Cheap imports, counterfeit cigarettes, rising state excise taxes and manufacturers who are not complying with Big Tobacco's Master Settlement Agreement are among the tobacco category's many new "moving parts" noted by Philip Morris executives as the lead causes of softer than anticipated volume this year.
One variable that wasn't mentioned by Philip Morris during a recent analyst conference, but which also represents a growing threat to profits, is the Internet.
Web sales of cigarettes constitute about 2% of all volume sold, per Rob Campagnino, a Prudential Securities analyst. He projects that figure could climb to 5.9% by 2005 due to rising state excise taxes.
Such growth will pull more business away from premium cigarette brands. Consider that between 2001 and the end of third quarter 2002, market share for discount cigarettes rose 1.9% to 28.3%, a figure that Maxwell Report analyst Jack Maxwell contends is under-reported because contraband, for example, is undocumented.
That gain prompted Philip Morris to tell analysts that it would likely fall short of its previously projected growth of 8-10% in 2003.
Of course, not all Web purchases involve discount brands, and if smokers buy Marlboro online, chalk it up as another distribution channel for Philip Morris.
But the threat to premium cigarette manufacturers is that if smokers change the way they purchase, they also could change their brand preference.
"Cigarette distribution is so efficient the only reason you would go to the Internet is tax avoidance," said Campagnino. "You're already price conscious, so you can be susceptible to trading down, because the Internet offers a larger variety of brands than you would get at your local retail store."
Philip Morris can track volume sold through stores and influence how its smokes are sold there via its Retail Leaders merchandising program. Yet the tobacco giant doesn't have that same power over Web vendors.
The company threw some stones in September by filing federal lawsuits alleging that eight defendants' Web sites violated company trademarks and illegally sold Marlboros manufactured for export.
The problem demands more comprehensive strategies, so Philip Morris is urging wholesalers and retailers to alert it about Web sites with suspicious offers and improper age verification. To hedge its bets, the New York-based tobacco giant is also taking a governmental route. Lobbyists armed with estimates about how much tax revenue states are losing via Internet sales ($1.4 billion by 2004, per the Government Accounting Office) are pushing for state legislation requiring Web sellers to be certified and to give state taxing authorities the names and addresses of companies and individuals receiving cigarettes.
At the federal level, Philip Morris is lobbying for enforcement of the Jenkins Act--a 1949 law requiring cigarette dealers to report out-of-state purchases to the buyers' state tax authorities--to be shifted from the Justice Department, which has its hands full with homeland security, to the Bureau of Alcohol, Tobacco and Firearms.
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