The past few years have witnessed the cigarette industry battling against the states' attorneys general, public health officials and anti-smoking advocates pushing for stiffer advertising restrictions and remuneration to injured smokers. But one of the most ferocious fights pits cigarette companies against each other, as they try to secure a foothold in one of tobacco's last remaining battlefields-the store.
Marketing restrictions continue to tighten, leaving fewer ad options available to the $50.1 billion industry and each player scrapping harder for sacred shelf space and point-of-sale signage in store-where the vast majority of tobacco marketing dollars are spent. According to a Prudential Securities report citing Federal Trade Commission figures, a stunning $6.6 billion was spent by tobacco companies on retail incentives in 1999, the most recent figures available. That outlay includes promotional allowances, coupons and other retailer incentives, far eclipsing newspaper and magazine ad expenditures at $428 million. By comparison, point-of-sale materials accounted for only $329 million of tobacco marketers' 1999 budgets (see chart, P. 20).
"That wall of cigarettes behind the counter-that's advertising," said Steve Montgomery, president of convenience store consultancy BtoB Solutions.
The focus of the store war is on how promotional money is being spent to gain share of shelf. It's a dirty fight, ripe with name-calling and virtual hair-pulling and eye-poking, as smaller cigarette makers throw punches and accusations. The sparring has also spilled over into courtrooms, legislatures and media outlets, as the Davids of the industry-No 2. R.J. Reynolds Tobacco Co. and No. 3 British American Tobacco's Brown & Williamson Tobacco Corp.-search for allies in their offensive against the industry goliath, Philip Morris Cos.' Philip Morris USA.
Leader Philip Morris wielded a growing 50.5% share of the cigarette market in 2000, according to company and industry reports compiled by Prudential Securities. RJR followed with 23%, B&W with 11.7% and Loews Corp.'s Lorillard Tobacco Co. with 9.6%. Prudential estimated the gap widened in 2001, with Philip Morris' share rising to 51.1% and RJR, B&W and Lorillard falling to 22.7%, 10.9% and 9.2%, respectively.
THE FOE: MARLBORO
Smaller competitors have a common foe in Philip Morris and its biggest weapon, Marlboro. Its rivals allege the industry leader's well-established and powerful Retail Leaders merchandising program, which among other things, allots the company equal shelf space to its market share in that location (see graphic, P. 18) violates antitrust legislation by unlawfully boxing them out of the marketplace. In essence, they claim the Retail Leaders program dictates not only what shelf space Philip Morris brands receive, but also what shelf space and in-store programs retailers can give and accept from its competitors. "What they've done is taken the [merchandising deals] on Marlboro and used that market power to foreclose on other manufacturers from competing," said Mark Kovatch, VP-trade marketing at B&W.
The irony is that according to marketing experts, dominant shelf position isn't crucial for strong brands like Marlboro, since premium brand smokers have decided what brand they will buy before they reach the store. "Somebody that's a tried-and-true, hard-core Marlboro smoker is not going to smoke anything else, even if you throw it at them," said Ken Harris, partner at Cannondale Associates, a marketing consulting firm.
Where the competitive opportunity lies is with value-brand smokers who might switch for a better price-making in-store positioning and marketing more crucial. "With a lack of broadcast advertising available to try to change behavior and drive demand, the work in stores is more important in tobacco than in any other product category," said Burt P. Flickinger III, managing director of Westport, Conn.-based Reach Marketing.
"While premium-branded cigarettes are still the highest category sold in terms of consumers' brand loyalty, in the value segment, there's a tremendous amount of consumer switching and very little loyalty, so in-store decisions are very critical," he said. "Historically, we look at about 40% to 50% of tobacco purchase decisions being largely influenced by price."
Philip Morris' rivals made their complaints public with an antitrust allegation in 1999 lawsuits filed by RJR, B&W and Lorillard against the industry leader. The disparate filings were consolidated into one suit in North Carolina federal court, putting Philip Morris, recently on the same side as its tobacco brethren, as the odd one out.
