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The Business Behind Plain Packaging Tobacco

On the 20th of May 2016, the increasingly progressive anti-tobacco efforts of the UK and Ireland will once again come into effect. This time it will be the introduction of plain packaging, involving the standardisation of all tobacco products. Products will appear homogenous with the removal of all marketing features, allowing for only the brand name and imagery promoting public heath warnings.

Understanding the implications of plain packaging tobacco is multiplex, which derives from the number of perspectives that need to be taken into consideration. A common, but somewhat naive outlook would be to simply suggest plain packaging results in a demand contraction, causing less people to smoke, thus lower profits for firms. In reality it important to consider that plain packaging is likely to have an array of effects beyond and even contrary to the theoretical predictions. This articles takes a forward looking analysis of the tobacco market, to uncover the likely effects and success of the plain packaging policy.

Market Analysis

In economic terms, the tobacco market can be classified as an oligopolistic structure, arising from the small number of companies with high individual market concentration, such as the well known Imperial Tobacco and Phillip Morris. The prominence of this market should not be understated, in 2012 the six largest tobacco companies outperformed; McDonalds, Microsoft and Coca-Cola’s earnings combined. In fact, the second largest US company Reynolds (RAI) share price has increased over 170% in the last five years, with others following similar growth.

However, the imposition of plain packaging policy is likely create permanent structural changes in the market, which will effect both the conduct and performance of incumbent firms. Firstly it’s important to recognise that firms currently compete on non-price factors, dominant firms have a high degree of brand loyalty, built up from years of marketing. Cigarette consumers often identify and associate branding with personal characteristics and have been found to value this superior to other factors such as taste and quality (Padilla). For example, one may associate a premium brand with higher social status – including characteristic such as wealth or attractiveness. This branding therefore acts as a significant barrier to entry for new firms aiming to successfully enter the market. Plain packaging is likely to reduce this barrier as product differentiation and this intrinsic value is removed, whilst the substitution ability between brands increases.

Plain packaging policy will force price competition, this is likely to encourage predatory pricing type behaviour, which has the potential to increase demand (opposite effect). Alternatively there could be a decrease in consumption, from the mandates on marketing and lower quality needed to retain profit margins whilst reducing prices. It would seem the desired effects of plain packaging on tobacco consumption is somewhat of a paradox. This may also be influenced by the ability of new firms to compete with incumbents and to combat other barriers such as economies of scale and market concentration.

Australia leading the way?

Although the UK, among many other advanced economies have previously remained hesitant over implementing plain packaging, Australia led the way. Australia is currently the only country to implement the policy, which they enforced in December 2012 and have since showed apparent signs of success. Recent figures released by the Australian Bureau of Statistics suggest an estimated $103 billion expenditure reduction on tobacco products between December 2012 (introduction of policy) and March 2014. Meanwhile daily smokers aged ’14 or older’ have significantly decreased from 15.1% to 12.8% between 2010 and 2013, with similar results in the ’18 or older’ group. Although causal relationships between plain packaging and consumption are difficult to make from these figures, they importantly show effectiveness in Australia’s anti-tobacco measures and they’re are on track to achieving smoking rates below 10% by 2018.

The future

In the short term, plain packaging policy may result in positive market performance, but it is important to recognise the new policy is likely to highly effective in deterring new smokers, especially if branding is such an influential factor. This will lead to a gradual reduction in the market size, which is the most important factor when considering the long-term health of the UK population. It would seem plain packaging may very much become a natural measure in efforts taken to reduce smoking rates in advanced economies, with many countries in the EU and beyond now considering it.

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