Slugfest in the Smoke Ring
Washington Post Staff Writer
Sunday, March 1, 1998; Page H01
Last week's news photographs of cigarette company executives jointly testifying before Congress gave the impression of a unified industry in which one company is indistinguishable from another.
The truth of the cigarette business is a good deal more complicated.
The picture that emerges from interviews with industry analysts and internal corporate documents is that the Big Four -- Philip Morris Cos.; Reynolds Tobacco Co., owned by RJR Nabisco Inc.; Brown & Williamson Tobacco Corp., owned by BAT Industries PLC; and Lorillard Inc., owned by Loews Corp. -- are locked in a fierce struggle for cigarette market share in the United States -- a content in which one competitor can gain only at the expense of the others.
A fifth company, Liggett & Meyers, owned by the Brooke Group, has less than 2 percent of the market and is no longer considered a competitive threat.
An understanding of the rivalry among the four largest companies goes a long way toward explaining their scramble to market cigarettes to younger smokers -- a strategy that has brought much current political and legal controversy. The companies say they marketed cigarettes not to juveniles but to young adult smokers, but their critics allege -- and internal documents suggest -- the cigarette makers also promoted their products to teenagers. (More detail about marketing practices is likely to emerge from thousands of pages of additional documents released by the companies Friday; those documents aren't included in this article.)
The lodestar for the industry was Philip Morris's Marlboro, which became the dominant brand by the early 1970s on the strength of its appeal to young baby boomers. Documents show that every manufacturer sought to replicate that success.
"Today's teenager is tomorrow's potential regular customer, and the overwhelming majority of smokers first begin to smoke while in their teens," noted a 1981 Philip Morris corporate memo. "At least part of the success of Marlboro Red during its most rapid growth period was because it became the brand of choice among teenagers who then stuck with it as they grew older."
The document defined teenagers as those 12 to 19 years old.
In 1990, RJR memos show, some RJR managers urged sales representatives to focus promotional efforts on stores close to high schools and colleges where potential young smokers would gather. The company reprimanded the managers, and in a letter of apology one of the managers explained he had been inspired with "a sense of enthusiasm with our company's decision to gain share of market by targeting the young adult market with numerous promotions geared toward the 'Marlboro' smoker."
"These companies compete viciously," said Morgan Stanley Dean Witter tobacco analyst David Adelman. "They know their market share down to the town, city and street."
The prize? The 48 million Americans who still light up each day.
The business is enormously profitable, but the number of smokers has been in decline for years. A company thus can boost its profit only by taking market share away from others. One additional point of market share for a premium brand can mean $450 million a year in additional sales, Adelman said.
Sanford C. Bernstein & Co. tobacco analyst Gary Black calculated in 1997 that the top seven brands (Marlboro, Newport, Doral, GPC, Winston, Camel and Basic) account for about two-thirds of retail sales. Since four companies control 98 percent of the market, there is little incentive for them to try to steal market share through price cutting. Heavy discounting only lowers everyone's profits.
A negotiated settlement of tobacco litigation, which would undoubtedly call for new restrictions on brand marketing, could curtail much of this competition.
In the future, the kind of advertising blitz that powered Marlboro to the top will end -- as print ads, billboards and sponsorships such as Winston's role in NASCAR racing are either restricted or prohibited. Top brands will likely maintain or expand their market share, while weak brands are likely to be dropped as companies.
The major companies had to shed years of cutthroat competition when they decided last year to seek a comprehensive settlement of legal claims against the industry. Competitive pressure has at times nearly derailed the still-fragile coalition, especially because the two weaker companies -- RJR and B&W -- feared they would be unable to compete effectively in the future, officials and industry analysts said.
RJR has been concerned about both the large payments the $362.5 billion deal would entail and "marketing restrictions that might favor its competitors," especially Philip Morris, a spokesman said. A Brown & Williamson spokesman said that the proposed settlement would place the company at a "significant competitive disadvantage in the U.S." and that "better-positioned companies may have been less reluctant to enter into the agreement."
The ultimate fate of the settlement is in doubt and, despite the uneasy pact made by the companies to seek a deal, analysts believe they will continue to battle for the allegiance of the next generation of smokers.
