(l.), while the Country Store effort is the latest chapter, offering Western-style merchandise. " We think the pain was worth the effort. We are not in this for the short term. We are in this for the long term."- William I. Campbell Counting by billions continues (graphic) U.S. tobacco revenue (billions) U.S. tobacco operating income (billions) MARLBORO FRIDAY: STILL SMOKING EVEN A YEAR AFTER PRICE CUT, INDUSTRY IS DIVIDED ON WISDOM OF PHILIP MORRIS STRATEGY

By Published on .

George Elia doesn't specifically remember Marlboro Friday. But he vividly recalls the rush of activity after Philip Morris USA's surprise announcement on April 2, 1993.

The owner of a 7-Eleven store on Chicago's North Side, Mr. Elia was visited repeatedly by cigarette salesmen, first posting huge price cuts and plastering his store with Marlboro Adventure Team signs, then returning with rebate checks.

He saw his customers switch back to Marlboro, as the price gap between it and some of the bargain cigarettes dropped from 80 cents a pack to just 40 cents a pack.

Most important, Mr. Elia was selling more cigarettes.

These days, he says, the switching has slowed. The Adventure Team promotion, which he says enticed smokers back to Marlboro Country, ended Feb. 28. Marlboro's initial price cuts were less appealing when eventually matched by competitors. And recently, he has noticed a new increase in sales of generic cigarettes.

Does that mean Marlboro's gains were only temporary? That's a question Mr. Elia can't answer, though he wonders.

"Generics are still cheaper. Lots of people are still switching from regular cigarettes to generics," he says.

Even after a year of analysis, Mr. Elia isn't alone in trying to figure out the long-term impact of Philip Morris' dramatic price-cut strategy.

Philip Morris' announcement of a drastic change in philosophy for the pricing and promotion of its cornerstone brand was wildly successful in boosting Marlboro's share and putting pressure on rivals.

The share increase has led some analysts to suggest Philip Morris Chairman-CEO Michael Miles is in the vanguard of a whole new breed of marketer. They say Marlboro Friday has forever changed the way brands will be looked at.

And certainly, in the era begun on Marlboro Friday, even Wall Street is skeptical of generous price hikes, the backbone of many package-goods marketers' annual earnings increases.

Analysts are now asking cereal and soft-drink marketers: Are price increases really warranted or do they run the risk of weakening the brand franchise?

"It sent a wake-up call to marketers that it is about time to get aggressive about private-label brands," says Gary Stibel, founder and principal in the New England Consulting Group, Boston. "It's the best thing that can happen to the package-goods industry. Very many companies were assuming that it wasn't as bad as it was and were hoping that [the threat of private-label brands] would go away because we are on the verge of coming out of recession."

Others, however, are less enthusiastic.

Though Philip Morris says its share of the declining cigarette market rose to 45.7% from 42.3% in nine months, and Marlboro alone grew to 26.8% from 22.1%, the gains came at the expense of $2.4 billion in Philip Morris USA's 1993 operating income-a 46% drop.

Philip Morris' stock, selling at $54 at one point last week, may have recovered from the worst of the Marlboro Friday price drop, but it was still worth nearly $10 a share less than a year earlier.

"They used an ax where a scalpel would have been preferable. It destroyed an industry's profitability," says Salomon Bros. analyst Diana Temple, pointing out that share price is Wall Street's way of telling management what it really thinks.

"They've done a great job on cost cutting and a super job on international, but the [share] price is still down," she notes.

More skeptical observers question whether Marlboro's impressive share gains will stick. Some competitors ravaged by Marlboro Friday are increasingly desperate to regain volume. Even if they don't undercut Marlboro by dropping prices, the brand faces the prospect of an involuntary price hike through a new federal tax.

Last week, a subcommittee of the House Ways & Means Committee recommended a $1.25-a-pack increase in the current 24 cent cigarette tax to help fund the Clinton healthcare plan.

That figure would likely induce major sticker shock and a new round of trading down; even the smaller tax hike that the industry has speculated is more likely (between 40 cents and 75 cents) could cause changes.

