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Tuesday, September 28, 1999 Published at 13:59 GMT 14:59 UK

Business: The Company File

The economics of tobacco

The tobacco industry continues to flourish despite legal costs

Since Christopher Columbus first stumbled on American Indians smoking rolled-up tobacco, many companies have turned a profit from selling cigarettes.

Tobacco wars
  • The US legal battle
  • Tobacco economics
  • Smoking goes global
  • Cigarette health file
  • Timeline: the tobacco war
  • Indeed, tobacco is one of the US' oldest and most profitable industries.

    Domestic sales alone exceed $45bn annually.

    But the tobacco market has been hit by price increases, higher state taxes, increased consumer awareness of the health risks and hefty litigation costs.

    During 1998, US cigarette consumption fell 2% to 470 billion cigarettes.

    But investor confidence in the tobacco industry remains unshaken.

    Some analysts still expect the tobacco industry to show earnings growth of 11.5% over the next five years.

    Tobacco companies hope to replace declining revenues in mature Western markets by targeting developing countries.

    [ image:  ]

    In Asia or Eastern Europe, the strict regulations that govern tobacco in the West often do not exist and cigarette smoking is emblematic of an affluent Western lifestyle.

    The potential of these markets has helped buoy shareholder expectations even as rising tobacco prices - to pay for litigation costs - cut into the volumes sold.

    Even without the prospect of developing markets, investors believe that tobacco companies can weather the storm.

    Most of the cost of litigation has been borne by US smokers, who have seen cigarette prices rise in the past 16 months by as much as during the past 16 years.

    The $206bn court settlement last year saw a price rise of almost 50 cents per pack.

    But these costs will diminish over time. New smokers, meaning anyone who started in the last 10-15 years, cannot sue because they took up smoking during a time when the health risks were publicly documented. Hence anyone who starts to smoke now just represents profit for tobacco companies.

    "In financial terms they are a cash machine because (cigarettes) are addictive and they are cheap to make. They are intrinsically a very profitable product," says Mr Bruce Hamilton, director of corporations at Fitch IBCA, a financial ratings agency.

    The "Golden Leaf"

    It is not just tobacco companies that benefit from the "Golden Leaf", the US government also benefits.

    The tobacco industry provides 50,000 manufacturing jobs and about 136,000 farming jobs directly, and generates another 400,000 jobs indirectly.

    Tobacco farmers enjoy a return per acre of about $1000, substantially more than other crops.

    [ image:  ]

    Tobacco money also generates a sizeable chunk of the cash that makes up the federal budget.

    The US Treasury is estimated to have pocketed $118.6bn in tobacco taxes in the past 10 years.

    The US government makes seven times more money from the sale of a pack of cigarettes than a cigarette maker does, R.J. Reynolds, the second biggest US tobacco company, is quick to point out.

    Global benefits

    Other countries enjoy similar economic benefits from cigarette production.

    The US tax on cigarettes is actually quite low. In many countries in Western Europe up to 80% of the price of a pack of cigarettes goes to the taxman.

    In the UK, the tobacco industry generated over £10bn in tax revenue in 1998, enough to pay for three quarters of the Education and Employment Budget.

    The industry directly employs 9,800 people and supports about 138,500 other jobs, according to the UK's Tobacco Manufacturers Association.

    "Tobacco growing is a key element of the economy in many developing countries in Africa and South America," it adds.

    [ image:  ]

    Asian economies, such as China, India and Indonesia, are also boosted by the tobacco dollar.

    Tobacco losses

    But not everyone believes that tobacco is for the economic good.

    "Tobacco not only kills people, it also saps national treasuries," says the World Health Organisation.

    It believes that the cost of smoking-related health care far outweighs the other financial benefits.

    Indeed, the World Bank says tobacco actually results in a global net loss of US $200bn per year. About one third of these losses are suffered in the developing world.

    And the detractors of tobacco companies argue that the profits from selling foreign tobacco do not benefit the developing world as they are returned straight to foreign investors.

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