One of the worst category declines ever because of fiscal reform
On 1 January 2013, the Dominican government implemented the most draconian fiscal austerity package in recent history, which triggered the worst economic slowdown in a decade. A wide range of public spending cuts was implemented. All types of taxes, without exemption, were raised. In cigarettes, the tax raise impact was two-fold: a 13% VAT increase and a 12% specific excise increase. As a consequence, prices grew more than double inflation (to 10%) and to make things worse, that was done within the context of consumer spending rationalisation across all categories to overcome the economic slowdown. The category volume decline was steep at -10%.
Illicit trade skyrockets
The economic slowdown along with substantial price increases led to massive downtrading. A big part of that downtrading went to licit economy brands. However, another big chunk went to cheaper, illicit products. Illicit trade saw its largest growth in many years (15%): only in 2007, when the government had the idea of increasing 5-fold the ad valorem tax, was the growth higher than in 2013. Illicit trade in the Dominican Republic has one of the most “fertile grounds” for growth: a relatively high price versus all its neighbours, very porous borders that include many non-controlled accesses by sea and a wild frontier with a failed state (i.e. Haiti), distribution channels dominated by informal, atomised independent small grocers difficult to police (even to tax), and a resource-short government with good intentions but serious policing limitations on the ground. Besides the major growth in numeric terms, illicit trade passed through a psychological threshold: it began to be sold in wholesalers by cases, more openly than ever.
Philip Morris Dominicana SA under attack
Philip Morris Dominicana has had a clear dominance of the cigarette category since Philip Morris bought Industria del Tabaco Leon Jimenes, the then leader, back in 2006. The company focused on upgrading and consolidating the best-selling brand, mid-priced Nacional, while building its premium range with Marlboro and later complementing with Virginia Slims. The economy segment was a nuisance that only served a tactical purpose: to defend from below the leading brand. Anyway, it was a dormant, small segment...until 2013, when slowdown-driven downtrading helped it to grow from 5% to 13% of total volume sales. Massive downtrading from Marlboro and especially Nacional was mainly capitalised by illicit trade, BAT’s Viceroy and Philip Morris’ L&M. As a result, Philip Morris saw its cannibalised profits decline and archrival BAT gaining four volume percentage points in share to 12% (while La Tabacalera remained stable at 4%). The worst part for Philip Morris is that this first serious challenge to its dominance is not clear to be over yet: the economy segment is still growing, and as long as that segment grows, Viceroy, the most established brand in the segment, will grow, taking further share away from Philip Morris.
Colmados remain unchallenged as the main sales channel
Modern grocery has been growing as a sales channel mostly due to the aggressive selling space expansion during the last few years. There have even been talks among retailers about the inevitable demise of traditional grocery. However, the economic slowdown has had a two-fold impact that helped independent small grocers (i.e. colmados) to strengthen their sales position: modern grocery halted its selling space expansion, and consumers (most of them cash-strapped) did not have the resources to buy frequently from modern grocery outlets. Hence, they were loyal to their “good old” colmados, where they can buy per stick, with credit, and even with a delivery service.
Volume decline to smooth out over the forecast period
The worst of the fiscal package is over. Over the forecast period, only normal annual raises will be applied to the specific excise. It is not expected that tax-driven price increases will be as sharp as recently. In fact, VAT should even decrease by two percentage points in 2016. As a consequence, illicit trade should become less detrimental to licit volume (in fact, it is expected that its volume CAGR will go down from 4% over the review period to 0% during the forecast period). This trend will help volumes to decline more smoothly than during the review period (from -6% CAGR in the latter to -3% over the forecast period).
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