The tobacco industry is a very competitive market and only about 3 very large corporations control the entire market. In Malaysia, British American Tobacco (BAT) is the biggest company in the industry, but others such as JT International are steadily growing in brand name. All companies battle for market share through heavy advertising budgets and slotting deals. The cigarette market is well into the maturity stage, and some might even argue that given the recent anti-smoking campaigns and lawsuits the industry is nearing the decline phase.
However, sales show that decline has not yet been reached. Apparently, brand loyalty still exists. The tobacco industry has a very low threat of entry. A few powerful firms control most of the industry. Any new entrants would be sure to receive heavy retaliation from the other companies fighting to keep their share of the lucrative industry. For example, BAT is by far the industry leader with estimated tobacco sales of RM 3 billion in 2009. They have a huge base of resources with which to attack other competitor entrants.
They could easily start promotions such as “buy one, get one free” or offer coupons at certain times during the year to discourage entrants to the industry. Many small companies will not be able to compete with the capital requirements in the tobacco industry. The barriers to entering the tobacco industry are numerous. First, the high volume of cigarette sales gives existing firms economies of scale, which would be a disadvantage for newcomers to the market. The products currently on the market are differentiated somewhat in their design, but mostly through the large advertising budgets that are used to promote them.
It isn’t odd now to see tobacco companies pour up to RM 40 million a year into promotions and advertising- nine times what they spent in 1971 (Elliot, New York Times, September 22, 1999). These firms have finely tuned distribution channels, which include numerous sales representatives competing for shelf space. One of the biggest obstacles to a new entrant would be finding a decent place on the shelf with such heavy-handed competition already occupying that space. Store managers may be hesitant to give away prime slots for fear of losing discounts or other offers from major players.
Government policy is another possible deterrent to enter the market. Large settlements against the tobacco companies have been the norm in the past several years. Although gigantic companies like Philip Morris and BAT are able to handle the charges because of their extensive monetary resources, it is difficult to imagine how a small startup company would be able to burden the expense. Switching costs are very high in the tobacco industry. Many smokers are still smoking the same brand they first started smoking.
Even if the price of their brand is raised, they would not consider switching to another brand (Focus group). Many companies who would want to come into the industry would not easily take away market share, due to high brand loyalty. The suppliers in the tobacco industry have a low level of influence, even though there are no close substitutes that the industry can use in place of tobacco. Tobacco is purchased from farmers, who essentially have to take the market-determined price for their crops. Tobacco is a commodity, so it makes no difference from which supplier a firm buys its materials.
The large number of individual farms that supply the industry makes it almost impossible for anyone to raise the price. There is not a threat of forward integration from suppliers because they have none of the tools necessary to manufacture or market tobacco products. The farmers have only the land and equipment necessary to grow the leaf. If they were to try to produce cigarettes, they would probably not be able to compete with the many large companies that have economies of scale (from Threat of Entry section).
The stores that sell tobacco products have a moderate influence on the market. Retailers have some power over manufacturers who need prime slotting to ensure strong sales. However, manufacturers have leveraged quite a bit of power by offering retailers special incentives for giving their products good placement or for installing certain numbers of brand advertisements around the store. To some stores, such as gas stations, losing a major cigarette brand would mean large loss of revenues from customers who would rather go to another gas station to locate their favorite brand.
Also, companies are trying to develop closer relationships with bars and coffeehouses. Tobacco companies offer ashtrays, napkins, and matches, saving each buyer thousands of dollars in supply costs with their retailers. The largest threat here in Malaysia though, is black market trade. The country is already at the top of the global illicit cigarettes trade incidence list in 2009 (according to a Global Tobacco Report from Goldman Sachs) and it looks like Malaysia’s illicit cigarettes trade is set to grow from strength to strength.
The end-users in the industry also have moderate power. Brand loyalty is very high, and it has been shown that smokers generally chose a brand in their teen year and continue to smoke that brand the rest of their lives (Focus group). However, in the face of a dramatic price hike, consumers have been quick to notice that brands are interchangeable and then go for the lowest price. But the virtual lack of substitutes for tobacco products makes it difficult for the industry to lose customers all together The effect of substitutes on profits is also low.
Nicotine can be found in cigarettes, as well as cigars, chewing tobacco, and snuff. But most people will not switch over to chew and snuff if the price of cigarettes rises. Chew and snuff do not substitute for the needs of a cigarette. Cigarettes are smoked for the nicotine and for social acceptance. Chew and snuff are not acceptable substitutes for most smokers; the nicotine is not inhaled but put on the skin for absorption.