The ongoing suit alleges that the industry giant's Retail Leaders program is illegal because it makes incentives paid to participating retailers conditional to them signing retail contracts that give Philip Morris brands prime positioning in displays.
The plaintiffs do not take issue with price promotions or retail merchandising programs themselves-since both B&W and RJR offer them-but disagree with tying display space to promotions and incentives as well as dictating what participating retailers can offer and accept from competitive companies. RJR's merchandising program, called Retail Partners, "is designed to get us the advertising and display space that we need to grow our brands," said Darryl Marsch, senior counsel at RJR. "There's nothing in our contracts that says what a competitor is not allowed to do. We don't have any restrictions in our contracts, but Philip Morris does," he said, "and Philip Morris also has the power of Marlboro to enforce those restrictions."
Brown & Williamson said its merchandising offering, called the Retail Alliance Millennium Program, gives additional payments to retailers who group B&W brands together on shelves or put signage next to those brands on the display space. But B&W's program does not make price promotions conditional to being part of the program, according to Mark Smith, director, public affairs and issues management at B&W.
"If you don't sign up with us, you're still going to get buy downs, discounts, promotions," Mr. Smith said. (Buy downs are payments made to retailers by cigarette marketers for product sold during a specific promotional period. Buy downs, as opposed to incentives, get passed on to the consumer in the form of a discounted price). Mr. Smith added that extra incentives are offered to guarantee that B&W brands get distribution.
B&W, struggling in third place, does not enjoy the same luxury as Philip Morris, which demands participants in its program afford its brands share of store equal to its share of market in that store. B&W offers incentives to store owners "to guarantee us distribution and give us some level of visibility to the consumer," Mr. Smith said. "Because of competitive contracts and the because of the amount of space they [Philip Morris] take, we couldn't get our share of store. We take what we can get."
Philip Morris acknowledges its Retail Leaders usually receive price promotions more weeks per year than non-participants. But the marketer said it does offer buy downs to all retailers-including those who do not participate in its merchandising program, according to Brendan McCormick, manager of media affairs at Philip Morris USA.
But one Retail Leaders participant insists that's not the case. "You don't get the promotion if you're not signed up with them," said the president-CEO of a 10-store convenience-store chain in New York who asked not to be named. "If you're going to offer something to one person, you should offer it to all of them," he said, but he claims all cigarette companies-not just Philip Morris-make buy downs conditional to contracts. "They're all doing the same thing. It wasn't that way, but now they're all following suit."
NOT SLOTTING FEES
Industry-watchers differentiate the cigarette store war from slotting fees, or payment for retail space common in the package-goods industry. "There's a fundamental difference" between smokes and traditional package goods, said Alan Silberman, an attorney at Sonnenschein, Nath & Rosenthal, Chicago, who specializes in antitrust, marketing and distribution issues but does not have any tobacco clients. "Typical slotting involves something that is buyer-driven," he said. "It involves a recognition by the retailers that they have an asset that is valuable, separate and apart from the product itself-that is, the shelf."
But the cigarette industry is seller-driven, he said. "The bottom-line question in all of this is whether that agreement [between the tobacco company and the retailer] promotes competition ... or does it try to stop competition in a way that ultimately prevents the consumer from getting benefit?"
The antitrust lawsuit is begging that same question, and the answer is still to come. But many think the case against Philip Morris is weak. "Competition is supposed to be tough. It's supposed to be rigorous. That's what the free market is all about," Mr. Silberman said. "The other companies have said, 'Why didn't we think of that?' and they're trying to beat it in court. The way to beat it is in the marketplace," he added.
"It isn't just about the Retail Leaders program," said Cannondale's Mr. Harris. "It's about the fact that these other companies are finding every other means [of marketing] cut off and their retail programs have become less effective because Philip Morris has spent more on it and it's more effective."
