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India is now Marlboro country!

November 15, 2003

It's a battle taking place behind a smokescreen. But as the smoke clears one thing is clear -- the biggest gunslinger in the tobacco world has just cantered into town. And a shoot-out is about to start.

On one side is American food and tobacco giant Philip Morris which went for its gun and called a hurried press conference in Delhi earlier this week.

The Philip Morris announcement sent a shiver down the spines of other Indian manufacturers. Philip Morris is launching the world's bestselling cigarette Marlboro at a relatively affordable Rs 75 for a pack of 20.

If that wasn't bad enough the cigarette giant had another surprise up its sleeve that stunned local companies.

It is abandoning long-time Indian partner Godfrey Philips India (GPI) -- owned by the K K Modi Group -- to launch the brand. Instead, the Marlboro Man will be going it alone.

In fact, Marlboro will be making its entry in a novel fashion. Philip Morris will start by importing the cigarettes and then sell them through non-exclusive distributors.

For starters it has signed a three-year agreement with Barakat Foods and Tobacco Pvt Ltd, to launch Marlboro in the metro cities of western India.

Why this strategy? Philip Morris says Marlboro is too big a brand to take any chances with.

"Marlboro is a valuable international trade mark for Phillip Morris. It is company policy to manage all aspects of the brand under direct control whenever possible and permissible, as is the case in India," says Ajit Sahgal, general manager, India.

Sahgal makes it crystal clear that Philip Morris doesn't have management control of Godfrey Philips, and therefore the question of entrusting the brand to it doesn't arise.

Not surprisingly, the domestic tobacco companies are already crying themselves hoarse. They are questioning whether Philip Morris can legally import cigarettes and thus, dodge the clearances it would have needed to start manufacturing.

Also, the local manufacturers point out that the Philip Morris move will fuel the problem of smuggled premium cigarettes which are already flooding the Indian market. They're demanding a level playing field against imports.

The worst hit is, of course, GPI, which is putting on a brave front even after being cut out of the action. Sahgal insists that GPI was informed about the move way ahead of time.

Nevertheless, GPI says it will approach Philip Morris and point out that it has a better distribution system than anyone else.

Also, GPI managing director Ram Poddar insists it didn't know about the Philip Morris move. Says Poddar: "We were not aware of this move. We have to study it in detail."

It goes without saying that the local cigarette companies aren't about to let the Marlboro Man ride into town without a fight.

Soon after the Philip Morris press conference, some of the country's top tobacco executives went into a huddle to decide their course of action.

While the companies are not ready to come on record, a three-fold strategy has already been put in place to combat the Marlboro entry.

The local companies are planning to erect roadblocks for the outsider by petitioning the government.

For a start, they will demand that import duty on tobacco which is under OGL (which means it faces a 30 per cent customs duty, apart from a countervailing duty equal to excise duty) be raised to 150 per cent. That's the highest slab which can be imposed under WTO rules for the product.

Alternatively, they say, tobacco should be moved out of OGL to the restricted list with higher duties.

Points out a tobacco executive: "After all, the government policy is to discourage cigarette smoking and various restrictions have been put on domestic companies. So how can you penalise us and encourage foreign brands? We want a level playing field."

They also point out that tobacco has been placed in a special category by the government (called the sensitive watch list). Therefore, this gives the government the right to hike duties if imports climb substantially.

If that isn't enough, the local tobacco companies are suddenly discovering the virtues of higher taxes -- for imported cigarettes.

They say that the existing customs duty on imported cigarettes accounts for only 5 per cent of the minimum retail price.

But for soaps and detergents the incidence is as high as 30 per cent of MRP. This, they say, is a difference that needs to be narrowed.

The tobacco companies will also be asking the government to follow the example of the Nepalese Government, which has fixed a minimum price at which cigarettes can be imported.

Says a senior executive of a tobacco company: "In Nepal, for instance, the government has imposed a minimum price at which a brand can be imported. This helps in preventing under-invoicing by importers."

One way to determine the price, say executives, is to peg it at the same rate that duty-free shops buy the brand. At the moment, duty-free shops buy Marlboro at $40 for packs with 1,000 sticks.

Most importantly, the tobacco companies are trying to block tobacco imports.

Philip Morris has, in fact, been extremely smart. It has taken permission from the Reserve Bank of India to set up a branch office in India which can also import and sell goods which are on the OGL list.

Sahgal says that it has also informed various ministries in the government that it would be importing cigarettes.

Says a tobacco industry executive: "The government has rejected proposals which entail foreign companies coming to India either to manufacture or trade in tobacco brands. So this loophole has to be tightened."

But why are domestic tobacco companies afraid of Marlboro using the import route? One reason is that smuggling is taking place on a gargantuan scale.

And local companies say that the Philip Morris move to India will only push up the contraband market which has grown by over 400 per cent in the last three years.

Local executives say the contraband market is already worth Rs 1,050 crore (Rs 10.50 billion) -- and it forms 9 per cent of the cigarette market.

Tobacco experts say that imports will encourage smuggling in two ways. Companies like Philip Morris will advertise their brands and make point of purchase pitches. That will help to push sales of smuggled Marlboros.

Secondly, retailers will now have an explanation about why they are stocking Marlboro. Therefore, it will become more difficult for the authorities to book them.

