Finance Report on Pakistani Tobacco Industry

 

1. Background

 

Presently there are seven listed tobacco companies in Pakistan which constitute as the organized sector of the industry:

 

Companies with foreign ownership

1. Pakistan Tobacco Company (PTC)
2. Lakson Tobacco Company (LTC)
3. Premier Tobacco Industry (PTI)

The two companies have merged together and are controlled by Lakhani group.

 

Companies with local ownership

1. Souvenir Tobacco Company
2. Khyber Tobacco Company
3. Sarhad Tobacco Company
4. Tobacco International Ltd.

 

• The unorganized sector mainly consists of the operations in NWFP and Azad Kashmir. This sector also includes foreign smuggled cigarettes.
• This unorganized sector constitutes of almost 13% of the total market in the country.

 

 

2. Products and Functions

 

The major product of this industry is cigarettes. Other than that, other products include cigars, ‘Bidi’, ‘Niswaar’, and tobacco for pipe and ‘Huqqua’. In Pakistan cigars and pipe tobacco are imported while the other products are locally manufactured. The production facilities for ‘Niswaar’, ‘Bidi’, and ‘Huqqua’ tobacco constitutes the unorganized sector and very little data is available. According to an estimate almost half of the tobacco consumption is through cigarettes while the rest through other means. As the prices of the products other than tobacco are very low, therefore the major source of revenue in the industry is cigarette manufacturing. Cigarette market can be divided into the following categories with the leading brand in each category and its market share. The categories are defined by the price range of each category.

 

Category	Price Range (Rs.)	Leading Brands	Market Share
A	23.75+	Gold Leaf	76%
B	17-16	Capstan	100%
C	15-6	Red & White	47%
		Wills Kings	10%
		Gold Flake	15%
D	6	Embassy	54%
		K 2	30%
E	Below 6	Royals	20%

(Source: PTC and Carr Mashriq)

 

3. Demand and Supply Trends:

 

• According to the recent estimate the total market in the country is estimated at 56 billion sticks per annum, with a market growth rate of 11% per annum.
• The shortage in production is covered by either smuggled/imported cigarettes or by the unorganized sector with understated or unstated capacity and capacity utilization.

 

 

4. Government Duty Structure:

 

Cigarette industry has two slab duty structure. The two slabs are:

1. A flat excise duty of Rs. 117,000 per million cigarette on brands costing less then Rs. 2.52 per pack of ten cigarettes (Categories D and E), exclusive of sales tax.
2. A 65% excise duty on brands costing more than Rs. 2.52 per pack of ten cigarettes, exclusive of sales tax.

• Other than that an 18% sales tax is also imposed on all the brands.
• The main burden on this industry is through indirect taxation which is applied on the revenues and not on profits. The direct tax is the normal corporate income tax @ 30%.

 

 

 

 

5. Employment:

 

Basically the industry is Capital intensive with the tobacco processing and cigarette manufacturing units only monitored by the people. The packaging job is also done through machines. However as far as the farming is concerned, it is still very much labor intensive, although the tobacco companies patronize the farmers through giving them various complementary inputs for farming. According to Economic Survey of Pakistan ‘95-96, total employment in the manufacturing side of the industry is 6000 employees with a total cost of Rs. 225 million.

 

6. Investment

 

According to a rough estimate, the total investment in the industry is around Rs. 3,900 million. However this figure is not very accurate as little data is available on the unorganized sector of the industry.

 

7. Exports and Imports

 

The imported brands have an important position in the upper category brands as there are very few brands which are manufactured locally (Gold Leaf, and recently Kenmore). Until a few months back all the foreign brands were smuggled in to Pakistan. Recently American company R. J. Reynolds started importing its line of brands (Camel, Aspen, and More) to Pakistan followed by PTC’s import of Benson & Hedges. In future the market is expected to be filled with other imported brands such as 555 (by PTC), Marlboro (by LTC/Philip Morris), and Dunhill etc.

 

As far as the import of raw materials is concerned, the paper roll and filters are imported while a part of the tobacco used in premium brands is also imported. Other than that, most of the raw materials are locally produced. The big companies, and among them the higher priced brands, use a larger proportion of imported raw materials. However there is a as such no international competition as the locally manufactures materials cannot compete their foreign counter parts in quality.

 

Pakistan also exports raw tobacco. The last five years figures for the export of raw tobacco are given below:

Year	Exports (Rs. million)
‘90-91	116
‘91-92	217
‘92-93	171
‘93-94	134
‘94-95	185
‘95-96 (July-March)	79

(Source: Pakistan and Gulf Economist, Oct. 7,1996)

Some cigarette is also exported to Middle East, Africa, and former Soviet Union but no figures are available in this regard.

 

8. Tax Revenues

 

As mentioned in the duty structured the industry is under a heavy indirect taxation from the government. According to a rough estimate the total indirect tax (duties and sales tax) paid by the two big companies (PTC, and LTC/PTI) amounts to around Rs. 12,903 million which is around 12% of total government tax revenue from these sources. On the other hand the these companies’ share in the total income tax collected by GoP is only 0.07%. The shows the extent of heavy indirect taxation on this industry.

 

       

 

 

9. Evolution of Market Structure

 

• In 1948 Pakistan started a trial plantation of flucured Verginia tobacco.
• The first production plant for tobacco was set by Pakistan Tobacco Company in 1950 at Karachi.
• In 1955 Premier Tobacco Industry started its operations. This was followed by various other small and medium sized companies.
• In 1968 GoP set up Pakistan Tobacco Board to regulate production, marketing, and export of tobacco.
• In 1070’s the companies imported technology from Holland, UK and Germany. The machined were called Mark 5 and Mark 8.
• PTC imported latest machinery in 1994 from Holland. The name of this machine is Loga Max.c
• In August 1996, PTC started the import of Benson & Hedges, manufactured by its parent company British American Tobacco Company, as a reaction to the R. J. Reynolds’ import of Camel etc.
• In November 1996, Economic Coordination Committee approved an increase by 10% in the support price of tobacco to offset the increase in cost of production and insure better returns to the tobacco growers.

