Located in Asia But Exhibiting Many Western Characteristics, Japanese Cigarette Market Remains A Bit of An Anomaly  

Source from:  Tobacco Reporter  11/19/2013

It was fashionable not so long ago for advertisements to depict people so agog at the brilliant products they were experiencing that their mouths had fallen open to the extent where, given the right vantage point, you could see their souls. Sometimes, what had enthused these people was little more than having used the latest smartphone to take pictures of themselves—selfies, I think they're called—with their mouths wide open. Perhaps they were view-ing and recording their own souls, which, I guess, would answer at least one enduring question and, fair enough, provide a reason for such excitement.

The question that exercises me, however, is would any-body buy a pair of brand X jeans just or partly because she had seen a picture of three people, with their mouths wide open, leaping in the air while wearing brand X jeans? Surely not.

But then again I have to assume that a lot of the com-panies that use such promotional devices do so having consulted with some of the best marketing people around, and there are some smart people in marketing. Also, I have to admit that, up to a point, I can be influenced by pictures of smiling people. In the morning, on almost a weekday daily basis, I visit the Altria website, where one of four rolling pictures on the home page is of a young lady with the brightest smile you could imagine. The smile is enough to give me a lift even on the grayest of English mornings.

And running the Altria picture a close second is one of three pictures on the home page of Japan Tobacco (JT). The JT picture used to be even better until a web-site redesign cropped the picture and covered up part of it with writing. In fact, the JT website has long had an uplifting feel to it. For some time, it was themed around the concept of "delight," and now smiling pictures crop up in various sections.

Steady decline

It is easy to be cynical and say that, like in the case of brand X jeans, these smiling faces are there to draw you in, but then if at the same time they lift the spirits, I'm happy to be drawn in. But not unquestioningly. I mean, why would there be so many smiling faces on the JT website when the Japanese market for cigarettes, which, business-wise, comprises by far the most important product JT offers, is not exactly on fire? (I am not concerned here with the company's overseas cigarette business, most of which is the responsibility of Japan Tobacco International.)

It's not even smoldering if one considers volumes, and, given the economic turmoil of the past five years and what caused it; across all industries, not just tobacco, volumes (and therefore jobs) must surely start to overtake profits as the most important smile factor on the faces of even the most rapacious CFOs.

Basically, Japan's market is a Western market that just so happens to be located in what we in the West call the East. So, unlike those of some of its near neighbors, the Japanese market has been in steady decline for years. In fact, what was a 336.6-billion-stick market in the year to the end of March 1999 was, in the year to the end of March 2013, a 195.1-billion-stick market. The market has fallen every year since 1999, without exception, and the total fall has been 42 percent.

And there would seem to be no way back. Japan's smok-ing prevalence, too, has been in long-term decline, and one of the reasons given for this decline is the country's aging population. A study conducted in May put the prevalence of smoking among Japanese adults at 20.9 percent, down 0.2 of a percentage point on that of a year earlier. In the year to the end of March 2006, smoking prevalence stood at 26.3 percent.

And while older people are turning away from smok-ing, so are the young. A story by Minoru Matsutani for the  Japan Times last month predicted that smoking could become an obsolete habit in Japan in the  near future  (my emphasis) because youngsters apparently now consider smoking to be "uncool." A December 2012 survey by the Ministry of Education, Culture, Sports, Science and Technology had shown that only 9 percent of high school senior boys wanted to smoke in the future. This figure was down from 30 percent in 2000 and 17 percent in 2006. In the case of girls, the figures were 11.5 percent in 2000, 7.5 percent in 2006 and 3.4 percent in 2012.

Seismic shifts

The decline in smoking prevalence is seen to have been caused also by a growing awareness about the health risks associated with smoking, the tightening of smoking-related regulations and a tax and price hike in October 2010. This reference to 2010 might sound odd but, even at this remove, no story on the Japanese cigarette market would be complete without mention of the October 2010 hike and the earthquake and tsunami that struck the coun-try with devastating effect on March 11, 2011.

