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A meeting of the Tobacco Strategy Group was held
on Wednesday 8th December 1993.
SECRL7
Present: Mr U G V Herter, Mr D F Allvey, Mr B D
Bramley, W N G Brookes, Mr D Brown,
Mr E Z Ettedgui,11-ft A Monteiro de Castro, Mr TE
Sandefur, Dr B Schweitzer, Mr
H A Tomat, 14iss H C Barton (Secretary)
W. N Davis was present for items 2 to 19; Dr E
Kausch for items 2 to 7; Drs R
Thornton and C Proctor for item 2; Messrs I
Snowden, N Bennemann, Goode,
Hernhold, R Harrison for items 12 to 19 ; W S P
Chalfen for items 19 to 30; and Mr
D C Potter for items 37 to 39.
Minutes
Amendments to minutes 13, 17, 33 and 38 of the TSG
meeting on Sth September were
circulated in advance of the meeting.
Reseirch And Develourrient
2. Dr T"hornton suiranarised the work of the
Scientific Research Group over the past year.
the screening or scientific literature ror the
alleged efrects of cigarette smoking; the
impartial
identification of research which should be done
and top quality researchers to do it; projects
which were completed during 1993; and newiy
approved projects. The two most rec-ently
appointed consultants are American and German, and
have high international scientific
reputations. Mr Herter thanked Dr Thornton, who is
shortly to retire, for his work over
the years in this area and the clear way in which
he explained the science to laymen.
NIr Davis presented some statistics on Patents
filed over the past year by BAT (59), Philip
Nfor-,*s (132) and ILI Reynolds (74). However, the
number of patents is not as 3ignificant. as
their commercial viability. P14 and RJR have been
filing smokeless cigarette type products.
PIA is currently filing novel pack designs, having
previously also filed novel ciga:ere
designs. Mr Davis could not see that commercial
advantage could be achieved from novel
packs, since, to deliver machines at a reawriable
cost, the equipment would need to be
supplied to several cigarette manuracturers, and
therefore machinery manufacturers would
not give exclusivity for more than two or three
ycus. The only successful novel cigarettes
have been Barclay and CaprL Nicotine-free
cigarettes have not taken off and Premier was a
failure. However, a smoke-free CigarCUC With an
acceptable taste would have a good chance
or success, therefore this is in area in which
BATCo is taking action. All issued patents are
reviewed monthly, but Nif r Herter requested a
more rormal annual review at the September
TSG meetings to ensure that no competitive trends
were overlooked.
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4. Dr Kausch presented the development work it
BATCF on Project Hamster. The novelty
is not in the co-axial cigarette rod or in the
co-&xW filter but in the combination of the two,
which gives flexibility for product development.
The current marketing objective is to
develop a full flavour cigarette with single digit
ur. It may also be possible to reduce
sidestream and ignition propensity.
5. As there is in urgent Group need for an
improved Lights cigarette, Mr Herter asked Dr
Schweitzer to make a proposal to him as soon as
possible for a Group project to develop a
co-axial Lights product. This should include an
objective and a time scale, a project
champion, a Est of"insiders" on the project, and
the R&D and Marketing resources &om 0
the Operating Groups that can be committed to the
project.
6. The possibility should be investigated of
holding a workshcp, for the Marketing and R&D
staff involved in the project, in Hamburg in early
February. An objective of this workshop
could be to "brain-storm" a total catalogue of
what could be achieved by usin& this
technology and then rrom this catalogue selecting
the key styles for development.
7. Mr Herter stressed that if the development is
successful, a launch covering key markets
should be considered to ensure that competition is
not allowed any lead time. Mr Sandefur
recalled seeing some RJR patents for co-axial
cigarettes in the US and advised that the
patcrit position should be checked.
Production
S. Mr Her-ter considered that, with increasing
complexity, BAT's manufacturing strategy
should be to have separate intemal units for high
volume and low volume brands within
each major factory. The European Manur2cturing
Location Strategy should set out the
objective to have two major rnanufa=ring sites in
Europe at the latest by the end of the
century. Mr Br2Mley said that BATCo would address
the possibility of closing Brussels
and transferring its production to Southampton,
with the exception of RYO for which a
more suitable location would be identified.
9. Mir Davis presented the cash flow implications
of closing the Brussels factory and
transferring manuracture to Berlin and Bayreuth
with B&H GT returning to Southampton.
