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The tobacco industry: imagine a pizza

In early 2017 I was invited to meet a group of students in the School of Economics at the University of Cape Town and engage with them in an informal discussion of the tobacco industry in South Africa. The invitation came from the professor who has been heading their research into the tobacco sector, Corné van Walbeek, whom I regard highly. He is one of the few academics in South Africa who truly understand the key dynamics in the industry and is probably the foremost expert on the tobacco sector in southern Africa, even if much of what he has published does not necessarily win the agreement or approval of the major players in the industry.

Facing the group of eager and bright students, I started off by using an analogy that best describes for me how the tobacco sector is composed and how it functions. ‘Imagine a pizza’, I began, ‘one large pizza.’ Each slice of the pizza represents the market share of the various role-players in the industry. As I made clear, my focus was only on the cigarette component of the tobacco industry, whose products also extend to cigars, cigarillos, snuff, chewing tobacco, tobacco for pipes or self-rolled cigarettes, or fancy contraptions like the ‘hubbly bubbly’, and even insect repellents. But the biggest game is in cigarettes.

How big the ‘pizza’ is overall is difficult to quantify. In 2012, it was estimated that approximately 7.7 million South Africans smoked about 11.4 cigarettes per day. That amounts to almost 880 million cigarettes each day or over 32 billion per annum. The annual revenue in 2012 was thought to be around R22 billion, with an additional R8 billion attributed to illicit activities. In that year, BATSA, the largest manufacturer and distributor, commanding the biggest slice of the ‘pizza’, reportedly employed about 14,000 people in South Africa and relied on over 150,000 retailers countrywide to sell its products.

The students listening to me at UCT were all in their twenties, and given the dramatic changes that have taken place in the tobacco industry over years, I took them back in time to when I was a young boy. This was the golden era for the big-name tobacco manufacturers, the makers of brands like Marlboro, Benson & Hedges, Dunhill, Rothmans, Winston, Camel, Peter Stuyvesant and Kent. They were the only players in the marketplace, and really had only themselves to contend with. The social and health problems we nowadays associate with smoking were simply unknown or else disregarded, and there were no restrictions on where you could or could not smoke. People regularly lit cigarettes in aeroplanes and in restaurants. Smoking also had a certain cachet, or so the advertisers would have one believe. I told the students how, without fail, one or other well-known cigarette brand would feature in lengthy advertisements shown at the cinema. These were almost a standard feature before the main movie would start. There was either the rough-and-tumble adventure man, who had just finished a cross-country race through the jungle in his hardy four-by-four vehicle, crossing muddy terrain and chopping down trees to build bridges across rivers, and at the end of it all he would settle down for a well-deserved cigarette. Alternatively, there were the cowboys, rustling cattle all day, chasing an errant cow or pulling a calf from a pit, who ended up around the campfire, lighting their cigarette with a burning twig. The adverts I enjoyed most played out on the Swiss Alps, with sportive young men and women criss-crossing the slopes on their skis, ending the day’s play before a log-cabin fireplace with a well-deserved cigarette. The message was clear: the tough guys and beautiful people who enjoyed all the pleasures of this world smoked cigarettes of a particular kind.

Back in the 1980s and 1990s, these brands and their manufacturers would have been easy to identify. Considerably more than two-thirds of our ‘pizza’ would have belonged to them. Of this the lion’s share was held by British American Tobacco, while the only other significant players at the time, though smaller in market share, were Philip Morris International, Imperial Tobacco Group and RJ Reynolds Tobacco Company (which became Japan Tobacco International in 1999). The remaining one-third of the pizza belonged to low-key informal and formal importers and traders and a few groups that were involved in smuggling operations and counterfeiting. Smuggling operations arguably benefited the big companies in the sense that it was their own products that were being smuggled in and sold on. So this was not such a great concern for them at the time. Their biggest bugbear was the counterfeiters, who made copies of the famous brands and sold these off as if they were the real thing. As the counterfeiters used cheaper or smuggled tobacco, paid low wages and didn’t have the huge costs of the big companies, they represented a big threat to the established players. Needless to say, the latter expected the state’s law enforcement agencies to deal with the counterfeiting.

By far the largest of what I call the ‘big boys’ was BAT South Africa. Its origins lie in a small company started by the Afrikaner entrepreneur Anton Rupert in the 1940s, which later became known as Rembrandt. By 1956 the company had listed on the Johannesburg Stock Exchange and by 1961 it was selling cigarettes in 120 countries. In 1972 Rothmans International, which represented Rembrandt’s non-South African tobacco interests, was listed on the London Stock Exchange. In the late 1990s Rembrandt sold off Rothmans International to British American Tobacco plc (BAT) in the United Kingdom, then considered to be the world’s second largest cigarette producer. Out of this merger was born BAT South Africa (BATSA). To give an indication of the size of BATSA, in 2012 the tobacco manufacturer was second only to BHP Billiton, the largest listed company on the Johannesburg Stock Exchange in terms of market capitalisation. (Market capitalisation is the total market value of a publicly listed company’s outstanding shares.) By 2015 it had overtaken BHP Billiton and by 2016 it had grown its market capitalisation to R1.5 trillion. In effect, it was richer than the South African government. BATSA is without doubt the biggest and most influential player in the South African tobacco market.