"We do not yet know what shape the marketing restrictions will take, but these are top marketing companies," said veteran tobacco analyst John Maxwell of the brokerage Davenport & Co., based in Richmond. "They will continue to find ways to tell their stories to the consumer."
The greatest success story of the past 30 years in the tobacco business has been Marlboro. The brand has become the cigarette equivalent of Coca-Cola, Budweiser beer and Jack Daniel's whiskey rolled into one. Philip Morris took a moribund brand aimed at women and successfully advertised it to baby boomers and, subsequently, to their children.
Beginning in 1954, the company tried to reposition Marlboro as a filter brand with a striking new red-white-and-gold box. But by 1960, Marlboro had only a 4 percent market share and a mere 3 percent of the 18-year-old market, while RJR's Winston had a 9 percent market share and 11 percent of 18-year-old smokers, according to a 1984 RJR internal report.
Marlboro did not really take off until 1963, when Philip Morris launched a big-budget television ad campaign with the Marlboro cowboy riding along through the sagebrush, creating an unforgettable image.
The key to Marlboro's success, according to the RJR report? Younger smokers.
"Marlboro succeeded with a 'first brand' strategy to target the leading edge of the Baby Bubble, who turned 18 in the 1960s," said the RJR report, which reviewed the rise of several of the top cigarette brands of the 20th century.
Confidential company studies show that in the early 1990s, when Marlboro had snared 26 percent of the U.S. market, the brand was young America's favorite by far, with 70 percent of young smokers.
A Philip Morris spokesman declined to comment on the RJR report or its own youth marketing efforts.
Marlboro's youth penetration has had the extra benefit for Philip Morris of extending the brand's life. As the baby boomers hit middle age, a period when per-capita cigarette consumption tends to increase, they have stuck with Marlboro. That, in turn, has allowed the brand to gain even more market share.
Investor Thomas A. Russo, a partner at Gardner Investments in Lancaster, Pa., who holds shares in Philip Morris for clients, said, "What makes Marlboro such a remarkable consumer product is that its market share among 20-year-olds is as high as its share among 40-year-olds and 60-year-olds."
Today, Marlboro accounts for 75 percent of Philip Morris's domestic tobacco profits, according to analyst Black, and has nearly half of the U.S. market for full-price cigarettes, which also explains why the company's profit margins are the highest in the business.
RJR is the competitor from which Philip Morris wrested the youth market. And that combative relationship has continued even into the 1990s. A Philip Morris strategic plan for 1992-96 said that the company's effort to win added market share "really must be primarily focused on one specific competitor, namely, RJ Reynolds."
The study stated three reasons for targeting Reynolds:
"Reynolds has the largest market share, about 28%, of our competitors; consequently, there is more market share to take. Reynolds is experiencing massive declines in their full margin brands. And, lastly, Reynolds is currently making an all-out effort to regain some of their lost market share through extensive [discounting]."
Once the industry giant, Reynolds has been slipping for decades. Now burdened with debt, it is a distant second to Philip Morris.
RJR has actually fared poorly in its efforts to target its products to younger smokers, even though its Joe Camel imagery stirred public and government criticism.
Confidential RJR memos from the 1970s and 1980s paint a portrait of a company frantic over losing the youth market, especially to Marlboro.
"In every sense, companies with strong younger adult brands hold the high ground, standing above the increasingly difficult and costly battle for switchers. Today, only Philip Morris and Lorillard are growing among younger adult smokers; RJR is losing," said a 1984 RJR marketing report.
"The 14-18 year old group is an increasing segment of the population. RJR must soon establish a successful new brand in this market if our position in the Industry is to be maintained over the long term," according to a company forecast of its business for the 1977-1986 period.
A company spokeswoman said that the forecast was a draft and that the reference to teenagers did not appear in the final document.
RJR hoped to counterattack with Camel. A 1980 memo prepared for RJR by its outside ad agency describes the Camel campaign's goal as key to RJR's efforts to capture youth market share from Marlboro -- an objective that led to the Joe Camel ads, which tried to appeal to younger smokers with the cartoon camel.