It is probably no exaggeration to say that the Japanese cigarette market was thrown into chaos in the run-up to an unprecedented tax increase on Oct. 1, 2010, which, together with a manufacturer's increase by JT, overnight raised the retail prices of some brands by 40 percent. As would be expected, manufacturing, distribution channels and retail sales were put out of joint leading up to and immediately after Oct. 1, and, from this point of view at least, the tax rise was probably an object lesson in how not to conduct fiscal policy.

Although the sales chaos occurred mainly either side of October 2010 (sales were up by 88 percent in September and down by 70 percent in November), its effects are still being felt. Sales during the year to the end of March 2011 were down by 10.1 percent on those of the previous year, way up on the average annual year-on-year decline of the previous four years, 4.9 percent. Sales were down by 6 percent in the year to the end of March 2012, but were down by only  1.2 percent during the year to the end of March 2013.

And while the sales and tax hike affected total sales, the earthquake and tsunami of 2011 changed the balance of the market. JT's volumes fell precipitously in the immediate after-math of the disaster because of the massive disruption caused to the company's manufacturing and distribution operations. It was only in July 2011 that JT was able to start shipping all of its then 73 products, and only in August of that year that it was able completely to remove purchase order ceilings.

Since 1999, JT's share has, anyway, been in long-term decline (though it was stable in 2004 and 2005 and up in 2008 and 2009), but from 64.1 percent in the year to the end of March 2011, it fell to 54.9 percent in the year to the end of March 2012. It was back up to 60.8 percent by August 2013.

The beneficiaries of JT's market share decline were Philip Morris International and British American Tobacco, neither of which has manufacturing facilities in the country.

Menthol and Mevius

But taking a longer perspective, JT has done reasonably well since the Japanese market was relaxed in 1985 with the "privatization" of the former monopoly, the Japan Tobacco and Salt Public Corporation, when the govern-ment's shareholding was reduced to 67 percent, a holding that was further reduced to just over 50 percent in 2004. In 2005, JT enjoyed a market share of about 73 percent, while PMI and BAT shared about 27 percent.

JT's relatively strong position is reflected, too, in a list of the 20 best-selling products by market share put together by the Tobacco Institute of Japan in respect of the year to the end of March 2013. JT holds the No. 1 with Seven Stars, which has 4.3 percent of the market, and the next five places with versions of Mevius. The first foreign prod-uct, Marlboro Lights Menthol Box, with 2.3 percent, is in seventh position, while BAT's best-selling product, Kent 1 100s Box, is in 15th place, with 1.5 percent.

Apart from the precision with which many Japanese-market products are described, a couple of things stand out here. The first is that the highest-placed foreign product is a menthol cigarette and the second is the dominance of Mevius, which would not have appeared in the figures the previous year.

Menthol cigarettes play a big and gently rising part in the market. In the year to the end of March 2000, menthol products overall accounted for 8.6 percent of the total market, and JT's menthol products accounted for 4.6 per-cent. By the year to the end of March 2013, overall, men-thol products commanded 21.6 percent and JT's menthol products 7.6 percent. But I should point out that even in the detail of menthol brands, it seems that the market dis-ruptions caused by the events of March 2011 are still being felt. JT's menthol brands had risen to take 8.3 percent of the market in the year to the end of March 2011, but fell back to 5.8 percent in the year to the end of March 2012.

With the gap between the total market share of men-thol products and JT's market share, the company clearly sees menthol products as a focus area. In late August, for instance, JT announced three additions to its Mevius Premium Menthol range: products using the company's new menthol dispersion filter, or spread filter, which is said to provide a menthol delivery not previously experienced.

Also in late August, JT announced that its Hi-Lite Inazma (lightning bolt) menthol cigarette, which is said to deliver a super-strong menthol sensation, would become part of the Winston brand in December. This announce-ment seemed to be less about menthol and more about branding and naming. Indeed, it was perhaps an effort fur-ther to bring JT's brands into line with international norms by getting rid of words such as "lite," "light" and "mild," which in many markets are simply banned.