Mr Ettedgui pointed out some technical errors in
the calculations- However they did not
affect the conclusion which was that inirnediate
closure ofthe Brussels factory could not be
justified because of the high severance payments
but that a managed run-down should be
pursued with a view to eventual closure.
10. Mr Castro reported the successfisl closure of
the Bonfim plant. The payback was estimated
at one year. Souza Cruz has reduced its number of
phuits from 7 to 3 over the past two
yeus. Mr Herter congratulated Mr Castro for
achieving this in a socially and politically
acceptable way.
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W Sandefur presented an interim report on Group
manufacturing capacity 'Which
showed that there is surplus rapacity overall in
every company but not in hinged Ed. The
final report wiU be presented to the TSG in March
together with the report on disasta
recovery. He reported that B&Ws capital programme
has been reduced consistent with the
latt3t volume forecast, and additional cost
avoidance has been achieved through
improvements in the Macon Expansion (&g.
establishing a super primary line). Mr Herter
requested that all operating groups should review
their capital expenditure plans to ensure
that there was no expenditure on expansion, with
the exception of Project Test. Expenditure
should be on conversion, replacement or
rationalisation only.
L _C2 r
12. Mr Snowden explained the relationship between
leaf specification and manufac:uring costs.
Stem in Lamina (SIQ has been reduced from 3.5% to
1.7%, wl~ich has resulted in cost
improvement. The objective: has been to achieve a
n=owcr distribution of particle size: with
fewer large particles and also less dusL This
process within GLT of reducing both SEL and
costs has been taken as far as possible. Lower SIL
could sO be achieved within GLT or
within manuracturing, for example, by winnowing.
However thcst possibilities will have
cost penalties and the quality benefits will need
to be traded off against the costs, but the
preferrcd option would be to do this at the making
level.
13. Mr Ettedgui presented Projcct Maple. Maples
shires have under perfon-ned those of their
competitors during 1993. Tobacco stocks have
increased from S133m in 1991 to S305m in
1993, taking the stock duration from 71 to 129
days. This has resulted in an increase in
borrowings. Gearing climbed from 260% in March
1991 to 344% in March 1993 and is
believed to be in excess of 400% at the end of
Scptember. Maple's bankM placed
restrictive covenants on its dcbcntures including
a minimum ratio of current assets to
current liabilities of 1.25. Maple is now in
breach of this at 1.20. A loss is forecast for
1993/4 partly as a result of an $1 8m stock
write-off
14. If Maple faded, BAT would have little problem
with purchasing. With respev, to selling,
Zimbabwe would have some difficulties until other
dealers were signed up, but this is
believed to be possible. The main problem would be
in Brazil, where Maple is the marketing
arm of Souza Cruz- If Souza Cruz could build up
its own marketing function it Is likely that
BAT's major competitors would be unwilling to buy
from it, although they are wining to
buy via Maple. This could result in a loss of 50%
of Souza Cruz leaf exports that currently
go through Maple (equivalent to 25% to 28% of
total leaf exports) and a higher proportion
of its profits-
15. Another possibility is that Maple could
conclude that it can Solve its difficulties only
by
making more profit from the Brazilian market
either by having it different relationship or
commission structure with Souza Cruz, or by
investing directly in Brazil, for example, by
purchasing Universal's surplus plant.
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16. Many options to prevent Maple from Wing or
being acquired by a competitor have be=
evaluated:
The stock quality is not very good. The most that
BAT believes that it could buy
which would meet standards is I.Sm kgs, which is
insignifica= since the total stock is
about 120m kgs.
The amount ofextra volume which could be
channelled via Maple is also insignificant,
leaving aside the additional risk ofdoing this.
Various possibiTities to invest in 1~ftple, work
with Maple's banks to restructure the
business, divest the wool business, etc. were
proposed.
17. It was agreed that BAT should not invest in
Maple's equity. Maple should be BAT`s first
choice for buying but it is important to maintain
a spread of dealers. Since the main problem
is in Bra;61, Mr Csstro and Mr Ettedgui will
consider the options and make a
recommendation to Mr Herter, both with respect to
Maple and with respect to Souza Cruz
establishing a leaf marketiig am. Discussion will
be held with Maple only after BAT has
agr.--.-d its position.
18. Mr Snowden reported that the LeafTrading Group
had discussed leaf buying, and agreed
tha- the policy should be that the first choice
would be to buy from a BAT associate, the
seccrd choice would be to buy from Maple and the
third choice would be to make strategic
purchases from other dealers in order to maintain
flexibility. The Group (which includes the
three key buyers) wM monitor adherence to this
poUcy, and Mr Snowden should provide a
progress report to the September TSG meeting.
