excise tax and VAT increases affecting tobacco which had the combined effect of raising the price of most cigarettes by 30% to 40%. But as an independent report released last year by British American Tobacco made clear, inflated basic cigarette prices force consumers to seek alternatives, in Germany's case turning towards home-produced cigarette substitutes which, for a time anyway, were taxed at a lower rate, or buying imported cheaper cigarettes (either legal or illegal) from Poland, the Czech Republic and the Ukraine. It was reported last year by the Verband der Cigarrettenindustrie (VdC), the association of German cigarette manufacturers, that the rise in German cigarette prices meant that the price of packs on offer in these countries was half, and in some cases even less, the price of the same sized packs in Germany. Imperial Tobacco, the holder of 20.7% of the German cigarette market through its subsidiary Reemtsma which owns Germany's second most popular brand West, told World Tobacco that the legal and illegal inflow of cigarettes into Germany from other countries rose significantly in recent years and was still climbing. "In 2006 there were 24 bn sticks sold which did not bear tax in Germany and we expect this to rise to 30 bn in 2007 which would mean that every fourth cigarette sold here would be from another country. Last year their share was 20% – or every fifth cigarette so it is clear that some consumers have switched over to the inflow of legal and illegal products from other countries," said Sebastian Blohm, Imperial Tobacco spokesman in Germany. The share of imports can be calculated by examining the tax stamp on packets which states whether the cigarettes have been taxed in Germany or in another country "but they can't say if they are imported legally or illegally," Mr Blohm said. "However the import figures are quite high in the western part of Germany and nobody there travels a hundred kilometres or so to buy a few packets of cigarettes as they do in the east so we can assume that the amount of illegal or smuggled cigarettes is quite significant," he said. In 2006 sales of German factory-produced cigarettes were down 9% on 2005 at 92 bn cigarettes, which was well over a third lower than in 2002. The overall tobacco market last year was down 6% to 135 bn cigarette equivalents, with a pronounced switch to RYO tobacco products including fine-cut. The net decline in total tobacco consumption over the four years to 2006 was less than 10% which seems quite modest when you consider the fall of over a third in factory-made cigarettes over the period. There was nevertheless a much sharper fall in tax revenues which is surely not what either the government or anti-smoking campaigners had in mind five years ago. According to Peter Halacz, director of corporate regulatory affairs for British American Tobacco in Germany, the federal government has lost a remarkable €4 bn in tax revenues as a direct result of the fall in sales of German-made cigarettes and the tobacco industry has lost €60 mn. "Tax revenue today is the same as it was five years ago as a consequence," he said, and this was continuing. He too predicted a rise to 30 bn in German sales of imported cigarettes this year. Mr Halacz was in little doubt that the vast majority of the imported cigarettes were smuggled in, in most cases by organised crime rings. The tax anomalies have been at least partly corrected however by the European Court of Justice (ECJ), which ruled in 2005 that singles (pre-rolled cartridges of tobacco for insertion into cigarette paper tubes with filters) should no longer enjoy a tax break that meant they could be sold at half the price of regular cigarettes. The ECJ said they should be taxed at the higher cigarette rate and Imperial, which sold around 7 bn of the 22 bn singles consumed in 2005, ceased production of them from April last year. The "singles migration" is still going on as stocks are wound down. Imperial is predicting that 20% of singles consumers will move into duty paids, 55% into other tobacco products and 25% into legal and illegal cross border products. Tobacco company reports for 2007 so far confirm the trend towards what Imperial calls the "value for money" sector where the company's JPS doubled its market share to 6% at the beginning of 2007 compared to 2006 and is now among the six most popular brands in Germany. Germany has come late to the growing enthusiasm in Europe for smoking bans but there is one sector where new government regulations are already having a quite savage impact on sales and this is in vending machines. Peter Lind, director of the Bundesverband Deutscher Tabakwarengrosshändler und Automatenaufsteller, the German tobacco wholesale and vending machine association, says there are roughly 500,000 cigarette vending machines in Germany and since 1 January this year all have been required to carry electronic age verification devices which means they will not work unless a card, issued by the banks and certifying the bearer's age, is presented. At present the minimum age for buying tobacco products is 16, rising to 18 on 1 September 2007 though for vending machines the higher age will not apply until the beginning of 2009. Mr Lind told World Tobacco that sales of cigarettes through vending machines had fallen by up to 20% in the months following introduction of the electronic scanners though he did not think this was a good guide to the future. "It's a very new system and we are not really disappointed. Not everybody had his card with age criteria ready. We are convinced that the vending machine will continue to be a successful point of sale," he said. But Philip Morris is less positive. The company's first quarter 2007 results showed a sales decline of 2.1% in Germany and fall in market share of 0.9 points, down to 36.2%, "largely attributable to the contraction of industry sales through the vending channel." PMI reported that total industry sales through the vending channel declined 38% in the first quarter of this year thanks to the new regulations. The market brand leader Marlboro, with a 42.1% share of vending machine sales, was "disproportionately impacted by the decline in industry sales through this channel" and its market share fell 3.5 points. More recently, the German tobacco magazine Die Tabak Zeitung has reported that cigarette sales through vending machines fell to 14.2% of total industry sales in the first four months of 2007 compared to 22.1% in the same period of 2006 and 23.1% in 2005. Against this background the federal government late last year introduced proposals to ban smoking in government buildings, on public transport and in restaurants, discothèques, schools and other public buildings, except in designated smoking rooms from September 1 this year. The proposal markedly less comprehensive than those of other EU countries – it excludes, for instance, bars, pubs or beer tents. It is also, even now, unclear as to exactly how and when it will be applied. "Some legislation, such as that for the trains system and for office buildings of the German government, will apply to the whole country but where HORECA (hotels, restaurants, cafes) is concerned it is a matter for the 16 Lander (provinces)" said Professor Wolf-Dieter Heller, head of the science department at the VdC. The legislation seems to be emerging on a piecemeal basis – some Lander have already produced tightly restrictive anti-smoking packages, others have left open loopholes for establishments able to prove minimum ventilation standards while others have not yet acted at all. Dr Martina Pötschke-Langer of the German Cancer Research Center welcomed the legislation as "a big first step forward for Germany" saying it was "only a question of time now before we have smoke-free restaurants and bars." The tobacco industry seems unworried however. "We don't expect any major effect on our business. Our experience in other countries is that smoking tends to turn down in the short term and then after about a month goes up again to close to the original level," said Mr Blohm at Imperial. Similarly Mr Halacz said that BAT "do not assume a big impact on total consumption." He predicted that "they will allow smoking by some device or other" in all 16 federal states." Philip Morris told us that "public smoking should be restricted but the law should permit a business owner the right to choose to allow smoking under appropriate circumstances in workplaces and the hospitality sector." The final word must concern the future of the VdC following the surprise announcement in May that Philip Morris is to leave the association at the end of the year. VdC membership will then be down to the two big British companies – Imperial and BAT (with just over half the cigarette market between them) – plus JT International Germany and two other smaller concerns. For all its small membership, VdC has always punched well above its weight where legislation is concerned and is credited with playing a significant part in Germany's long opposition to controls over tobacco. Perhaps this will continue, but Philip Morris's departure, following "different views on the effectiveness of further tax increases to regulate consumption," may well be taken as a sign that the industry's muscle in Germany is not what it used to be. Enditem