The midprice tier of cigarette brands is making a small comeback, and that comeback may continue, says Jim Fritz, a Minnesota cigarette distributor and president of the American Wholesale Marketers Association, the organization of cigarette and candy wholesalers.

"The cigarette companies have to make money, and to do that they will raise prices," Mr. Fritz says. "That will allow room underneath, and we will have the same old thing."

Salomon Bros.' Ms. Temple says the tax increase could determine the final outcome of Philip Morris' strategy.

That strategy, which wreaked such havoc, was outlined in a straightforward three-page announcement on Marlboro Friday.

"Philip Morris USA ... announced a major shift in business strategy designed to increase market share and grow long-term profitability in a highly price sensitive market environment," it said.

The statement quoted tobacco unit President-CEO William I. Campbell: "We have determined that in the current market environment caused by prolonged economic softness and depressed consumer confidence, we should take those steps necessary to grow our market share rather than pursue rapid income growth rates that might erode our leading marketplace position."

Philip Morris outlined those steps:

An extensive retail promotional program.

Greatly expanded spending and attention to the Marlboro Adventure Team continuity program, begun in October 1992.

An increased effort to take share in the discount cigarette market, with a new push behind the company's Basic brand.

And finally, a major cut in the price of Marlboro, which the marketer predicted would cut earnings for the most profitable of Philip Morris Cos.' businesses by 40%.

Wall Street reacted instantly.

By day's end, Philip Morris Cos. stock had plummeted from $64.12 to $49.37, a 23% drop that represented a one-day loss of $13 billion in shareholder equity. That day, the Dow Jones industrial average dropped 68.63 points, 30 points attributable to Philip Morris alone.

Philip Morris' stock would hit a low of $45 before starting back up.

But there was no secret about the reason for Marlboro Friday: Philip Morris could see what was happening, and it was scared.

Perhaps it was the economy, or maybe it was competitors' push for quick volume increases. Some observers point to tobacco companies' new willingness to produce private-label cigarettes alongside their premium brands. Others suggest the store brand smokes were just getting better. Or just maybe it was a few too many years of taking three-times-a-year price increases well above the cost of living.

Whatever the reasons, the market for discount cigarettes in early 1993 was growing at an incredible pace, gaining nearly a share point a month. In a three-tier pricing structure, the 80 cent to $1 gap between the premium brands and the generics was a yawning gap that competitors could, and would, target.

Even today, there's argument among marketers and wholesalers about how long the quick growth would have continued.

"My view is that once the convenience stores had gotten to 95% distribution [of store brands], the growth would have slowed," says Gary Black, an analyst with Sanford C. Bernstein & Co., New York.

For Philip Morris, however, the growth was especially worrisome. Marlboro, the country's No. 1 cigarette, and Philip Morris' other premium smokes were losing market share. Worse, though Philip Morris produced several discount brands, those brands weren't getting the majority of the switchers. In 1992, Philip Morris sold 48% of premium smokes but only 19% of discounts.

Philip Morris was concerned that if it didn't act quickly to slow the booming discount segment, smokers who switched because of low prices would get used to the cheaper brands and be next to impossible to lure back.

"Our judgment [was] that had we not responded promptly to this discount challenge mounted by our competition, share losses in full-margin products would have accelerated further, and damage to our premium franchises could have become irreversible," Philip Morris Exec VP-Worldwide Tobacco Geoffrey Bible told analysts recently. "We saw this as an all-out attack on our premium brands."

Ellen Merlo, VP-corporate affairs, is even more specific.

"When we started, Marlboro was down to a 22% share of market," she says. "Had we done nothing, we projected we would have had an 18% share. Instead, today, it's 26%."

Philip Morris decided it needed a drastic move: It would take the three-tier cigarette price structure-the premium brands, the discount labels and the generics-and cut it to just two tiers. Most significantly, it would cut Marlboro's price to just above the discount brands'.

"A little bit of this and that wouldn't have turned the business around," Ms. Merlo says.

