Discount and profits

Price Segmentation takes hold in Canada

The recent appearance of price competition in the Canadian cigarette market, driven by small manufacturers, marks a significant change to Canada s tobacco market. The market share of less expensive cigarettes produced by discount manufactures (those who are not part of the oligopoly) has increased by an estimated 57% from mid 2002 to mid 2003. Price discounted cigarettes manufactured by the big three are variously called value for money (VFM),» price category or discount brands . This segment of the market has doubled its market share in the same period.

There are now three categories of cheap cigarettes on the Canadian market

&#9658 those which are taxed at a lower rate (sticks and roll your own),
&#9658 discount brands manufactured by small companies and
&#9658 discount name brands manufactured by the big three.

This phenomenon is not without precedence in the United States, a market once characterized by uniform prices was transformed in less than 10 years to a market where more than 40% of the cigarettes sold were in discounted brands.

The emergency of a price segmented market for cigarettes presents both the opportunity and the need for a governmental response. Public measures could include a review of profit taking in the tobacco market, and the implementation of measures to ensure that cigarette prices continue to discourage smoking and that appropriate shares of cigarette revenues are received by the public agencies which must underwrite the health care, social and economic costs of tobacco use.

The tobacco market is becoming increasingly price segmented.

Cheaper cigarettes undermine the public health objective of reducing the amount of cigarettes smoked and reducing the number of Canadians who smoke. Yet there have been few times in Canadian history when cheaper cigarettes have not been available, and the availability of cheaper cigarettes is now growing.

The two familiar sources of cheaper cigarettes available on the Canadian market have been smuggled cigarettes and roll your own tobacco. Smuggled cigarettes were cheaper because excise and other duties had not been paid on them roll your own cigarettes were cheaper because they were taxed at a lower rate than regular cigarettes. In this sense, both can be seen as the failure of tax policy (either the enforcement of excise taxes, or the levels at which they were set).

In recent years, two new sources of lower priced cigarettes have emerged new lower priced brands introduced by small manufacturers, and new or newly priced brands marketed by the three big tobacco companies. Together with roll your own and tobacco sticks, these lower priced cigarettes have emerged as a price category. One in five cigarettes smoked in Canada in 2003 is a lower priced product.

The market share of discount cigarettes has doubled in the past year and the total market share of the price category has grown from 15% to 20%

Micro brands are gaining market share

There are several small tobacco manufacturers registered with Health Canada (see sidebar). Federal regulation requires that all tobacco manufacturers provide Health Canada with corporate and operational information.

The more successful of these manufacturers are Tabac ADL, Grand River Enterprises, and Bastos du Canada Ltee. Their brands (i.e. «Seneca») are sold for $1 to $1.25 less a pack than leading brands sold by Canada’s «big three» tobacco companies.

Two of the companies (ADL and Grand River) are based in Native reserves.

The «Big Three» have introduced cheaper brands. The major tobacco companies are competing for «discount» cigarettes with their own brands. Both Rothmans, BEnson and Hedges and IMperial Tobacco have lowered the price on existing brands (Number 7 and Peter Jackson, respectively. JTI Macdonald has launched new so called value for money brands, Studio and Legend. Price segmentation undermines public health objectives

Although multinational companies marketing in Canada have, until recently, maintained oligopolistic uniform pricing, they have previously used discount coupons and other market incentives. Such incentives act as temporary price reductions, or reduce the real price cigarettes. These marketing practices were ended in 1972, when the manufacturers adopted a voluntary advertising code which prohibited coupons, discounts and other incentives.

The current federal law banning tobacco advertising, which came into effect in 1997 prohibits most marketing incentives, such as gift to a purchaser or a third party, bonus, premium, cash rebate or right to participate in a game, lottery or contest

In many other countries, price segmentation continues to exist, and is achieved by a variety of marketing techniques. These include creating categories of cigarette brands (i.e. imported premium, domestic premium, and discount) using price discounts, rebates and other coupon schemes to reduce the purchase price using two for one, or larger pack sizes to reduce the real price selling with t shirts, lighters or other bonus gifts to reduce the real price. Reviews on the impact of these practices suggest that these industry practices erode health policy objectives in a number of ways.

Australian bonus packs undermined government tax policy.

When Australian cigarette taxes were based on the weight of tobacco used, tobacco companies found they could lower the price of cigarettes by using less tobacco in each cigarette. (The Canadian tobacco companies similarly reduce taxes on roll your own tobacco, as previously discussed). The Australian tobacco companies began to market low priced cigarettes in packages of up to 50.

Following the introduction of lower priced cigarettes in the state of Victoria, the government Office of Prices evaluated the impact on smoking. The authors of this report found that tobacco companies were able to take advantage of differences between smokers, and to use price segmentation to thwart public health initiatives

the price sensitive smokers are a minority but they are the key market segment which manufacturers have been targeting. It appears this same group are less likely to respond to health awareness messages and hence are a relatively secure base provided prices are held down in real term the industry pricing strategy is specifically designed to cushion this key market segment from the effects of increased taxation and hence retain them as smokers.

The implicit recognition is that older and white collar smokers are more easily influenced by health awareness promotion. By removing the hip pocket motivation for quitting, the companies know they are making the task of health educators much harder with respect to the young and blue collar female smokers who are less concerned about health.

