Eastern Europe: EU Rxpansion Offers Opportunities and Challenges

Source from:  worldtobacco.co.uk 28 January 2008 09/22/2008

The expansion of the European Union (EU) eastwards has been welcomed by most industries, and the tobacco market is no exception, although the EU enlargement has also created a series of problems for the industry to manage. The accession of Bulgaria to the EU club in 2007 brought a significant tobacco industry player into the fold. The smoking prevalence in Bulgaria is high, about 50% of the adult population according to 2005 figures, and smokers in Bulgaria tend to smoke, on average, more than 20 cigarettes a day, making them one of the most prolific smoking groups in Europe. Bulgaria also ranks first in the EU by the percentage of total agricultural land devoted to growing tobacco. Yet while foreign companies, such as Philip Morris and BAT, have moved quickly to establish a presence in Bulgaria, the familiar challenges of EU membership have quickly emerged. The key hurdle for the industry in Bulgaria has been the requirement to dismantle the near monopoly enjoyed by the state tobacco firm Bulgartabac and to introduce minimum excise duties on cigarettes by 2013, amounting to at least Û64 on 1,000 cigarettes (Û1.28 on a pack of 20). The production of cigarettes in Bulgaria is still under the monopoly of the state-owned Bulgartabac Holding, which has a market share of more than 90% of the cigarettes sold legally on the market. "Tobacco producers have been heavily subsidised in comparison with other entrepreneurs and as a result, the tobacco production in the country is not efficient," said a spokesman for industry analysts Euromonitor. Bulgaria's government last year delayed any privatisation until later in 2008, even though the company's own CEO Hristo Lachev warned that failure to privatise would mean that three of the company's four plants would have to close. Bulgaria has been raising excise duties since 2002, and in 2006 it increased excise taxes from Û6.1 per 1,000 cigarettes plus 31.8% on sale price to Û7.7 plus 48% on sale price, leading to a hike in retail prices of 62%. The next (and last) tobacco price adjustment is scheduled for 2010 when taxes will increase by more than 40%. The side-effects have been predictable, according to a spokesman for Bulgartabac, with the company's sales falling by 24% on an annual basis in 2006, while revenues from core operations fell by 48%. Price hikes have also increased the importation of black market cigarettes. "Because of the hike in excise duties at the beginning of the year, Bulgaria is experiencing an influx of smuggled cigarettes, which account for more than 15% of the market," said the Euromonitor analyst. Philip Morris representatives in the country have also expressed concern in local newspaper reports that cigarette smuggling was causing losses for producers. Similar challenges are now looming for the probable next new member state - Croatia - which has been firmly pencilled in by the EU as a new member state - maybe as early as 2010. Wealthier than Bulgaria ahead of accession, this former Yugoslav republic offers an attractive market to the tobacco industry: more than a million of the four million population are smokers. According to Euromonitor, just over 7bn cigarettes were consumed in Croatia in 2006, with Croatian smokers spending on average 3% of their personal income on tobacco. As well as the opportunities, the problems facing the tobacco industry in Croatia also mirror those in Bulgaria. It too has a taxation regime that has helped create a monopoly for the local, national company Tvornica Duhana Rovini at the expense of the other two major players, BAT and Philip Morris. "The government of Croatia has encouraged the monopolisation of tobacco by Tvornica and the system of taxation has prompted British American Tobacco and Philip Morris to move production outside of Croatia," said the spokesman for Euromonitor. BAT has closed its plant in Zadar and Philip Morris discontinued its licensing arrangement with Tvornica. In 2006, both British American Tobacco and Philip Morris imported their own products into Croatia. "If Croatia is to achieve full integration into the EU this will mean the acceptance of free competition and the government of Croatia will need to make changes to its legislation regarding competition," said the Euromonitor spokesman. "Tvornica Duhana Rovinj has enjoyed a dominant position but will need to prepare for a future where it has to defend its position." Philip Morris and BAT are understood to anticipate returning swiftly to Croatia once harmonised EU legislation has been passed in the country. A major challenge for the tobacco industry in Croatia will be the need to tackle the trade in counterfeit and illicit cigarettes. The illicit trade volume of cigarettes amounted to 1,800mn sticks in 2005. About 24% of all cigarettes consumed in Croatia are obtained via the black market. "The structure of taxation on tobacco in Croatia makes the retail prices of products in cigarettes higher than those of such products in neighbouring countries and this has prompted illicit trade," said another spokesman for Euromonitor. To see how the future may play out in Bulgaria and Croatia, it is worth looking at Poland, which joined the EU in 2004. The impact of higher prices on smoking trends can be seen in Poland, which has only partially implemented EU smoking regulations and must raise tax prices on cigarettes by 33% by the end of 2009. According to industry analysts Datamonitor, cigarette consumption in Poland fell by 2% in volume terms during 2006 mainly due to growth in smoking tobacco. "Tobacco represents an increasingly attractive, cheaper alternative," said a spokesman for the analysts, adding that falling smoking rates among the male population also contributed to the decline. Another side effect was a fierce price war throughout 2006 and into 2007 between manufacturers of mid-priced cigarettes that benefited Philip Morris's L&M brand and saw a growth in mid-priced brands at the expense of economy cigarettes. Enditem