BATSA’s closest formal rivals are three in number. The one is Philip Morris South Africa, whose parent company, Philip Morris International, with its famous brands of Marlboro and Chesterfield, held for many years the number one position as the world’s leading tobacco manufacturer. Philip Morris SA was re-established in South Africa in 2003. The second is Imperial Tobacco with its famous brands like Gauloises and Embassy. The third rival is JTISA, whose parent company, Japan Tobacco International, was formed after incorporating with the US multinational RJ Reynolds in 1999. JTISA is a late entrant to the South African market, having been established here in 2007. Its best-known brands are Camel, Benson & Hedges, and Silk.

To represent, protect and advance their common interests, the large, established tobacco manufacturers and growers combined to form the Tobacco Institute of Southern Africa (TISA) in 1991. Effectively, this means that TISA was the only organisation of manufacturers and other role-players in the tobacco industry in South Africa at that point. At the time of writing, TISA consists of a number of companies and groupings, including British American Tobacco South Africa (BATSA), Alliance One International, JTI South Africa (JTISA), Philip Morris South Africa, Imperial Tobacco Southern Africa, Universal Leaf South Africa (ULSA), Limpopo Tobacco Processors, Tobacco Traders, Clippa Sales South Africa, and OTP Distributors. Together, in particular with reference to the manufacturers BATSA, JTISA, Philip Morris SA and Imperial Tobacco, they bring with them some serious money and clout. As a lobby group and collective, they represent the biggest manufacturers and distributors of tobacco products and cigarettes in South Africa. In other words, TISA is the big boys’ club.

TISA represents not only big money, but old money. What I mean is that most of their members have been in the game locally and internationally for many years, during which they increased their own market shares worldwide, and grew into multinationals listed on stock exchanges worldwide, with complex business structures. They were big contributors towards developing economies from a tax perspective while simultaneously being rooted in developed economies and were generally seen as the good guys who created jobs, contributed towards the economy and could do no wrong. Where these companies are listed on stock exchanges, you’ll find pension and retirement funds, investment houses and even government investment institutions investing heavily in their shares. These dynamics not only give the perception of respectability, but also provide power, influence and leverage. They make their directors, senior managers and representatives important people who can pick up a phone and call a meeting to raise one or other issue with senior government officials and politicians. Indirectly, without it ever being said overtly, it is always understood that if they are under any kind of threat, this will have a massive impact on jobs, tax revenues for government and their own shares on various stock exchanges around the world, which in turn will affect pension funds, investment houses and, ultimately, the country’s economy. They are not to be trifled with or easily gainsaid.

From the early 1990s the tobacco manufacturers began to face a number of unprecedented challenges that started to subvert their dominance and eat away at their profits.

For one thing, proportionate to population growth, the number of smokers in South Africa started to decline. In 1993, the Tobacco Products Control Act was introduced which required that health warnings had to be prominently displayed on cigarette packs and advertising material. Smoking on public transport was also banned. Around this time, too, government taxes on tobacco products started increasing significantly. The average tax on tobacco products in the mid-1990s was around 30 percent of its sold value and by the end of 1997 this had increased to 50 percent. Simply put, it became more expensive to smoke. In 2000, South Africa became one of the first countries in the world to ban smoking in public places by means of the Tobacco Products Control Amendment Act. This law prohibited smoking in restaurants, shopping malls and public buildings, and limited smoking to areas where there were dedicated enclosed smoking rooms. Advertising and sponsoring of public events were also banned. It is estimated that these measures alone led to a decrease in the number of active smokers to around 25 percent of all adults. By 2003, it was estimated that the number of smokers in South Africa had declined to 23 percent. The original large pizza was now truly a medium-sized one.

By 2005, excise tax – the tax paid on the import and production of cigarettes – had increased to 52 percent of their retail value. This meant that more than half of what a smoker paid for his fix was supposed to go to SARS. By then, the so-called sin taxes had become a standard feature in the annual budget speech of the finance minister. Year by year, it became more and more expensive to smoke. New legislation also made compulsory further extensive health warnings at any point of sale. Soon thereafter, the government banned smoking in partially enclosed public places such as covered patios, verandas, balconies, walkways and parking areas, and smoking in cars when children under the age of 12 were present. Children under the age of 18 were also prohibited from entering designated smoking areas and from purchasing cigarettes. In 2016 it was estimated that the proportion of active smokers had declined to about 16 percent of all adults. The pizza kept on shrinking. Quite clearly, the big brands were starting to lose money as a result of an ever-decreasing number of smokers.

