The discounting-which could reach as much as 80 cents per pack for brands including Marlboro-is incremental to the $350 million in worldwide promotional spending announced by the company July 18.
Philip Morris Chairman-CEO Louis Camilleri cited the weak economy, consumer frugality, rising state excise taxes, continued growth of deep-discount brands and the influx of illegally imported cigarettes as reasons for the additional investment. On Sept. 26, the company revised 2002 guidance to 3% to 5% growth in underlying diluted earnings per share, down from earlier expectations of 9% to 11%, prompting a selloff in the stock to its lowest price since 2000.
Philip Morris' market share dropped 3.7 points to 47.1% in the second quarter of 2002 vs. the year earlier period, the biggest decline since Q3 1990, according to a Philip Morris document obtained by Advertising Age that outlines Management Science Associates' shipment share data since 1974. Marlboro declined 3 points to 35.9% in Q2 2002 against the same period last year, its biggest drop since Q2 1993, when Marlboro Friday answered six successive quarters of share decline against the year earlier periods (see chart below).
"Marlboro alone is bigger than the eight next brands and therefore has a much broader appeal," Mr. Camilleri said in a conference call with analysts. "Given the economy, it has suffered a bit more than the others."
Reaction to Philip Morris' move last week illustrates how the tobacco industry has changed since Marlboro Friday. On April 2, 1993, Philip Morris began slashing prices of its flagship, a move that had huge repercussions for branding in general and the stock market in particular. Then, Philip Morris' stock plummeted 23%, accounting for 30 points of the Dow Jones Industrial Average's 69-point drop. On Sept. 27, a Friday nearly a decade later, Philip Morris' stock took an 11.4% hit, closing at a 52-week low of $37.86 after decreasing its profit outlook, reflecting an industry in which price cutting is now the norm. While the Dow fell 295 points on Sept. 27, the drop was attributed not simply to Philip Morris' revised guidance, but also negative announcements from General Electric Co. and SBC Communications (see AdMarket, P. 8).
The scope and longevity of Philip Morris' discounting could adversely effect its iconic brands. "You train the consumer to buy on promotion and therefore you create a commodity product," said Ann Gurkin, an analyst at Davenport & Co.
But since most consumers perceive that discounts come from the retailer and not the marketer, "there should not be significant long-term impact on brand equity," according to Robert Campagnino, an analyst at Prudential Securities. He expected Philip Morris to further increase promotional spending, but he was surprised by the size of the investment. Mr. Campagnino' Sept. 27 report was titled: "Did Philip Morris do this on Thursday so no one would call it Marlboro Friday II?"
Philip Morris is not alone. The entire premium-cigarette industry faces an increasingly competitive environment spurred by low-priced brands from fourth-tier manufacturers, who are exempt from Big Tobacco's Master Settlement Agreement penalties. Conditions could improve for the Big Four tobacco companies next year when they can pass reduced MSA payments onto consumers, a reality recognized by Mr. Camilleri, who maintains the spending boost is a short-term strategy necessary for the long-term growth of business. That sentiment echoes company executives' characterization of its Marlboro Friday price cut as an investment in the future.
The industry leader's boost in promotional spending this summer spurred R.J. Reynolds Tobacco Co. to follow suit, but its strategy going forward is still uncertain. "As far as our response, if any, to this latest announcement, we need to evaluate it," said an RJR spokesman.
Mr. Campagnino thinks RJR will raise price promotions to some degree. "Philip Morris was taken back a bit by the fact that RJR was willing to spend as much as they did. Philip Morris has now pushed its wallet to the center of the table and said `ours is bigger than yours,' " he said.
No. 3 Brown & Williamson Corp.'s divergent strategy of every-day low pricing instead of heavy discounting could prove to be the best bet. "It seems that B&W was on the right side of the curve on this one," Mr. Campagnino said.