Mr. Campbell, the tobacco unit president-ceo, today says the pricing had just reached a point where something was needed.

"The price-value relationship got out of line," he says. "First, small competitors were underpricing us and then some bigger competitors. We had to readjust."

While not naming names, Mr. Campbell makes clear that he believes R.J. Reynolds Tobacco Co.'s 1992 decision to start making low-price generic brands available on a widespread basis fueled the consumer switch away from premium. RJR says it was responding to Philip Morris' actions.

"There had been some ups and downs in [pricing in] the past, but we had never seen that before," Mr. Campbell says, adding that Philip Morris' aim with the changes was repricing its brands for long-term growth.

"We think the pain was worth the effort," he says. "We are not in this for the short term. We are in this for the long term. This is an investment in the future. The trends in the business are back on a track that will produce growth and profitability."

Competitors and some retailers wonder whether there might have been other goals-to weaken rivals or to position Philip Morris' brands for the anticipated excise tax increase.

"It kills their competition in the value brands to the point where the competition might have to give up," says a spokesman for a major Midwest-based grocery chain, which didn't want to be identified. "It's an attempt to kill [R.J. Reynolds parent RJR Nabisco, currently engaged in a stock offer aimed at reducing debt load] while it's down."

Small competitors that thrived by undercutting Philip Morris' pricing have been especially hard hit, several analysts say. Even No. 4 cigarette marketer American Brands reportedly cited the loss of tobacco profits in asking some of its other units to cut back on ad spending. And according to one report, American Brands last week was ready to sell its American Tobacco Co. subsidiary.

Philip Morris denies both intents.

"Bullfeathers. It was not a competitive move. It was a move focused on our brands," Ms. Merlo says. "It is what was right for our brands." She also says the looming federal tax hike wasn't a factor.

Philip Morris believed a price cut would help Marlboro. In late 1992, it had tested a Marlboro price cut in Portland, Ore. Though small in scope and short in length, the company believed the test clearly demonstrated the problem wasn't the Marlboro brand itself but the gap between Marlboro's price and that of cheaper cigarettes. The company was worried, however, that a wholesale price cut might not fully get passed onto customers.

After internal discussion of potential actions, Philip Morris decided on the four-step Marlboro Friday plan. While much of the press and analyst coverage focused on the Marlboro 40 cent to 50 cent per-pack price cut that took effect in late May, other elements in the plan may have been nearly as significant.

Philip Morris expanded the Adventure Team promotion, from Leo Burnett USA, Chicago, both to improve Marlboro's store visibility and drum up excitement. And in a very expensive decision, Philip Morris decided to ensure the price cuts would be passed along to consumers by buying down retailers' stock rather than changing the wholesale price.

Retailers could participate in the buydown only by agreeing to put up signs advertising the Marlboro price cut, carrying Adventure Team catalogs and then allowing themselves to be checked weekly to monitor sales.

A promotion of that scope had never been tried before nationally, and even Philip Morris didn't have enough people to do it. The company hired hundreds of temporary workers to help audit the retail accounts.

The promotion shaped up even better than Philip Morris had hoped because among its competition only RJR matched the price cuts on key premium cigarette brands.

At the end of the original six-week promotion schedule in June, Philip Morris decided to extend the program through Aug. 8. Then in July, Philip Morris announced it would make the price cut permanent and ex tend it to other brands like Benson & Hedges and Virginia Slims.

There was another ele ment too, an attempt to get more of the discount cigarette action. Basic, Philip Morris' value- price brand, suddenly got its first major ad cam paign, from Burnett, and it grew to become the na tion's No. 3 cigarette.

Despite the growth, Philip Morris USA is a smaller company these days. The revenues and profits consumed by the price cuts were followed by layoffs and other cut backs in everything from marketing to customer service.

The Midwest grocery chain says it has noticed that stale cigarettes are no longer being pulled off shelves by tobacco representatives. The chain has to send them back to its warehouse if it wants them pulled.

A number of tobacco wholesalers have disappeared in the past year, either pressed by declining revenues or having decided a future of profit pressure wasn't worth it.

