Tobacco companies in some parts of the West have to cover half their cigarette packs with photos of smokers’ ailing organs. They have long been pariahs in their home countries. Recently even Philip Morris, the largest cigarette maker in the world, was compelled to redirect its efforts to financial and investment activity and change its name. Tougher regulations will most likely effectively reduce smoking, and transnational companies will have to seek new markets for growth and distribution. Russia, so far very loyal to tobacco producers, is one of them.

As of June 1^st, 2003, there were 96 authorized tobacco producers in Russia. According to Business Analytica, by the end of last year Western transnational companies (TNC) made more than two thirds of the cigarette sales in Russia. They are, first and foremost, the big four: Philip Morris, Japan Tobacco, British American Tobacco, and Gallaher. The four TNCs are followed at a considerable distance by domestic players Balkanskaya Zvezda and Donskoy Tabak, and another Western company, Imperial Tobacco, which entered the Russian market much later than the rest TNCs.
Russia is ranked third in the world in terms of cigarette output, tied with Japan (and lagging behind the US and China). 2002 was a record year for the Russian tobacco industry. According to analysts, it produced about 380 billion cigarettes, of which filter cigarettes account for 72%, unfiltered cigarettes 26%, and papirosy (Russian-style smokes) 2%.
While production has expanded, cigarette consumption has remained unchanged over the last three years. According to various estimates, Russians smoke from 270 to 300 billion butts a year. As a result, the supply of tobacco products in Russia last year exceeded demand by one third. While previously surplus Russian cigarettes would be shipped to the CIS countries, this year export was severely limited. Gallaher, whose Moscow-based factory Liggett-Ducat, led domestic cigarettes sales in Ukraine over the last two years, opened a factory there, and Belarus’ government established a new procedure last year for importing cigarettes through authorized companies, which greatly hampered Russian exporters.
Thus the Russian tobacco industry is suffering from a crisis of overproduction. However, not everyone on the market is anxious about the crisis. While Russian tobacco companies are cutting production and asking for government aid, foreigners on the Russian market are actively investing in new projects and products.

The crisis of overproduction hit domestic producers of cheap papirosy and cigarettes the hardest. The reason lies in the change in Russians’ consumption patterns, the increased sales of more expensive cigarettes and declines in consumption of the cheapest unfiltered cigarettes and papirosy. “Our company, as well as our closest rivals, is not very worried about overproduction. This problem affects small producers of cheap cigarettes. Their factories stand idle while ours expand, since the market segments where we compete are growing,” Philip Morris-Russia Managing Director Mark Durst says.
Analysts at AC Nielsen also confirm this: “The decline in the cheap cigarette segment has been pronounced since the beginning of 2003. Consumers of non-filter cigarettes and papirosy, whose share in total sales has fallen by 10% over the last two years, have switched to more expensive filter cigarettes. While papirosy were among the top 10 most popular brands in August 2001, now mid-priced cigarettes from international brands are winning out.”
In experts’ opinion, the market is gradually returning to a post-crisis pattern of consumption. The inexpensive Russian cigarettes consumers switched to after the 1998 crisis, when the price of a pack of imported cigarettes rose by 4-5 times, no longer enjoy their former popularity.
Most Russian producers failed to catch this trend in time and simply continue to take advantage of favorable post-crisis market conditions, churning out cheap smokes like unfiltered Prima cigarettes. Only a few companies have managed to make the most of the sudden break in competition, large Russian factories like Donskoi Tabak and Balkanskaya Zvezda. Placing their bet on Prima products, they made their way to the top after the crisis and later launched filter cigarettes brands under the same name.
However, no one else followed this path, and as a result, the cheapest unfiltered cigarettes are suffering from overproduction today. But even the best strategy can’t always guarantee success.

Experts agree that Russians won’t smoke more in the future. All further changes in the market will be linked to changing patterns of tobacco consumption. Companies’ survival will depend on their ability to respond to fluctuations in demand. For example, inexpensive filter cigarette consumption is growing most rapidly today. Following this trend in the last two years, TNCs have actively launched new brands of this type of cigarette like Optima, Next, Maxim, Alliance, and others. The strategy has proven quite successful: “Optima now holds over 3% of the market, and our company has gone from 9^th to 2^nd place in the cheap filter segment,” says Durst.
Russian consumers’ lack of loyalty to cigarette brands contributes significantly to new products’ success. According to statistics, about 30 million smokers change cigarette brands annually. Due to this fickleness, there are about 1,200 tobacco brands on the Russian market and almost 170 new brands appeared over the last two years.
There is another important trend on both the world and the Russian tobacco market. TNCs are increasing the share of light cigarettes in their product range. “Lights used to be positioned in the most expensive segments. However, over time producers began to launch new light varieties in cheaper segments, thus responding to changes in consumer preferences,” Business Analytica’s General Director Andrei Sterlin noted. “As a result, the share of lights in almost all price segments is growing.”
The Russian tobacco makers are currently unable to counter this import variety with something of their own and therefore have practically no chance of survival. The situation on the market is aggravated by the fact that, according to experts, only two or three years are left to effectively promote cigarette brands before tobacco advertisement (in particular outdoor advertisement) will be prohibited. As a result, those whose products are already popular and who actively invest today in brand development and promotion will be the big winners.

Thus, in very near future, there will be practically no room left for domestic producers. The inexpensive filter cigarette sector, the area that looks the most promising for Russian producers, is gradually being occupied by Western brands. Yet another reason why Russian tobacco producers are having a tough time: even a slight rise in excise rates might be fatal, whereas transnational companies’ margin of safety is still very large. Transnational companies are prepared keep working, even with a three- to fourfold rise in excise duties and a complete advertising ban. Andrei Sterlin of Business Analytica believes that much depends on whether the Russian tobacco producers will be able to change their product policy and make a breakthrough into higher price segments, as well as improve the efficiency of their distribution, where they lag far behind foreign companies.
Expert forecasts for the market as a whole are quite optimistic. Although cigarette consumption will remain stable, in monetary terms the market will grow by 15-18% due to increased sales of more expensive cigarettes and the relatively stable dollar exchange rate. But make no mistake: transnational companies will power this growth. Russian producers of cheap smokes will most likely remain in business but will have to reduce production and balance on the edge of survival unless the state steps in.

Table 1

Main cigarette brands on the Russian market (first half of 2003)

Brand	Producer	Share of total sales, 2002 (%)	Share of total sales, 2003 (%)
L&M	Philip Morris	5,6	6,1
Balkanskaya Zvezda	Balkanskaya Zvezda	5,0	5,4
Yava Zolotaya	BAT	5,2	4,8
Bond Street	Philip Morris	4,4	4,7
LD	Gallaher	4,7	4,3
Pyotr I	JTI	4,5	4,0
Winston	JTI	2,7	3,4
Yava	BAT	3,2	3,3
Optima	Philip Morris	2,5	3,2
Troika	Gallaher	2,2	3,1
Maxim	Imperial Tobacco	2,0	2,5

Source: Business Analytica

Table 2

The tobacco market by price segment (%)

Price segments	Share of total sales (in monetary terms) in August 2001 (%)	Share of total sales (in monetary terms) in August 2002 (%)	Share of total sales (in monetary terms) in July 2003 (%)
Premium (over 18 rubles/pack)	23	24,3	26,8
Mid-price (12.5 – 18 rubles/pack)	19,5	22,6	25,6
Economy (8 – 12.5 rubles/pack)	31,9	29,5	24,5
Low-price (under 8 rubles/pack)	17,3	17,4	18,4
Unfiltered cigarettes and papirosy	8,3	6,2	4,7

Source: AC Neilsen

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