The case for changing the name of Mild Seven, which, on the domestic market, became Mevius in February, is clear. This is an international brand for which JT has big ambitions: to become the No. 1 global premium cigarette brand. But it is less clear why Hi-Lite should be absorbed by Winston (if this is indeed happening), unless, perhaps, JT is aware that the government is planning to ban descrip-tors such as "mild" and "lite" in the future.

The state's stake

So what is the relationship between JT and the govern-ment? Although the government sold off another tranche of its shares in JT in March, reducing its holding to about 33 percent (with about 37 percent voting rights), it remains the biggest shareholder. According to one report, JT had been keen for the government to sell all of its shares because the company felt that this would remove certain management constraints. I have no idea how JT feels about the partial sale, but Erik Bloomquist, a senior analyst, con-sumer staples, at Berenberg Bank, told me that he didn't believe the further sell-down of the government stake would make much, if any, difference to the way that JT was managed. "I think JT operates within certain constraints in Japan, but those are cultural and unique to how they believe it is best to do business in Japan, not really related to the government ownership stake," he said.

Tobacco growers, whose produce JT is obliged to buy, were not in favor of the share sale, but the government had little choice because it needed funds to help pay for reconstruction following the 2011 earthquake and tsunami. In fact, some reports suggest that it will sell the rest of its share over the next 10 years, by which time tobacco growers, many of whom have already been bought out, could be a thing of the past.

If JT is intent on getting rid of descriptors such as "mild" and "light," it is interesting to note that, while it is falling into line with international norms in this regard, it seems to be moving against international currents in the case of menthol. Overseas, the drift seems to be toward banning menthol or possibly regulating the intensity of menthol delivery, while at home it seems to be in the direction of more menthol products and stronger menthol tastes.

But then, looked at from outside, the Japanese market has always been something of an anomaly. Although the preva-lence of smoking among Japanese men has been relatively high, the incidence of lung cancer among this group has been low compared to that in Western countries. A num-ber of theories have been put forward over the years in an attempt to explain this phenomenon, but I'm not sure that any have managed to explain it away to wide satisfaction.

At one time, it might have been said that tar levels might have played a part, but low-tar products, like the descrip-tors that announce them, have long fallen out of favor. In any case, these days it is less convincing than it once was to describe the Japanese market as low-tar. Products that deliver 14 mg or more of tar account for 14.3 percent of the market. This is significant, perhaps, since the equiva-lent figure for 2000 was 13.7 percent, and since 14 mg is higher than the maximum allowed within the EU. On the other hand, 1 mg products account for 24.5 percent of the market, up from 11.7 percent in 2000; 2–3 mg products account for 8.2 percent, up from 7.9 percent; 4–6 mg prod-ucts account for 19.8 percent, down from 25.9 percent; and 7–13 mg products account for 33.1 percent, down from 40.8 percent.

The Japanese cigarette market is different, too, because of the presence of what is known as D-spec products, which employ odor-reducing technology. Such products commanded only 1.72 percent of the market in 2006 but have risen in popularity to the point where they now account for 9.7 percent.

It even has different smokeless products. Zerostyle Mint, which JT launched in Tokyo in May 2010, is referred to as a "snuff," but it is a non-lit, cigarette-shaped product containing a replaceable cartridge with tobacco and fla-vors. It has a tapered mouthpiece and removable cap. The product was enthusiastically received and, at one point, JTI had to move quickly to boost production so it could keep abreast of demand and expand the areas where the prod-uct was available. Original Zerostyle Mint was followed by Zerostyle Bitter Leaf at the end of 2011, the new product being a response to requests for one with the "flavor and aroma of a regular product." And Zerostyle Mint was relaunched from late May this year as Zerostyle Blue Mint, a product based on Zerostyle Drive Concept, which proved popular with consumers when it was launched in limited quantities in October 2012. Zerostyle Drive Concept was described as having a "brisk and strong menthol flavor and aroma," combined with a "subdued sweetness."

Then, in August, JT said it was adding two snus prod-ucts to its Zerostyle smokeless tobacco line: Zerostyle Snus Regular and Zerostyle Snus Mint. The taste, aroma and portion size of Zerostyle Snus is said to have been developed specifically to meet the preferences of Japanese consumers. Enditem