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Philip Morris Readies Aggressive Global Push

Division Spinoff Enables Blitz of New Products; High-Tar Smokes in AsiaBy VANESSA O’CONNELL – January 29, 2008; Page A1 – The Wall Street Journal

LAUSANNE, Switzerland — Sitting in his office overlooking Lake Geneva, Philip Morris International Chief Executive André Calantzopoulos takes a long drag from an unusually short cigarette. Called Marlboro Intense, the product has been shrunk down by about a half inch, and offers smokers seven potent puffs apiece, versus the average of eight or so milder draws.

The idea behind Intense is to appeal to customers who, due to indoor smoking bans, want to dash outside for a quick nicotine hit but don’t always finish a full-size cigarette. Pointing to his lit Intense, the CEO says there are “possibly 50 markets that are interested in deploying it.”

Marlboro Intense is likely to be part of an aggressive blitz of new smoking products PMI will roll out around the globe once the company — now a unit of New York-based Altria Group Inc. — becomes a standalone entity. That change will be set into motion tomorrow, when the Altria board is expected to approve a long-awaited decision to split PMI from Philip Morris USA. The move would free the tobacco giant’s international operations of legal and public-relations headaches in the U.S. that have hindered its growth.

The separate entity, for example, would be exempt from U.S. tobacco regulations and out of reach of American litigators. Importantly, its practices would no longer be constrained by American public opinion, paving the way for broad product experimentation.

By as early as March, PMI could be operating as an independent company — the third most profitable consumer goods concern in the world after Procter & Gamble Co. and Nestlé SA. The move will make it easier for the tobacco behemoth to market an array of new smoking concepts, each targeted to different foreign populations, who, collectively are expected to smoke 5.2 trillion cigarettes this year.

Among the new products in test phase is a hand-held electronic smoking device called the Heatbar, which emits less smoke than a regular cigarette. Another is Marlboro Wides — an extra-thick cigarette whose package flips open from one side. To appeal to customers in some emerging markets, the company is making sweet-smelling cigarettes that contain tobacco, cloves and flavoring — with twice the tar and nicotine levels of a conventional U.S. cigarette.

While smoking rates in developed countries have slowly declined, they have shot up dramatically in some developing counties, where PMI is a major player. These include Pakistan (up 42% since 2001), Ukraine (up 36%) and Argentina (up 18%).

Some antitobacco types are sounding alarm bells that an independent PMI will be a corporation which, from a practical viewpoint, is stateless and answers to no one. “There is a fear that after the spinoff, PMI will become even less accountable than it is today,” says Richard Daynard, a professor of law at Northeastern University, who worked as a consultant on class actions against tobacco companies.

Mr. Calantzopoulos, 51 years old, says such concerns are a “misconception.” He notes that regulatory regimes in Europe, for instance, are harsher than in the U.S., where the most severe restrictions were created in a late 1990s settlement of antitobacco lawsuits by the states.

The World Health Organization’s Framework Convention on Tobacco Control, an international public-health treaty, has 152 participating countries, including China, Brazil and Pakistan. While it has led to greater regulation in many of the world’s markets, countries such as Indonesia and Russia haven’t signed on.

Given the fast-changing legislative climate around the globe, “manufacturers are needing to spot potential first, act rapidly on a national level rather than on a regional level,” says Zora Milenkovic, head tobacco analyst for the research firm Euromonitor International.

Moving Headquarters

Mr. Calantzopoulos, a former automotive engineer and PMI’s CEO for the past six years, will become president of PMI, reporting to Louis Camilleri, the current chief of Altria. Mr. Camilleri will depart Altria and relocate to Switzerland to run the independent, publicly-traded international tobacco business. Altria, which plans to move its headquarters to Richmond, Va., will consist of the company’s domestic tobacco businesses and a 28.6% stake in United Kingdom-based brewer SABMiller.