Joe Camel was a success, but a limited one. The brand has gained youth market share, but not at Marlboro's expense.
Analyst Black estimates that Marlboro still has about 60 percent of the 18-24 market while Camel has about 15 percent.
London-based BAT is the outsider in the U.S. tobacco market, according to industry analysts and executives. The company, which purchased Brown & Williamson in 1927, has historically been more of a force overseas, where it derives 80 percent of its tobacco revenue.
Wall Street analysts said BAT has often been the last to raise prices in an industry noted for lock-step increases. BAT had no comment.
BAT has also taken a hard-nosed stance toward tobacco critics -- unlike its U.S. brethren, which have tried to blunt regulatory attacks via high-priced lobbying and huge campaign contributions to important politicians. A few years ago, Brown & Williamson went so far as to run a legal and public relations campaign against a former company executive who had become a whistle-blower.
"Our position is that we will vigorously defend the company against any false allegations," said a B&W spokesman.
BAT's 1994 purchase of American Tobacco boosted BAT's U.S. market share to about 17 percent. Its most popular brands are GPC, a discount cigarette, and Kool, a menthol product.
Like its competitors, B&W wooed the young. A 1973 marketing memo for Kool said that a smoker aged 16 to 25 was about "three times as important to Kool as a prospect in any other broad age category." Because of the vital role played by young smokers, the memo said, Kool marketing will be evaluated "to see how efficiently they reach this group."
But B&W, like RJR, has had trouble holding on to the teenage market.
A 1983 B&W memo written in response to the continued decline in Kool's fortunes said the relaunch of the brand should include a "new campaign squarely aimed at young adults including starters."
"Be at every major young adult gathering place we can find," the memo continued.
A spokesman for Brown & Williamson said: "In at least one-third of the states at that time, it was legal for 16-year-olds to buy cigarettes." Commenting on Kool's ongoing failure to appeal to younger smokers, the spokesman said, "The age of the average Kool smoker today is, unfortunately, about 45 years old."
In the battle for menthol smokers, B&W faced a competitor that proved to be a mini-version of Philip Morris's Marlboro -- Loews's Lorillard unit and its Newport menthol brand.
Lorillard's sales are just one-sixth of Philip Morris's, but its profit rate rivals the industry leader, according to industry analysts. Both companies derive most of their revenue from premium brands, as opposed to discount cigarettes, whose pricing is more cutthroat.
"Lorillard is a well-oiled machine," said Russo of Gardner Investments. "They know their market, which is menthol." Menthol brands account for about 25 percent of the cigarettes sold in the United States. Newport dominates the menthol market, and it provides 75 percent to 80 percent of Lorillard's profits, according to industry analysts.
Taking a page from the Philip Morris playbook on Marlboro, Lorillard has for decades concentrated on building the Newport brand among the young. As Marlboro was to displace RJR's Winston as the most popular brand, Newport was to overthrow Kool as the top menthol.
"The success of Newport has been fantastic during the past few years," according to a 1978 Lorillard document, which said that the brand's growth was driven by "black people (all ages)" and "young adults (usually college age)" but added that "the base of our business is the high school student."
Newport succeeded because Lorillard relentlessly focused its ads at blacks living in the Northeast, according to industry analysts. A 1969 memo by rival RJR noted that Lorillard's "Negro market budget was increased 87 percent over 1968." The majority of the increase went to build Newport among black Americans.
A subsequent review of the industry by RJR in 1984 described how Newport overtook Kool.
The RJR document said that "Newport was completely redone between 1970-73 -- campaign, product, package" and that RJR marketers went after Kool by targeting inner-city blacks in the Northeast, especially with billboards.
"By 1978," according to the RJR report, "Newport's regional spending against Blacks equaled Kool's national Black market spending. Newport had picked Kool's prime market, with a size it could afford, and essentially bought it. The results among younger adult smokers, especially younger adult Blacks, were immediate."
A spokesman for Lorillard declined to comment.
By 1983, Newport had the youngest franchise of any brand, with 53 percent of sales to people aged 18 to 24, and it had doubled its penetration of the young black market, according to the RJR document.
Today, Newport is second among premium brands. Kool is ninth.
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