The authors of this government report considered that the tobacco companies cross subsidized the lower priced cigarettes in order to keep smokers. The entire industry strategy for the last decade of targeting low priced large packs of cigarettes at price sensitive smokers appears to have been based on cross subsidization by committed smokers and was intended simply to counter Government pricing policy and health awareness programs.

AT the end of 1990s, and in response to the impact of these marketing practices, the Australian government reformed its tax policies and adopted per cigarette excise taxes similar to those in Canada.

Documents reveal discount brands introduced to increase youth cigarette market in the United States.

U.S. tobacco companies employ a variety of marketing techniques to reduce the real price of cigarettes. These activities have increased marketedly in recent years, and tobacco companies now spend $4.7 billion on coupons and buy one get one free style incentives. The companies have also created a price segmented market where brands sell in several price tiers, with premium cigarettes selli
ng for approximately 30% more than discount brands.

The release of tobacco industry documents which resulted from a legal settlement between six tobacco companies and the state of Minnesota permitted U.S. researchers to study how tobacco companies used price strategies. These documents revealed that the companies concluded that they could increase the number of young people who smoked by introducing cheaper cigarettes, provided that they could brand the cheaper alternatives.

Younger adults smokers are interested in price, but unlikely to adopt a brand whose only hook is price. To maximize the possible pricing opportunity among younger adult smokers, several alternatives should be considered .a price/value brand would need conspicuous second hook to reduce possible conflict between younger adults value wants and imagery wants. The most saleable hooks are likely to be based on product quality, since those provide easy to explain public reasons for switching. Suitable imagery should be used.

February 2004 RBH introduces Number 7 in Ontario, Quebec and Maritimes. Previuosly its «price category» had been in the form of sticks, or roll your own.

Cigarette Manufacturers in Canada

«The Big Three»

Imperial Tobacco
3711 rue St. Antoine West
Montreal, Quebec
H4C 3P6

JTI Macdonald
Suite 6000, 100 King Street
Toronto, Ontario
M5X 1A4 Rothmans, Benson and Hedges
1500 Don Mills Road
North York, Ontario
M3B 3L1

Other manufacturers registered with Health Canada

ADL Tobacco
1665, rue Nishk
Point Bleue

Bastos of Canada Limited
371, rue Saint Marc
Louiseville, Quebec
J5V 2G2

Choice Tobacco
R.R. # 4
Montague, PEI

Distribution MCS Inc
711 D De Martigny
Bellefeuille, Quebec

Distribution Dominic Lafreniere
31 Vincent
St. Alexis des Monts, QC

Enterprises Francois Enr Lyne Rocheleau Enr/Ferme Harnois Enr/Tabac Amical Inc
300 Rand Double
St. Ambroise de Kildare QC

Grand River Enterprises
2176 Cheifswood Road
Ohseweken, Ontario

Lepine Tabacco/ Tabac Lepine
1970, rue Notre Dame
Lavaltrie, Quec

Les Produits de Tabac Tremblay
6450 boul Langelier Ouest
Quebec, QC
G1K 5R3

Les Tabacs Tabec
175 Sutton
Delson, QC

Midwest Tobacco
301 47 Street S.E.
Calgary, Alberta
T2A 1Pe

National Tobacco Company Ltd
1000, boul St. Jean, Suite 319
Pointe Claire, Q.C.
H9R 5P1

Tabac l’Eminent
721, Rang St. Charles
St. Thomas de Joliette
JOK 3LOs 5/15/13

A tobacco product with a label, labeling, or advertising that uses the descriptor «light,» «mild,» or «low,» or a similar descriptor, is a «modified risk tobacco product» under section 911(b)(2)(A)(ii) of the FD&C Act (21 U.S.C. 387k(b)(2)(A)(ii)). A tobacco product is also considered a «modified risk tobacco product» under section 911(b)(2)(A)(i) of the FD&C Act (21 U.S.C. 387k(b)(2)(A)(i)) if its label, labeling, or advertising explicitly or implicitly represents that (1) the product presents a lower risk of tobacco related disease or is less harmful than one or more other commercially marketed tobacco products (2) the product or its smoke contains a reduced level of a substance or presents a reduced exposure to a substance or (3) the product or its smoke does not contain or is free of a substance. Under section 911(a) of the FD&C Act (21 U.S.C. 387k(a)), no person may introduce or deliver for introduction into interstate commerce any modified risk tobacco product without an FDA order in effect under section 911(g) of the FD&C Act (21 U.S.C. 387k(g)). A product that is in violation of section 911(a) of the FD&C Act (21 U.S.C. 387k(a)) is adulterated under section 902(8) of the FD&C Act (21 U.S.C. 387b(8)). Because the website uses the descriptor «Light,» or similar descriptors for the above listed products and includes claims that the above products contain a reduced level of a substance, these products are modified risk tobacco products. Because these products are offered for sale to customers in the United States without an appropriate FDA order in effect under section 911(g) of the FD&C Act (21 U.S.C. 387k(g)), these products are adulterated under section 902(8) of the FD&C Act (21 U.S.C. 387b(8)).