But these legislative restrictions and requirements of government weren’t their only headache. In the 1990s, partly because of these pressures, the various schemes and scams which had once cornered the remaining third of the pizza or what was left of the trough after the big boys had fed, started increasing in volume and prevalence and began eating into the dominant share of the big companies. Firstly, there were those unscrupulous people who would smuggle cigarettes into South Africa by not declaring them at all for tax purposes or only declaring limited amounts. The effect of these practices was that they could then sell their cigarettes in the local market at the same price as the legitimate companies, and thereby make a huge profit because they didn’t pay duties or value-added tax (VAT) to the revenue authority. Just to give a sense of scale, a 40-foot container can carry between 1500 and 2000 master cases (containing either 50 or 100 cartons each with 10 or 20 packets of cigarettes) with a yield of about R10 million if you are successful in smuggling it into the country.

Related to this are two other scams known as ghost exports and round-tripping. Ghost exports, in their essence, seek to create the illusion of goods having been exported when they were not. In its simplest form, exporters simply provide the paperwork that appears to show the goods have been exported, thus permitting the deduction of VAT and duties. Its more sophisticated form requires the actual exportation of one or more containers, often holding less than what is claimed on the paperwork or nothing at all. Previously corrupt customs officials would ‘confirm’ by way of a stamped customs document that the goods had left the borders of South Africa when they had not. As SARS began to clamp down on corruption at ports of entries and modernised its customs systems, more sophisticated versions of the scam appeared.

Another variation of ghost exports involves importers who claim to be importing goods for purposes of exporting them. Sometimes they claim the goods are being kept in bond in their warehouse, which defers the obligation of having to pay duties and taxes, and then fraudulently obtain proof of export thereof in one way or another. Alternatively, they claim that the goods are being imported into South Africa en route to another country, typically the two landlocked countries of Lesotho or Swaziland or countries north of our borders. Round-tripping is a derivative of ghost exports – the sophisticated cousin. Here, the goods are actually exported to another country, but then brought back by way of smuggling into the country for local consumption. All these scams have one aim in common: they seek to circumvent the legal requirement to pay excise, duties and taxes on the local sales of cigarettes.

Yet another scam that emerged in the 1990s was illicit or unrecorded manufacturing. While cigarettes are being made, the exact number of sticks coming off the production line is recorded by a counter fitted to the machine. In theory, they are sealed units and cannot be tampered with. They become the record-keeping devices that keep track of the volumes of cigarettes produced, for tax and excise duty purposes. Unscrupulous manufacturers use a secret and unrecorded manufacturing machine, either somewhere within South Africa or outside, in which case the cigarettes had to be smuggled into the country, or, more commonly, disconnect the counter and then produce as much as possible without the quantity being reflected on the counter. The result is that manufacturers are able to sell more packets of cigarettes than what they actually declare to the taxman and, as a consequence, pay less excise duty and pocket the difference.

As I’ve indicated, the fourth most prevalent scam in the golden era up to and including the 1990s was counterfeiting. Crooks would simply produce cigarettes in underground manufacturing plants and package them with the counterfeited branding. The most popular brands suffered most from this scam. Smokers buying them would have been none the wiser unless they knew exactly what to look for on the packaging, including the so-called diamond stamp (with the letters RSA within it), which is issued by SARS as part of the licensing rights of manufacturers. Some counterfeiters were extremely professional in copying brands. Of course, none of those involved in these scams would pay income tax on the profits from their earnings. The net effect of these illegal practices was that the market share of the well-known brand holders began to shrink.

Soon they began to cry foul. In 2010, BATSA went on record to state what a serious problem illegal cigarettes constituted. ‘More than 15 million illegal cigarettes are sold daily in South Africa and the profits are used to fund organised crime.’9 According to a BATSA spokesman, containers used to smuggle illicit cigarettes into the country also often carried guns and weapons. ‘There are clear links between illicit cigarettes and organised crime, drug smuggling and arms smuggling.’10 Moreover, the trade in illicit cigarettes was ‘directly linked to organised crime and the profits used to fund prostitution, gangsterism, human trafficking and even terrorism’.11 Unfortunately for BATSA, not a single person convicted of smuggling cigarettes into South Africa has been found with guns, weapons or drugs included in the cargo or shipment or to have been involved in human trafficking. The claim is pure hocus-pocus – scaremongering on the part of the big companies. In reality, counterfeiting of the big brands had declined by 2010 to levels that were measurably low. In January 2005, SARS confiscated 1500 cartons of counterfeit cigarettes with an estimated retail value of around R4.7 million. But this was one of the last recorded seizures of this size. Indeed, counterfeiting and the other scams were by 2010 no longer the big headache they had once been to the ‘big boys’. Another, more serious threat had emerged: the ‘new independents’ who started to flood the market with cheaper, lesser-known brands – the ‘cheapies’. They would change the tobacco trade for ever.