ITC, India's biggest FMCG company and leader of India's tobacco market, has taken a different strategic direction from major international tobacco companies like PMI, BAT and Imperial: while they divested non-tobacco businesses years ago ITC has become a conglomerate. Given that all the above-mentioned companies started from the same tobacco base, why has ITC followed a different roadmap?
ITC is the leading FMCG marketer in India, the second-largest hotel chain, the market leader in the Indian paperboard and packaging industry and the country's foremost agri-business player, while ITC's wholly owned subsidiary, ITC Infotech India Limited, is one of India's fast growing Information Technology companies. Overall growth has been steady over the last fifteen years: according to the company, ITC's gross turnover and post-tax profits recorded compounded growth of 12.7% and 21.7% per annum respectively. Profitability, as measured by ROCE (return on capital employed) improved substantially, from 28.4% to 43.4% during this period.
Growth in sales in financial year to end March 2011 stood at 16.6% achieved by ITC, as reported in its annual report to end March 2011, and was primarily due to its non-tobacco FMCG business, which grew net turnover by 23.1%, as well as its agri business, which grew by 22.9%, and its hotels business which grew by 17.6%. This was a strong performance by the company.
The company's enthusiasm concerning its non-tobacco businesses evidently stems in part from the problems surrounding the operating environment of the tobacco industry. Some of these are those shared by the rest of the world's tobacco companies, such as being heavily taxed as part of governments' tobacco control strategies. Also a perennial problem shared by tobacco companies the world over is illicit trade perceived as being exacerbated by the higher prices caused by tax hikes. However, as well as these, ITC's tobacco business has problems which are unique to India, and one in particular.
Indian cigarette taxation - the critical fact
As the company states in its annual report, the problem with increasing taxes in India as a measure to reduce tobacco use is that it overlooks the critical fact that, in India, cigarettes constitute less than 15% of tobacco consumption whilst the larger proportion of tobacco consumption in the country is accounted for by beedis (a crude, homemade cigarette) and the smokeless products khaini, gutkha, zarda etc. Not only do these products have the advantage over tobacco of being lightly taxed, they can also actually avoid the taxman by virtue of being products of the 'unorganised sector'. The net result is that cigarettes, despite accounting for only a small portion of tobacco consumption (there are eight times as many bidis smoked than cigarettes in India and smokeless tobacco usage is higher than that of cigarettes and bidis combined), cigarettes contribute more than 75% of the tax raised from the tobacco sector.
Per capita consumption of cigarettes - lowest in the world
In fact according to the latest research findings published in the Global Adult Tobacco Survey (GATS), conducted under the stewardship of the Ministry of Health and Family Welfare, cigarettes are the least popular form of tobacco consumption in India. So, despite India's cigarette consumption being some 95bn sticks in 2010 according to Euromonitor International, only 5.7% of all adults smoke cigarettes while almost 35% of Indian adults consume tobacco. This is why, according to ITC, any tax hike directed at cigarettes not only causes illicit trade to rise, it causes consumers to migrate to other tobacco products.
As a result, per capita consumption of cigarettes in India is among the lowest in the world: less than a tenth of that in the US and a twentieth of the rate in Japan. At the same time, tax per 1,000 cigarettes as a percentage of per capita GDP is among the highest in the world. According to ITC, 'disproportionate and high taxation on cigarettes has led to a dwindling of its share in total tobacco consumption from about 25% in the 1970s to about 15% currently'. But this does not mean fewer tobacco users: at the same time total tobacco consumption in India has continued to grow by way of increased consumption of other, 'revenue inefficient', forms of tobacco.
According to the company its tobacco business is also suffering as a result of the 'burgeoning illegal trade in cigarettes' which accounted for more than 16% of total cigarette consumption in 2011, giving India a rank of sixth biggest country in the world for illicit cigarette trade with one of the highest illicit growth rates, namely 58% over the five years 2004 – 2009.
Competitive activity leads to innovation
Another challenge faced by ITC has been 'unprecedented' competitive activity in the Indian cigarette market including new brand launches by global cigarette companies trying to gain a foothold in India, seen as the sleeping giant of the global cigarette industry because the tobacco using population is second only to that of China and because such a low proportion of tobacco users are cigarette smokers. The company has responded to this challenge by what it calls 'continuous value creation through innovative and differentiated products and investments in trade marketing'.
New product developments highlighted by ITC include the launch of Lucky Strike at the premium end of the market, Gold Flake Classic Menthol Rush, Gold Flake Sleek Line Kings and Gold Flake Arctic Menthol. Players Gold Leaf and a variant of Gold Flake Premium Filter were also launched during the company's last financial year. In addition, ITC claimed to have consolidated its position in the cigar market through the Armenteros brand manufactured in the Dominican Republic.
Cigarettes – still ITC's dominant product
Despite the company's tobacco problems, and despite its success with other FMCG products, in the year to end March 2011 cigarettes were ITC's dominant product, accounting for 65% of total company sales and recording sales growth of some 15%. And, although the annual report does not separate profits segmentally, it is common knowledge that there are few, if any, FMCGs able to match cigarettes for margins and raw profitability. This is the reason why PMI (when it was part of Altria) stopped being the world's biggest food company, why BAT stopped being a global scale financial services company and retailer, and why Imperial stopped being a food company, brewer and owner of the iconic Howard Johnson in the US.
So why then does ITC see things differently from its international rivals and wish to embrace the conglomerate style of business? The reason is India. The Indian FMCG industry accounts for 2.2% of the GDP of the country but has tripled in size over the last 10 years and has grown at approximately 17% CAGR in the last 5 years, driven by robust macroeconomic conditions, rising income levels, increasing urbanisation and favourable demographic trends. These drivers are expected to continue to favourably impact the industry, which is estimated to further triple in size by 2020 according to the CII FMCG Roadmap to 2020 (as quoted in the ITC annual report).
With its packaged food business growing by a quarter in 2011, its hotels business by 18% and its lifestyle products (branded garments, education and stationery products, personal care products, incense sticks, etc) increasing sales by 28%, deploying the unrivalled cash flow from tobaccos to help grow these business and take advantage of the massive growth in FMCG usage in India as the country grows to become the third largest economy in the world appears a logical use of resource.
The strategy is also vindicated by the relatively low levels of per capita consumption within many FMCG product sectors in India, the growing population of working women, plus increased government spending on education. According to a study by Deloitte Touche Tohmatsu Limited 'Consumer 2020: Reading the signs', India will emerge as the world's fifth largest consumer market by 2025, providing significant opportunities in FMCG for companies positioned to take advantage. As demonstrated by the growth of Altria and BAT in the 1980s by following the same route internationally, the tobacco cashflow-driven consumer product conglomerate is a business model that makes sense. Whether there comes a time in the long term when ITC also makes the decision to return to core values and divest the (probably) less profitable non-tobacco businesses remains to be seen.