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WWW.IBISWORLD.COM Cigarette & Tobacco Manufacturing in the US August 2016 1

IBISWorld Industry Report 31222 Cigarette & Tobacco Manufacturing in the US August 2016 Ibrahim Yucel

Smoke free: Declining cigarette use will shift industry’s focus to smokeless products

2 About this Industry 2 Industry Definition

2 Main Activities

2 Similar Industries

2 Additional Resources

4 Industry at a Glance

5 Industry Performance 5 Executive Summary

5 Key External Drivers

7 Current Performance

10 Industry Outlook

13 Industry Life Cycle

15 Products & Markets 15 Supply Chains

15 Products & Services

18 Demand Determinants

19 Major Markets

21 International Trade

23 Business Locations

25 Competitive Landscape 25 Market Share Concentration

25 Key Success Factors

26 Cost Structure Benchmarks

29 Basis of Competition

30 Barriers to Entry

31 Industry Globalization

33 Major Companies 33 Altria Group Inc.

35 Reynolds American Inc.

36 Imperial Brands plc

39 Operating Conditions 39 Capital Intensity

40 Technology & Systems

40 Revenue Volatility

41 Regulation & Policy

43 Industry Assistance

45 Key Statistics 45 Industry Data

45 Annual Change

45 Key Ratios

46 Jargon & Glossary

www.ibisworld.com | 1-800-330-3772 | [email protected]

This report was provided to Ohio State University - Columbus Campus (OhioNet) (211852729) by IBISWorld on 14 September 2016 in accordance with their license agreement with IBISWorld

WWW.IBISWORLD.COM Cigarette & Tobacco Manufacturing in the US August 2016 2

Operators in this industry manufacture cigarettes, cigars, loose pipe tobacco, smokeless (i.e. chewing) tobacco and e-cigarettes. Tobacco manufacturers acquire raw materials from tobacco

growers, paper and fiber manufacturers, tobacco stemmers and tobacco redryers and process these into ready-to-use products sold to wholesalers and retailers.

The primary activities of this industry are

Manufacturing cigarettes

Manufacturing cigars

Manufacturing smokeless tobacco

Manufacturing electronic cigarettes and vaporizers for tobacco use

Reconstituting tobacco

11191 Tobacco Growing in the US This industry farms and sells tobacco to wholesalers to be used in tobacco product manufacturing.

32211 Wood Pulp Mills in the US This industry produce wood pulp which is used to manufacture filters for cigarettes and tobacco products.

32229b Paper Product Manufacturing in the US This industry manufactures paper used to wrap tobacco for cigarette production.

42494 Cigarette & Tobacco Products Wholesaling in the US This industry wholesales tobacco products such as cigarettes, snuff, cigars and pipe tobacco.

Industry Definition

Main Activities

Similar Industries

About this Industry

The major products and services in this industry are

Cigars

E-vapor products

Menthol cigarettes

Regular cigarettes

Smokeless tobacco

Other

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WWW.IBISWORLD.COM Cigarette & Tobacco Manufacturing in the US August 2016 3

About this Industry

For additional information on this industry

www.ttb.gov Alcohol and Tobacco Tax and Trade Bureau

www.cdc.gov Centers for Disease Control and Prevention

www.cigarassociation.org Cigar Association of America

www.truthinitiative.org Truth Initiative

www.industrydocumentslibrary.ucsf.edu/tobacco/ Truth Tobacco Industry Documents

www.census.gov US Census Bureau

Additional Resources

IBISWorld writes over 700 US industry reports, which are updated up to four times a year. To see all reports, go to www.ibisworld.com

Provided to: Ohio State University - Columbus Campus (OhioNet) (211852729) | 14 September 2016

WWW.IBISWORLD.COM Cigarette & Tobacco Manufacturing in the US August 2016 4

%

21

15

16

17

18

19

20

2006 08 10 12 14 16 18Year

Percentage of smokers

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-15

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-5

0

5

2208 10 12 14 16 18 20Year

Revenue Employment

Revenue vs. employment growth

Products and services segmentation (2016)

51.2% Regular cigarettes

2.5% Cigars

26.3% Menthol cigarettes

11.2% Smokeless tobacco

4.5% Other 4.3%

E-vapor products

SOURCE: WWW.IBISWORLD.COM

Key Statistics Snapshot

Industry at a Glance Cigarette & Tobacco Manufacturing in 2016

Industry Structure Life Cycle Stage Decline Revenue Volatility Medium

Capital Intensity High

Industry Assistance Medium

Concentration Level High

Regulation Level Heavy

Technology Change Medium

Barriers to Entry High

Industry Globalization Low

Competition Level High

Revenue

$37.6bn Profit

$12.1bn Exports

$422.7m Businesses

144

Annual Growth 16-21

-2.4% Annual Growth 11-16

-2.3%

Key External Drivers Percentage of smokers Excise tax on tobacco products Regulation for the Cigarette and Tobacco Production industry Consumer spending World price of tobacco

Market Share Altria Group Inc. 49.1%

Reynolds American Inc. 32.9%

Imperial Brands plc 7.0%

p. 33

p. 5

FOR ADDITIONAL STATISTICS AND TIME SERIES SEE THE APPENDIX ON PAGE 45

SOURCE: WWW.IBISWORLD.COM

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Key External Drivers Percentage of smokers Cigarette consumption has declined steadily since the early 1980s because of increasingly unfavorable public attitudes toward smoking. Information disseminated by health authorities on the health consequences of smoking damaged industry performance as people purchased fewer cigarettes. Furthermore, rising excise taxes on tobacco products at

the federal, state and municipal levels have raised tobacco prices, further reducing per capita consumption. As the percentage of smokers declines, demand for cigarettes and tobacco products deteriorates, hampering industry revenue growth. The percentage of smokers is expected to continue decreasing through 2016, presenting a potential threat to the industry.

Executive Summary

Over the past five years, the Cigarette and Tobacco Manufacturing industry has persevered despite facing increasingly challenging operating conditions and intense scrutiny from both the government and the public. Federal excise taxes on cigarettes were raised to historic highs in 2009, and individual states increased their own excise taxes on tobacco several times in the following six years. Meanwhile, cigarette consumption continued to decline steadily, further reducing demand for the industry’s largest and most profitable product segment.

Nonetheless, sustained demand for noncigarette industry products, such as smokeless tobacco, minicigars and electronic cigarettes (e-cigarettes), helped mitigate declining sales of traditional cigarettes. Furthermore, industry operators raised prices on cigarettes several times in the past five years, which has partially offset declining consumption. Overall, industry revenue is expected to decline an annualized 2.3% to $37.6 billion over the five years to 2016, including a projected decline of 1.2% in 2016. Despite rising operating costs,

increased consolidation has helped boost average profit during the past five years. In addition, the industry’s two largest operators, which currently account for a combined 81.9% of the market, have successfully raised prices on tobacco products in line with rising compliance costs. Overall, average industry profit is expected to rise to an estimated 32.7% in 2016.

Over the next five years, fewer Americans will consume tobacco because of rising excise taxes, greater social stigma associated with smoking and a better understanding of the health risks associated with tobacco use. Rising public scrutiny and an increasingly stringent regulatory environment, as well as ongoing class action suits against major tobacco manufacturers, will continue to tarnish the image of tobacco, accelerating the decline of this industry. As cigarette consumption continues to dwindle, operators will increasingly focus on developing and marketing products perceived to have lower health risks, such as e-cigarettes, which are currently subject to a lower tax burden than cigarettes. In addition, operators will continue to raise prices on conventional tobacco products, which will help partly offset declining unit sales. Overall, industry revenue is forecast to decline an annualized 2.4% to $33.3 billion in the five years to 2021.

Industry Performance Executive Summary | Key External Drivers | Current Performance Industry Outlook | Life Cycle Stage

Demand for industry products such as smokeless tobacco helped mitigate declining sales of cigarettes

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Industry Performance

Key External Drivers continued

Excise tax on tobacco products Cigarettes and other tobacco products are heavily taxed, forcing manufacturers to raise their product prices in order to offset declining sales volume and maintain profitability. As federal and state governments raise excise taxes, price- conscious smokers will naturally demand fewer industry goods. However, due to the addictive nature of tobacco products, demand tends to fall slowly. Furthermore, rising excise taxes on cigarettes usually causes heightened demand for other tobacco products, which partially offsets the effects on industry revenue of higher taxes. Excise taxes are expected to increase in 2016.

Regulation for the Cigarette and Tobacco Production industry Cigarette and tobacco manufacturing is one of the most highly regulated industries in the United States. During the past five years, the industry has faced increasing scrutiny from both public and private institutions, rising compliance costs associated with the 2009 Family Smoking Prevention and Tobacco Control Act and ongoing costs associated with the 1998 Master Settlement Agreement (see Regulation section). The industry has also faced greater regulatory scrutiny from state governments, growing

social stigma and increasing litigation from private parties. The regulatory environment is expected to remain unfavorable to industry operators through 2016.

Consumer spending Consumer spending on new goods, including cigarettes and tobacco products, expands as disposable incomes rise and as the economic outlook improves. Higher consumer spending allows smokers to purchase cigarettes more frequently or trade up to premium brands, which boosts industry revenue. Consumer spending is anticipated to increase in 2016, which presents a potential opportunity to the industry.

World price of tobacco Industry operators source tobacco leaves, the industry’s main raw material input, primarily from domestic and some international farmers to produce cigarettes and other tobacco products. When the price of raw tobacco increases, manufacturers either absorb the higher cost at the expense of profit or raise their product prices at the expense of sales. The world price of tobacco is expected to increase in 2016.

$

5

1

2

3

4

2006 08 10 12 14 16 18Year

Excise tax on tobacco products

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%

21

15

16

17

18

19

20

2006 08 10 12 14 16 18Year

Percentage of smokers

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Industry Performance

Current Performance

Despite steadily declining smoking rates since the early 1980s, the Cigarette and Tobacco Manufacturing industry continues to adapt to increasingly challenging operating conditions. Overall, industry revenue is anticipated to decline an annualized 2.3% to $37.6 billion over the five years to 2016. In 2016, industry sales are expected to decline 1.2% as continued declines in cigarette consumption are partly offset by stronger demand for smokeless tobacco products. In addition, operators will continue to pass on higher excise taxes and compliance costs to consumers in the form of higher prices. In turn, price markups will help offset declining unit sales of

cigarettes, which are expected to generate 77.5% of industry revenue in 2016.

Profit expansion and industry consolidation

Compared with other nondurable goods manufacturing industries, tobacco manufacturers have experienced strong profit growth over the past few years. Profitability in this industry is a function of exceptional brand loyalty for most of its products, as well as the addictive nature of tobacco products, which naturally contain nicotine, harmaline and other addictive chemicals. These factors have allowed operators to mark up their products without significantly hindering demand for tobacco products. Indeed, raising prices has been a key driver of this industry’s resilience, despite steadily declining demand, rising compliance costs and increasingly challenging operating conditions.

