EU Comes Up With A Plan To Prevent Illicit Cigarette Trade

December 28th, 2016 by Trefis Team

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Philip Morris International

A draft report commissioned by the EU has stated a Europe-wide system should be developed to track cigarettes, which should be run by the industry together with independent third parties, according to the Financial Times. This new program should be up and running by May 2019 in order to prevent the smuggling and counterfeiting of cigarettes, which costs €10 billion a year, according to the European Commission. As per the new laws, European Union countries must ensure that all tobacco packets are “marked with a unique identifier,” as well as a security stamp, so that the packet can be tracked from the factory to the shop floor. The Commission is yet to decide whether the tracking and tracing program should be implemented by the tobacco industry itself, or if it should be given to a third party.

While the commission says that the tobacco companies must work with numerous third parties to implement this system, the tobacco industry has maintained that it should be allowed to run the system by itself, arguing that external influence would cause disruption. Meanwhile, anti-tobacco groups have asserted the need for outside help to tackle this problem, given past allegations that some tobacco groups have benefited as a result of smuggling of, and illicit trade in, cigarettes. This recommendation comes after the ending of a $1.25 billion tracing deal between the EU and Philip Morris International (NYSE:PM) this year, which was agreed in 2004, following criticism by lawmakers.

See Our Complete Analysis For Philip Morris International

What Are Illicit Cigarettes?

Illicit cigarettes enter or are sold in a market in violation of certain rules and regulations, such as without payment of import duties, excise tax, or VAT. Such products can be genuine products manufactured by a official tobacco company, and sold without payment of applicable taxes, or else counterfeit cigarettes, made without the consent of the trademark owner. A number of regulatory measures and actions have been taken up by the government in response to this. Such trade harms governments, consumers, and manufacturers. According to World Health Organization (WHO) estimates, the illegal, unregulated black market in cigarettes amounts to 11% of the global consumption. Tobacco manufacturers themselves have taken a series of measures to ensure their brands are protected and consumers receive genuine products.

How Bad Is The Situation?

Counterfeit and Contraband (C&C) cigarettes declined by 6% in 2015 in the EU, over the previous year. This was against a backdrop of improved economic conditions and increased measures undertaken to counter the illicit trade activities. According to the Economic Intelligence Unit, personal disposable income rose at an average of 2.6% in 2015 across all EU member states. This may have prompted consumers to increase the consumption of Legal Domestic Sales (LDS). Furthermore, after a rise in tobacco taxes to meet the minimum EU excise requirements in a number of countries in 2014, 2015 was a year of more stable prices, which contributed to the decline in the sales of C&C cigarettes; prices rose by three percentage points less in 2015 than in 2014.

EU Cig Consumption

However, C&C still accounts for close to 10% of the total consumption, with high consumption in countries such as Greece, Norway, UK, and Ireland, which have the highest prices within Europe. In Eastern EU, high levels of C&C were seen in those regions bordering non-EU countries, where average prices tended to be four times lower. France was noted to have the largest volume of C&C, though it did not have the highest level as a proportion of consumption.

EU Top 10 C&C Countries

The major source of C&C are non-EU countries, with Belarus being the largest contributor, followed by Ukraine, Algeria, and Russia. The volume of counterfeit cigarettes continued to decline from EU countries, accounting for just 12.2% of the total in 2015.

EU C&C Consumption

Illicit Whites (IW), which are cigarettes manufactured legally in one country, but which are smuggled across borders, accounted for over a third of C&C, of which 5.3 billion cigarettes has Belarusian labeling. These have grown as a proportion of total C&C from 7.8 billion in 2009, to 18.8 billion in 2015. Further, counterfeit cigarettes increased 28% during 2015, but remain less than 9% of the illicit consumption in Europe.

During 2015, Philip Morris reported revenue, net of excise, from its EU segment of $8.07 billion. If we consider the rate of illicit trade in EU to be 10%, this would amount to over $800 million in lost revenue for the company. In May, the company pledged $100 million to fund projects to confront this problem. The company has come up with a new initiative – PMI IMPACT – to combat illicit trade practices. Besides expending the aforementioned sum, the initiative will also raise funds from public and non-governmental organizations. Given the large amount of lost revenue annually for Philip Morris from just the EU region, this is definitely a move that would be beneficial to the company.

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Notes:

1) The purpose of these analyses is to help readers focus on a few important things. We hope such lean communication sparks thinking, and encourages readers to comment and ask questions on the comment section, or email content@trefis.com

2) Figures mentioned are approximate values to help our readers remember the key concepts more

intuitively. For precise figures, please refer to our complete analysis for Philip Morris International.

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