Both Philip Morris and RJR are publicly acknowledging the cutbacks that have affected personnel and profits have also been felt in advertising and marketing.

Philip Morris will unveil its Marlboro Country Store promotion from Burnett in letters to Marlboro smokers this month and in ads slated for May issues of magazines.

Like the Adventure Team promotion, the Country Store will get heavy advertising. Philip Morris will insert 35-page catalogs of "gear" in GQ, Sports Illustrated and People, and support the promotion with heavy point-of-purchase materials. This time the catalog offers 18 items, with Western-oriented merchandise ranging from bandannas and denim shirts to a billiard table that can be "bought" through proofs-of-purchase.

But analysts say Philip Morris will spend nowhere near the estimated $325 million it spent in advertising and furnishing products for the Adventure Team.

While acknowledging that, Philip Morris says the 1993 profit cuts won't hurt its ability to provide marketing support for major brands.

"We are certainly focusing our efforts on our premium brands-Marlboro, Benson & Hedges, Merit, Virginia Slims, and regionally Parliament, and Basic in the discount segment," Ms. Merlo says. "With this pricing action, we cut out coupons and point-of-sale" coupons.

Philip Morris' chief rival, RJR, says fewer brands will be heavily advertised this year.

"There has been overall belt tightening by the industry," says David Iauco, senior VP-marketing. "It's not like things have gone dark for us and our competitors, but everyone is focusing on the things that most affect the bottom line."

Mr. Iauco says that while RJR may experiment less with new cigarette products, it will still continue to aggressively support Camel, Winston and Winston Select.

Murray Hillman, a management consultant at the Strategy Workshop, New York, says Marlboro Friday was nothing short of brilliant.

"What Mike Miles has done with Marlboro Friday was a stroke of genius," Mr. Hillman asserts. "He has rejuvenated an established franchise."

If an outsider had entered the cigarette industry, spending $2.4 billion, and had obtained a 5% market share-nearly Marlboro's growth-by yearend, the acquisition would have been classified as "positively brilliant," says Mr. Hillman, adding that he can't understand criticism of Marlboro Friday.

The New England Consulting Group's Mr. Stibel says Marlboro Friday was viewed as extreme mostly because the company waited so long.

"They went to the extreme ... having not acted sooner, they needed to take drastic action," he says. "In retrospect, they should be faulted for being slow to act. If they had acted earlier they might have achieved the same results with less dramatic actions."

Mr. Stibel points to the cereal industry, and specifically Kellogg Co., as a likely candidate for similar action.

"At some point in time, there is a point where the consumer isn't willing to pay, where the extra price isn't relative to value," he says. "Sure, you can get your share back at a price, but once the consumer learns that private-label brands are good, it becomes a much different game."

Sanford C. Bernstein's Mr. Black, a former brand manager, delivers a similar warning.

"This has radically changed the way people think about brands," he says. "It's made brand managers realize they can't keep taking and taking from consumers because consumers have other choices. They can trade down."

Salomon Bros.' Ms. Temple is less convinced.

"All companies have to be come a little more value conscious," she says. "But you can do it with a little more fine- tuning that Philip Morris did. A consumer always wants value, but during a recession, value is more important. As the economy improves value is less important."

She also notes that across-the-board rules that fit all categories are difficult. The consumer who would rebel at paying premium prices for their pack to pack-and-a-half of cigarettes a day, may be willing to pay premium prices for products bought less often.

Philip Morris, for itself, remains pleased.

"What we did was position the business for long-term growth," Ms. Merlo says. "We put Marlboro back on its traditional growth curve. Our objective was to get our premium brands growing."

She says the experiences of the past year have "energized" the company. And while the tax hike wasn't a reason for the move, the company feels it will be better able to withstand the impact if the gap between premium and discount brands is small.

Mr. Campbell says he came out of the experience with a lesson learned.

"Great brands are still great brands," he says, "but you have to keep the price value in line with today's discerning consumers."

Most Popular
In this article: