Economic Analysis of Phillip Morris International

 

Introduction
Marlboro is a cigarette brand owned by the Altria Group in USA and by Philip Morris International outside USA. Hence, in Singapore the company is under Philip Morris International (PMI). The company emerged in England in 1847 and targeted female customers. Later in 1920, it emerged in US markets targeting mainly women smokers. During 1950’s it targeted the health conscious people by introducing filtered cigarettes and also targeted men. The brand is well-known for its advertisements like ‘Marlboro man’, slogans like ‘Mild as May’ and for sponsoring various motor-sports events. The brand has shown its presence and has been closely related to sports specially racing. During 1972 it became one of the most admired brands in the world (Marlboro Cigarettes). In 2012, Marlboro brand was rated 53 amongst the top 500 global firms of the world with a brand value of $15,171 million and a venture value of $180,739 million. (studymode, 2012)”
Executive Summary
The company PMI plans to begin a new reformed cigarette in the markets of Singapore where they already enjoy a market share of 50%. The product is being called ‘Marlboro Switch’. This cigarette contains less harmful ingredients which will reduce odor and smoke. It will give a different experience to smokers by providing them three distinct flavors. Along with this it will give the smokers pleasure of enjoying two flavors in one cigarette by pressing a switch and changing the flavor from regular to menthol. The product will be sold in an attractive and convenient packaging which will have a slot for the lighter. It will give the consumers luxury of carrying the lighter along with the packaging hence making the product unique, stylish and have less harmful effects (studymode, 2012).” (studymode, 2012) (studymode, 2012)

The company wants to release this product by the year end and gain a competitive edge over their competitors. The product will not be overpriced but will be competitive with other brands. By providing less harmful cigarette it will target the health conscious people and thereby tend to increase its market share by 10% by 2015 (studymode, 2012).
MICROECONOMIC ANALYSIS
Tobacco Industry Overview
The tobacco industry is made up of a small number of companies that grow, distribute and sell tobacco and related products throughout the world. Barriers to entry to this market are high due to the size of distribution networks required and government restrictions on marketing and promotions. These restrictions stem from health warnings, which will limit the room for future growth in this already mature market. Companies often use mergers and acquisitions to expand abroad and bring down their costs by taking advantage of economies of scale. They often integrate vertically, meaning they have control over every aspects of the supply chain from production to distribution. Due to these factors, the market can be described as an oligopoly.
The industry is constantly having to deal with tightening regulations as governments look to discourage the use of their products due to health concerns. This is playing a role in decreasing the demand in the developed world, but as of now is not affecting the developing world, in fact the opposite as demand is growing in these countries.
Market Structure
 

The tobacco industry in Singapore is earning supernormal profits no matter long-run or short-run. This is because the barriers for new companies to enter are huge and it almost blocks the new entrants from entering the market. In oligopoly, the key feature of earning supernormal profits is that a firm must consider the reaction of other firms to its own actions. As a result, when PMI Singapore increased their price in 2013 by 3%, BAT and JTI was bound to take proper action towards this.

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An oligopoly is the market structure of a few large firms dominating the industry. The number of seller or firm in an oligopoly market is very few but there are numerous buyers in the market. Some industry produces differentiated products or homogeneous products.Homogeneous products are goods that are with no preferences; differentiated products are goods with a lot of variety.In short homogeneous are products that are close substitute to each other and are an identical produce. The example of homogeneous products including cement and steel. The example of differentiated products including automobiles, cigarettes and soft drinks.
Tobacco industry has an oligopoly market structure. There are 3 major companies dominant the tobacco market in Singapore, they are British American Tobacco (BAT), JT International (JTI) and Philip Morris International (PMI). The total market share of the above three major companies is about 91%.With PMI Singapore holding the highest market share (The Star, 2008). Although they are selling the same products, cigarette, but with different taste, feeling and smoke from different brand names. So cigarette is a differentiated product.
Most of the firms under oligopoly have almost blocked the entry for new entrants. This is due to three reasons, economics of scale, government legal barriers and substantial investment. The barrier to enter the tobacco industry in Singapore is very high. PMI has been around over the times, therefore it makes difficulty for the new entrant to survive in the tobacco industry in Singapore. Therefore, PMI Singapore is taking the advantages of economics of scale. They have the advanced technologies over the year. Economics of scale is about when increasing the scale of production leads to a lower long-run cost per unit of output. (Curran, 2007).
Fixed Costs and Variable Costs
Fixed costs refer to the costs that do not depend upon the level of output. They remain constant throughout. Its graph is a horizontal straight line. Some of the examples of fixed cost are rent of building machinery etc. On the other hand, variable costs refer to the costs that change with the level of output. It is generally seen that variable cost increases at a constant rate with an increase in the level of output. Its graph is an upward sloping curve. Some of the examples of variable costs are wages, utilities, raw material used, etc.

Some of the fixed costs incurred by Marlboro are salaries to the employees, taxes payable to the government, property tax, interest payable, etc. Variable cost for the company includes the cost for raw material and packaging. The raw materials are purchased from different suppliers. No single supplier provides a majority of portion of the raw material required by the company. In order for new suppliers to supply the raw material, the suppliers have to qualify under PMI and also the government standards. Some example of raw material required in production of cigarettes is firstly being tobacco, paper, synthetic cotton, seed flax etc.
Economies of scale

Besides that, the tobacco industry in Singapore is under the interventions of government. Although most of the oligopoly differentiated their products with strong investment in advertisements, but in case of cigarette the Singapore government has strict laws. So advertisements no longer work in the tobacco industry.
Apart from that, the barriers to enter the tobacco industry locally is initially low.
The tobacco industries in Singapore are non-collusive oligopoly or non-price competition. This is because each tobacco company perceives that its rivals will easily and quickly match any price reduction. in addition to that, the government tax of cigarette is always increasing. in order for government to reduce the demand of cigarette, the most effective ways is to increase the tax (The Star, 2011).
Inelastic Demand

The demand for cigarettes is inelastic. This is because no matter how much the price of the cigarettes increase, there will still be buyers in the market. Due to the fact that cigarettes can make the consumer addicted, buyers can’t stop purchasing cigarettes till they can’t get rid of the addiction. On an average of price rise by 10%, the demand is expected to be reduce by 4% in high income countries and 8% in low and middle countries. In Singapore, the estimated cigarette price elasticity is about 0.38. This means that when 10% increase in the price of cigarette, the demand tends to decline by 3.8%. This means that changes in the price brings about lower effect or no effect to the changes in the quantity demanded and thus resulting in a steep curve.

 
For instance, the increase of the cost of raw materials in PMI Singapore had pushed the marginal cost from MC1 to MC2. From the diagram, we can see that this change may not necessarily lead to a higher price of the cigarette that MC2 cuts the MR curve at the same output (Q1). The gap between a and b where MR=MC the profit is maximum. If the price MC of Marlboro Singapore lies between the point a and b, the profit maximizing price and output will be P1 and Q1.The price will stick to the market price and the firms will concentrate more on non-price competition to earn revenues .
MACROECONOMIC ANALYSIS
General Economy
The economy of a country is calculated or determined by the GDP or GDP per capita of the country, GDP is the indicator of the recession or inflation of the economy. The Singaporean economy has been growing rapidly since the time Singapore achieved independence, as a result the Singapore has the highest GDP per capita in the world. (taborda, 2013)
The Gross Domestic Product (GDP) in Singapore expanded 1.30 percent in the third quarter of 2013 over the previous quarter. GDP Growth Rate in Singapore is reported by the Statistics Singapore. From 2007 until 2013, Singapore GDP Growth Rate averaged 5.5 Percent reaching an all time high of 36.4 Percent in March of 2010 and a record low of -13.0 Percent in September of 2010. The economy depends heavily on foreign trade; both from port activities and from exports of electronic components and refined oil. The country is a leading foreign direct investment recipient due to its status of one of the freest, most competitive and most business-friendly economies in the world. (taborda, 2013)

