2.d SECRET SOUZA CRUZ GROUP COMPETITOR ANALYSIS FEBRUARY 26th, 1992 l.INTRODUCTION ------------ TOTAL KUMT ------------ Domestic market volume in 1991 reached 156.3 billion sticks and was 4.7% below 1990. As 1991 has been a very turbulent year, in order to explain this market performance , it will be necessary to focus on independent periods. Brazilian economy in 1991 registered an insignificant 1% GNP growth over 1990. lot. Quarter ------------ In this quarter market sales were stable compared to the same quarter in 1990. By the end of January the Government authorized a 50.3% price increase for the product, 24.1% in real terms, freezing prices at this level. This new Erice positioning negatively affected February sales but, y Marchr it was already absorbed by consumers and sales regained growth momentum, being, in real terms, 6.3% superior to March 1990. 2 nd. Quarter ------------ Durina this quarter demand continued to grow significantly, as a result of theiprice freeze. Besides this, Souza Cruz detected that t would face tobacco shortages. In order to guarantee a normal cigarette supply in the key competitive marketsr the Company dec ided to limit sales in low competition areas, more precisely in the North, Northeast and parts of the Centre. Together with this, to adnindse the supply problem in these region S, Souza Cruz decided to manage its sales mix, reduci.g dramatically the volume of the low price sector. Ln C) r%~) Lil 00 BATCO document for Province of BritiSh Columbia 25 October 1999 With Souza Cruz sales limitation, total market grew by only 1% compared to the same quarter in 1990, otherwise, this growth would have bee. considerably greater. 3 rd. Quarter ------------ During the 3rd. Quarter the market supply was improved by Souza Cruz, which developed three new blends with the available tobacco; permitting increasing volume levels in the areas affect d by the cigarette shortfall. These blends were destined to BELMONT SUAVE in a first stage and later to LUIZ XV and CONTINENTAL. Also in July, the Government agreed with the Industry a strategy to increase real prices of cigarettes. This ~trateqy was succesfull and besides a 18% real price increase, a reduction in the number of price categories from 10 to 6 was authorized in August. With this, the 7ap between the lower and the highest price categor2.e-s declined from 280% to 230%, increasing both th:oloy~lty.of the consumers of high priced brands and the ntribution of the low sector of the market. As a result- of the above scenar:o, total market sales volume in the 3rd. quarter was 2.3% lower than that reached in the same quarter of 1990. 4 th. Quarter ------------ During the 4th quarter the Governnent continued to authorize zeal price increases for cigarettes and the average price in December was US$ 0.73 per 20, up 53% compared to September levels (US$ 0.48). This resulted in a significant 14.1% retraction in market sales compared to 4 th. quarter 1990. In December Souza Cruz initiated a slow return to normal sales in the areas affected by the cigarette shortfall, and in January sales are bein normalised in these areas. With this, it is expected a s9are reduction for HOLLYWOOD and CARLTON, brands which had benefitted from the mix management. LTI c0 t"I CX) BATCO document for Province of BritiSh Columbia 25 October 1999 3 2. PXB Strategy in 1991 -------------------- In 1991 PMB strategy was very clear. The key points identified were: a) Development of Marlboro ----------------------- During the year PMB dedicated the major part.of its investments to MARLBORO. Strongimedia suppErm was given to the brand, around US$ 13.0 m llion, concentrated in the strategic markets of the Centre/Sou,::h. Additional visibility was achieved as a result of the International media, which in commercial terms repr;se.t.d US$ 26.0 million during the year. In areas affected by Souza Cruz cigarette shortfall, PMB increased MARLBORO' s volume and distributicn. MARLBORO LIGHTS was extended on a na"onal basis in November. The version reached in the mo.