Smelling of lemons

Japan Tobacco still thinks that the tobacco business has a healthy future

To see why Japan Tobacco is expected to bid in an auction in Turkey next week, visit
Tokyos teen-centric Shibuya district. Youngsters happily puff on cigarettes there, but
ignore them they are not the real story. Although nicotine has hooked males in Japan
more than in any other rich country, even the Japanese market is shrinking faster than
those smoking teens would suggest. Instead, stroll to the nearby Tobacco and Salt
Museum. There the story is told of tobacco's globalisation as it spread from the
Americas; of how technology has made consuming nicotine more convenient; and of the
role that brands have played in marketing the deadly drug. No cigarette firm anywhere
is striving harder to make money from the continuation of all three strands of that story
than Japan Tobacco.
Its interest in globalisation is easy to understand. Japan Tobacco's domestic market is
now shrinking, not least thanks to successive tax hikes on cigarettes. In 1996-2001, the
number of smokers in Japan as a share of people aged 20 or over fell from 27.1% to
24.4%, says the health ministry. Japan Tobacco's domestic tobacco sales fell by 2.4%
by volume in fiscal 2001, and by 3.5% last year. Taizo Demura of Morgan Stanley
reckons that they will fall by a hefty 5.5% this year.
In April 2005, Japan Tobacco will also lose its licence to sell Philip Morris's Marlboro
brand domestically, which the company says will knock 50 billion ($455m) off its annual
operating profits around one-fifth. Japan's low population growth, moreover, will
continue to hold back domestic sales in the future, even if those Shibuya teens keep
getting hooked. To boost tobacco profits, therefore, Japan Tobacco is banking on higher
revenue overseas. To this end, it has bought and is now aggressively promoting a
portfolio of leading international brands. In 1999 it acquired the international business of
America's RJR, giving it the rights to the Winston, Salem and Camel brands outside
America. Japan Tobacco hopes that growing such high-margin brands will boost its
profits in Europe.

But, even though the firm is confident perhaps overly so that Europe is unlikely to
follow America's courtroom assault on the cigarette business, demographics, health
concerns and politics (such as proposed bans on smoking in public) make western
European countries, such as Britain and Germany, look potentially as unexciting as
Japan. This leaves the big emerging economies to be more thoroughly and profitably
addicted. Alas, some of the biggest emerging markets are not very promising either, at
least in the short term. In China, the world's biggest market by volume, Japan Tobacco
cannot get past a state-run monopoly. Indonesia, the fifth-biggest market, is dominated
by locally made kretek cigarettes (laced with cloves from the country's eastern islands).
Japan Tobacco has been especially aggressive, therefore, in Russia, the world's fourthbiggest market, where smokers lit up 300 billion cigarettes in 2002. And then there is
Turkey, the world's eighth-biggest market.
On October 24th, Tekel, a Turkish state-run firm that sells tobacco products, salt and
alcohol, will put its tobacco business on the auction block. Although they are still looking
over the details, Japan Tobacco's executives say they have a strong interest in making
a bid. Around half of Turks aged 18 or over smoke, and Tekel has 61% of the market.
Better still, Turkish smokers are showing growing interest in higher-priced upmarket
brands. Japan Tobacco is also acting on the third lesson from the industry's history, by
using more technology.
Earlier this year, in and around Tokyo, it began selling Lucia, a new citrus-flavoured
cigarette that has been specially blended to reduce odour. It claims these are as popular
with non-smokers, most of whom usually hate the smell of cigarettes, as with smokers.
Lucia will be sold nationwide from November 4th. The firm will also begin to sell a
similar reduced odour cigarette under its Mild Seven brand name which should make
it more appealing to male smokers than girlie Lucia in Tokyo.
Yet even if it keeps up its profit margins, shareholders are not convinced that they will
reap the benefits. Unlike the world's biggest tobacco company, Philip Morris, which
(through its parents Altria) pays out half of its net income in dividends, Japan Tobacco
only returns about 20% of its net income to shareholders. Earlier this month, it
announced plans to buy back 50 billion of its shares. But so far it has repurchased only

about 70% of this total and most ofthese were from the government's 66% stake. The
firm was partially privatised in 1994.
One reason why the firm is loath to return more cash, says Masakazu Kakei, the
president of the tobacco business, is that it wants to invest more in its pharmaceuticals
business even though it has yet to produce a marketable drug. Perhaps, a few
decades from now, there will be a pharmaceutical museum in Tokyo telling how cash
flows from tobacco were used to build one of the world's leading drugs companies.
More likely, Japan Tobacco's profits will instead go up in smoke.
TOKYO
Source: Economist.com, 2003 October 16

QUESTIONS
1. Do you think Japan Tobacco (JT) is following a smart strategy?
2. Why is globalisation important to tobacco companies like JT?
3. Do you think China should open its tobacco market up to international
competition?
4. Do you think the Chinese government should impose a high tax on cigarettes like
governments in other countries have done?
5. What do you think about the fact that the Chinese government monopolises the
tobacco industry in China?
6. Can you think of some ways JT can get past Chinas state-run monopolies?
7. In the West you can see both men and women smoking but in China, although
many men smoke, it is rare to see a woman smoking. Why do you think this is so?
8. Why do marketers have to worry about demographics?
9. What do you think about the new Lucia cigarette?
10. Aside from a reduced-odour cigarette, what other ways do you think technology
can be used to sell more cigarettes?
11. What do you think about JT investing money in its pharmaceutical business?
12. Why are brands so important to cigarette companies? What about the situation in
China?
13. Do you think managing a tobacco company would be any different to managing
another type of company?
14. What do you think the future is for tobacco companies?