BAT Chief is Fired Up by Innovation

Source from:  FINANCIAL TIMES 05/11/2009

Sitting in the glass-fronted private dining room that overlooks the Thames, Paul Adams, the no-nonsense chief executive of British American Tobacco, pulls out a cigarette from a pack of Kool menthol and asks: "Do you know what the magic in this is?" The product, called Kool Boost, features a small capsule that, when the filter is squeezed, releases an extra boost of menthol flavour. Launched in Japan - where it has built up a 1 percent share of the market - in 2007, the product is part of a range of new smoking products that BAT has been rolling out in recent years. "People ask me how I plan to get premium brands to grow and the answer is right here," says Adams, pointing to his pack of Kool Boost. "Innovation". As the head of the world's second biggest publicly-listed tobacco company with a market value of £33.5bn, the 55-year-old has good reasons to be focusing on product innovations. Like its competitors, BAT has seen cigarette sales in the US, parts of Europe, and other mature markets fall amid increasing health concerns, smoking bans, higher taxes and advertising restrictions. But the company, whose brands include Kent, Lucky Strike and Dunhill, has sustained growth by cutting costs, increasing sales in developing countries where tobacco use is growing, and shifting customers to higher-priced products such as Kool Boost and Kent nanotek - an ultraslim cigarette that offers the same potent puffs at half the size of a normal cigarette. But none of this comes cheap. Last year, BAT spent £105m on research and development, with the bulk of that going to research of "reduced harm" cigarettes. Only Philip Morris International spent more, with a R&D budget of $300m (£200m). Imperial Tobacco, whose business is more geared towards the value segment of the market, does not give a figure on R&D spend. But the investment has not been in vain; BAT shares have more than doubled in value in the past five years from 834p to £16.84. Meanwhile, Adams has beaten BAT's goal for high single-digit growth in earnings per share every year since taking over in 2004. Signs that global demand for higher-priced cigarettes is softening are appearing. Last month, Philip Morris International said first-quarter shipments of Marlboro declined 2.4 percent; this week BAT reported a sharp slowdown in the volume growth of premium brands such as Kent and Lucky Strike, which Adams smokes himself. "What we are beginning to see now is a significant deceleration in the growth of the premium segment, particularly in central and eastern Europe," says Adams, adding that the company could see some continuation of the deceleration, or even a reduction in the growth of the premium cigarette sales, especially in markets where unemployment will rise significantly. "That's why we believe that innovation is so important," he says. "If you are trying to get consumers to uptrade from medium price to premium price cigarettes, why would they do that unless there's value added?" Still, Adams, a former marketing director at Pepsi-Cola, recognises that innovation on its own will not be enough to ensure BAT's long-term growth. That is why, after five years of watching its competitors consolidate (it thought prices for big listed companies were too high), the group came off the sidelines to do two deals in six days last year. Enditem