China's tobacco industry

Mengcheng doesn’t have the ring to it that Havana or Montechristo have. But for what this modest city in Anhui Province cigareteslacks in Caribbean romance it has in ambition, aiming to make its mark on the world with high-quality cigars. In true China style, rows of serious-looking female workers in grey overalls, hair in disposable white caps, roll brown tobacco leaf into fat fingers which are then shipped to another assembly line to be clipped, smoothed and stamped and boxed as Wangguan (“crown”) cigars, which are then sent across China and the US to be sold.
China’s tobacco industry as a whole is growing as ambitiously as Mengcheng. With the industry already contributing 8% to the country’s total tax income there’s little wonder China wants to be the largest tobacco exporter in the world by 2010, particularly because much of the cultivation takes place in the poorest rural areas of the country. But they must heed changing tastes, and a disorganized management system in order to achieve their goal.
HIGH SOCIETY
Cigars are currently only a minor luxury item in the massive tobacco industry, which makes the bulk of its money producing cigarettes. The industry is still a hopeless myriad of companies all managed under the loose banner of the State Tobacco Monopoly Administration (STMA). Chinese smokers bought 1.2 trillion cigarettes in the first 6 months of this year. That’s a 3.6% climb on the same period last year. But the rate at which sales are growing is down, by 0.5% in the first half of 2009 according to STMA figures. Sales slowed faster in the same period last year: 2.8% over the figures for the first six months of 2007.
The dip in sales growth — in volume terms — is connected with the industry’s drive towards consolidation and quality, says David Chia, a research analyst at the Singapore office of Euromonitor, which publishes an annual research report on China’s tobacco industry. The incredible diversity of brands in any Beijing cigarette shop (100 different labels were found in one city center shop) is slowly becoming a thing of the past thanks to an STMA-driven consolidation of the sector.
In 1993 the STMA oversaw nearly 3,000 cigarette brands nationally. By 2003 the number was 550. Analysts predict the number to reach 100 by 2010. Currently, ten dominant players account for 69% of overall cigarette sales (by volume) according to Euromonitor research. The government’s consolidation drive is obvious when you look at dominant players across various market tiers: Cheap cigarettes, going for under RMB 10 (USD 1.46) a pack, account for the bulk of overall sales volume. Three brands: Baisha, Hongtashan and Honghe lead the pack: each shifting 50 billion sticks in the first six months of this year, according to Euromonitor data. At the premium end of the scale, with packs costing RMB 25 or more, five brands hold 74% of the market: Furongwang, Chungwa, Yuxi, Huanghelou and Liqun.
LOCAL FLAVOR
With their typically red-gold packaging, Chinese cigarette brands are produced by local cigarette factories, under the management of provincial tobacco firms, which are in turn controlled by the STMA, headquartered in Beijing. Even more than auto-making or coal mining, China’s tobacco industry remains aligned with provincial government earnings.
In southern provinces like Yunnan, where the climate is suited to tobacco leaf growing, cigarette companies are behemoths. None other than the country’s largest cigarette producer by volume, Hongta, is headquartered in Yuxi, one-hour south of Kunming. The Yuxi factory takes its name from the surrounding city, located in a fertile agricultural valley which grows mushrooms, tea and tobacco. The flagship of the state-owned Hongta Group, the Yuxi plant hires a staff of 2,500 to produce an annual 2.5 million cases of cigarettes, including iconic local brands like Yuxi, Hongmei and Hongtashan, as well as the foreign brand West, owned by Imperial Tobacco.
This is where China’s cigarette industry began. In 1914, the local government, seeing the advantages of a mild, moist climate, imported tobacco seeds from the US and Turkey. Virgina-style tobacco seeds came to the province courtesy of American pilots flying out of Kunming during the 1940s war against the Japanese.
Hongta and the province’s other cigarette giant, Hongyun Honghe, have spent heavily on modernizing their cigarette factories with German-made Korber cigarette rollers and other imported gear. But they’ve invested equally in their huge tobacco growing operations. Both firms have learnt from global peers like Philip Morris how to improve crop consistency and leaf processing, using the flue-cured method — dried artificially, indoors — which China relies on for the bulk of the tobacco chopped and rolled into cigarettes. China produced 2.2 billion kilos of flue-cured tobacco in 2008, and STMA circulars are pointing to a 2.5 billion kilo crop for 2009.
MOVING MARKETS
Major lifestyle changes are currently impacting China’s largest cigarette consumers. Cigarette makers depend on the country’s tobacco-addicted working classes for the bulk of sales. Yet a perusal of STMA statistics for national sales shows an interesting shift in sales from the wealthier southeast provinces like Guangdong to inland regions like Henan and Hunan, mirroring the inland shift in migrant labor, following massive government infrastructure projects under the USD 586 billion economic stimulus plan.
The STMA has spotted the trend, says Li Ping, a section chief from Hongta’s marketing department in Yuxi. “A priority for 2010 will be improving the rural distribution networks, so we have more sales in rural and western areas of China as it’s clear that migrant workers and investment are both heading inland.”
