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    China Business
     Mar 10, 2006
Marlboro Country's borderline with China
By Matt Young

The largest tobacco producer in the world is the Chinese government, and despite loosening trade barriers, it appears it wants to stay that way by mastering the game of Monopoly at home and blowing more local smoke abroad.

The tobacco trade in China has opened up to some extent since the country's admittance to the World Trade Organization in 2001. Yet today, despite foreign players keen on profiting from the

world's largest tobacco market, where about 60% of men smoke, their combined market share there is trivial.

The China National Tobacco Corp (CNTC) still holds at least a 90% share of the Chinese cigarette industry, and it appears that won't change any time soon.

"China will not approve the establishment of new cigarette factories, including joint ventures or foreign tobacco companies establishing their sales offices in China," Xing Wanli, State Tobacco Monopolization Administration (STMA) director of foreign affairs, said in the January issue of the industry publication Tobacco Reporter, which publishes a China edition in cooperation with the STMA.

But China's official word isn't keeping foreign producers at bay. The industry smells smoke, and it's salivating, even if what it's really sensing is only smoke and mirrors.

A coup for Philip Morris
In December, Philip Morris International, a fully owned subsidiary of Altria Group, announced that it had concluded a major agreement with the CNTC. While Marlboro cigarettes have long been imported into China, the deal would allow the company to produce Marlboro cigarettes directly at the CNTC's affiliate factories beginning in the first half of this year and distribute them in China.

The deal has been seen as a win for Philip Morris, especially after rival British American Tobacco (BAT) announced prematurely that it had its own factory agreement in China before being told by the Chinese government that no, in fact, it didn't.

It remains to be seen whether the Philip Morris deal will hold water, especially since aside from Xing, a senior Chinese ambassador to the United Nations office in Geneva reiterated in a Xinhua story that China would not approve any new cigarette factories, including joint ventures.

While Philip Morris press officers declined to comment about their China operations, a company employee answering press calls said, "as far as we're aware, there's no change" in the Morris deal. A press release announcing the deal, after all, didn't mention anything about constructing new cigarette factories.

But even if Philip Morris can flawlessly implement the CNTC tie-up, the company could be advancing the Chinese government's control over the country's tobacco industry even more than its own interests. "It's a way of learning new technologies and new capabilities" for the government, said Dayton Matlick, editor-in-chief of Tobacco Reporter. "You learn the most by the people that perhaps have an edge on you."

Beyond intangible learning, the deal would also help internationalize local Chinese cigarette brands. That's because the other half of the agreement, involving a Switzerland-based joint venture between Philip Morris and a CNTC subsidiary, would market Chinese-brand cigarettes globally. Overall, although the deal does signify Philip Morris International's partnership with the Chinese government monopoly, the more significant aspect may ultimately be that Big China Tobacco will be poised to grow bigger and faster worldwide because of the arrangement.

Making deals with the dragon
Other tobacco players besides Philip Morris have managed to penetrate the Chinese market in recent years.

For example, the production of UK-based Gallaher Group Plc's brand Memphis began last May under a license arrangement with Shanghai Tobacco Group (STG). Gallaher also began importing the LD brand into the market in August. And Imperial Tobacco recently expanded the West brand to Beijing. Even with its premature-factory-announcement mishap, BAT was able to extend the Kent Mintek range, developed in Japan, to Hong Kong and mainland China, exceeding expectations in the growing menthol-lights sector, according to company officials.

But Luke Falvey, managing director for Gallaher Asia-Pacific, hinted at how difficult it still is to get a good deal.

"At the end of the day importation and distribution [are] regulated and controlled by the state monopoly," Falvey said. If a company wants to import tobacco products into China, it first has to create a demand within a particular province. Then, he said, the company must negotiate every fiscal quarter with the Chinese authorities to get what amounts to a quota. Authorized volume for a new brand will be small, he said.

Reflecting what may have clinched the Morris deal, Falvey said the key to Gallaher's success in China is a "mutually beneficial relationship". Gallaher's licensing agreement with Shanghai Tobacco is actually a reciprocal one, he said.

"Under this agreement Gallaher's strategic brand Memphis is locally manufactured ... and distributed by STG, and Gallaher manufactures ... and distributes STG's Golden Deer brand in Russia," Falvey said.

Multinational tobacco companies keep profitability figures from China close to the vest, but they appear to be interested more in strategy at this point anyway. They want to develop better relationships with key players in China and a better product foundation there should the market liberalize further in the future.

For the time being, even if companies make new inroads with China's tobacco gatekeepers, they face a new foe from outside China: the World Health Organization's (WHO) Framework Convention on Tobacco Control (FCTC).

It's merchandising, not advertising
Last August, China ratified the FCTC, which presents a host of new difficult challenges to multinational tobacco corporations. Among its stipulations the treaty requires China to ban tobacco advertising, promotion and sponsorship on radio, television, print media and the Internet within five years, according to the WHO. It also forbids tobacco-company sponsorship of international events.

That leaves Gallaher and other companies using traditional methods of marketing, such as running "gift with purchase" promotions and advertising, Falvey said. In other words, if you purchase a pack of company cigarettes, you might get a lighter or cap.

Judith Mackay, director of the Asian Consultancy on Tobacco Control, said such promotional efforts still seem to be effective. During a trip to Xinjiang province in 2001, she said, her tour guide was wearing a Marlboro-branded cap. "It was the most stylish hat available" in the area, Mackay said.

There's also evidence suggesting Western brands, beyond being stylish, are effective in hooking new customers. In the 1980s and '90s, markets in Japan, Taiwan, South Korea and Thailand opened to US cigarettes. According to the National Bureau of Economic Research, per capita cigarette consumption in those countries in 1991 was nearly 10% higher than it would have been had those markets remained closed to US cigarettes.

China, no doubt, is a unique Asian country. But the research shows the success foreign brands can have when unleashed into the region's market. So if companies can begin to negotiate better deals with the Chinese government, they might find their market shares could grow beyond trivial.

Matt Young is a Washington, DC-based freelancer and a staff writer for EyeWorld Magazine and EyeWorld Asia-Pacific Magazine.

(Copyright 2006 Matt Young. Used by permission.)

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