-:h 0.40% s.o.m. contributing to a historic sales recor4 for the brand family in Brazil. In December PMB maintained stronq sales support for thelLights version, negative-.7 affecting the results 0 f the Fu 1 Flavour-Box version, w:=:-ch lost 0. 3 pp som in the month. MARLBORO family share e7olution was as follows: --------- ----------- S.O.M. --------- ----------- ------------- S.O.M. --------- 1979 ----------- 0.2 --------- 1990 ----------- ------------- 1.6 1980 0.2 1991 Jan/Jun 1.9 1981 0.4 1991 Jul/Sep 2.3 1982 0.5 1991 October 2.3 1983 0.6 1991 November 2.5 1984 0.7 1991 December 2.1 1985 0.8 1986 1.1 1987 1.4 1988 1.3 1989 --------- 1.4 ----------- -------- ------------ ------------- (-n C-D r\j (-n c0 c0 rQ BATCo document for Province of British Columbia 25 October 1999 b) S*lectiv* communication support to PALACE ----------------------------------------- P-ALACE, in the price category II, is PMB's key brand in t~:e low priced sector. The brand has been su ported in the key competitive areas of the Centre/SoutE and was also beiefitted during Souza Cruz's cigarette shortfall period. C=mmunication investments dedicated to the brand of US$ 1.0 million were 142% higher than 1990 level. Family share e7 olution was as follows: ------------- S.O.M. ---- Jun --------- 89 --------- 1.3 Dec 89 1.5 Jun 90 1.6 Dec 90 1.9 Jun 91 2.4 Nov 91 2.8 Dec --- 91 --------- 2.7 ---------- c) Distribution Optimisation ------------------------ 1991 PMB implemented several changes in its c-:.stribution profile. Direct distribution was eliminated the North, Northeast and in low competitive azeas of Centre/South. In these areas PMB distribution is ~:-:zrently held by authorized distributors. Some of them were also operating with Sudan products. -Y1 is concentrating its distribution resources in the key cFmPetitive and strategic markets of the Centze/South, civing priority to retailers which commercialize more than 0 thlousand cigarettes per week. In the low volume catlets PMB has been working with on the spot sales aiming 1 = take advantage of the retailer's cash availability. d) ftrtfolio Rationalization ------------------------ r,:~ring 1991 PMB continued to cleaniup its brand portfolio &iming to maximise sales, distr bution and industrial coerations. Qn Ln CO U11 OD BATCo document for Province of BritiSh Columbia 25 October 1999 5 Since A--ril 1990, when PMB took control of Reynolds oKerations, 21 brands were withdrawn from the market. T ese brands represented approximately 2.5% of the market. In Decem:ber 1991 PMB portfolio was composed of 24 brands and versions. Brands vithdrawn from the market and respective market share pre-merger were the following: --------------- Category ------------------------------- Brands Withdrawn - - - -------------------- S.O.M. pre-merge - ---- - -- - --- -------------- ------------------- ------- -- Shelton Lights Slims - -- -- - - - 0.19% Ella 0.10% V Camel Box 0.04% Camel Sc 0.04% Salem Box 0.03% --------------- ------------------------------- Winston SC -------------------- 0.33% Winston EL 0.19% IV Monterey Lights Slims 0.06% Parliament SC 0.04% Vantage Family 0.02% Salem SC 0.01% --------------- ------------------------------- Tropical Box -------------------- 0.13% M.istura Fina Slims O.li% III Mustang Box 0.08% Monterey Lights SC 0.02% Luxor Box 0.01% --------------- ------------------------------- Vila Rica KS -------------------- 0.52% Tropical Sc 0.45% II Commander 0.10% Dallas 0.04% Master - - - - 0.01% Total S!:are 2.52% -------------------------------------------------- ------------------ e) Cigarette Export Expansion ------------------------- In 1991 ?A(B expanded significantly its exports. The volume evolutior and the turnover generated by these operations were the !ollowing: 00 (-n CO BATCo document for Province of British Columbia 25 October 1999 ------------------------------ volume ---------------- Turnover (Billions) --- - -- (US$ Million) -- -------- -------------- -- 1989 4.0 -------------- 