7.eeaLfRe2ulatorv T-sue3
19. Mr Chalfen reported that the leaf contracts
had been reviewed over the past few months.
A framework contract has been established for
exports which ensures that the balance of
risk3 is corr=. AIr Snowden said that the
framework provided a tight guideline which was
often difficult to apply in practice. B&W and
BATCF have buying contracts, but BATCo
does not. Deals are often done on the telephone or
by a handshake. Mr Chailren will review
the position within BATCo with respect to a buying
contract.
20. Afr Chalrcn also reported that the distributor
contract was being progressed with BATCo.
21. I%fr Chalfen reported progress with respect to
counterfeiting over the past year. The
Group Security Manager has co-ordinated the Group
approach by bringing together
appropriate representatives from each operating
group. Common interest has been
recognised, and the active exchange of information
has greatly alleviated the problem and
has already led to some successes in the field and
in court. The organisation ofthe activity
has been benchmarked against other companies that
face similar levels of counterfeiting.
BAT's military intelligence approach compares well
with the physical security approach
taken by our main competitors. The key to future
success is continued improved co-
ord:nation.
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22. Mr Chalfen demonstrated how the brand
categories currently in use for trade mark
protection purposes are out of date. The ctisting
policy of which companies should file in
which countries has not been adhered to. Both
these factors indicate the need for a revised
trade mark policy and procedure.
23 In September 1992, the TSO set up the Trade
Mark Counsel Group (TMCG) with
responsibiEty for Project ReMark and for the
review of the Group's trade mark policy and
procedures. With respect to the trade mark policy,
the TMCG concluded that:
the responsible companies! register could be made
to work irdesired-,
Project Stem dom not affect this;
the absence oflegal/marketing co-ordination and
the absemce ofa procedure is lead4
to problems despite the TMCG-,
the 'group-widc interest, especially where there
are ininority interests are not
adcquatcly recognised;
there is no strategic planning oftrade marks to
complement any strategic planning of
brands;
the legal situation is more complex than it needs
to be,
tax planning is not taken sufficiently into
account.
24 The T.MCG met with the Marketing DirWors on 7th
December and agreed in principle to
the adoption of a trade mark *template" (which is
efrectively the data input form to a.
sophisticated trade mark management programme) in
order to maximise efficiency and
fl=-billty. Generally the file manager for a trade
mark will be its brand manager. One of the
main purposes of completing the template is to
decide on the territorial coverage for filing.
The programme will have pre-assigned lists of
territories whir-~ will wist with ensuring the
-apprcpriate coverage and will prompt periodic
review ofthe Ming for all trade marks.
25 The TMCG had also considered and conrcptuafly
supported establishing a central trade
mark owning company. This is not possible for the
B&W trade marks in the US because of
the tax implication% but it may be possible for
most of their other trade marks. The legal
feasibility and tax costs of this are being
progressed but could take one to two years to
&chic-.-e. A central trade mark owndng company
will strengthen the legal ability of the Group
to en."orce its trade marks, permitting the legal
"notoriety" ofa mark in one country to assist
in protecting it in another.
26 Mr Herter pointed out that the development of
economic blocks meant that even local
brands should be protected in their whole regions.
It was agre-.d that all major local brands
should be protected in their region, that regional
brands should be protected internationally,
and that international brands should be protected
world-wride. All new trade mark
re3istrations should be made through the central
trade mark ow-ning company.
2-7. The decision with respect to territorial
coverage must be made by the filing manager in
consultation with the marketing stair Marketing
staff must involve the trade mark staff in
product devc1opmcnt as early as possible in order
to avoid potenial problems.
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Froiect Stem
29. Mr Herter explained that the Marketing
Directors would be invited to the TSG each May
to present all international and regional brands
and important local brands. Hence the
importance of the paper that had been distributed
in advance of the meeting proposing a
br-And classirication. He wished to propose one
amendment to the circulated paper which
was the add:6on of Derby to die rLst of'regional
brands. He asked all members to send thci~r
proposed additions to the classMeation to him as
soon as possible, together with supporting
evidence fortheir proposed classification.
29. T*,-,e brand presentations in May should cover
product, pricing, communica6on and priorities
by market, in order that the strategy and concept
should be agreed. They should include
rr----.rial as we!l as figures. The communication
should focus on basic positioning unless
p-.;: motions are part or the basic concept.
