This article first appeared in The Edge Malaysia Weekly on May 13, 2019 - May 19, 2019

FEW would envy Erik Stoel his post as the big boss of a tobacco company in Malaysia today, especially when the industry is waging a war against illicit cigarettes and trying to maintain its margins as consumers downgrade to cheaper brands.

However, the group managing director of British American Tobacco (M) Bhd is determined to put the group back on a growth path despite it having few weapons to fight the illegal cigarette trade in the country.

“Obviously, I want to get the group back on a growth path,” says Stoel when met at his new office in Damansara City, Bukit Damansara. “We saw a double-digit decline in 2016 and 2017, so when we had a marginal decline in 2018, I was happy,” he says, adding that the market has stabilised.

In 2016, the year Stoel took the helm at BAT Malaysia, the legal cigarette market was reeling from a hike in excise tax, and contracted 25.7% year on year. This resulted in a 27.8% drop in the group’s volume that year.

In 2017, total legal domestic volume contracted 8.8% year on year, leading to a 14.5% fall in the group’s domestic volume. The contraction in domestic volume stabilised to 3.5% year on year in 2018, which saw BAT Malaysia’s volume shrink 4.6%.

Nevertheless, says Stoel, for BAT Malaysia to return to a position of growth, the fight against illicit cigarettes has to intensify.

When presenting Budget 2019 last year, Finance Minister Lim Guan Eng said the government intended to raise RM1 billion in revenue by clamping down on illicit trades.

If the entire RM1 billion were to come from cigarettes, some 2.5 billion sticks would need to flow back into the legal market, which, in turn, means a more than 20% reduction in illegal cigarettes, explains Stoel.

“This makes taking down the illegal cigarette syndicates the biggest priority to unlock growth for the legal industry. If the government pursues this with high intensity, then clearly, this would give us the opportunity to grow in 2019,” he says.

However, Stoel laments, the government has not shown the rigour required to clamp down on the illicit cigarette market. The agility with which syndicates adapt to law enforcement actions shows the worrying capacity of these black-economy operatives to outpace all efforts to thwart their activities, he points out.

“If the current size of the illegal market remains status quo, it would be difficult for any company to grow because affordability constraints among smokers still dictate the legal market,” he says.

As BAT Malaysia is not a law enforcement agency, how will Stoel help the group grow?

To him, the key is affordability, although the government has vowed to clamp down on illicit trades. Stoel says at RM17.40 per pack of 20 sticks for Dunhill, the price gap with illicit cigarettes is just too big, especially for consumers in the bottom 40% of the population.

“If you ask smokers whether they want to consume strong legal brands like Dunhill, you would still find them preferring to smoke Dunhill. But as long as you have a tobacco product that is priced at RM3 to RM5 in the market, then the consumers feel justified buying it.

“This is wrong as there are risks associated with it because nobody knows the content of the product. There are published reports globally, there have been cases of poisoning, but consumers take the risk because the price difference between the legal and illegal products is significant.

“So, if you really want to address the issue, you also have to look at the affordability,” says Stoel.

Closing the price gap with new products

According to BAT Malaysia’s 2018 annual report, it commanded 56.3% of the legal cigarette market that year, making it the largest among the legal cigarette players. This market share, however, is of a small segment of the total industry volume of cigarette products in the country.

Last year, a study conducted by Nielsen, commissioned by the Confederation of Malaysian Tobacco Manufacturers, estimated that of the 20.4 billion sticks of cigarettes smoked by Malaysians, about 12 billion were illicit cigarettes. This translates into an illicit cigarette incidence of 58.9% of the total industry volume in Malaysia. From the looks of it, the incidence of illicit cigarettes has been increasing with the rise in specific excise tax per stick.

A study by Universiti Putra Malaysia in 2015 found that the incidence of illicit cigarettes had spiked to 27.3% in 2015 from 12.4% in 2011.

In 2011, the specific excise tax per stick was 21 sen. This rate was maintained from 2010 to 2012. In 2013, the rate was bumped up to 26 sen per stick and in 2014, it was again increased to 28 sen per stick.

The biggest jump in the last nine years was in 2015, when the specific excise tax per stick was pushed up 42.9% year on year to 40 sen. This rate has since been maintained.

However, BAT Malaysia is not just watching while the government is doing all the heavy lifting. The group has been running pilot tests on products that could be sold at a price point that would entice smokers away from illicit cigarettes.

In Sabah and Sarawak, BAT Malaysia has rolled out a new product that does not have to comply with the minimum price as it is not a cigarette. The product is a Dunhill cigarillo, or a mini cigar, which retails at RM9 per pack of 20s.

“So, if you can bring a reputable brand closer in price to the illegals, then we are pretty sure that you can bring people who currently smoke illegals to legal. This category allows us to adjust the pricing to where we want it to be, so we are currently selling this at RM9, which would be much closer to alternative products. We can get illegal smokers to change to legal consumption by means of the price point,” says Stoel.

Whether the rollout of the Dunhill cigarillo will have an impact on the illicit cigarette market in Sabah and Sarawak remains to be seen. These two states have the highest incidence of illicit cigarettes in Malaysia, according to the Nielsen study. In Sarawak, illegal cigarettes make up about 83.5% of the total market while in Sabah, it is 81.3%.

It is worth noting that BAT Malaysia is also in the process of introducing new products that offer more choices to consumers, especially those who seek harm-reduction nicotine products. However, it could not roll out Glo, a heat-not-burn product, early this year because the government did not approve of the pricing. Market watchers were puzzled by the government’s move because it had approved the sale of a similar product by a BAT Malaysia competitor.

Last year, Philip Morris International Sdn Bhd launched a heat-not-burn product called IQOS and nicotine sticks called HEETS.

“This is a bit of a mystery to us because we don’t know why the approval is taking so long. It has been four months but until now we have not been given any reasonable answer for the delay.

“We are ready to launch but we don’t have an answer. And under the same law, our competitor is already in the market. So, we have two similar products under a similar legislation where one is allowed and the other is not,” Stoel remarks.

Meanwhile, it is not clear how successful the government has been in clamping down on the illicit cigarette trade. Nevertheless, in the first quarter of the year, the value of tobacco imports was up 15.4% year on year to RM210.3 million.

This could be a signal that more Malaysians are switching back to legal cigarettes. However, it is too early to tell as the illicit cigarette trade is a complex problem, and a difficult one to resolve, especially if the government has yet to find an effective way to eradicate it.

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