27.1 1990 6.5 43.8 1991 (Est) 16.0 ------------------------------ 107.2 ---------------- The 146% volume growth registered in 1991 is basically due to a co-packing system coordinated by PMI in order to attend Easterm Europe markets. Considering the current production capacity of PMB , in three shifts, 1991 output could have been ll..5 billion cigarettes higher. ------------------- ------------- Volume Billions ------------------- Total Capacity ------------- 49.0 Domestic Sales 21.5 Expc--t Sales 16.0 Spaze Capacity ------------------- 11.5 ------------- It has also !:een identified in 1991 that PMB imported US$ 2.0 million of reconstituted tobacc 0 from Belgium, Switzerland a=d U.S.A.. As this type of product has not been found -'- the domestic brands, it was possibly utilized in 2;MB export brands through the year. Although impossible t= c onfirm, there is a chance that this reconstituted tobacco originated from a draw-back operation. The following picture indicates P. Morris key export brands and markets: (JI CD co co BATCo document for Province of British Columbia 25 October 1999 7 V Z -------- B;.-; d- ---------------- K-e-y --- M -a r k- -e t- -s -------------- 1/1'71 ------------- B ;-; ;t i a Midd E Russia We ond St e t Af 1 st Congres a West Africa Middle East Russia / E. K LS Middle East Suriname r S LM Middle Ea t Suriname / E. Europe CoTmander Chile / Aruba Marlboro Menthol Asia Marlboro FF/Lights E. Europe -------------------------------------------------- ------------- Master Paraguay / Chile / Suriname / Bolivia S Flint Lights Chile K LM Aruba / West Africa S Majorca Paraguay Peru Ga. axy Paraguay Monte Blanco Paraguay Bolivia / Chile ------------------------------- -------------------------- f) New RA-inistrative Structure As from August PMB administrative structure has been modified with the merger of the cigarette and the ice cream divisions, the latter represented by KIBON (General Foods). Since then, both businesses are reporting to the C.E.O., Mr. Paulo Bennia and the structure is as follows: C E 0 -------------------------------------------------- ----------- I ---- ----- I ---------- I --------- I .Juan M. Forn Richard Sucre J J Cardoso Lucena Clodoaldo Ce Group Finance PM. Kkt- S/A Kibon S/A Group Corp vice President General Mng. General Mng. Affairs Di ---------------- --------------- -------------------- ------------- Following data summarizes some key information about the two groups: ------------------------ P. Morris Kibon Gross Turnover (US$ Million) 485 150 Profit 1990 (US$ Million) - 15 Staff 5,000 3,000 1991 S.O.M. (%) 13.7 60.0 -------------------------------------------------- ----- CD CO C.n cc ON BATCO doCUrnent for Province of British COIUMbia 25 October 1999 3. PHB Possible Strategy 1992 and Souza Cruz Responses -------------------------------------------------- - a) High Priced Sector (Price Categories IV to VI) ---------------------------------------------- In this sector of the market PMB will probably continue to focus MARLBORO develoEment as its principal objective is to make MARLBORO the est selling brand in Brazil. It is estimated that 90% of total communication investments of PMB will be dedicated to the brand. Souza Cruz will maintain its multibrand attack strategy against MARLBORO. HOLLYWOOD, CARLTON, FREE and LUCKY STRIKE, each with its own role, will be the ANTI-MARLBORO brands. Increasin and strategic-orientated mmunication investments, coupyed with high product quaclioty, will be given to these brands during the year. b) Low Priced Sector (Price categories I to III) --------------------------------------------- in this sector of the market PMB will probably maintain its direction of 1991, giving support to PALACE, which is showing some potential. There is another possible movement, which is the launch of a low tar or mild option (local or international), in price category III. With this new brand PMB would be able to attack PLAZA directly, and HOLLYWOOD and FREE indirectly, as an undercut. ' Souza Cruz