For traders, selling smuggled cigarettes is quite an attractive proposition: the margins on legally imported Marlboros are around 8 per cent to 9 per cent.

On smuggled Marlboros a trader can make as much as 25 per cent. Marlboro is available at between Rs 60 and to Rs 65 in the smuggled market.

These aren't entirely fanciful fears. Advertising has helped to boost smuggled brands. For instance, when 555 and Benson and Hedges were advertised, the immediate impact was a two- to three-fold increase in smuggling of these brands into India.

But there are more serious fears. Over 48 per cent of the premium king size market is dominated by smuggled brands and any increase would mean that domestic brands like Classic or India Kings and foreign brands manufactured in India like 555 would get squeezed even further.

Worse, Marlboro is the hottest selling smuggled brand accounting for over 22 per cent of the premium market.

What's more, Marlboro at Rs 75 won't be much costlier than the domestic premium brands. ITC's India Kings, for instance, also sells for Rs 75.

Similarly, brands like Classic, the Indian-made State Express, and Benson and Hedges all sell at between Rs 59 and Rs 72.

Says a tobacco company executive: "We have already lost a market of 2.7 billion cigarettes annually due to contraband in the premium segment which is legitimately ours. The government loses Rs 700 crore (Rs 7 billion) in excise."

He estimates that Indian premium brands could lose around 3 per cent to 4 per cent market share due to the combined onslaught of imported Marlboro and its impact on increased contraband sales.

But Phillip Morris says that the fears are unfounded. The company argues that upmarket smokers prefer to buy the legally imported product with the MRP printed on the pack rather than smuggled cigarettes.

So, it argues, smuggling of Marlboro will go down. Additionally the company says it will help the law enforcement agencies fight smuggling through its "Brand Integrity group".

Some experts who have been pushing for FDI in the tobacco sector say that the fears about Philip Morris are baseless.

Says an FDI consultant: "The premium market is very small. Indian domestic companies have used this as a pretext to ensure that no one can enter the field and compete with them."

Where does GPI stand in all this? Tobacco industry says the message is clear: GPI won't get a share of the big brands unless it gets a say in management.

Poddar denies that there's any tension between the two partners. Philip Morris merely says that the launch of Marlboro through GPI had never been finalised and that it has a good working relationship with GPI.

But tobacco watchers say that discussions between Modis and their partners have been on to bring in more international brands into India.

But they have been stuck on the question of management control (the Modis have 32 per cent equity, Phillip Morris has 36 per cent but the company is controlled by the Modis).

At the moment Philip Morris is determined to launch its world-famous brand through the import route. But domestic tobacco companies are equally determined to stop it from doing so. What we can expect in the coming weeks is more smoke and lots of fire.

An unexpected entry

It's a smart move that has left the corporate world watching in awe. Philip Morris has made its debut in India by a route that nobody had ever considered using.

It's important to understand that foreign tobacco companies aren't exactly welcomed with open arms these days. So, a company which wants to enter India has to face one of two hurdles.

First, it has to get a clearance from the Foreign Investment Promotion Board which isn't exactly bending over backwards to attract tobacco companies into India.

Secondly, if the foreign company happens to have a local partner (like BAT and ITC) it has to get a no-objection certificate (NOC) from the Indian company.

Philip Morris has bypassed both these requirements. It has taken Reserve Bank of India permission to set up a branch office in Mumbai. The rules allow it to export and import goods under OGL.

Philip Morris -- and one or two others like Rothmans -- have already felt the Government's cold shoulder in recent years. Indonesian company Sampoorna, for instance, wanted to import and undertake wholesale trading a year ago but it didn't get the Government's green signal.

Back in 1997 Philip Morris was permitted to set up a fully-owned subsidiary that would get into a range of businesses including food processing and beverage products.

But in the face of hectic lobbying by tobacco majors, the Government clarified that the permission didn't include cigarette manufacture.

Another attempt to get into cigarettes went up in smoke when an application by FTR Holdings, a Philip Morris subsidiary, to process tobacco in India and export it, was kept in abeyance.

Argues a tobacco company executive: "Importing Marlboro and selling it to a distributor, supporting the effort through advertisement all come under trading activities, which cannot be undertaken without FIPB approval."

The need for clearance from the local partner has also stalled many companies. BAT, for instance hasn't made a solo debut in India because ITC might have blocked it.

Similarly, FTR Holdings realised that partner GPI wouldn't give it an NOC. Rothmans also withdrew because it was clear that ITC -- in which it had a minority stake -- wouldn't play ball.

Philip Morris seems to have found a way around all these difficulties. It argues that the government's rule about NOCs from local partners only applies to foreign direct investment. But, Philip Morris says its branch office will only give marketing support to legally imported Marlboro cigarettes.

The local tobacco companies differ with that interpretation. They say it all constitutes trading activity which in India which the government does not allow.

If Philip Morris is correct it have revealed a gaping loophole in the government's regulations.

Indian companies are planning to raise a ruckus and insist that the government stop companies like Philip Morris. One thing is certain: there'll be a lot of companies who've been given a fright by Philip Morris' latest moves and there will be plenty of lobbying to stop it in its tracks.

Additional reporting: Parul Gupta



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