Despite rising input prices, hikes in excise taxes and several pending lawsuits against industry operators, industry profit has expanded over the past five years. For instance, the world price of tobacco, the primary input for producing cigarettes, rose at an average annual rate of 2.2% in the five years to 2016. Yet industry profitability expanded as

operators raised their product prices aggressively, successfully passing on the cost increases to their customers. While profit margins vary widely across manufacturers, average profit is estimated to account for 32.7% of revenue in 2016.

The boost in profit margins was driven by the industry’s two largest players, Altria Group and Reynolds American Inc. (RAI). Altria’s profit margin expanded significantly through its acquisitions of cigar manufacturer John Middleton and US Smokeless Tobacco Company prior to this five-year period. Moreover, Altria consolidated its production facilities in the United States at the end of 2009 to focus on growing markets abroad. By reducing the number of workers employed in the United States and consolidating its production to one factory, Altria was able to boost its operating income significantly. Likewise, RAI’s margin expanded from a low of 15.3% in 2012 to 20.9% in 2013, driven by price markups for cigarettes and increased demand for its iconic and

% c

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2208 10 12 14 16 18 20Year

Revenue Exports

Revenue vs. exports

SOURCE: WWW.IBISWORLD.COM

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Industry Performance

Profit expansion and industry consolidation continued

highly profitable smokeless tobacco brands, Grizzly and Kodiak. More recently, the company’s high-profile merger with Lorillard Inc., which was previously the third-largest operator in this industry, further consolidated RAI’s operations and boosted profit margins through 2016.

In an effort to sustain previous profit margins in spite of greater compliance and input costs, the industry has consolidated aggressively while trimming employment. Consequently, industry employment is expected to decline an annualized 1.7% to 13,827 workers over

the five years to 2016. At the same time, Altria’s decision to move its production for European markets from Cabarrus, NC, to Europe caused exports to continue declining. Overall, industry exports are anticipated to decline an annualized 4.3% to $422.7 million during the five years to 2016. In contrast, greater domestic demand for premium, handmade cigars made in the Caribbean has boosted imports for tobacco products. Consequently, IBISWorld estimates imports to have grown an annualized 8.7% to $1.2 billion during the five- year period.

Regulatory challenges and rising public scrutiny

The tobacco industry as a whole has been characterized by steadily declining demand for cigarettes, the industry’s largest and historically most profitable product segment. According to data from the Federal Trade Commission, total carton sales fell an annualized 3.3% over the 10-year period from 2003 to 2013 (latest data available), while the average excise tax collected per pack rose significantly over the same period. According to retail sales data from Management Science Associates Inc. and IRI, cigarette shipments declined a further annualized 1.4% from 2013 to 2015.

In 2009, Congress enacted the Family Smoking Prevention and Tobacco Control Act (Tobacco Control Act), placing more stringent marketing restrictions on tobacco products, banning the sale of flavored cigarettes and prohibiting the use of terms such as “light” or “mild” on tobacco packaging. The law also tightened restrictions on advertising and marketing. The strict regulations on advertising have led to lower brand visibility, placing downward pressure on industry revenue growth. This law was followed by the unprecedented April 2009 federal excise tax hike, which raised

the federal tax on cigarettes from $0.39 to $1.01 per pack. During the six years following the Tobacco Control Act, state-level excise taxes on tobacco products were raised more than a hundred times by almost every state. In mid-2016, state and local taxes ranged from just $0.17 per pack in Missouri to $6.16 per pack in Chicago, according to the Federation of Tax Administrators. The large discrepancy between excise taxes of neighboring states caused tobacco smuggling and tax evasion to rise at alarming rates, undermining the efforts of regulators and tobacco manufacturers alike.

Nonetheless, declining sales of cigarettes have been partially offset by increasing per-pack prices, as well as unexpectedly strong demand for noncigarette products such as smokeless tobacco, machine-made cigars and, especially, electronic cigarettes during

The growing use of e-cigarettes has prompted several new companies to enter the industry

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Industry Performance

Regulatory challenges and rising public scrutiny continued

the first half of the five-year period. In response to broadening regulation of cigarettes and declining consumption levels, industry operators have increasingly focused on marketing and distributing these noncigarette tobacco products, which are currently taxed at lower rates and subject to less regulatory scrutiny than cigarettes. Consequently, demand for these alternative products rose considerably over the five years to 2016, somewhat offsetting the decline in cigarette sales. However, the Food and Drug Administration (FDA) drafted new rulings on electronic nicotine delivery products, which extend the FDA’s regulatory control to all products that contain tobacco.

Since then, smokeless tobacco has gained wider market acceptance, mirroring the desire for more socially acceptable tobacco products. Dissolvable tobacco, another smokeless tobacco product recently introduced, has become popular among smokers who prefer to

use tobacco discretely in public areas where smoking is prohibited. Furthermore, annual retail sales of e-cigarettes, which are electronic devices designed to simulate the act of actual smoking, grew rapidly from less than $30.0 million in 2010 to an estimated $2.0 billion in 2015, according to data from Altria Group and the Society for Research on Nicotine and Tobacco. While claims that e-cigarettes less harmful than regular cigarettes are debatable, the growing use of e-cigarettes among Americans has prompted dozens of new companies to enter the industry, though this growth was partially offset by increased merger and acquisition activity and reduced consumer confidence in e-vapor products since late 2015. Driven primarily by new entrants into the e-vapor market, overall industry participation is expected to increase an annualized 8.7% to 144 companies over the five years to 2016.

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Industry Performance

Industry Outlook

The Cigarette and Tobacco Manufacturing industry will continue to face major challenges over the next five years, including gradual drops in smoking rates, higher excise taxes and rising compliance and litigation costs. Despite its remarkable resilience during the past several years, the industry is anticipated to continue shrinking during the next five years, especially as demand for all product segments begins to decline in response to broader regulatory pressure by the Food and Drug Administration (FDA), Federal Trade Commission, Alcohol and Tobacco Tax and Trade Bureau and numerous other public and private institutions. In addition to broader regulatory scrutiny of tobacco products

and diminishing social acceptance of smoking, excise taxes at both the federal and state levels are anticipated to rise significantly through 2021, effectively increasing the price of tobacco products and further discouraging price-conscious smokers. Accordingly, industry revenue is projected to decrease at an annualized rate of 2.4% to $33.3 billion in the five years to 2021.

Excise tax at both the federal and state levels are anticipated to rise significantly through 2021

Profit margins squeezed

Although profitability will remain high in comparison with other manufacturing industries, rising compliance costs and dwindling demand for industry goods will have a negative effect. These factors will be slightly offset by falling input prices. In particular, the world price of leaf tobacco is forecast to decline an annualized 1.2% in the five years to 2021. Nonetheless, ongoing annual payments through 2025 in accordance with the Master Settlement Agreement, in addition to rising litigation expenses

associated with the Engle progeny cases (see Regulation section) and other class action suits will increasingly burden the industry’s largest operators, thereby constraining overall profit.

Rising compliance costs and dwindling demand will have a negative effect on profit

Diminishing social acceptance

Despite major efforts to curb smoking and regulate tobacco over the past few decades, smoking remains the leading cause of preventable disease in the United States, according to a landmark 2012 study by the surgeon general. Furthermore, while the percentage of youth who smoke cigarettes has fallen to less than 15.7%, the share of young Americans who still experiment with other tobacco products, especially

e-cigarettes, has remained high. Accordingly, antismoking organizations will continue to focus on reducing tobacco use among younger Americans since they are more likely to experiment with tobacco than adults. Negative attitudes toward smoking are a major factor that will affect this industry over the five years to 2021, and continued antismoking campaigns are likely to lower tobacco consumption among adults aged 18 to 26.

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Industry Performance

Federal and state excise taxes are expected to continue increasing through 2021, not only for cigarettes (which have traditionally been the focus of price-based regulatory control of tobacco), but also for smokeless tobacco, e-cigarettes and other tobacco products. If the current budget proposal for 2016 is approved, the federal excise tax on cigarettes could rise to $1.95 per pack, while the tax rate on other tobacco products, such as moist snuff and minicigars, would likely rise proportionately. In addition to federal excise taxes, taxes at the state level are expected to rise. Since the beginning of 2016, six states have proposed or already drafted excise tax hikes on tobacco products, and this trend is expected to continue in the coming years. These excise taxes will adversely affect industry performance by raising the final price that consumers pay at retail stores, thereby driving down demand for industry products.

While regulations that restrict the use of e-cigarettes were recently proposed at the federal level by the FDA, implementing new regulations will remain a top priority for state and local authorities. These new regulations and taxes are anticipated to slow the adoption of e-cigarettes among consumers, as

existing regulations pertaining to cigarettes continue to place downward pressure on demand for traditional tobacco products. Lastly, antismoking campaigns are anticipated to further tarnish the industry’s image and hinder revenue growth through 2021.

Unfavorable shifts in consumer health trends, antismoking campaigns and increased costs have compelled operators to consolidate in previous years, and this trend is expected to continue in the upcoming years. As demand for the industry’s products continues to fall, smaller operators that are unable to compete will exit the market, providing a window of opportunity for larger operators to obtain greater market share. While the four leading manufacturers already account for almost 92.0% of industry revenue in 2016, they will continue to acquire smaller competitors to further drive up market share concentration. Consequently, the number of operators is projected to fall an annualized 2.5% to 127 companies in the five years to 2021. As companies consolidate, employment is forecast to fall at an annualized rate of 3.4% to 11,634 workers during the same period.

Due to the popularity of e-cigarettes, leading manufacturers Altria and Reynolds American Inc. (RAI) have launched their own e-cigarette brands in the past two years. In 2014, both of these companies expanded their distribution of these products nationwide, helping drive demand for e-cigarettes. Smokers benefit from being able to use e-cigarettes where the use of traditional cigarettes is banned. Analysts at various investment banks estimate that sales of e-cigarettes could surpass sales of traditional cigarettes in the next decade. Indeed, the retail market for e-cigarettes has already surpassed $2.5 billion, according to

estimates from Altria Group, though sales have decelerated markedly since late 2015 because of new regulations and waning consumer confidence in alternative tobacco products.

To combat the negative associations encouraged by antismoking campaigns, industry players are looking to develop new products with

Operators look to develop new products with potentially fewer health risks or less social stigma

Product innovation

Diminishing social acceptance continued

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Industry Performance

potentially fewer health risks or less accompanying social stigma. For example, Altria Group recently announced plans to jointly develop and market new e-vapor products with its global counterpart, Philip Morris International. Large manufacturers will also focus more on marketing secondary products, such as machine-made cigars and smokeless tobacco, to counterbalance declining demand for cigarettes in the next five years. These products currently face less regulatory pressure than cigarettes, although the regulatory environment is

likely to change in coming years. Nonetheless, rapidly growing demand for premium, handmade cigars will boost imports an estimated annualized 2.3% to $1.3 billion during the five years to 2021. In contrast, the leading operators are expected to continue divesting their foreign operations and focus exclusively on domestic markets, especially as global regulation of tobacco increases. Consequently, industry exports are anticipated to decline at an annualized rate of 5.1% to $325.5 million over the next five years.

