The Smoke Clears At Marlboro

Ralph Lauren, watch out. Philip Morris Cos. is staking a claim for Marlboro in the urban-cowboy fashion landscape. Sometime this spring, Philip Morris USA, the company's $12 billion tobacco division, will roll out the Marlboro Country Store, a mail-order promotion that will enable smokers to exchange their empty Marlboro packs for Western wear such as boots, cowboy hats, belt buckles, denim shirts, and leather jackets, discreetly stenciled with the Marlboro brand logo.

Some deal, right? But it's even better for Philip Morris. The campaign is expected to build the company's data base of smokers and turn millions of Americans into walking Marlboro ads.

Whoa, there. Aren't brands supposed to be dead? That was the conventional wisdom in the wake of "Marlboro Friday" last Apr. 2. Then, Philip Morris announced it was slashing the price of Marlboros by 40 per pack to stanch the brand's market-share deterioration. Philip Morris' stock sank 14 points and pulled down the stocks of other consumer-goods companies. It became the biggest marketing story of 1993--a symbol of the vulnerability of big brands in the price-conscious, value-minded '90s. By yearend, analysts estimate, the strategy had cut Philip Morris' domestic tobacco unit's earnings by $2.3 billion, to $2.84 billion.

But nine months later, it's clear that as a market-share gambit, the price-cutting maneuver worked. Marlboro's share of the $47 billion U.S. cigarette market, which fell to 20% before Marlboro Friday, has rebounded to 25%--higher than it has been since 1989 (chart). The stock, which cratered at 45, has crept back up to around 57.

Now, Philip Morris is embarking on Phase Two. Philip Morris executives declined to comment. But tobacco analysts, consultants, distributors, and sources familiar with the company say that Philip Morris is preparing a methodical offensive to secure the competitive gains it has made. It is stepping up consumer promotions such as Marlboro Country Store. It is working on a series of new products, including a shorter cigarette, dubbed the Marlboro Express, for time-pressed smokers. And observers also expect Philip Morris, which raised its cigarette prices by 4 per pack in November, to continue nudging up prices.

If Philip Morris can pull it off, Marlboro's managers will have proven that they can keep their brand strong--and begin to command premium prices once again--even in an era when consumer loyalty is waning. "I would not want to gloss over the degree of pain that it has taken to get here," says Marc Cohen, a tobacco analyst at Goldman, Sachs & Co. "But I think we're at a stage where Philip Morris can begin to build its brands again."

The architect of the plan is James J. Morgan, who took over as senior vice-president for marketing at Philip Morris USA in April after a three-year stint as vice-president for marketing planning at the parent company. A strong performance could catapult Morgan into position to succeed William I. Campbell as chief executive of Philip Morris USA. "From what we hear, Jim Morgan is really calling the shots over there," says Gary Black, a tobacco analyst at Sanford C. Bernstein & Co.

He'll have to make those shots count, because he's fighting with less ammo. Thanks to the earnings drop, Black estimates, Morgan's $1.1 billion 1994 promotional budget is $500 million lower than last year's total. The $400 million advertising budget is flat, Black says. It's a marked change from the 1980s, when price hikes funded seemingly bottomless marketing war chests. "Philip Morris raised prices on Marlboro twice a year for 10 years, and those easy profits were able to mask their marketing inefficiencies," says Murray Hillman, president of the Strategy Workshop, a New York consulting firm.

A lot is riding on Marlboro's ability to do more with less. The brand accounted for 60% of Philip Morris USA's sales and 75% of its operating income in 1993. Largely because of Marlboro Friday, analysts estimate the parent company's worldwide operating income slipped to $9.3 billion in 1993 from $11 billion in 1992. In November, Philip Morris Cos. announced plans to eliminate 8% of its work force--roughly 14,000 people--close 40 plants, and take a $457 million charge against earnings. And the pain isn't over: Domestic tobacco's operating income may fall 31% in the first quarter of 1994, says Black. But unit volume should be up 10%, and he expects earnings to start to recover in the second quarter.