Craig O'Keefe, CEO of Interpublic Group of Cos.' promo shop Marketing Drive Worldwide, Chicago, said he doesn't think the plaintiffs have much of a case because retailers choose whether or not to participate in marketers' merchandising programs. "If [Philip Morris] is giving retailers incentives, whether it's price discounts or portfolio bundling ... why wouldn't they have the right to be able to do that?" asked Mr. O'Keefe, who worked on Philip Morris and RJR cigarette brands when he was at WPP Group's Young & Rubicam in the early 90s. "The retailer can say no," he added.
Saying "no" could be particularly risky for convenience stores, where close to 60% of all cigarettes are sold. According to the National Association of Convenience Stores, cigarettes were c-stores' No. 1 category in 2000, bringing in 37% of top-line sales inside the store, and the No. 2 gross-profit driver, accounting for 20%, behind food service. The average convenience store made about $247,000 in profit on $311,800 in cigarette sales in 2000.
"They're out of business without tobacco," said Dick Meyer, president of c-store consultancy Meyer & Associates. He said cigarette smokers are stores' most valuable patrons, adding that brand-loyal smokers will switch stores if they find their brand out of stock twice.
"Philip Morris treats you like they think your business is their business," said the c-store chain executive who requested anonymity, "they strong-arm you." But choosing not to participate could mean financial suicide. "Cigarettes are a huge, huge part of our business, so you have to play the game," he added.
B&W and RJR particularly question Philip Morris' practice of demanding a percentage-instead of an absolute amount-of store shelf space proportional to its market share in that particular location. In effect, B&W contends, even if B&W offered to supply and pay for additional tobacco display space in a store, Philip Morris would get a portion of that space in accordance with the percentage allotted in its contract with the retailer.
But Philip Morris thinks demanding its share is fair. "We have never asked for more than our share, and our competitors have programs that ask for more than their share, which frankly doesn't make any sense for the retailer," said Andy MacRae, director of trade marketing at Philip Morris USA. The company determines its percentage share of store by averaging its share of total market and its share sold in that location.
RJR's program has 20 to 25 contract variations, and retailers receive different incentives, or "retail display allowances" depending upon which contract they sign. "There are different resource packages for retailers depending on what they provide for us in terms of product visibility and retail space," said Bryan Stockdale, VP-trade marketing at RJR. Price promotions are available to all retailers, regardless of participation in Retail Partners, he added.
Philip Morris demands a percentage of shelf space equal to its share or market in a particular location. But RJR asks for a percentage-equal to its share of store-of shelf space actually visible to the consumer, which RJR defines as the portion of the fixture at least 36 inches off the floor.
But in reality, space does not allow for all cigarette companies' demands to be met. "I have major chain contracts where I have less than my share," Mr. Stockdale said. "We've bent our standards like there's no tomorrow, because our alternative is being out of the store altogether."
B&W and RJR also claim that Philip Morris imposes other restrictions. One alleged restriction challenged in the lawsuit is the stipulation in Philip Morris' original Retail Leaders program, since amended, that prohibited retailers from accepting competitors' price promotions three weeks out of every quarter-or three months each year-as well as dictating where point-of-sale signage from competitors can be displayed.
"Philip Morris has gone beyond fair competition," said RJR's Mr. Marsch. "Their contracts don't just pay for the best space, the best signs. Their contracts pay to not have competitors signs in the store, to shove competitors' products out of the line of sight."
But Philip Morris claims that many complaints in the suit, filed in 1999 against its 1998 Retail Leaders program, have since been remedied by subsequent generations of the program.
For example, Philip Morris pulled the restriction limiting rivals' price promotions a few months after it was initiated, according to Mr. MacRae, because "the feedback [from retailers] was that it just doesn't make sense and it can't be administered by the retailers or by Philip Morris."
The 2001 version of the Retail Leaders program, which has been altered every year since its 1998 introduction, is vastly different from the initial iteration that the lawsuit attacks, Mr. MacRae contends. He stressed that removing the price promotion exclusivity clause was a response to retailers' feedback, not the antitrust suit.