strategy for this segment is clearly defined. PLAZA is the key brand of the sector and must be protected from categoryttII mild offers. On the other hand, PLAZA must also e a ractive for category IV dow-n-traders. With this, the new PLAZA campaign, an evolution compared to the previous one, will be run in the key coTpetitive markets of thellco~ntry. A new pack design is being extended nationa y in February 1992. RITZ and BELMONT will be supported at the point of sale, and will only receive TV media support in reactive terms. All Souza Cruz brands in the segment will suffer substantial product improvements, particularly smoking quality. Un CD N) (D co c0 BATCO document for Province of BritiSh Columbia 25 October 1999 9 c) Advantages of the Now Administrative Structure ---------------------------------------------- There is a big chance that PMB will try to take advantage of the new structure after the merger of the cigarette and ice cream areas. The merchandising dominance of Kibon, mainly in the key bakeries of the strategic markets, is a threat to Souza Cruz. It is expected that PMB will pressure these key retailer looking for merchandising exclusivity for the cigarett: business, aiming to increase MARLBORO visibility. At the moment Souza Cruz is evaluating possible directions to counter- balance this competitive advantage. d) Price Freedom Process / Excise ------------------------------ With the possibility of a new price scenario it is clear that the. objective of PMB is to obtain total pricing freedom, if possible changing the excise from "ad valorem" to with a single bracket. With this, PMB would reac;pecifmicr'e competitive price positioning for its key asset, MARLBORO. Souza Cruz supports price freedom, however, the company will notiaccept losing its current advantage, in terms of price.pos tioning, which has been built over several years and is one of its key strengths. To make this possible, the way to implement price freedom should have certain rules: - The maintenance of a structure of price categories - An excise structure that avoids MARLBORO price competitiveness The kejlpr~ce Eositioning that must be maintained involves the fo owing rands: CARLTON and LUCKY STRIKE same price as MARLBORO HOLLYWOOD SC and FREE SC 20% cheaper than MARLBORO RITZ SLIMS and KSISC same price as PALACE SLIMS and SC PLAZA SC 10% cheaper than HOLLYWOOD and FREE PLAZA SC 10% more expensive than PALACE BELMONT FF and Mild same price as MUSTANG FF and Mild co V1 co C-1) BATCo document for Province of BritiSh Columbia 25 October 1999 10 3) PRODUCT VARIABLE COST ANALYSIS In order to better understand the variable cost structure of PMB main products, based on analysis of these products by the R&D division, certain key conclusions were reached by Souza Cruz: - Philip Morris costs are higher than Souza Cruz's and this difference lays basically in the packaging material. While Souza Cruz has its own Graphic Department, PMB depends on third-parties. - PALACE SLIMS is a very expTnsive brand. Its cost analysis shows that its price positioning is not allowing an adequate contribution. If one considered PMB marketing investments to the brand, the situation worsens even more. - Even with its current premium price positioning (category V), MARLBORO contribution level is not representing a competitive advantage to PMB, as Souza Cruz brands of category IV generate similar results. MUSTANG and BELMONT contributions are almost the same. Xey Variable Cost Figures -MARLBORO costs are -MARLBORO costs are MARLBORO costs are MARLBORO costs are PALACE SLIMS costs PALACE SLIMS costs PALACE SLIMS costs 31.7% higher than FREE FAMILY 51.9% higher than HOLLYWOOD FAMILY 28.4% higher than CARLTON 7.0% higher than LUCKY STRIKE are 19.2% higher than PLAZA FAMILY are 14.9% higher than RITZ FAMILY are 47.1% higher than BELMONT SUAVE MUSTANG KSF/FF costs are 4.52% higher than BELMONT KSF/FF MTEHM2 HKA.PE1059 1 B/02/92 Cn CD r\j (-n c0 (-n 00 BATCo document for Province of BritiSh Columbia 25 October 1999