ROLL 'EM. Morgan's strategy is to win consumers' loyalty with promotions such as Country Store while using new products to respond to the industry's new challenges. In anticipation of the Clinton Administration's plans to raise excise taxes by up to 75 per pack in 1995, Philip Morris has considered roll-your-own cigarettes in the U.S.--because loose tobacco and rolling paper are taxed at a lower rate than cigarettes. Philip Morris already markets such a product in Germany. It also has studied selling cigarettes loose in a carton, which could cut the price of a carton by roughly 60 .

Marlboro Express, the shorter smoke, would be about 15 millimeters shorter than a conventional 85-millimeter-long cigarette. A Philip Morris insider says the company has been considering this demi-cigarette as an option for people who must take quick smoking breaks while at work. The idea is to reduce the size of the cigarette but deliver the same amount of nicotine and tar. "Express is supposed to be a fast smoke so you can get a quick fix," says Rob Huberman, general manager at Starkman Distributors in Atlantic City, N.J.

Philip Morris won't comment on the status of Express, but an executive familiar with the project says advertising for Express has been created. One ad depicts a horse running across the plains, conjuring up the Pony Express. Will Express make it to market? It's not a sure thing. Launching a new product could interfere with the existing Marlboro line's momentum. Still, "the advertising means it's a high priority," says the executive. Consultants believe smokers would be receptive. "How many times have I seen people in their office lobbies exhausting their cardiovascular systems trying to down a cigarette between breaks?" asks Jeffrey Hill, a managing director at Meridian Consulting Group in Westport, Conn.

Just as Express would offer smokers the same nicotine fix in a smaller package, Marlboro's brand managers are viewing promotions as a way to get more bang from a smaller marketing budget. Country Store is slated to replace the Marlboro Adventure Team, which began in October, 1992, and ends in February. Adventure Team, a $200 million direct-mail and ad effort, worked much like a catalog: Smokers saved up empty Marlboro packs, sent them to Philip Morris, and received free merchandise from a Marlboro catalog. For 130 packs, for instance, smokers could get a Weber charcoal grill. The program gave Philip Morris a data base of more than 2 million smokers.

Marlboro isn't the only smoke to benefit from Philip Morris' faith in premium brands. More advertising and promotions are also expected for Virginia Slims at the expense of Basic, Philip Morris' high-riding discount cigarette. Much of Basic's $10 million ad budget will be shifted to Virginia Slims, says one insider. The reasoning: Premium-priced cigarettes, which start at $1.90 per pack, are three times as profitable as discount smokes, at around $1.35.

CAREER MOVES. In another move to shift smokers into premium-priced cigarettes, Philip Morris and R.J. Reynolds Tobacco Co. this month cut in half the 60 per carton they give tobacco wholesalers to push discount brands. And smokers barely seemed to notice when Philip Morris and its rivals raised prices by 4 per pack in November. A year ago, premium-priced cigarettes accounted for 61% of the domestic market; Black expects that figure to stand at 66% by the end of the first quarter. Analysts and tobacco distributors believe another price hike is imminent. That would bolster Philip Morris' earnings. The trick is to raise prices without undermining the company's efforts to position its cigarettes as good value--and without triggering a price war.

Morgan's career could depend on the outcome. At Philip Morris' Dec. 16 holiday party at New York's Metropolitan Museum of Art, Michael H. Miles, Philip Morris' somber CEO, milled around, chatting amiably about the company's tobacco business. "He's normally not very personable," says one partygoer. "But he was very congenial, telling people how happy he was with Marlboro's increased share in convenience stores. It was his way of saying that even though he's a food guy, he's watching tobacco." It's a good bet Miles is watching Morgan pretty carefully, too.


PRICING Philip Morris uses price as an aggressive marketing tactic. Last spring's 40 -per-pack cut grabbed consumers' attention, narrowed the gap with discount brands, and squeezed rivals. Step Two: The company is expected to nudge prices back up quietly this spring.

PROMOTION Relying less on broadbrush image ads. "Continuity" programs such as the Marlboro Adventure Team and the upcoming Country Store campaign--with their offers of Marlboro merchandise--build consumer loyalty and data bases.

NEW PRODUCTS The shorter Express, aimed at the time-pressed and price-conscious, is being considered. Other options: cartons of loose cigarettes and roll-your-own smokes.

Before it's here, it's on the Bloomberg Terminal.