30. T*.-.m May TSG would be devoted to this
subject and the Tobacco Strategy Review, and
sh-culd be attended by the BATCo regional
directors as well as by the operating group
maActing direvors.
31. It was agr=d that B&W would continue to manage
the relationship with Kental in
E,.ilgarlsk and Rom.ani2, but that BATCF would be
responsible on the ground in Bulgaria
t~zough the organisation which it has skeady
established, and that it would seek to set up an
organisation in Romarda.
32. B&-W and BATCF use the same agent in Turkey.
Mr Her-ter will consider following his
visit in Januar-,,- whether the agent is the best
one to use.
33. BATCo is scning up &-i organisadon in
Uzbekistan to manage impor.3 in addition to NBD
ac';Ivities.
34. Exports to Austria, Belarus, Ukraine and
Macedonialformer Yugoslavia are the
res;onsibill-,; ofBATCF.
35. Lithuania %h~Lil be rca:-ocatcd to BATCo since
it is effectively the sarn, e market as Latvia
&n~ Evortia.
36. Th-- principle was agreed that one company
should be responsible for international duty
fret in each =untry. Mr Bramley will make a
recommendation to the TSG.
37. Mr AlIvey re;orted progress in developing
management information by end market and by
brand. There &re two aspects to this: approximate
figures for 1994 Will be presented to the
TSG in Nfa:chl in parallcl a working group is
addressing the future provision of more
ac:'-ratc &no cansistent management information.
Ile cmphasiscd the importance that each
rrember should ensure 'hat his managers are aware
of this development work to avoid the
pcisibility that the work could be being
duplicated by end market or brand managers.
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39. 'dr Bramley proposed that the working group
should discuss the issues with other
international companies in similar positions. The
issues that am being generally debated
include whether the transfer price in the
management acz=t3 should include a return on
the capital invested in manufacturing capacity,
and the impact on marketing decisions of
allocating more management profit to the end
markem Mr Brantley suggested talking to
United Distillers and Mr Castro suggested GWette.
39. Mr Br2M]ey explained how BATCo makes sourcing
decisions for contract manufa=e.
This will need to be taken into account when
designing future management information
systems. Better forecasting wiH be needed for
contract manufacttire in the future.
40. it was agreed that Mr Herter would write to
the agents explaining the changes &S a result
of end market control, All members should send to
W Her%er a list of agents who should
be written to. Mr Allvey proposed that a questions
and answers book should be prepared,
in consultation with Mr Pride2u%, to be used to
answer questions from the agents
themselves and from the press.
41. It was agreed that the costs of taking over
markets would be absorbed by the company
incurring the costs, and that, if necessary,
adjustments would be made to profit figures at
&.e year end.
42. All members reported that the end market
hand-over was going weU. The transfer of
Norih Africa from B&W to BATCo will be phased over
1994. Mr Dunt is forming teams
%ith a mix of staff from many companies in South
America. The key issue in Eastem
Europe is how quickly BATCF can set up its
organisations. Therefore the transfer is
unlikely to be complete until the end of 1994.
Marketing
43. It was agreed that the Lucky Strike pricing
strategy would be to price at parity with
Marlboro where possible. Where there is
substantial volume ofLucky Strike, changes to the
price position will be made with extreme care.
Where the brand is progressive the current
price position will remain, but any opportunitics
to close the gap will be taken if possible
ove.- the longer term-
44. Nir Sandefur updated the TSG on advcriising
developments for Lucky Strike, Kent, PaU
?.13U and Viceroy. Mr Winebrenner has assembled
joint teams who are working with
different agencies around the world to product
recommendations to be tested
intcrnationzfly. A uniform pack for Pall Mall is
urgently needed. Mr Dramley will
in, -estigate the suggestion that BATCo is
considering launching Pall Mao in 253 at a slight
discount to the next to the lowest price point in
Belgium-
45. It was agreed in principle that the floor
price for Lucky Strike should be $15 and that over
the rnediurn term it should be moved up to S17 in
eastern Europe to be at parity with
Camel. Mr Sandefur will send the latest pricing
information on Lucky Strike to Mr ~-n
Herter. CZ)
CZ)
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46. Mr Sandefur presented the latest developments
in the US price war. Since May VFM has
fallen rrom 37% to 32% ofthe market but has
recently stabilised. Marlboro rose from below
19% to 221/9 and is being maintained at this level
by some use of couponing. Wiwgon grcw
from 7% to 10% as a result of Wunton Select but
has now fallen back to 71/4% as the
discount has been reduced- Newport is pining share
as a result of its widespread
discounting. Basic is growing through undermining
and outspending GPC on distribution,
advertising and discounting. However GFC is
holding up reasonably well by good tactical
use of the discounting of $1.30 per carton on
average.