PMI stands to rank as the world’s largest nongovernment tobacco company, with sales volume totaling more than four times that of its U.S. sibling. In 2006, PMI had revenue of $48.26 billion, compared with $18.47 billion at Philip Morris USA.

Mr. Camilleri has argued that the breakup will lead to a “renewed” focus at PMI. Ahead of the restructuring, Mr. Calantzopoulos has simplified PMI’s decision making to quicken the introduction of new products. Local managers have the “power to decide” which new ideas might have legs in a particular region, he says.

PMI is also streamlining manufacturing. By this fall, it will halt imports of about 57 billion cigarettes annually from its U.S. sister company. Instead, it will begin to get its entire supply internationally, primarily from its own 42 manufacturing centers, the largest of which are in Holland, Russia, Germany, Turkey and Ukraine.

One of PMI’s immediate goals is to harness the huge potential of China’s smoking population, as well as some of that country’s own brands.

After more than three years of negotiations with the Chinese government, PMI is expected this year to begin marketing three home-grown brands. The smokes — selected from hundreds of varieties produced by state-run China National Tobacco Corp. — will be sold in Central Europe, Eastern Europe and Latin America, according to PMI.

The launch is slated for sometime in the next six months. It is part of a December 2005 deal in which Philip Morris agreed to market Chinese brands internationally in exchange for the right to produce its own Marlboro brand at state-owned factories. At the moment, Philip Morris is limited to importing its cigarettes for sale in China and is restricted by stringent quotas.Lighting Up

China National Tobacco, based in Beijing, declined to comment.

With some 350 million smokers, China has 50 million more cigarette buyers than the U.S. has people, according to Euromonitor. Its booming tobacco industry, which the government says generates around $30 billion in tax revenue in 2005, is a pillar of the economy.

China and PMI, says Mr. Calantzopoulos, spent the past year figuring out which of China’s top brands might have the greatest potential for sales abroad.

“The objective is not to sell Chinese brands to the Chinese immigrants. That’s not difficult,” says Mr. Calantzopoulos. “But what we want and they want is to adapt these products in a way that they become appealing” to foreigners.

Chinese smokers, for instance, prefer the stronger taste of full-tar cigarettes, while most Europeans and Latin Americans favor lower-tar cigarettes with blends of different tobacco leaves. Another concern: The packaging of Chinese brands tends to be “flashy,” says Mr. Calantzopoulos.

One of the three brands to be sold abroad is called RGD and is manufactured by Wuhan Cigarette Factory of Wuhan city of Hubei province. It’s a milder version of an existing Chinese brand called Red Gold Dragon. In preliminary marketing materials, China National Tobacco touted it as being “carefully formulated” with Chinese and non-Chinese tobacco leaves, “and flavored by fragrance extracted from the unique natural plants from Central China.” PMI says the positioning has changed, but declines to be more specific.

Many of PMI’s other new products are intended to strengthen and broaden the world’s leading Marlboro brand, whose sales volumes outside the U.S. slid by 0.53% from 2001 to 2006. “It’s in pretty good shape, but we can do much more with the brand,” Mr. Calantzopoulos says.

High Nicotine, High Tar

Recent Marlboro launches include Marlboro Mix 9, a high-nicotine, high-tar cigarette introduced in Indonesia last July. PMI is poised to export the clove-infused Mix 9 to other Southeast Asian markets as soon as this year. Another iteration of the iconic brand, the Marlboro Filter Plus, is being sold in South Korea, Russia, Kazakhstan and Ukraine. It touts a special filter comprised of carbon, cellulose acetate and tobacco that claims to lower the tar level while giving smokers a smoother taste. The short but strong Marlboro Intense, which the CEO lit up in his office, is newly available in Turkey.

A more unusual product, the Heatbar, has a different objective: preparing for the onslaught of smoking bans in some mature markets. But it’s risky — requiring consumers to embrace an odd-looking product that is as far from a Marlboro as a cigarette can be.