But B&W contends that Philip Morris pulled that restriction after the suit was filed. Although Philip Morris voluntarily reneged on that limitation, the plaintiffs kept the complaint in the suit to ensure that Philip Morris cannot reinstate it, and the judge overseeing the case prohibited that clause in a preliminary injunction, according to B&W's Mr. Smith. "There is no requirement that a retailer must take our promotions at any time," Mr. MacRae said, "and there is absolutely no requirement at any level that ever prohibits a competitor from having any type of promotion in the store-either a price promotion of a product promotion."
But RJR disagrees.
"I don't know of anybody else's contracts that have language in them that dictate what their competitors can't have," said RJR's Mr. Stockdale.
The biggest weapon in the Philip Morris arsenal-Marlboro-has become its opponents' biggest target, which B&W deems the "Marlboro monopoly."
"One brand in our industry accounts for nearly 40 share points," said B&W's Mr. Kovatch. "You have one marketer using the market share power to foreclose retailers," he said. "We can't respond to that. We don't have a 40-share brand."
Bonnie Herzog, a tobacco analyst at Credit Suisse First Boston, said retailers are free to choose which brands they sell. "From the retailers' standpoint, they are going to look at and carry whatever brand generates the most foot traffic and the most revenue," she said.
But smaller tobacco companies think this puts consumers at a disadvantage. "We all believe that Philip Morris is using its position in the marketplace to restrain trade," Mr. Marsch said. "The result is to injure adult smokers by not allowing them to get the information that they are entitled to with competitive brands," he added.
Philip Morris rebuts these claims, arguing that rivals' market movement suggests healthy competition exists. "Nothing in our merchandising programs or as the suit has been going on has precluded RJR, B&W or any other companies from promoting their brands," Mr. McCormick said. "Through their actions in the marketplace, other manufacturers have demonstrated that the marketplace is working," he added. "There are a lot of opportunities to compete successfully, and companies like Reynolds have been doing that."
But RJR's take has not moved much-share for only two of their four major smokes has risen. Camel and Winston were up slightly for the 12 months ended Sept. 30, 2001, according to tobacco industry publication The Maxwell Report. Camel rose to 5.5% from 5.3% in the year earlier period, and Winston increased to 4.9% from 4.8%. Salem and Doral were both down.
As for B&W, its overall share has fallen every year since 1995, from 18.0% that year to 11.7% in 2000, according to company and industry reports compiled by Prudential Securities. "It is and has been difficult for smaller manufacturers to compete at the retail level, absolutely, but that's not dissimilar to other industries," Ms. Herzog said.
THE 'REAL WORLD'
But in a category where most mainstream advertising is banned, paying top dollar for store space is just the way of the world, said some industry insiders.
"It's a competitive world," said David Adelman, a tobacco analyst at Morgan Stanley. "This is the real world. It's fierce competition and companies are going to do whatever it takes for their advantage," Mr. Adelman said. "This is a big battle, and they're going to go at it."
But Philip Morris is choosing not to fight on all fronts. It argued that its self-imposed advertising limitations-such as pulling ads from more than 50 magazine titles with high youth readership and off the back covers of all magazines-have created venues for other companies to market without a Philip Morris presence.
"We're yielding the tobacco advertising in more than 50 publications to other tobacco companies. We're yielding the back covers, which most people would agree is a premium spot, to our competitors. We don't distribute free samples of our products. We don't send our products through mail," Mr. McCormick said, all of which "is reducing the opportunities we have to market our products."
B&W sells directly to smokers through the mail via its BW Direct division. RJR sells its Eclipse brand through the mail as well as low-volume brands Vantage, More and Now in a seven-state test market; some Camel styles are sold through Camel's custom publication CML.
Currently these programs collectively account for less than 1% of cigarette sales, leaving real market movement to happen in store.
"Winning at retail in the marketplace is critical," Mr. Adelman said.
Contributing: Ira Teinowitz