47. Mr Herter concluded from the price war papers
that if a price war is anavoidabie it is
better to enter it full heartedly. Although price
brands can be selected from the existing
portfolio, there is a good case for choosing a new
free-standing brand, for example, GPC'
Basic, Derby. Margins in the ruture are expected
to be narrower than in the past. However
BAT contributes to the pricing level and there may
be more scope for price increases than
assumed. All members should circulate the BATCo
and BATCF papers to key managers.
Proviress Revorts
48. Mr Herter requested that information on
volumes in Ukraine and ofLucky Strike in France
should be added to the regular reports.
49. New West in Germany is not selling well.
Environmental considerations do not appear to be
of overriding concern to smokers. Mr Allvey
pointed out that there is an environmental
plan at each company to comply with the Group
poUcy, and Ws covers fbil, acetate, etc.
over a period of time.
50. Mr Herter said that the perfbrmance of the
IBs, with the exception ofPGL and SE555,
was disappointing, and he was concerned about the
outlook for 1994. Mr Ettedgui pointed
out that the trend in domestic markets was even
poorer. However in some domestic
markets, market shares arc holding up even if
absolute volumes are down. Dr Schweitzer
observed that all the papers rcilected
considerable downtrading around the worid as a
result
of the recession, which gives less room for real
price increases than previous years. Mr
Herter stated that the main price decreases have
been caused by the major players
themselves. The plans must place more emphasis on
the development ofdomestic markets.
51. Mr Brookes reported on progress on investment
in new Markets. A proposal on
"ble pref
converti erence shares has been received from the
Yava factory manager which is
being considered. The CEC has approved a potential
greenfield site in Saratov. Mr Herter
and the Cbairmaa are visiting Uzbekistan in order
to try to win the personal support ofthe
president. proposals in Moldova and Belaru3 are
moving ahead quickly. News ofa delay in
Vietnam has just been r=',Ycd. The inconsistency
in approach to project teams between the
operating groups is being discussed by NBD and
BATCo.
52, Mr Bramley mportcd that a project team in Hong
Kong is considering joint venture
options in China. They are due to report by the
end of January on the potential partners, k-71
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53. Mr Allvcy presented the Tobacco results for
the nine months and the forec4st for the year.
The posit;on at the full year assumes no trade
load in B&W in the fourth quarter as weg as
being adversely impacted by the reduced US profit
margins. Excluding the one-off profits
from the brand exchange and the sale of Nfillbank
the result even after 9 months was
considerably worse than the same period last year.
1994-1998 Plan Preview
54. Mr Allvey presented summary figures from the
Plan Previews and discussed the projected
growth patterns in re-lation to financial
guidelines.
55. He also presented the key points that &rose
during the Plan Preview meetings. Additional
points that were made in the meeting were that:
the ITC Preview volume is doubtful
although the value may be achieved; the tax
provision of S36m in Souza Cruz wiU be
insufficient; the curTent situation in Canadz
cannot lam, as there may be a tax roll-back to
reduce the smuggling which could endanger the
planned price increase.
56. Mr Herter emphasised the necessity ofachieving
the 1994 initial projections as a minimurn
in order to maintain market credibility and not to
endanger future plans. 6% p.a. volume
increases and 9% p.iL turnover increases imply no
real price increases, which underlines the
need to speed up cost reductions.
Any other business
57. Mr Ettedgui presented a paper comparing BAT"s
new market acquisition criteria with
those which might be used by PbLp Morris. It
showed that no one factor could account for
the apparent difrererice in valuations. However aU
the factors multiplied together (vol=r,
price, discount rate, and growth) could expWn the
difference. AR members were asked to
circulate the paper to their Finznce Dirwors who
were to refer any comments to Mr
Ettedgui.
58. Mr Herter concluded from the review that BAT
must use the most realistic assumptions in
its valuations, but be prepared to offer A
premium, &s a conscious decision, if the project,
was strategic. BAT must use its strengths to win
the hearts and minds ofmanagements and
governments. Mr Brookes pointed out that it may
help to provide machinery for a market
in advance of an investment, but this could not be
done by NBD only through the operating
groups.
H C Barton
13(h January 1994
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