Heatbar smokers insert specially-designed cigarettes into the device, a plastic holder resembling an electric toothbrush. They place their lips on the cigarette but when they inhale, the device heats up the cigarette, delivering a flavored aerosol, without causing any tobacco to burn. PMI says Heatbar releases 90% less smoke into the atmosphere than a traditional cigarette. Smokers can either rent or buy the device, which is powered by a rechargeable battery.

The gadget’s prospects are uncertain. Philip Morris USA struck out with a similar product in the late 1990s. Known as the Accord, it was pulled from U.S. store shelves after a test market run in Richmond, Va., failed to generate interest.

In late 2006 PMI opened an intimate wine and coffee bar, Heatbar Tasting Room, to drum up interest in its latest version. One night in late October, business at the Zurich lounge was so slow that nobody showed up over the course of an hour and a half. A lone employee, trained to teach customers the merits of Heatbar, blamed the chilly weather. But surrounding pubs and restaurants were packed with smokers.

PMI shuttered the bar last month, taking down its prominent displays of the device in a range of colors, and of packs of cigarettes that go with it. But late last year, PMI convinced two independent Zurich bars to carry the product. The idea, says a spokesman, is to test Heatbar in pubs and other places where smokers would naturally tend to gather. In December it took Heatbar to Australia, opening another PMI-owned store, New Movement Tobacconist, in Melbourne.

Mr. Calantzopoulos says the device is in the midst of an upgrade that’s easier to use and provides a better taste.

Meanwhile, PMI has shown prototypes of the technology to regulators in Australia, New Zealand and the U.K., among other countries with tough antismoking policies. The idea, says Mr. Calantzopoulos is to engage them in early discussion about any future marketing restrictions on so-called reduced-risk cigarettes.

“It gives us some access to regulators,” he says. “If you don’t have a concrete product out in the market, it is very difficult for regulators to focus” on the issues.

Seeking Attention

At times PMI says it will also launch new products specifically to draw attention to paradoxical regulatory or tax policies.

Internationally, 62% of the average retail price of a cigarette is attributable to taxes, versus roughly 50% in the U.S., according to PMI data. But in certain countries in Europe and elsewhere, tax rates on roll-your-own tobacco products are one-third to one-half the rates on cigarettes, the CEO notes.

That explains PMI’s launch of TBS (“Tobacco Block System”) in Germany, where roll-your-own tobacco is taxed at significantly lower rates.

Smokers use the system — which includes a foot-long machine and compressed blocks of tobacco — to assemble their own cigarettes. After inserting empty paper sleeves into the side of the device, a dose of tobacco shoots inside the shell to create a cigarette.

PMI says it hopes the unusual tobacco kits can expand its market share so it can apply more pressure on the German government to close the disparity in tobacco tax rates.

Future products in the PMI pipeline will feature unusual packaging, a response to limits on cigarette advertising imposed by the WHO antitobacco treaty. Marketing restrictions are a particular challenge to PMI. Roughly half of its cigarettes, and all those bearing the Marlboro name, are so-called “premium” brands at the top end of the price spectrum in their local markets. That makes PMI highly vulnerable to competition from cheaper local smokes.

Without traditional advertising, “your product and your packaging become the key conveyor of what the brand stands for,” Mr. Calantzopoulos says, noting that there’s always an opportunity for gaining market share.

Fancier packs are intended to lure smokers into paying a premium for the company’s brands. One example is the Marlboro Filter Plus, which Mr. Calantzopoulos thinks might work in as many as 50 additional markets. The top third of its pack slides straight up, and then backwards — a sleek design similar to a cellphone.

“If I put in front of you two packs of cigarettes and asked you to choose, you will choose, based on some criteria,” Mr. Calantzopoulos says, adding: “The whole idea” is to give smokers a reason to choose the PMI-made cigarette — “not one made by somebody else.”

–Nicholas Zamiska in Hong Kong and Gordon Fairclough in Shanghai contributed to this article. 

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