"Philip Morris International: Profits & Ethics"

July 28, 2011

Philip Morris International: Profits & Ethics.

Browsing through the list of Fortune 500 companies, I was searching for a suitable subject for today's thoughts. I came across Philip Morris and was intrigued. One does not read about Philip Morris in the news much and smoking is increasingly frowned upon in the U.S. Yet, Philip Morris continues to reign the tobacco industry with force. Benefitting obviously from a "loyal" customer base, as any drug supplier does, the company prevails changing legislations and is ranked 94^th on Fortune's list of the largest 500 companies... Philip Morris International (PMI) that is. PMI generates over $27 billion in sales annually with profitability at 27% of sales (ranked at 24). The history of the company is interesting and provides evidence of acquisitions and international expansion, leading to the spin-off of Philip Morris International from the Altria Group in 2008. Interestingly, the Altria Group maintained ownership of Philip Morris U.S. and separately generated $21.6 billion in cigarette sales in 2010.

During my limited research, I was hoping to find clues and insights into what strategies were employed to be that successful in an industry that is as labeled as the tobacco industry. Do any of the normal business rules apply, or if it is a completely different ball game considering tobacco is a highly regulated product? And most of all: How does an individual such as Louis C. Camilleri, CEO and Chairman of the Board of PMI, deal with the scrutiny of his organization and civil attacks, negative press and associations? He surely has a strong backbone … and a cushioned pocket. I guess >$30 million in total annual compensation can thicken the skin.

Unique is probably the right descriptor for the company and its operations as well as for the industry overall. News coming out of PMI seem to be primarily related to announcements regarding its financial performance or decisions pertaining to some kind of litigation. Clearly needed is a team that works with regulators/government in different countries to fully grasp and stay on top of changes in legislation relating to the sale, marketing, and use of tobacco in the various countries. Volume growth stemmed only from the merger with Fortune Tobacco Company in the Philippines. Pro-forma sales volume declined 2.5% in 2010 compared to the prior year. The total market in units did take a hit based on the difficult economic climate as well as higher excise tax in several countries. 

In his latest address, L. Camilleri points out that PMI has worked aggressively with legislatures to adhere to and even support some of the new regulations. Additional regulations are pending, which include product display bans, bans on the use of ingredients, as well as further regulation pertaining to packaging to which the CEO clearly objects. He points out that the Australian government "has released an exposure draft of its plain packaging bill", which would mandate plain packaging in 2012.

It truly is like swimming upstream; imagine being a marketer in this environment. Imagine having to constantly battle government regulations across the globe. Particularly as health care cost escalate across the globe, the impact of smoking will continue to be scrutinized. The CDC states that 1 of every 5 deaths in the U.S. each year is caused by cigarette smoking leading to a total of 443K deaths annually (including deaths from secondhand smoke). Tobacco companies will clearly continue to be a target.

But financially, there still seem to be enough $$ to go around. Let's think about it: Is there much investment in R&D? Probably not, we are not talking about  advances in new product technology that need to be explored. According to PMI's 2010 Annual Report, total marketing, administration and research costs accounted for roughly 9% of sales. I cannot think of another industry where that is the case. I am used to operating expenditures in the 40% range!!! Interestingly, PMI does highlight its strength in innovation and development.  I would imagine that in terms of head count, the legal team must be unusually large and account for a significant portion of salary expense.

COGS were cited as <15% of sales. So how do we get to the previously mentioned 27% of sales net profits? Excise tax! Excise taxes account for almost a whopping 60% of sales. But as highlighted by Fortune, PMI remains the most profitable Tobacco company in the world. Brand image is fundamental to the success of its products in the various countries, understanding cultural differences and perception of smoking are key. Unique to this space are the fact that the top countries are not the top countries for most other industries: Russia, Indonesia, and Japan.

So, in terms of strategy: Strong investments in legal and regulatory teams to stay abreast of ever changing regulation and the litigation/lawsuits. Without question, tobacco companies have strong political ties that prove crucial in delaying (derailing?) certain legislation. Brand image is critical along with local marketing power and influence. Clearly, there is no global marketing approach given the vast differences in perception, image, and cultural influences in this space.

In terms of leadership: Without question, it takes someone stubborn, confident, and with thick skin to lead such an organization. Personally, my ethical believes would be stretched if I had to attempt to drive adoption of tobacco products. The negative impact of tobacco products is unrefutable and stretches far beyond basic health issues. To quote the WHO: "Tobacco and poverty are inextricably linked. Many studies have shown that in the poorest households in some low-income countries as much as 10% of total household expenditure is on tobacco [and therefore] less money to spend on basic items such as food, education and health care. In addition to its direct health effects, tobacco leads to malnutrition, increased health care costs and premature death. It also contributes to a higher illiteracy rate, since money that could have been used for education is spent on tobacco instead. Tobacco’s role in exacerbating poverty has been largely ignored by researchers in both fields."

NO THANKS, Mr. Camilleri, it is all yours!!!!