Batsa’s cigarette pricing strategy has b …

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(Photo: Gallo Images / Ziyaad Douglas)

After two decades of limited competition and ever-growing profits, things started to go downhill for British American Tobacco SA in 2010 after a number of aggressive small cigarette manufacturers entered the SA market. Previously, the company had been able to harness its near-monopoly power to increase cigarette prices and therefore profits.

Corné van Walbeek and Samantha Filby

Corné van Walbeek is Professor at the School of Economics at the University of Cape Town and Director of the Excise Economics Research Unit (Reep). Samantha Filby is a research fellow at Reep.

Recently, Stop Tobacco Organizations and Products (Stop), an industry watchdog, released two reports (here and here) which describe the efforts of British American Tobacco (BAT) to undermine the businesses of its competitors, primarily by questionable or unlawful means.

The content of these reports was summarized in an article in Daily Maverick. Among other things, reports say that British American Tobacco South Africa (Batsa) and its UK-based parent company BAT plc spent hundreds of millions of rand to fund a surveillance system that spied on – and disrupted – people. activities of its competitors.

The ramifications of this scandal are potentially huge: Not only are organizations like Stop pressuring authorities to punish BAT’s actions, but the average South African smoker has glimpses of the “harmful”, “colonial-type” practices which can have negative consequences on the image and demand of its brands. We believe that the situation BAT finds itself in is, in large part, the result of its own actions.

In 1999, when Batsa was formed after the merger of Rothmans and BAT-affiliated United Tobacco Company, the merged entity had almost 95% of the cigarette market in South Africa. In 2019 he had a 71.4% market share of the legal market. Its share of the total market, ie including the illicit market, is probably less than 50%. How is it that a company that was so dominant could have fallen so far?

One possible answer: corporate greed.

History has a long history. During the 1970s and 1980s, Rembrandt, the South African subsidiary of Rothmans, was able to increase its market share by producing the cigarettes the market wanted and selling them competitively. South Africa experienced high inflation during the 1970s and 1980s, but Rembrandt generally increased its prices less than the rate of inflation, which meant that his cigarettes became relatively cheaper.

There was a warm relationship between Rembrandt and the apartheid government. For many years, excise taxes were not increased, and when they were, they were increased by less than the rate of inflation. The combination of sub-inflationary tax increases and sub-inflation tax-free price increases meant that the actual retail price of cigarettes in 1990 was 40% lower than in the late 1960s.

Things changed in 1990. The ANC was not banned, Nelson Mandela was released from prison and negotiations for a democratic dispensation began. The ANC made it clear that it would prioritize primary health care and disease prevention, and that it would have a strong tobacco control policy. It therefore seemed unlikely that the cigarette market would continue to develop as it had in previous decades.

In response to this threat, Rembrandt changed his strategy. Whereas previously it had gradually reduced the real price of cigarettes to attract more customers, it has now embarked on a strategy of substantially increasing the retail price of its products. While this may have caused it to lose customers who could not afford the higher prices, this loss in volume was more than offset by an increase in profit per cigarette. This strategy increased Rembrandt’s total turnover and total profit.

Importantly, this was only possible thanks to Rembrandt’s near-monopoly control over the South African cigarette market: owning around 85% of the total cigarette market at the time meant he could increase his prices without too much fear of dying. ‘be undermined by its competitors.

When the ANC came to power in 1994, it dramatically increased the excise tax on tobacco products. These increases were publicly lambasted by Rembrandt as unfair and discriminatory. However, Rembrandt used these excise tax increases as a smokescreen. increase the retail price of cigarettes by much more than the increase in excise tax. The result was that their profit per cigarette increased even more.

Since 1994, the National Treasury has followed a clear and transparent principle in setting the level of excise duties. It sets the excise tax so that the total tax burden (i.e. the sum of excise duty and VAT, expressed as a percentage of the retail price) of the highest cigarette sold or 50%. This percentage was increased to 52% in 2002. This meant that if the tobacco industry increased the retail price, the Treasury would increase the excise duty in the next budget cycle in order to meet the target tax burden percentage.

Between 1994 and 2010, this system worked very well for Rembrandt, and, since 1999, Batsa. Twice a year, in March / April and again in August, the company would increase the retail price of cigarettes, by a rate typically well above the rate of inflation. The price of cigarettes, in inflation-adjusted (i.e. real) terms, has only increased. Consumption fell 2-5% each year, but the drop in consumption was more than offset by the increase in profit per cigarette.

In 2010, the tobacco industry’s total real tax-free turnover was more than 30% higher than in 1994, despite the fact that the total number of cigarettes smoked fell by 37%. The creation of Batsa in 1999, following the merger of Rothmans and United Tobacco, further strengthened the company’s dominance by increasing its market share to 95%.

In the early 2000s, some competitors, including Apollo Tobacco, Mastermind Tobacco, Masters Tobacco and Philip Morris, entered the South African cigarette market, although these entrants do not pose an existential threat to Batsa. Philip Morris marketed his Marlboro brand as a popular price tag, rather than a discount brand, and did not cut prices for Batsa. Brain tobacco posed a temporary threat to Batsa’s market share by producing significantly cheaper cigarettes, but they were shut down in 2006. The other companies were just too small to pose a significant threat.

After nearly two decades of limited competition and steadily rising profits, things started to take a turn for the worse for Batsa in 2010. The very large profits made by Batsa have attracted a number of aggressive small cigarette manufacturers to the South African market. The new entrants were mainly competing in the low price segment, selling at prices significantly lower than the economy brands sold by Batsa. Some of these manufacturers were legal, some were not.

The presence of cheap cigarettes has drastically changed the cigarette market. Previously, Batsa had been able to harness his quasi-monopoly power to increase cigarette prices and therefore profits, but this was no longer possible after 2010. Indeed, Batsa sowed the seeds of its own destruction. If they had been more modest in their pricing strategy, they would not have encouraged competitors to enter the market. These competitors ruthlessly eroded their market share after 2010.

Batsa’s main response to these low-cost competitors is to argue that they are competitive because they do not pay taxes. There is certainly some truth to this. Testimonials collected by our colleagues from the Excise Products Economics Research Unit (Reep) indicates that a substantial part of the cigarettes produced by Batsa’s competitors are sold to price so low that it is impossible that the total tax amount had been paid. It did not help Batsa’s situation that South African tax services were incapacitated from around 2014, which allowed unpaid cigarettes to undermine Batsa’s market share.

However, Batsa is not a saint. As the research compiled in the Tobacco Control Data Initiative the website shows that small national companies and large international companies like BAT contribute to the illicit tobacco trade.

Despite attempts to present himself as a pillar of virtue in an ocean of vice, Batsa’s use of spies, lies and bribes recovering some of its market share reveals its greedy and filthy belly. It’s going to be hard to get over it. DM



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