A bigger problem could be that Chinese consumers are beginning to wake up to the health issues of smoking. Having ratified the World Health Organization’s Framework Convention on Tobacco Control, China — the world’s largest producer and consumer of tobacco — promised to warn its 350 million smokers of their addiction’s health hazards. But so far it’s doing so only reluctantly.
Rather than scaring people about the fact that one million Chinese die every year from smoking-related cancer, Chinese cigarette packs carry a polite warning in small print, on a background the same color of the rest of the box lest anyone might notice it. Packages in Hong Kong, by comparison, carry graphic imagery of lung cancer. The Chinese tobacco monopoly has meanwhile been reportedly taking advice from multinational cigarette firms on how to counter the scientific findings linking tobacco with cancer.
CASH CROP
This reticence may be explained by the state-owned tobacco industry’s 8% contribution to the country’s tax take, about USD 60 billion a year, and the lobbying power that comes with such a contribution. Yet even as STMA officials and provincial leaders fight for the industry, Beijing policy makers have vowed that a blanket ban on all publicity for tobacco products will be enacted from 2011.
Pressure on the public purse has strengthened the government’s hand, allowing it this year to hike taxes on tobacco while cancelling all tax deductions on advertising spending previously given to tobacco firms. To help pay for its economic stimulus plan, the government slapped a 56% tax on cigarette packs costing more than RMB 70, up from 45%. Tax on so called ‘medium grade’ cigarettes meanwhile was pushed from 25 to 36% and a VAT-type 5% tax slapped on wholesalers, though it remains to be seen how the latter is being enforced.
Aside from tax, the STMA continues to struggle with smugglers. It’s not hard to find illicit cigarettes in Beijing. When asked, a cigarette seller in the Sanlitun entertainment district whipped out a black plastic bag with a 10-pack of cigs4us.biz/marlboro-cigarette for RMB 10, with a health warning in French, cheaper than the RMB 15 equivalent box Marlboro makes in China through a joint venture between brand-owner Philip Morris and the China National Tobacco Company – also controlled by STMA. Various industry sources suggest as much as USD 5 billion worth of cigarettes are smuggled into the country each year, with legal imports by comparison accounting for only USD 665 million. Multinational tobacco firms have been accused of colluding with third party middle men who smuggle the cigarettes into major markets like China.
SOPHISTICATED LADIES
Challenged by rising taxes and the WHO-prompted push for more awareness about the dangers of smoking, China’s cigarette industry is looking to female smokers and exports for future growth. Up to 70% of Chinese men smoke but so far in most parts of the country less than 5% of women do, though that figure is already up to 10% in larger cities. As the last, untapped, frontier for the global tobacco industry, women have been the focus of new products.
Another focus, says Chia, is sales overseas. Those looking to exports include the Shanghai Tobacco Corporation, which has been distributing its Chungwa 500 brand through duty free shops across Asia. The firm won’t reveal sales figures, nor will the Changde Cigarette Group, whose Furongwang premium brand is distributed across Southeast Asia as well as Hong Kong and Macau.
THE OLE’ PLANTATION
While it may be raising awareness about the ills of smoking, China is vigorously promoting the growing of tobacco leaves. Though the country’s output is crimped by a shortage of arable land, the STMA’s well-trumpeted ‘Program for Sustainable Development of Leaf Tobacco Production’ envisages rural China becoming the world’s number one exporter of tobacco, with 150 million kilos a year by 2010.
It intends to reach that goal by chiming in with the government’s policy of a wealthier rural China. STMA-paid experts have fanned out across poorer provinces like Anhui and Gansu, training villagers in how to grow and tend tobacco. Elsewhere, the STMA has encouraged mechanization and the use of IT (even sending SMS messages of advice to growers) to lift the yield per hectare.
And in “tobacco towns” entire cities are developed around cigarette companies. Opulently appointed, the Hongta headquarters is nestled between lushly landscaped gardens ringed by tea and tobacco plantations. Going against a planned ban on tobacco publicity perhaps, there is a public park with pine and leafy shrubs and a giant silver-coloured smoking pipe. On the other side of wide Hongta Dadao Street, named for the cigarette company, locals exercise by climbing the steps of a to-scale replica of the red pagoda after which the brand is named (Hongta translates as “red tower”).
In Mengcheng, meanwhile, there’s no shortage of ambition. A factory floor manager good-naturedly reveals there were plans to employ pictures of Che Guevara and Fidel Castro to market the cigars in China, until provincial officials nixed the idea.
The secretive nature of the factory management and the reticence of the parent cigar factory owner, China Tobacco Anhui Industrial Corporation — and, in turn, the STMA — makes it hard to assess the marketing plans of China’s tobacco industry. Yet it’s clear that consolidation will continue, as will the shift to premium products, and exports. China has no plans to kick its most dangerous, and lucrative, habit any time soon.
By Mark Godfrey | From CIB December 2009

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