(Source: focus-economics.com)
The above figure describes the changes in quarterly GDP (in percentage) of Singapore within the latest years.
Unemployment
The unemployment is proportional to tobacco use, as studies show that as unemployment increases so does tobacco use. People tend to smoke more if they are tensed or under pressure. Hence, the employment rate effects the consumption of tobacco in form of cigarettes in the economy. The unemployment rate of Singapore has decreased from 2.10% from second quarter to 1.80% in the third quarter. The unemployment rate of Singapore is averaged between 2.51% from 1886 to 2013. (taborda, 2013)
The governments has taken radical steps to reduce unemployment in the country by bringing in measure and laws that limit foreign workers in working in Singapore and making it compulsory for companies operating in Singapore to hire Singaporeans or PR’s. Since the unemployment rate is going down in Singapore it can have a negative effect on the sale of cigarette’s in the Singaporean economy.
Inflation
Inflation is the percentage change in the level of prices (as measured by the CPI) from one period to another. The inflation rate of alcoholic beverages and tobacco was recorded at 16.2% , The rise of 16.2% was mainly attributable to price increases of cigarettes (+15.6%) and alcoholic beverages (+16.7%). (Pothegadoo, 2013)
The inflation rate is one of the main discouraging factors that affect the sale of tobacco in the country but studies show that irrespective of the high inflation rates the number of young smokers is increasing in the country. The most recent figures from the National Health Survey conducted last year indicate an alarming increase in the percentage of Singaporeans smoking cigarettes. 14.3% of adults are now smokers compared with 12.6% in 2004. (Tobacco free singapore, 2011)
Government Policies
Smoking in Singapore was first banned in few places and the law was eventually added to areas that must be smoke free, now the smoke free zones in Singapore include the bus interchanges, shelters, public washrooms, swimming complexes and entertainment outlets.
Cigarette butt littering is also one of the greatest high rise problem, Singaporeans found breaking the rules are fined minimum of SGD 200 to SGD 1000 if found guilty in court.
The policies in Singapore are very strict and anti smoking, they have impose high taxes and inflation rates on the sale of tobacco and cigarettes, to discourage the sale or use of cigarette, but even after all the rules and regulations the sale of cigarettes has gone up or increased.
Up to March 2003, excise duty on cigarettes was by weight per kilogram of tobacco. From July 2003, excise duty on cigarettes was revised to a unit-based (per stick) system. This change to a unit-based system was in response to the emergence in 2000 of low-priced cigarettes that had less tobacco content and less weight per cigarette and which, due to their price, were attracting young people to smoke and encouraging smokers to smoke more, as evidenced in a shift in consumer behavior pattern (sales of low-priced cigarettes increased from 6% in 2000 to 25% in (2003).
CONCLUSION
Recommendation
The comprehensive prohibition on advertising does not prevent the companies from advertising cigarettes to Singaporeans. Other strategies can be used to advertise such as use of Malaysian television to advertise into Singapore. To launch a new brand of cigarettes under PMI, a non-tobacco product, such as beverage or coolers can be used. Other creative strategies such as innovative packaging and vivid obvious in the face display units at retail outlets can be explored to overcome the restrictions. Philip Morris experimented with developing a prototype cigarette using aroma and sweetened tipping paper to target the young and health conscious. This idea could be implemented in the next few years.
Future of the company
Looking ahead, the company expects the growth prospect to continue in the year 2014 as well. The company being able to face the macroeconomic challenges of changing currency values and strict government laws and taxes, will continue its workings in the same way in order to keep up with the changing world scenarios.
The company further expects development of some new and innovative products in the coming years and continue their worldwide restructuring program. Philip Morris International plans next year to enter the electronic cigarettebusiness, a $2 billion-plus global market recognized by the maker of Marlboro cigarettes as its “greatest growth opportunity”. The world’s largest listedtobaccocompany will launch a varied range of products, called “Reduced-Risk”. Year 2014 will be a key investment year behind the concept of Reduced-Risk products.
Profit margins have gone up since the last 20 years because the company is able to reduce its cost and use the savings for further reinvestment in order to increase the sales.
Looking at the current trend the sales of the company are expected to increase at a rate of 8% annually in the next 5 years. PMI is able to grow tremendously in the emerging markets combining it with a package of new innovative, different and consumer appealing products, implementation of cost reconstruction with new ideas, the market share of the company can boom further in the upcoming years.
Conclusion
Singapore has one of the strongest tobacco control legislation in the world. In In Singapore Philip Morris has the largest share with 60% of the cigarette market. British American Tobacco (BAT) has 21%, Japan Tobacco International (Thong Haut) 17%, with other small companies having 2%.Land devoted to tobacco cultivation in Singapore dwindled over the years from 365 hectares in 1970 to nil today. Singapore’s cigarette exports have increased from 1550 million sticks in 1970 to 27 562 million sticks in 2010, indicating Singapore’s role as a cigarette processing, production, and export centre for the Asia Pacific region.
The industry was concerned that “Singapore has become the world’s most hostile environment for our industryhaving one of the world’s most restricted markets”. Having said that Singapore’s cigarette industry, especially Phillip Morris International is booming in economic terms. And one of the major reasons for this progress is that an aggressive industry pricing has also made Singapore the most profitable market in the world.
The company have a committed team of people concentrating on keeping the brand image, innovating the products, and maintaining efficiency and effectiveness. In order to become stronger on the ground the company have undertaken activities such as shared service centres which led to an improved cost structure leading to a reduction of redundancies.
Bibliography
Ministry of Trade and Industry. (2011, february 17). Retrieved from mti.gov.sg: http://www.mti.gov.sg/MTIInsights/Pages/CPI Inflation in Singapore.aspx
studymode. (2012, december). Retrieved from studymode.com: http://www.studymode.com/essays/Marketing-Plan-For-Marlboro-1333204.html
studymode. (2013, january 01). Retrieved from studymode.com: http://www.studymode.com/essays/Philip-Morris-Analysis-1369920.html
Towards tobacco-free Singapore. (2011, february 26). Retrieved from tobaccofreesingapore: http://www.tobaccofreesingapore.info/2011/02/smoking-in-singapore-on-the-rise-new-approach-needed-urgently/
Trading Economics. (2013, february 17). Retrieved from tradingeconomics.com: http://www.tradingeconomics.com/singapore/gdp-growth
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