 

 

 

 

10. Environmental Pollution

 

The issue of environmental pollution is not of critical nature in the industry as the industry is not responsible for any anti-environment activity. However it is heavily criticized for the health hazards that are caused by smoking. The tobacco companies try to improve their public image first through media advertising and secondly by engaging in other activities that improve their overall image. PTC started its plantation campaign in this regard few years back and also started the production of edible oil (Sundrop) for these reasons.

 

11. Market Structure

 

1. a) Factors Effecting Market Demand

• As there is no cigarette export currently from Pakistan there is no such demand. However, opening up of trade with India increase the export potential of cigarettes.
• Cigarette demand is not derived demand.
• Cigarettes have both price and income elastic demand. Changes in prices are responsible for the fluctuation in cigarette consumption, while increase in the income of the consumer often results in the upscaling of the consumer to a higher category brand.
• Product characteristics that effect demand include foremostly the price, quality of filter, quality of tobacco, packaging, and brand image etc.
• Bayer’s characteristics that effect demand include the income of the consumer, social status, health consciousness (determines the tar/nicotine level of his brand), the image of the brand in his mind, and the social circle of the consumer.
• Other demand determinants include the population growth rate and the percentage of young people in the population (as younger population tends to consume more cigarettes).
• The increased exposure of the rural masses to the media results in the younger populations inclination towards smoking, especially up scaling from ‘Bidi’, ‘Huqqua’, and ‘Niswaar’ to cigarettes.

 

1. b) Factors Effecting Market Supply

• A successful tobacco crop is a major prerequisite for the supply. If the crop fails due to bad weather or any other reason, this can result in supply shortage.
• Mostly there is an under supply situation in this industry as the demand is always in excess of the supply.

 

 

12. Pricing Trends

 

The pricing in this industry has a steady upward trend with an average rate of 5-8% per annum. This due to the sales tax and excise duties which the government imposes on the industry and which in turn are passed on to the consumers. The most significant feature of the pricing is the effect of taxes and duties. The industry does not increase the prices to improve its margins but it only attempts to maintain them.

 

The two big companies (PTC, and LTC/PTI) usually set the prices in cohesion. The prices of their brands competing in the same category are exactly equal to each other. The smaller companies however try to under cut the prices of big ones to capture the market. It is easier for the small companies to under cut the prices as they constitute the tax evading sector of the economy.

13. Non price competition

 

Product Styling:         

In tobacco industry the product styling plays a very important role as the image of the brand is an crucial factor in the overall success of the brand. The company’s try to compete with each other through giving a distinct image to the product through various marketing activities. This image helps in the differentiating the brand from its competitors in the same price range.

 

Advertising:         

Advertising or “above the line promotion” activities help the brand to achieve its desired image among the consumers. However the competing companies try to consolidate their own image through advertising rather than try to undo the competitor’s brand. For example, Red & White and Wills Kings are two competing brands in the same category but their advertising campaigns are completely independent from each other. The reason being that their desired brand image and brand styling is different.

 

Product Branding:     

There are very strong brand names in this industry. In fact the brand name and image is of greater importance than the quality of the product.

 

Dealer’s Discount:     

The dealers play a major role in the industry as they can easily ‘make or break’ a brand in the market. But still the dealers’ discount in the business is very low and like the companies they earn their profits on sales volume rather than profit margin. Following are the profit margins for various types of dealers:

Retailer            2.8%

Wholesaler     0.5%

Distributor      1.3-1.8%

 

Introduction of New Products:   

Currently in Pakistan there is a room for the tobacco products like cigars and pipe tobacco. However due to the low demand of these products and high costs of production no company is interested in launching these products either through local production or imports.

 

Other Non Pricing Factors:         

Other non pricing factors include the following:

• Taste of the brand
• Quality

 

14. Profitability

Following are the profit figures (in millions) of the major companies:

 

Company	1991	1992	1993	1994	1995	1996
PTC	N.A	N.A	158	47	(24)	139
LTC	N.A	N.A	30.3	33	40.2	49
PTI	(2)	24.8	36.1	27.8	N.A	N.A

(Source: Carr Mashriq & First Capital).

 

 

15. Product Quality

 

Features of product quality:      

• Taste of the brand
• Packaging
• Coloring
• Design
• Stick size
• Filter quality
• Roll paper quality
• Tobacco color and texture

 

Product Availability: 

The availability of the product is a very crucial factor because of the nature of the product. If the smoker of a particular brand fails to get his brand then he would be willing to switch to another brand for the time being. This change can also prove to be permanent. Therefore the companies try to make sure that the brands are available at the outlets according to their expected demand. This requires a very efficient distribution network as possessed by the leading companies (PTC and LTC/PTI).

 

16. Prospects of Future Growth:

 

Tobacco industry is a world wide growing industry, despite all the criticism it is facing in today’s world. From Pakistan’s point of view there are a number of important points.

• Pakistani market has a great potential of up scaling to the higher categories brands and cigarettes.
• The export market of Pakistan has a big potential. Pakistan’s duty structure for the industry is much lenient than the rest of the world. Pakistani industry can capitalize on this advantage and export to the countries of the region and also to Far East and Africa.
• As mentioned before in the report GoP has imposed a very heavy duty structure on the industry. But still this structure is much lenient when compared to the other developing countries and developed countries. Therefore it is safe to say that the government policy is conducive for the industry.