Made of plastic and standing six feet tall, retail cigarette racks seem an unlikely flash point for a multimillion-dollar legal brawl among the titans of the tobacco business.
But war it is. Three of the country's largest cigarette makers have accused industry leader Philip Morris Cos. of coercing retailers into placing its brands on the choice parts of custom-built display racks supplied by the company, relegating rivals to near-obscurity.
The skirmish is drawing new attention to the long-running practice of paying for prime space on the nation's retail shelves--a topic that federal antitrust cops are starting to scrutinize, and which was the focus of a Senate hearing yesterday. And the litigation demonstrates how last year's landmark settlement with state attorneys general is reshaping the supercompetitive cigarette market.
Indeed, the rack battle is already getting ugly. In June, RJR Reynolds Tobacco Co., Lorillard Tobacco Co. and Brown & Williamson Tobacco Corp. won a court-ordered injunction halting parts of Philip Morris's incentive campaign, called Retail Leaders. Signaling that it would rather fight than retreat, Philip Morris recently retained superlitigator David Boies, the hired gun leading the Justice Department's case against Microsoft Corp.
According to experts, the lawsuit is the unintended offspring of the historic truce signed in November with 46 state attorneys general. As part of that deal, cigarette makers agreed to abandon stadium and billboard advertising, thus turning retail outlets--and racks in particular--into hot properties.
"It's basically as valuable to the cigarette makers as real estate in San Francisco," said Emmanuel Goldman, an analyst at Merrill Lynch & Co.
Cigarette makers, meanwhile, are struggling to pay the $246 billion they've promised to states in the coming 25 years. But with the percentage of smokers flat at about 24 percent of the adult population, the industry has been forced to raise prices, which is leading to a downturn in consumption. About 420 billion packs of cigarettes will be sold this year, down from 468 billion in 1998, New York investment bank Salomon Smith Barney Inc. said.
So winning the attention of smokers has never been more important or more difficult, which, according to experts, is why Philip Morris launched Retail Leaders last November. At the top levels of participation, signing up for the Leaders program can mean payments from Philip Morris of as much as $1,000 per month, said one local store owner who declined to be identified. A more typical payout is about $300 a month, this owner said, though the exact amount hinges on the number of cartons sold.
Soon after Leaders launched, Reynolds filed suit, arguing that Philip Morris had violated antitrust law by making stores an offer they could ill afford to refuse. With Philip Morris commanding 50 percent of the market, retailers could either sign up or risk being undersold by those who had, Reynolds claimed.
And stores that enrolled were prohibited from discounting rival cigarettes during Philip Morris's quarterly price promotions, Reynolds alleged. Most galling, the campaign required participants to place competing brands in the hard-to-see part of the racks, usually well below the counters. "PM's Program is an exclusionary campaign to turn the entire United States into Marlboro Country," Reynolds lawyers stated in the suit.
Philip Morris has denied the allegations, countering that the program and racks are simply a response to retailers who for years have been asking for better and more flexible display cases.
"We also designed the racks to reduce shrinkage," said company spokesman Michael Pfiel, using the industry term for theft. "It's a very competitive business and Philip Morris will certainly compete vigorously but will do so in full compliance with all applicable laws."
Philip Morris officials declined to discuss the particulars of Retail Leaders. The injunction by Judge Frank Bullock, issued in late June, blocks some of the more restrictive elements of the campaign and allows others to continue until a trial on the matter, now slated for next year.
Why all the fuss over a piece of bland-looking laminated furniture? It's not simply that the racks are among the few places tobacco makers can legally appeal to smokers, say industry analysts. Manufacturers have long understood that nabbing the ideal space on a shelf can mean the difference between failure and fortune.
"About 60 to 70 percent of the things we buy in supermarkets and convenience stores we had no intention of buying when we walked in the door," said Paco Underhill, author of "The Science of Shopping." "That's why products aren't just packages with stenciled names and why our stores have become visual cacophonies."
The prime shelf spots are generally 49 inches to 72 inches off the ground, Underhill said. Manufacturers pay handsomely for that space through "slotting fees" and pay more money to ensure that a particular number of, for example, jelly jars face consumers when they pass through the aisles.
Supermarkets--which typically squeak by with tiny 1 percent or 2 percent profit margins--are delighted to pocket the money. And the payouts can benefit consumers, too, since retailers often use the cash to lower prices or upgrade stores.
That's why for years antitrust enforcers have largely ignored the topic. Traditionally, when manufacturers complain about getting crowded off the shelves, or shut out of stores entirely, the Federal Trade Commission urges them to simply fight back by offering heftier payouts of their own. Shelf space was a small part of an FTC investigation into the cereal business in the 1980s, but there's been little other government action.
Trustbusters in the more activist Clinton administration, however, are now taking a hard look at slotting fees, according to sources. In part, it's a matter of philosophy. Both the FTC and the antitrust division of the Justice Department are taking tougher stands against dominant companies that use their muscle and deep pockets to win special treatment from retailers.
"It stems from a concern with the success of large companies in foreclosing access to markets for competitors," said William E. Kovacic of George Washington University Law School. "It's a distinctive Clinton administration theme and it's found cases against Intel Corp., Microsoft Corp. and Toys R Us, to name a few."
That seems to have emboldened some companies to file private antitrust suits. Last year PepsiCo Inc. sued Coca Cola Co., alleging that it was trying to monopolize the fountain-drink market. But even with trends in antitrust law in their favor, the plaintiffs in such suits face steep odds.
The problem for Reynolds and its co-plaintiffs is that Philip Morris's campaign doesn't actually require stores to forgo rival brands altogether. In addition, Reynolds, B&W and Lorillard aren't exactly minuscule and defenseless; together, they make up nearly half of the U.S. market. In fact, Reynolds has its own retail promotion program.
For Reynolds, the stakes in this suit are particularly huge, analysts said. In June, the company was spun off the sprawling RJR Nabisco food empire and its international tobacco unit was sold to Japan Tobacco Inc. for about $8 billion. Reynolds's sole source of revenue these days is domestic tobacco sales, said Salomon Smith Barney analyst Martin Feldman, and the company has been steadily losing market share to Marlboro and to Lorillard's Newport brand.
"They've got nothing to offset the difficult U.S. environment for cigarette sales," Feldman said, "so they've got to fight harder than they've fought before."
In a tough market where cigarette consumption has been shrinking . . .
Cigarette packs sold
'98 468 billion
'99 (Projected) 420 billion
. . . tobacco firms are struggling to maintain market share, and Philip Morris is fighting hard to keep its solid lead.
Among Philip Morris brands
Benson & Hedges
Among RJR Reynolds brands
U.S. market share
Philip Morris 50%
RJR Reynolds 24%
Brown & Williamson 13%
SOURCES: Salomon Smith Barney, Goldman Sachs, Tobacco Merchants