Product innovation continued

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Industry Performance Antismoking campaigns and strict regulation have gradually reduced cigarette consumption since the early 1980s

Industry value added and total revenue are expected to decline over the 10 years to 2021

Industry employment is anticipated to fall substantially during this 10-year period

Tobacco is one of the most heavily regulated products in the United States and is likely to face even greater scrutiny in the future

Life Cycle Stage

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Decline Shrinking economic importance

Quality Growth High growth in economic importance; weaker companies close down; developed technology and markets

Maturity Company consolidation; level of economic importance stable

Quantity Growth Many new companies; minor growth in economic importance; substantial technology change

Key Features of a Decline Industry

Revenue grows slower than economy Falling company numbers; large fi rms dominate Little technology & process change Declining per capita consumption of good Stable & clearly segmented products & brands

Grocery Wholesaling Seasoning, Sauce and Condiment Production

Wood Pulp Mills Supermarkets & Grocery Stores

Cigarette & Tobacco Manufacturing

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Industry Performance

Industry Life Cycle The Cigarette and Tobacco Product Manufacturing industry is in the declining stage of its life cycle. Over the 10 years to 2021, industry value added (IVA), which measures an industry’s contribution to the economy, is projected to rise an annualized 0.5%. In comparison, GDP is forecast to grow at an annualized rate of 2.1% over the same period. While there was some positive movement in IVA during the first half of the period due to higher profit margins, the industry is expected to continue shrinking during the second half.

During the next five years, IVA is anticipated to decline as the number of smokers in the United States dwindles. The growing social stigma associated with smoking, rising excise taxes and rising health consciousness among Americans have all contributed to the decline of cigarette consumption in the United States. Although demand for noncigarette tobacco products, such as smokeless tobacco or electronic cigarettes (e-cigarettes), has slightly offset declines in cigarette consumption, this trend is unlikely to generate further industry expansion during the next five-year period. Furthermore, litigation and compliance costs associated with tobacco-related lawsuits and regulation have increasingly burdened industry operators during the five years to 2016, and these costs are likely to increase through 2021.

Characteristic of most declining industries, the tobacco industry is also

undergoing significant consolidation. The industry’s manufacturing facilities are being restructured to balance supply with falling demand. In particular, Reynolds American Inc. (RAI) merged with Lorillard Inc. in mid-2015, which has significantly boosted its share of the market. This merger has further concentrated the industry into the hands of only a few players, with the two largest companies alone expected to account for 81.9% of industry revenue in 2016.

Furthermore, IBISWorld anticipates stricter regulation of e-cigarettes and other novel tobacco products during the five years to 2021, which will burden smaller operators and is likely to drive several small e-cigarette manufacturers to leave the industry or merge with larger competitors. For example, Altria Group acquired major e-cigarette company Green Smoke in early 2014, while RAI introduced VUSE, a new line of e-cigarettes that has quickly become the best-selling brand nationally. Smaller e-vapor retailers and mixers are likely to face significantly higher compliance costs associated with the recent FDA ruling on electronic nicotine delivery systems (ENDS), which is also likely to raise barriers to entry for potential new entrants. Consequently, the number of establishments and total employment are expected to decline during the latter half of this 10-year period as operators seeks to sustain profit margins through consolidation.

This industry is Declining

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Products & Services Cigarettes Cigarettes constitute the single-largest class of tobacco products offered by industry operators, accounting for an estimated 77.5% of revenue in 2016. Within this broader category, industry operators market cigarette brands under two categories: discount and premium. According to retail sales data from MSAI/ IRI, premium cigarettes currently account for 75.2% of total cigarette sales within the United States. The cigarette segment can be further divided into two broad cigarette varieties: regular (non- mentholated) and mentholated: regular cigarettes account for an estimated 51.2% of revenue, while menthol cigarettes

account for the remaining 26.3% of industry sales. Almost all cigarettes produced today contain some menthol, although only those with 0.1% or more menthol by weight are typically classified as menthol cigarettes.

There were an estimated 20 million menthol cigarette smokers in 2010 (latest data available), according to the American Legacy Foundation. Menthol, which is derived from peppermint, spearmint and other related plants, provides a natural cooling effect when inhaled. Since menthol’s cooling effect helps relieve the throat irritation sometimes caused by cigarette smoke, it is particularly appealing to new smokers.

Products & Markets Supply Chain | Products & Services | Demand Determinants Major Markets | International Trade | Business Locations

KEY BUYING INDUSTRIES

42441 Grocery Wholesaling in the US Grocery wholesalers constitute another significant downstream market for industry operators as they resell cigarettes and other tobacco products to grocery stores, supermarkets and other retailers.

42494 Cigarette & Tobacco Products Wholesaling in the US Cigarette and tobacco product wholesalers are the primary downstream market for manufacturers.

44511 Supermarkets & Grocery Stores in the US Supermarket and grocery store chains with sufficient purchasing power may buy cigarettes directly from the sales and distribution branches of manufacturers to resell at their retail stores.

44512 Convenience Stores in the US Some major convenience store chains with sufficient purchasing power may purchase tobacco products directly from manufacturers, although almost all convenience store chains source tobacco products from intermediary distributors.

KEY SELLING INDUSTRIES

11191 Tobacco Growing in the US Manufacturers purchase tobacco leaves, the primary ingredient used to produce cigarettes, from tobacco farmers.

31194 Seasoning, Sauce and Condiment Production in the US Cigarette and electronic cigarette manufacturers buy flavoring extracts from producers of seasonings, sauces and condiments to produce menthol cigarettes and flavored electronic cigarettes.

32211 Wood Pulp Mills in the US Cigarette manufacturers purchase wood pulp from mills to create filters for tobacco products.

32212 Paper Mills in the US Manufacturers source rolling paper and packaging material from paper mills.

Supply Chain

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Products & Markets

Products & Services continued

Accordingly, menthol cigarettes are disproportionately popular among younger adults and other inexperienced smokers. While sales across all cigarette categories have fallen in recent years, consumption of menthol cigarettes has decreased at a slower rate than consumption of regular cigarettes. As a result, menthol cigarettes’ share of industry revenue has increased marginally over this five-year period. Furthermore, tobacco-related legislation has yet to specifically target mentholated cigarettes, though efforts were made by the FDA in 2013. Accordingly, the lack of concrete legislation, coupled with an enduring public perception that mentholated cigarettes are less harmful than conventional cigarettes, will likely continue to increase the menthol cigarette segment’s share of revenue in upcoming years.

The prevalence and public acceptance of smoking has fallen steadily since the mid-1960s, which has consequently shrunk the overall cigarette product segment’s share of revenue over the past 50 years. More specifically, the percentage of the population that smokes has fallen from 42.4% in 1965 to a low of 16.8% in 2014, according to estimates from the Centers for Disease Control and

Prevention (CDC). In order to remain profitable in spite of falling consumption, manufacturers have raised their product prices several times over the past five years, thereby passing on higher input and compliance costs to their downstream customers. Furthermore, rising excise taxes at both the federal and state levels have increased the retail price of tobacco products, further driving down demand for cigarettes. Consequently, cigarettes’ share of industry revenue has fallen over the five years to 2016.

Smokeless tobacco Smokeless tobacco products, which include chewing and spitting tobacco, snuff and snus, account for an estimated 11.2% of industry revenue. Snuff is a tobacco product made from finely ground tobacco leaves, whereas snus is a moist powdered tobacco consumed by being placed under the lip. The category also includes a variety of novel tobacco products such as dissolvables or lozenges that contain nicotine. Demand for smokeless tobacco products has grown in recent years, because the rising price of regular cigarettes has made alternative products more attractive in terms of price. Secondly, smokeless tobacco products are currently taxed at lower

Products and services segmentation (2016)

Total $37.6bn

51.2% Regular cigarettes

2.5% Cigars

26.3% Menthol cigarettes

11.2% Smokeless tobacco

4.5% Other 4.3%

E-vapor products

SOURCE: WWW.IBISWORLD.COM

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Products & Markets

Products & Services continued

rates than conventional cigarettes. Furthermore, the discreet nature of smokeless products allows consumers to avoid the negative social stigma of smoking while still obtaining their nicotine fix. As the social acceptability of smoking erodes and the number of restricted smoking areas increases, more consumers are expected to turn to smokeless tobacco products in the upcoming years. This segment’s share of revenue is expected to continue expanding in upcoming years, as more smokers are expected to switch from cigarettes to smokeless tobacco alternatives.

Cigars Domestically produced cigars are expected to account for 2.5% of industry revenue in 2016. The term “cigar” denotes a broad category of smokeable tobacco products that range from machine-made little cigars (cigarillos) to imported, hand-made cigars sold at a premium. The key distinguishing feature between cigarettes and cigars is that the former is wrapped using paper while the latter is typically wrapped with rolled tobacco leaf.

The cigar segment has benefited from the Food and Drug Administration (FDA) ban of flavored cigarettes, as younger smokers have turned to chocolate-, candy- and fruit-flavored cigars to satisfy their craving for flavored tobacco products. According to the CDC, little cigars are particularly popular among the youth because aside from the wrapper they are almost identical to cigarettes. Furthermore, cigars are typically taxed at lower rates than cigarettes and can be sold individually. Despite the

growing awareness of the health risks associated with tobacco products, the use of large cigars has increased 233.0% from 2000 to 2011, according to a study conducted by the CDC (latest data available). Consequently, cigars’ share of industry revenue has increased over the past five years.

Other Other products are estimated to account for the remaining 8.8% of revenue. They include pipe tobacco, tobacco substitutes (e.g. clove cigarettes or e-cigarettes), homogenized and reconstituted tobacco, tobacco extracts and essences. While sales of tobacco substitutes are growing in the domestic market, a small percentage of the population currently uses these products. Therefore, it represents a rapidly growing, but small share, of industry sales. This segment’s share is anticipated to have increased in the past five years, primarily driven by the continued market expansion of e-cigarettes in the United States. E-cigarettes and other novel tobacco products were effectively unregulated by the FDA for most of the five-year period, although product-specific regulation passed in early 2016. The e-cigarette product group in particular is expected to continue growing, especially as leading cigarette manufacturers develop their own e-cigarette brands or continue to acquire existing brands. According to major player Altria Group, annual retail sales of e-cigarettes and related accessories doubled every year through 2014 to $2.0 billion, though growth has decelerated in more recent years due to new regulations and reduced consumer confidence in e-vapor products.

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Products & Markets

Demand Determinants

Demand for cigarettes and other tobacco products is primarily driven by the social acceptability of smoking. The association of smoking with a certain lifestyle became engrained in American culture through popular movies in the 1940s. However, as public awareness of the adverse health risks associated with smoking became widespread, the percentage of adults who smoke began to drop significantly in the late 1970s. While the number of adults who smoke continues to decline, the percentage of teen smokers has declined more slowly in recent years, as smoking has come back into fashion among this age group. In particular, the rising use of electronic cigarettes, smokeless tobacco and other novel tobacco products among millennials has once again boosted demand from this consumer group, despite the efforts of anti-tobacco groups to curb teen smoking in recent years.

While the addictive quality of nicotine safeguards demand for tobacco products to a certain extent, demand for cigarettes is declining due to growing health concerns and social stigma associated with smoking in public places. Consumption of cigarettes has also declined because of extensive steps taken by the federal and state governments to discourage consumption of tobacco products. These measures include strict restrictions on advertising and sales promotion activities, requirements that health warnings be printed on cigarette packets, bans on smoking in specified locations and public antismoking campaigns funded by annual payments from the largest tobacco manufacturers (see Regulation section). For example, regulations restricting the use of cigarettes in public areas make smoking

less convenient and cause people to smoke less frequently when traveling or at work.

Higher excise taxes enforced by state and federal authorities have significantly raised the retail price of tobacco products over the past several years. In addition, the rising cost of tobacco leaves has caused manufacturers to raise their products, further discouraging smokers from purchasing cigarettes as frequently as before. In order to manage their spending on tobacco products, some smokers have switched to alternative tobacco products that are taxed at lower rates, such as snuff, chewing tobacco or cigarillos (little cigars).

Lastly, the introduction and quick adoption of the electronic cigarette (e-cigarette) has helped drive demand for industry products over the five years to 2016. This innovative product is perceived as a less harmful alternative to traditional cigarettes and is produced in a variety of flavors that appeal to younger smokers. Furthermore, e-cigarettes are currently not subject to the same level of excise taxes at the federal or state levels, making this product more affordable than regular cigarettes. However, recent uncertainty over the future regulation of electronic cigarette products has decelerated growth during the latter half of the five-year period. In early 2016, the FDA finalized its ruling on e-vapor products, stating that innovative tobacco alternatives would be subject to the same level of regulatory scrutiny as traditional tobacco products. Overall, demand for tobacco products has declined steadily since the early 1980’s, and is expected to continue declining unabated in the coming years.

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Products & Markets

Major Markets

Tobacco product manufacturers typically sell their products to intermediary wholesalers who in turn, resell the products to retail establishments such as convenience stores, grocery stores, supermarkets, pharmacies, dollar stores and smaller street vendors. Some large supermarket or grocery store chains, such as Walmart, have the purchasing power to source tobacco products directly from the manufacturers, thereby bypassing the wholesaler. Nonetheless, the majority of industry products are distributed to retail channels via the Cigarette and Tobacco Products Wholesaling industry (See IBISWorld report 42494).

Wholesalers Wholesalers constitute the largest downstream market for tobacco product manufacturers, accounting for a combined 84.0% of industry revenue in 2016. This market segment consists of two broad types of wholesalers: consumer packaged foods (e.g. candy and tobacco) distributors and broadline grocery distributors.

The first group, which accounts for a 71.4% share of the industry, consists of national and regional wholesalers that primarily distribute tobacco products,

snacks and confectioneries to convenience stores, dollar stores, pharmacies and other related retail channels. The two largest operators within this market are McLane Company, a subsidiary of Berkshire Hathaway, and Core-Mark International. McLane Company is the largest tobacco wholesaler to major retail chains Walmart, 7-Eleven and Family Dollar. Core-Mark International is a major distributor to convenience store and gas station chains such as Alimentation Couche-Tard and Turkey Hill. This segment’s share of industry revenue is expected to rise over the next five years as demand from convenience stores picks up.

The second group, broadline grocery distributors, is estimated to account for a 12.6% share of the industry in 2014. Wholesalers within this product segment distribute a variety of groceries, foodservice products and other nondurable goods to supermarkets, grocery stores and restaurants. Consequently, tobacco products represent only a small and incidental share of these companies’ broad product portfolios. This segment’s share of total industry revenue has shrunk over the past five years and is expected to continue shrinking as major broadline

Major market segmentation (2016)

Total $37.6bn

71.4% Candy and tobacco wholesalers

1.1% Exports

12.6% Broadline grocery distributors

8.8% Supermarkets

3.1% Other major retail chains

(pharmacies, grocery stores)

3.0% Other

SOURCE: WWW.IBISWORLD.COM

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Products & Markets

Major Markets continued

distributors, such as C&S Wholesale Grocers, increasingly divest from tobacco in response to growing public scrutiny of tobacco use.

The rising prevalence of wholesale bypass, which has negatively affected almost all other nondurable product wholesaling industries, is not a significant issue for tobacco wholesalers because of tobacco’s unique regulatory environment. Although manufacturers are responsible for paying federal excise taxes, downstream wholesalers and retailers are responsible for excise taxes at the state level. Since these taxes can vary greatly across state lines and product groups, only specialized wholesalers that have a well-established presence in the tobacco industry typically have the knowledge and resources to collect and remit the appropriate taxes. Consequently, IBISWorld expects wholesalers to remain the industry’s largest market segment in the near future.

Retailers Direct sales to retailers, which include large supermarkets, grocery store and pharmacy chains and dollar stores, account for an 11.9% share of revenue in 2016. Typically, only large supermarket chains with sufficient purchasing power, such as Walmart or Kroger, are able to purchase tobacco products in bulk directly from manufacturers. In practice, however, even major supermarket chains typically source tobacco products through intermediary wholesalers. For example, Walmart, which is presently the largest supermarket chain in the United States, sources the bulk of its regular tobacco purchases from McLane Company. This market segment’s share is expected to shrink slightly in upcoming years as demand for cigarettes and other tobacco products from convenience stores (and ultimately, demand for convenience store wholesalers) outstrips demand for tobacco products from traditional grocery stores, supermarkets and pharmacies.

Exports Exports have historically accounted for a small share of industry revenue because manufacturing is localized due to extensive domestic and international regulations. Consequently, exports are estimated to account for only 1.1% of industry revenue in 2016, representing a decline from 1.2% in 2011. Due to an appreciating dollar, industry exports became less affordable to consumers in foreign markets, causing exports to decline overall during this five-year period. Additionally, industry leader Philip Morris moved its production for the European market from North Carolina to Europe, further lowering industry exports. The Master Settlement Agreement signed in 1998 between the attorneys general of 46 states and four largest tobacco companies (see Regulation section), has also kept exports of tobacco products low during the past five years. The vast majority of US-made tobacco products are exported to US military bases overseas or duty-free shops located in international airport terminals. Sales to all other foreign retail outlets account for an insignificant portion of export volume.

Other Other markets for tobacco products account for the remaining 3.0% of revenue in 2016. These include specialty outlets such as cigar shops, hookah bars, duty-free shops at US-based international airports and other travel hubs, army bases, online tobacco retailers and other niche stores. While many hospitality industries, including hotels, bars and casinos, buy tobacco products from wholesalers, some major chains that operate nationally can purchase directly from manufacturers. Many niche shops that offer premium, handmade cigars and premium pipe tobacco also purchase these products directly from manufacturers.

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Products & Markets

International Trade The Cigarette and Tobacco Manufacturing industry has a low level of international trade, primarily due to a rapidly developing regulatory environment at the global level that has discouraged domestic producers from exporting tobacco products to international markets.

Imports Imported cigarettes and tobacco products are anticipated to account for 3.0% of domestic demand for industry goods in 2016, representing a significant increase from 1.8% in 2011. Imports of industry products have historically been low, as domestic producers have satisfied demand for tobacco products among American smokers. However, imports have grown over the past five years, as regulation and the growing price of domestic products have driven smokers to purchase imported handmade cigars from the Caribbean region or imported snus from European countries such as Sweden or Denmark. In terms of product categories, large cigars accounted for 75.1% of total import volume in 2015, while cigarettes and tobacco extracts (e.g. used in e-vapor devices) accounted for 17.6% and 2.1% of volume, respectively.

Imports of cigarettes and tobacco products mainly come from premium handmade cigar producing countries in Latin America. Specifically, industry goods from the Dominican Republic are anticipated to account for 52.0% of total

imports in 2016. Cigars from this country, which are ranked as one of the best in the world, have helped boost demand for imports. Nicaragua and Honduras represent the second and third largest sources of industry imports, respectively. Cigar imports from Nicaragua have grown in recent years as several leading premium cigar producers, such as Rocky Patel Premium Cigars Inc., have established factories in this country. The majority of premium cigars produced in Latin America are imported and distributed domestically by S&K Imports Inc., the largest cigar and cigarillo importer in the United States.

Exports Global tobacco producers have shifted their focus on growing markets like the Middle East and Asia, where per capita smoking rates are rising, by establishing production facilities in strategic locations. For instance, industry leader, Philip Morris, consolidated its domestic production to one factory and transferred its production for the European market to Europe. Likewise, Reynolds American Inc. (RAI) is effectively a spinoff of global company British American Tobacco, which produces iconic cigarette brands Kent and Pall Mall for distribution in non-American markets. More recently, RAI sold the international rights to the American Spirit brand name to Japan Tobacco Inc. As a result, the top two largest tobacco manufacturers, Phillip

Major Markets continued

Online retailing has grown slightly due to the convenience of shopping at home through the internet, although expansion has been offset by the constantly changing and unpredictable regulatory framework surrounding online tobacco sales. This uncertainty is exacerbated by concerns of minors illegally purchasing tobacco online

without providing adequate proof of age, as well as the possibility of tax evasion if tobacco products are sold across state lines without collecting the appropriate state-level excise tax. Accordingly, online sales of domestically-produced tobacco products are expected to account for less than 1.0% of industry revenue in 2016.

Level & Trend Exports in the industry are Low and Decreasing

Imports in the industry are Low and Increasing

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Products & Markets

International Trade continued

Morris and Reynolds American, are now almost entirely focused on domestic operations. Consequently, exports’ share of industry revenue has declined from 1.2% in 2011 to an estimated 1.1% in 2016. Exports are expected to continue declining in the coming years, accounting for an estimated 1.0% share of revenue by 2021.

Exports of US-made tobacco products are primarily made to US military bases and duty-free shops overseas. Accordingly, Japan represents the largest export market by a significant margin, due to the large number of US military personnel positioned in that country. However, exports to Japan have declined moderately in recent years, due to a strengthening dollar that makes American cigarettes more expensive and the declining demand for tobacco products in Japan. According to Japan Tobacco Inc.’s annual survey, the percentage of Japanese adult smokers hit an all-time low of 20.0% in 2014,

and is expected to continue dropping through 2016. Exports to Canada, another important market, have also decreased over the past five years. However, exports to the Dominican Republic and Russia have grown significantly during this period, helping offset some of the losses from Japan and Canada.

Imports From...

Total $1.2bn

6.3% Honduras

8.7% South Korea

13.0% Nicaragua

20.0% Other Countries

52.0% Dominican

Republic

Exports To...

Total $422.7m

62.7% Japan

15.4% Dominican

Republic

13.8% Other Countries

5.6% Canada

2.5% Russia

Year: 2016 SIZE OF CHARTS DOES NOT REPRESENT ACTUAL DATA SOURCE: USITC

$ m

ill io

n

1000

-1500

-1000

-500

0

500

2208 10 12 14 16 18 20Year

Exports Imports Balance

Industry trade balance

SOURCE: WWW.IBISWORLD.COM

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Products & Markets

Business Locations 2016

MO 2.0

West

West

West

Rocky Mountains Plains

Southwest

Southeast

New England

Great Lakes

VT 0.0

MA 0.0

RI 0.0

NJ 1.0

DE 0.0

NH 0.0

CT 2.0

MD 0.0

DC 0.0

1

5

3

7

2

6

4

8 9

Additional States (as marked on map)

AZ 2.0

CA 3.0

NV 2.0

OR 0.0

WA 0.0

MT 0.0

NE 0.0

MN 0.0

IA 0.0

OH 0.0

VA 6.9

FL 15.8

KS 0.0

CO 1.0

UT 0.0

ID 0.0

TX 4.0

OK 1.0

NC 18.8

AK 0.0

WY 0.0

TN 5.9

KY 6.9

GA 3.0

IL 1.0

ME 0.0

ND 0.0

WI 0.0 MI

1.0 PA 9.9

WV 1.0

SD 0.0

NM 1.0

AR 0.0

MS 0.0

AL 1.0

SC 1.0

LA 0.0

HI 0.0

IN 1.0

NY 7.9 5

6 7

8

3 21

4

9

SOURCE: WWW.IBISWORLD.COM

Mid- Atlantic

Establishments (%)

Less than 3% 3% to less than 10% 10% to less than 20% 20% or more

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Products & Markets

Business Locations The Southeast region of the country, which accounts for 60.2% of establishments, dominates the Cigarette and Tobacco Manufacturing industry. The region’s share of establishments is more than double the percentage of the population that resides in this region. A majority of manufacturers are established in this region due to the abundance of tobacco farms in the area, giving producers easy access to the key ingredient for their products. In addition, industry operators benefit from being located near sources of key inputs, as the cost of transporting materials is relatively low. North Carolina, in particular, accounts for 18.8% of establishments. Major players Reynolds American and Lorillard Inc. are also headquartered in North Carolina. Finally, Florida is another major contributor, accounting for 15.8% of total establishments, with the majority of these establishments involved in the e-vapor category.

The Mid-Atlantic is another major region in this industry with 18.8% of establishments. New York, New Jersey and Pennsylvania together hold nearly the entire share of establishments for the region, as many tobacco farms are located in these states. Therefore, easy access to inputs and low transportation costs make the region attractive to industry operators.

The Southwest and West account for 8.0% and 5.0% of industry establishments, respectively. However, their share of total establishments has declined due to greater investment in plants in other regions. In addition, the Rocky Mountains (1.0%), New England (2.0%) and Plains (2.0%) regions do not represent significant operating areas for this industry. These regions are not suitable for tobacco farmers so establishments are less likely to operate in these areas.

%

75

0

15

30

45

60

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hw es

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t

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la nd

Pl ai

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R oc

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So ut

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Establishments Population

Establishments vs. population

SOURCE: WWW.IBISWORLD.COM

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WWW.IBISWORLD.COM Cigarette & Tobacco Manufacturing in the US August 2016 25

Key Success Factors Economies of scale Successful companies benefit from the large scale of operations, which allows them to spread production costs over a large volume of output, reducing per-unit costs.

Ability to effectively change community behavior The leading producers have introduced new products, such as electronic cigarettes, that are viewed as less harmful alternatives to traditional tobacco products to maintain demand for industry goods.

Marketing of differentiated products Tobacco companies are effectively banned from using conventional marketing methods (i.e. commercials,

billboards), so manufacturers must market their products aggressively through other means to maintain market share in a highly competitive market.

Ability to pass on cost increases Due to rising excise taxes and falling demand for industry products, the leading producers have increased their product prices to maintain earnings.

Effective quality control It has become imperative for operators to produce high-quality cigarettes due to extensive media coverage of the negative health consequences of smoking. Also, faulty products can lead to product recalls and taint a brand’s reputation.

Market Share Concentration

The Cigarette and Tobacco Manufacturing industry is highly concentrated. Based on data from IRI Group and Management Science Associates Inc., made publicly available by Altria Group and Reynolds American Inc. (RAI), Altria’s Marlboro brand alone accounted for a 44.0% share of the cigarette market, while RAI’s respective cigarette brands (which now include Camel and Newport) accounted for 32.0% of the US retail market in 2015. These two companies alone are expected to generate a combined 81.9% of industry revenue in 2016.

Despite the dominant position that these producers have held for decades, market share concentration has further intensified over the past five years as these manufacturers engaged in several acquisitions. For example, Altria Group acquired US Smokeless Tobacco Co. in 2009 to expand its product portfolio and grow its market share. In 2012, Lorillard acquired Blu eCigs, a manufacturer of electronic cigarettes, for the same reasons. More recently, RAI completed its acquisition of Lorillard for an

estimated $27.4 billion. Lorillard was previously the third-largest operator in the industry, accounting for an 18.4% share of the market in 2014. This acquisition boosted RAI’s share of the market from 22.3% in 2014 to an estimated 32.9% in 2016. As a part of this merger, RAI and Lorillard also agreed to divest several assets, including certain brands, a manufacturing facility and over 2,700 employees, to ITG Brands (a subsidiary of Imperial Brands plc). Due to this restructuring, ITG Brands’ share of the tobacco industry also increased from less than 3.8% in 2014 to an estimated 7.0% in 2016. Overall, the combined market share of the top four tobacco manufacturers has increased to an estimated 91.6% of industry revenue in 2016.

Due to rising barriers to entry and an increasingly stringent regulatory framework that prevents smaller companies from entering the industry or gaining a meaningful share of the market, IBISWorld anticipates this industry’s market share concentration to continue increasing over the next five-year period.

Competitive Landscape Market Share Concentration | Key Success Factors | Cost Structure Benchmarks Basis of Competition | Barriers to Entry | Industry Globalization

Level Concentration in this industry is High

IBISWorld identifies 250 Key Success Factors for a business. The most important for this industry are:

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Competitive Landscape

Cost Structure Benchmarks

Due to its unique regulatory environment, the Cigarette and Tobacco Manufacturing industry’s cost structure differs substantially from that of any other manufacturing industry. Cost structures vary among industry operators, depending on their size and scale of production, proximity to tobacco farms, exposure to litigation claims and levels of technology and capital investments. Large manufacturers typically incur lower per-unit production costs than smaller competitors because these operators are able to spread production costs out over a large volume of output and spend more on brand development. Consequently, the industry’s largest operators benefit from much higher profit margins than niche and small-batch producers.

Profit Profit, or earnings before interest and taxes, is estimated to account for 32.7% of industry revenue in 2016. Tobacco

companies’ profit margins are relatively high when compared with other manufacturing industries because the naturally addictive nature of tobacco products in addition to strong brand loyalty allows manufacturers to charge a premium for their products without a significant drop in demand. Additionally, due to the small package sizes of cigarettes, packaging material accounts for a small share of total purchases. Finally, the price that producers charge their downstream customers is much higher than the cost of inputs.

Even though the retail price of tobacco rose steadily over the past five years, companies raised their prices at a slightly faster pace to maintain their profit margins. Additionally, the consolidation of industry operators has allowed the leading producers to reduce costs through economies of scale. Lastly, the five years since the ratification of the

Sector vs. Industry Costs

n Profi t n Wages n Purchases n Depreciation n Marketing n Rent & Utilities n Other

Average Costs of all Industries in sector (2016)

Industry Costs (2016)

0

20

40

60

Pe rc

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f re

ve nu

e

80

100

SOURCE: WWW.IBISWORLD.COM

8.1

32.3

56.7

0.41.81.6 5.0 2.2

19.9

2.1 0.62.6

54.2

12.0

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Competitive Landscape

Cost Structure Benchmarks continued

2009 Tobacco Control Act (see Regulation section) have given manufacturers enough time to adjust their prices appropriately to sustain profit margins. Consequently, the industry’s profitability has risen significantly since 2011.

Purchases Purchases, which account for an estimated 5.0% of revenue, include a variety of raw materials, such as tobacco leaves, paper, additives, cellulose materials and packaging. However, the most important and substantial input for industry producers is tobacco leaf. According to data sourced from the World Bank, the world price of tobacco leaves is anticipated to rise an annualized 2.2% in the five years to 2016. Additionally, the cost of wood pulp, which is used to create filters in cigarettes, has risen at an average annual rate of 0.4%, further boosting the cost of inputs for manufacturers. Consequently, purchase costs have risen as a share of industry revenue over the past five years. Nonetheless, fluctuating material costs have very little impact on the industry’s overall performance due to the industry’s unique cost structure and high profit margins.

Wages Wages are estimated to comprise just 2.2% of industry revenue in 2016, relatively unchanged as a share of revenue since 2011. Producers have increased their reliance on technology and equipment over the years, boosting production efficiencies. Additionally, the leading cigarette producer, Philip Morris USA, consolidated its US manufacturing facilities during the past five years, substantially reducing the number of industry employees. Industry operators are likely to keep labor costs low over the next five-year period as other costs, including expenses related to regulatory compliance, excise tax remittance and litigation, continue to rise.

Marketing Relevant marketing expenses account for a combined 1.8% of industry revenue in 2016. As part of the Final Tobacco Marketing Rule passed in 2010, tobacco-affiliated businesses are effectively prohibited from engaging in traditional methods of advertising, including outdoor billboards, TV or radio commercials and attractive product packaging. These prohibitions are intended to curb tobacco products’ appeal to youth, who are otherwise susceptible to traditional forms of tobacco marketing. Moreover, the Food and Drug Administration implemented new rules in 2010 that ban tobacco companies from sponsoring sporting and entertainment events, prohibit free cigarette samples and giveaways and restrict the use of self-service displays, among other restrictions. In 2016, the FDA released new rulings that expand such restrictions to electronic cigarettes and other innovative tobacco products.

Examples of marketing programs that can still be used by manufacturers include exclusive consumer engagement programs, promotional pricing through discounts and retail coupons, advertising in certain magazines and advertising in adult- only venues. According to the Federal Trade Commission’s latest reports on the tobacco industry, operators spent a total of $9.4 billion on advertising and promotional activities in 2013 (latest data available). However, 92.0% of these expenses was spent on non- traditional marketing methods such as price discounts and promotional allowances, neither of which are considered relevant marketing expenses in IBISWorld reports. During the past five years, spending on traditional advertising methods fell, while spending on promotional allowances has increased.

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Competitive Landscape

Cost Structure Benchmarks continued

Other All other costs are estimated to account for 56.3% of industry revenue in 2016. This segment includes a number of expense categories that are unique to the tobacco industry, including federal excise taxes, tobacco-related litigation costs and ongoing payments to the signatories of the 1998 Master Settlement Agreement (MSA). For example, federal excise tax payments accounted for 25.8% of Altria Group’s industry-relevant revenue in 2015, while MSA and FDA user fees accounted for an additional 18.9% of net sales in that year. Although payments associated with the Fair and Equitable Tobacco Reform Act (FETRA) were concluded in 2014, these costs were significant in previous years (see Regulation section).

Litigation costs and settlement payouts are unique costs for operators in the Cigarette and Tobacco Manufacturing industry and are estimated to account for a significant 18.6% share across all industry operators. These costs, which are mostly associated with annual payments in accordance with the MSA, are much higher among the two largest manufacturers (Philip Morris USA and Reynolds) than among smaller operators. For example, Phillip Morris USA (Altria Group) faced over 62 independent tobacco-related cases at the end of 2015, in addition to several class action suits and ongoing costs unrelated to the MSA. Likewise, Reynolds has paid over $130.0 million in unfavorable tobacco-related judgments unrelated to

the MSA in just the past three years. However, as the number of smokers in the United States continues to decline in the near future, the frequency of lawsuits brought against producers is anticipated to fall. In particular, litigation costs unassociated with the MSA are expected to decline as a greater number of cases related to the Engle vs. Liggett decision are settled (see Regulation section).

Remittance of federal excise taxes also constitutes another major expense. Federal excise taxes on tobacco products are levied exclusively on the manufacturers, which collect the appropriate per-unit tax on their products and pass down the added expense to wholesalers or retailers in the form of higher selling prices. Since excise taxes are usually adjusted to unit sales volume, declining shipment levels in recent years have lowered this expense’s share of industry costs since 2011. Nonetheless, excise tax’s share of industry costs is likely to increase considerably over the next five-year period because the government may raise tax rates on cigarettes another $0.94 per pack as part of the proposed federal budget.

Depreciation is anticipated to constitute 1.6% of industry revenue in 2016. While capital investments have remained steady over the past five years, they have declined in the past decade as operators have consolidated their manufacturing facilities. As a result, rent and utilities are also anticipated to have declined over the past five years, accounting for just 0.4% of industry revenue in 2016.

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Competitive Landscape

Basis of Competition The level of competition that industry operators face is very high, with internal competitors constituting the majority of competition. Manufacturers primarily compete based on product price, quality and differentiation. The high level of market share concentration and continued consolidation of industry operators have heightened the level of competition in this industry. Finally, the leading manufacturers have competed to acquire small producers of niche products, such as electronic cigarettes and smokeless tobacco, to expand market share and reach new consumer groups in response to declining tobacco consumption across all demographics.

Internal competition The perceived quality of a particular product or brand determines the price that consumers are willing to pay. While there are many different products available in the market, the leading manufacturers enjoy a high degree of brand loyalty for their cigarettes and tobacco products. Qualities including taste, nicotine strength, smell and length of burn determine a smoker’s preference for a specific brand. Producers have also driven brand loyalty through branding, advertising and packaging. For instance, the preeminence of Marlboro is underpinned by its clean-cut packaging and the association of the brand with a certain lifestyle. Indeed, Marlboro, Newport, Camel and Pall Mall have been iconic cigarette brands for decades, having developed a strong association with a distinctively American culture during that time. Strong brand loyalty for cigarettes, along with the addictive nature of nicotine, hedges producers against declining demand prompted by intensifying public scrutiny, social stigma and more comprehensive regulation.

Falling volume sales of cigarettes has prompted producers to introduce a variety of new products to attract

smokers seeking a healthier alternative to tobacco. Although electronic cigarettes have not yet been proven to be less harmful than traditional cigarettes, many consumers perceive them to be less harmful to the body and the environment. In response to the growing demand for this product, many small-batch producers have entered the industry, while large manufacturers like Reynolds American Inc. (RAI) have acquired smaller companies that specialize in electronic cigarettes. Additionally, industry leader, Altria Group, introduced its own electronic cigarette brand, MarkTen, in 2013. More recently, RAI rolled out its VUSE brand of disposable e-cigarettes nationwide, after a year of strong sales in limited test geographic regions. According to IRI retail sales data, VUSE is now the leading e-cigarette brand sold in convenience stores.

Despite the addictive quality of nicotine and strong consumer loyalty to specific brands, significant price increases can cause smokers to trade down to more affordable brands or purchase a smaller volume of cigarettes. Consequently, industry operators compete to offer affordable product prices at different retail channels. Larger producers benefit from possessing substantial market power and long-term contracts with suppliers of key industry inputs, as well as strong relationships with major downstream tobacco wholesalers such as McLane Company or Core- Mark International. Consequently, the leading manufacturers enjoy lower input and purchase costs when compared with smaller producers, allowing them to give their downstream customers promotional allowances or contingent price discounts to drive demand for their brands.

Level & Trend Competition in this industry is High and the trend is Increasing

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WWW.IBISWORLD.COM Cigarette & Tobacco Manufacturing in the US August 2016 30

Competitive Landscape

Barriers to Entry The barriers to entry in the Cigarette and Tobacco Manufacturing industry are extremely high. First, industry prospects must obtain a permit from the Alcohol and Tobacco Tax and Trade Bureau (TTB), which operates under the Department of the Treasury. The bureau’s process allows companies to submit an application for permits to manufacture and import cigarettes, cigars, chewing tobacco, snuff, pipe tobacco and roll-your-own tobacco. Applicants must secure manufacturing facilities, obtain a bond for compliance, determine how to address environmental regulations and pay taxes before beginning operations. If the TTB determines that the applicant is eligible, a tobacco application specialist conducts an interview for additional screening. Finally, the Trade Investigations Division conducts an on-site investigation to approve or deny the manufacturer’s application. This lengthy process presents a significant barrier to entry for

this industry. In recent years, several operators have entered the industry to capitalize on the burgeoning electronic cigarette or vaporizer market, which was relatively less regulated until early 2016. However, the FDA’s recent rulings on electronic nicotine delivery systems (ENDS) are likely to increase compliance costs considerably for these smaller players, in turn raising barriers to entry (see Regulation section).

Additionally, this industry necessitates significant initial capital investments, which represent another significant barrier to entry. Potential new entrants must purchase machinery and equipment to produce and pack cigarettes. While used cigarette producing and packing machines are available, the price of used equipment is still significant and can lead to greater maintenance fees in the long term.

The eight leading cigarette and tobacco product manufacturers effectively control over 99.0% of industry market share.

Basis of Competition continued

External competition The main source of external competition that cigarette and tobacco manufacturers face are producers of smoking cessation products. The nicotine patch, gum and pill are designed to help people slowly decrease their dependence on the nicotine content of tobacco. As more smokers reduce their reliance on nicotine through these products, demand for cigarettes will fall. However, some firms are beginning to gain ownership over these products and services. For example, major player Reynolds American acquired a smoking cessation firm, Niconovum, which sells mouth sprays and gum to reduce cigarette cravings. Such acquisitions are an attempt made by industry operators to serve as a hedge against declining

demand for traditional cigarettes and tobacco products.

Industry operators also face external competition from imported products. While imports only account for an estimated 3.0% of domestic demand for cigarettes in 2016, this represents an increase from 1.8% in 2011. The majority of imported tobacco products are premium handmade cigars from Latin American countries or premium snus from Sweden or Denmark. Despite the higher price of imported tobacco products, rising disposable income levels in the United States has allowed more consumers to purchase premium imported goods. Furthermore, tobacco products sourced from Caribbean and Latin American countries are ranked as the best in the world due to the quality of the tobacco grown in this region.

Level & Trend Barriers to Entry in this industry are High and Increasing

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Competitive Landscape

Industry Globalization

The industry has a low level of globalization, as most of the leading producers’ operations are concentrated in the United States. Production for the domestic market takes place within the United States due to the efficiencies and cost savings of localizing production and distribution. Furthermore, complex foreign regulations and tax laws caused industry leader, Altria Group, to spin-off its international business in 2007. This divestiture allowed the parent company to focus on growing its domestic market share through its Philip Morris USA and John Middleton business segments. Likewise, Reynolds American Inc. is a US-based spinoff of the global cigarette conglomerate, British American Tobacco. In addition, while Imperial Tobacco is based in the United Kingdom, the company entered the US market through its acquisition of Commonwealth Brands in 2007.

Industry operators engage in very limited international trade. Most of the trade for tobacco takes place within the Tobacco Growing industry (IBISWorld report 11191). In addition, because cigarette production is localized, domestic producers usually satisfy domestic demand for cigarettes and tobacco productions. As a result, imports are expected to account for 3.1% of domestic demand in 2016, with the majority of imports consisting of handmade cigars from the Caribbean. Likewise, exports are estimated to account for only 1.1% of industry revenue. Exports fell over the past five years, partially driven by the consolidation of Philip Morris’ US operations and the expansion of its production facilities abroad. In contrast, imports have grown during this period as smokers have taken a greater interest in premium cigars and snus made from foreign tobacco leaf.

Barriers to Entry continued

Furthermore, these large companies have acquired smaller producers in recent years to expand their market share, which has consequently raised entry barriers. The leading cigarette manufacturers also benefit from lower per-unit production costs due to economies of scale. Consequently, they are able to lower the prices they charge their downstream customers to outperform new entrants. Most importantly, declining demand for cigarettes poses the most significant barrier to entry, as the industry presents very limited opportunities for growth. In effect, intensifying competition, the well-entrenched positions of the top

manufacturers, sinking demand for the industry’s major products and an increasingly stringent regulatory environment make it impractical for newcomers to enter the industry.

Barriers to Entry checklist

Competition High Concentration High Life Cycle Stage Decline Capital Intensity High Technology Change Medium Regulation & Policy Heavy Industry Assistance Medium

SOURCE: WWW.IBISWORLD.COM

Level & Trend Globalization in this industry is Low and the trend is Steady

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Competitive Landscape

Industry Globalization continued

SOURCE: WWW.IBISWORLD.COM

Trade Globalization Going Global: Cigarette & Tobacco Manufacturing 2003-2016

Ex po

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Re ve

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150

100

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0

200

150

100

50

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Imports/Domestic Demand Imports/Domestic Demand 0 040 4080 80120 120160 160

International trade is a major determinant of an industry’s level of globalization.Exports offer growth opportunities for fi rms. However there are legal, economic and political risks associated with dealing in foreign countries.Import competition can bring a greater risk for companies as foreign producers satisfy domestic demand that local fi rms would otherwise supply.

Export ExportGlobal Global

ImportLocal ImportLocal

Cigarette & Tobacco Manufacturing 2003

2016

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Player Performance Altria Group, formerly known as Philip Morris Companies Inc., is a Virginia- based holding company whose subsidiaries engage in the production and distribution of cigarettes, cigars, pipe tobacco, smokeless tobacco products and wine. While the company was originally incorporated in 1985, its involvement in manufacturing tobacco products dates back to 19th-century London, and the company’s cigarettes have been sold in the United States since 1902. The company has several leading tobacco product brands: Marlboro (the top- selling cigarette brand in the United States since the 1970s), Black and Mild cigars, Copenhagen and Skoal smokeless tobacco and smaller cigarette brands such as Benson & Hedges and Virginia Slims. As of early 2016, Marlboro alone had a 44.0% share of the total US cigarette market, while the Copenhagen and Skoal brands had a combined 51.3% share of the smokeless tobacco market, according to retail sales data from Management Science Associates Inc. and IRI. The company as a whole shipped 126.0 billion cigarettes from its domestic production facilities in 2015, up 0.5% from 2014.

Altria Group’s wholly owned tobacco businesses include Philip Morris USA, US Smokeless Tobacco Company and John Middleton, which collectively employ 8,800 workers. Altria participates in the industry through its cigarette, cigar and smokeless product segments, which accounted for 97.0% of the company’s total revenue in 2015. Although the

company does have a global presence, its tobacco manufacturing and distribution operations are based almost entirely in the United States, following the split from Philip Morris International (PMI) in 2007. PMI continues to market the company’s iconic Marlboro brand outside of the United States. Across all operating segments, the company generated net sales of $25.4 billion in 2015.

In 2009, the company acquired US Smokeless Tobacco Company (USSTC), producer of the Copenhagen and Skoal brands of premium smokeless tobacco. With its core cigarette business in decline, the USSTC acquisition helped Altria Group diversify its product portfolio into faster-growing tobacco products. In 2012, the company reorganized its operations to reduce costs and achieve operational efficiencies by combining its cigarette and cigar segments into a single smokeable products segment. Altria Group now divides its operations into smokeable products, smokeless products, wine and financial services. More recently in mid-2014, the company entered the electronic cigarette category by acquiring the e-vapor segment of Green Smoke Inc. for $130.0 million. In mid-2015, Altria group announced plans to collaborate with its global counterpart, Philip Morris International, to jointly develop and market e-vapor products both in the United States and abroad.

In 1998, Philip Morris and several other major US tobacco companies (present-day Reynolds American Inc.)

Major Companies Altria Group Inc. | Reynolds American Inc. Imperial Brands plc | Other Companies

11.0% Other

Altria Group Inc. 49.1%

Reynolds American Inc. 32.9%

Imperial Brands plc 7.0% SOURCE: WWW.IBISWORLD.COM

Major players (Market share)

Altria Group Inc. Market share: 49.1% Industry Brand Names Marlboro Virginia Slims Cambridge Lark Merit Chesterfield L&M Saratoga Nu Mark US Smokeless Tobacco Company

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Major Companies

Player Performance continued

settled litigation under the Tobacco Master Settlement Agreement, agreeing to pay $206.0 billion over 25 years in lieu of continued tobacco-related litigation arising from 46 states. However, the company still faces more than 62 individual pending cases as of mid-2016, ranging from individual health cases and class action suits to claims related to marketing “Marlboro Lights” prior to the 2009 Tobacco Control Act (see Regulation section). In addition, the company continues to face more than 2,860 cases associated with the Engle vs. Liggett decision, among others, though the company resolved roughly 415 of these cases in 2015.

Financial performance IBISWorld estimates Altria Group’s industry-relevant sales to grow an annualized 2.3% to reach $18.4 billion in the five years to 2016. Altria has grown only slightly during this five-year period, mostly due to stagnating sales of cigarettes, which have been partially offset by regular price markups and increased sales of noncigarette products such as smokeless tobacco. The primary drivers of the company’s performance include its well-established brands,

higher product prices and the consolidation of its manufacturing facilities in 2009. While the declining number of smokers has placed downward pressure on the company’s volume sales, it has benefited from brand-loyalty for products like Marlboro, which has consistently grown as a share of the total US cigarette market since 2011.

Despite the hike in federal excise taxes prior to the current five-year period, as well as continually rising tobacco-related litigation costs, the company was able to pass on increased operating expenses to consumers, enabling Altria Group to sustain high and rising profit margins over this five-year period. Indeed, the company’s industry-relevant operating margin has risen from 23.5% in 2011 to an estimated 34.6% in 2016. Although currently a small share of total group revenue, Altria Group’s smokeless tobacco segment was a key driver of growth over the past five years due to the product segment’s lower effective tax rate and per unit cost relative to cigarettes. Altria Group is expected to perform well in 2016, driven primarily by increased prices on cigarettes and sustained demand for the company’s smokeless tobacco brands.

Altria Group (PM USA, USTC and JM operations) - fi nancial performance*

Year Revenue

($ million) (% change) Operating Income

($ million) (% change)

2011 16,416.0 -4.0 3,850.0 -4.1

2012 16,436.0 0.1 4,324.0 12.3

2013 16,865.0 2.6 4,785.0 10.7

2014 17,194.0 2.0 5,343.0 11.7

2015 18,115.0 5.4 5,955.0 11.5

2016 18,424.0 1.7 6,376.0 7.1

*Estimates; revenue given is net of excise taxes SOURCE: ANNUAL REPORT AND IBISWORLD

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WWW.IBISWORLD.COM Cigarette & Tobacco Manufacturing in the US August 2016 35

Major Companies

Player Performance Reynolds American Inc. (RAI) was founded in August 2004 following the merger of North Carolina-based RJ Reynolds Tobacco Company and British American Tobacco’s US business, Brown and Williamson. Incorporated in 1875, RJ Reynolds Tobacco Holdings Inc. was a publicly traded company until July 30, 2004, when it became a wholly owned subsidiary of Reynolds American Inc. RAI is now the second-largest US manufacturer of cigarette and smokeless tobacco products. With more than 5,600 employees, RAI produces about 110.0 billion cigarettes per year through its main manufacturing facilities located in Winston-Salem, NC.

RAI’s operating segments include RJ Reynolds Tobacco Company, Santa Fe Natural Tobacco Company, producer of super-premium tobacco, and American Snuff Company (ASC), formerly known as Conwood Sales Company. While RJ Reynolds and Santa Fe produce regular tobacco products, ASC manufactures smokeless tobacco products under brands including Grizzly, Kodiak and Levi Garrett. The company is best known for its iconic cigarette brands, Camel, Pall Mall and Salem. In recent years, the company’s Natural American Spirit brand has boomed, reaching a record high of 2.0% of the total cigarette market

in 2016, with volume up 22.1% since last year. In addition, the company’s e-cigarette brand, VUSE, quickly became the best-selling e-vapor product at convenience stores following the national rollout in 2015. In 2016, the company introduced a new subsidiary, RAI Innovations Company, which will manage RAI’s e-vapor product portfolio and fund all new research and development within the innovative tobacco products category.

In mid-2015, Reynolds merged with the third-largest industry operator, Lorillard Inc., for an estimated $27.4 billion. As a part of this merger, RAI acquired the Newport brand, which is the best-selling brand of mentholated cigarettes in the United States. However, RAI also divested several assets, including four cigarette brands and one e-vapor brand and a large manufacturing facility as a condition for this merger. These assets were sold for an estimated $7.1 billion to competitor Imperial Brands (ITG Brands), which is now the third-largest tobacco company in the United States. Overall, the merger boosted the company’s share of the industry from just 22.3% in 2014 to an estimated 33.0% in 2016. More recently, the company sold the international (non-US) marketing rights for its

Reynolds American Inc. - fi nancial performance*

Year Revenue

($ million) (% change) Operating Income

($ million) (% change)

2011 8,541.0 -0.1 1,406.0 5.2

2012 8,304.0 -2.8 1,272.0 -9.5

2013 8,236.0 -0.8 1,718.0 35.1

2014 8,471.0 2.9 1,445.0 -15.9

2015 10,675.0 26.0 3,253.0 125.1

2016 12,347.6 15.7 4,494.5 38.2

*Estimates; revenue given is net of excise taxes SOURCE: ANNUAL REPORT AND IBISWORLD

Reynolds American Inc. Market share: 32.9% Industry Brand Names Camel Salem Winston American Spirit Grizzly Kodiak Evo Flask Doral Kool GPC

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Major Companies

Player Performance Imperial Brands, previously known as Imperial Tobacco, is a UK-based tobacco manufacturer that specializes in cigarettes, fine tobacco, cigars and snus. With operations located throughout Europe and the Americas, the company employs more than 38,000 workers globally. Imperial Brands entered the Cigarette and Tobacco Manufacturing industry in 2007 when it acquired Commonwealth Brands Inc. Imperial’s global brands include products under the L and B, Gitanes and Skruf brand names. Global revenue from the sale of tobacco products, including remittance of excise taxes, totaled $29.0 billion in 2015. The company segments its operations into two geographic areas: growth markets and return markets. US operations were included in the growth markets segment for most of the five-year period, until the company restructured its operations in late 2015.

With manufacturing facilities in Reidsville, NC, Commonwealth produces eight cigarette brands, including USA Gold, Davidoff and Malibu. Within the cigarette segment, the USA Gold and

Sonoma brands experienced some growth over the past five years, though intense competition from premium cigarette brand manufacturers have hurt financial performance. Despite the competitive nature of the market, Imperial Tobacco also increased product prices in the United States and focused on expanding its USA Gold product line, which is marketed as an economic brand of cigarettes in 19 states.

As mentioned above, the company acquired several assets from RAI and Lorillard after the two companies’ merger in mid-2015. These assets include cigarette brands Maverick, Kool, Salem and Winston, as well as RAI’s Blu electronic cigarette brand. Furthermore, the company acquired one of Lorillard’s manufacturing facilities, as well as its national sales force of 2,750 employees. As a contingency of the merger plan, both companies agreed to continue manufacturing each other’s brands until the transition was finalized, which occurred in July 2016. Following the acquisition, Imperial Brands formed a new holding company, ITG Brands, to

Player Performance continued

American Spirit brand to Japan Tobacco Inc., for an estimated $5.0 billion. However, this divestiture has not affected the company’s share of the domestic tobacco industry.

Financial performance RAI has performed well over the past five years, driven primarily by its 2015 merger with Lorillard, as well as sustained demand for the company’s existing smokeless and innovative tobacco brands. Following the national rollout of flavored cartridges, the company’s VUSE brand quickly gained a 33.6% share of the convenience store market for e-vapor products. Mirroring the overall tobacco market during the

five-year period, Reynolds experienced declining consumption levels for most of its cigarette brands, although growing demand for smokeless tobacco products, as well as increasing pricing on premium cigarette brands, has helped offset this negative trend. Like its larger competitor, RAI’s profit margins have also improved significantly over the five-year period, effectively doubling from 16.5% in 2011 to an estimated 36.4% in 2016 because of the Lorillard merger and divestiture. Overall, RAI’s industry-relevant sales are expected to rise an annualized 7.7% to $12.3 billion over the five years to 2016, with most of this growth attributable to the Lorillard merger in mid-2015.

Imperial Brands plc Market share: 7.0% Industry Brand Names Newport Kent True Old Gold Maverick

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Major Companies

Other Companies Vector Holding (Liggett Group) Estimated market share: 2.6% Vector Group participates in the Cigarette and Tobacco Manufacturing industry through its two wholly owned subsidiaries, Liggett Group LLC and Vector Tobacco Inc. The company also owns New Valley LLC, an investment company based in Miami. Vector Group’s industry-specific operations employed a combined 470 workers and produced 8.7 billion cigarettes in 2015.

The company is primarily involved in the discount and deep discount segment

of the cigarette market. Vector Holdings’ discount cigarette brands include Eve, Grand Prix, Pyramid and Liggett Select. Vector Group tends to focus on developing its marketing efforts for these discount cigarette brands. Since Liggett Group has historically had a small share of the US cigarette market, it is not a signatory to the Master Settlement Agreement, thereby giving the company a significantly different cost structure from its three larger competitors. Nevertheless, due to lower smoking rates in the United

Player Performance continued

consolidate its new US operations, as well as separating its US sales from the broader growth market into a new business segment. The company’s premium brand portfolio now includes Winston and Kool, and its discount brands include USA Gold and Maverick. Cigarettes are roughly 85.0% of ITG Brand’s net revenue, with the remaining 15.0% generated from machine-made cigar sales. At the beginning of 2015, ITG brands employed roughly 2,700 workers, including a national salesforce of 950 people.

Financial performance ITG Brands experienced weak performance during the first half of the

five-year period, as intense competition from other brand-name cigarette manufacturers and overall declines in tobacco consumption led to reduced sales. However, the company’s $7.1 billion acquisition of Maverick, Kool, Salem and Winston from RAI, coupled with other assets like a national salesforce and manufacturing facilities, helped double ITG Brand’s share of the market in 2015. Overall, IBISWorld expects industry-relevant revenue to rise an annualized 12.4% to $2.6 billion over the five years to 2016, with most of this growth attributable to the Lorillard merger/divestiture deal in mid-2015.

Imperial Brands plc (ITG Brands) - fi nancial performance*

Year Revenue

($ million) (% change) Operating Income

($ million) (% change)

2011 1,469.8 6.3 244.3 -0.6

2012 1,476.6 0.5 225.2 -7.8

2013 1,452.6 -1.6 225.5 0.1

2014 1,437.7 -1.0 388.7 72.4

2015 2,162.9 50.4 573.2 47.5

2016 2,632.6 21.7 719.5 23.8

*Estimates SOURCE: ANNUAL REPORT AND IBISWORLD

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Major Companies

Other Companies continued

States and intensifying competition from premium brands such as Marlboro, Camel or Newport, Vector Group has suffered from declining volume sales of its brands

over the past five years. Consequently, revenue from tobacco sales is estimated to decline an annualized 1.7% to $1.0 billion over the five years to 2016.

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Capital Intensity The Cigarette and Tobacco Manufacturing industry exhibits a high level of capital intensity. Using wages to represent labor costs and depreciation as a proxy for capital, IBISWorld estimates that for every dollar spent on labor, industry operators will spend $0.75 on capital in 2016. This figure represents a slight increase from $0.71 in 2011. Depreciation costs have remained relatively steady over the past five years, as few industry operators purchased new machines to boost production efficiency. However, wage costs have significantly declined due to the falling number of employees in the industry. In particular, the consolidation of Philip Morris’ manufacturing facilities caused the number of employees per establishment

to decline drastically in 2010. More recently, both Reynolds American and Imperial brands have also consolidated

Operating Conditions Capital Intensity | Technology & Systems | Revenue Volatility Regulation & Policy | Industry Assistance

Tools of the Trade: Growth Strategies for Success

SOURCE: WWW.IBISWORLD.COM

La bo

r In

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Capital Intensive

Change in Share of the Economy

New Age Economy

Recreation, Personal Services, Health and Education. Firms benefi t from personal wealth so stable macroeconomic conditions are imperative. Brand awareness and niche labor skills are key to product differentiation.

Traditional Service Economy

Wholesale and Retail. Reliant on labor rather than capital to sell goods. Functions cannot be outsourced therefore fi rms must use new technology or improve staff training to increase revenue growth.

Old Economy

Agriculture and Manufacturing. Traded goods can be produced using cheap labor abroad. To expand fi rms must merge or acquire others to exploit economies of scale, or specialize in niche, high-value products.

Investment Economy

Information, Communications, Mining, Finance and Real Estate. To increase revenue fi rms need superior debt management, a stable macroeconomic environment and a sound investment plan.

Tobacco Growing

Grocery Wholesaling Seasoning, Sauce and Condiment Production

Wood Pulp Mills

Supermarkets & Grocery Stores

Cigarette & Tobacco Manufacturing

Capital intensity

1.0

0.0

0.2

0.4

0.6

0.8

SOURCE: WWW.IBISWORLD.COM Dotted line shows a high level of capital intensity

Capital units per labor unit

Cigarette & Tobacco

Manufacturing

ManufacturingEconomy

Level The level of capital intensity is High

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WWW.IBISWORLD.COM Cigarette & Tobacco Manufacturing in the US August 2016 40

Operating Conditions

Revenue Volatility The Cigarette and Tobacco Manufacturing industry exhibits a low to moderate level of revenue volatility. Over the past five years, industry revenue has declined by as much as 8.9% in 2014 and grew as much as 0.3% in 2012. This industry has traditionally exhibited very little revenue volatility because of the addictive nature of it key products. In fact, tobacco has colloquially been known as a “recession-proof” product because sales are not significantly impacted by short-term changes in economic factors such as per capita disposable income or unemployment.

Unlike sales for most other nondurable goods, sales of tobacco decreased only

slightly during the recession, and have endured in spite of major public efforts to curb smoking among Americans over the past several decades. For example, the April 2009 national tax hike on tobacco, which raised the federal excise tax per pack of cigarettes from $0.39 to $1.01, is expected to encourage over one million smokers nationwide to quit. Even though this 159.0% spike in cigarette taxes has moderately reduced per capita cigarette consumption, according to 2013 figures from the Centers for Disease Control and Prevention, it has yet to have a significantly negative effect on either the Tobacco Manufacturing or Wholesaling (IBISWorld report 42494) industries’ sales performance. Although total

Technology & Systems The United States is at the forefront of developing tobacco manufacturing technology. Improved manufacturing processes such as the use of computers to track production runs and monitor the moisture content of products have boosted production efficiencies while improving product quality. These developments have allowed industry operators to rely more on machines and less on manual labor, which has decreased wage costs for producers.

In response to rising regulatory scrutiny and excise tax rates on conventional tobacco products (i.e. cigarettes), US producers have also focused on developing alternative tobacco products such as electronic cigarettes (e-cigarettes, snus and other

dissolvables. For example, e-cigarettes were first invented and produced in 2003 by a Chinese pharmacist and are now one of the fastest growing product segments in this industry. E-cigarettes are battery-powered devices that simulate tobacco smoking by vaporizing a liquid solution. Although claims that e-cigarettes are less harmful alternatives to conventional cigarettes remain unsubstantiated, the leading tobacco producers, including Altria Group and Reynolds, have already entered this market. More recently, Philip Morris USA (Altria Group) announced a partnership with its global counterpart Philip Morris International to jointly develop and market e-vapor products in the United States.

Capital Intensity continued

operations at their production facilities by reducing headcount. Overall, wages as a share of industry revenue have reached a low of 2.2% in 2016. Increasing compliance costs due to an increasingly stringent regulatory environment, along

with higher excise taxes, will likely force operators to further cut production labor costs in upcoming years. Consequently, IBISWorld anticipates this industry’s level of capital intensity to continue rising over the next five-year period.

Level The level of Technology Change is Medium

Level The level of Volatility is Medium

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WWW.IBISWORLD.COM Cigarette & Tobacco Manufacturing in the US August 2016 41

Operating Conditions

Regulation & Policy In terms of compliance costs as a share of annual revenue, the Cigarette and Tobacco Manufacturing industry is the most heavily regulated industry in the United States. Tobacco companies face intense regulation from a variety of federal, state and local governments, as well as scrutiny from several public and private anti-tobacco advocacy organizations. The following sections briefly describe the regulatory

organizations, laws or events that have been most relevant to the industry’s performance over the past five years.

Family Smoking Prevention and Tobacco Control Act In 2009, the US Congress approved legislation that allows the Food and Drug Administration (FDA) to regulate cigarettes and other tobacco products in the United States. Known as the Family

Revenue Volatility continued

shipments of cigarettes have fallen steadily over the past five years, tobacco manufacturers have been able to offset this decline by increasing the per-unit price of their products or by focusing their marketing resources on alternative tobacco products, such as smokeless tobacco or e-cigarettes, which continue to face less regulatory scrutiny than regular cigarettes despite the recent FDA ruling on novel tobacco products.

While the addictive quality of nicotine shields tobacco manufacturers from drastic declines in demand, rising excise taxes on cigarettes and higher product prices continue to reduce demand for cigarettes, albeit slowly. Growing health concerns and awareness of the health

consequences of smoking tobacco products has also placed downward pressure on demand for industry products. On the other hand, the continued innovation of noncigarette tobacco products such as e-cigarettes and smokeless tobacco is likely to help the Cigarette and Tobacco Manufacturing industry endure in spite of an increasingly unfavorable regulatory environment and growing social stigma against tobacco use. Consequently, IBISWorld expects this industry’s level of revenue volatility to remain low during the five years to 2021, with continued declines in consumption and production volume partly offset by higher per-unit prices.

SOURCE: WWW.IBISWORLD.COM

Volatility vs Growth

Re ve

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y* (%

)

1000

100

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1

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Five-year annualized revenue growth (%) –30 –10 10 30 50 70

Hazardous

Stagnant

Rollercoaster

Blue Chip

* Axis is in logarithmic scale

A higher level of revenue volatility implies greater industry risk. Volatility can negatively affect long-term strategic decisions, such as the time frame for capital investment.

When a fi rm makes poor investment decisions it may face underutilized capacity if demand suddenly falls, or capacity constraints if it rises quickly.

Cigarette & Tobacco Manufacturing

Level & Trend The level of Regulation is Heavy and the trend is Increasing

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Operating Conditions

Regulation & Policy continued

Smoking Prevention and Tobacco Control Act, the law bans flavored cigarettes (excluding menthol cigarettes), which appeal to younger people. The FDA also announced plans to place graphic warnings on cigarette packages and banned the use of the term “light” to describe cigarettes because it can be misleading. Additionally, the administration now requires all retailers to sell cigarettes only through direct, face-to-face transactions with proof of identification, thereby making online cigarette stores a gray market. Later in April 2014, the FDA proposed further regulations that would extend its authority to cover all products that contain tobacco, including e-cigarettes and dissolvables; these rulings were ratified in early 2016.

Alcohol and Tobacco Tax and Trade Bureau The US Alcohol and Tobacco Tax and Trade Bureau (TTB) operates under the Department of the Treasury and was established in 2002 under the Homeland Security Act. The bureau reviews applications for permits to manufacture tobacco products, import tobacco products and operate tobacco export warehouses. In order to qualify for a permit, an applicant’s tobacco products must pass a product analysis conducted by TTB authorities. Additionally, the TTB ensures that industry operators comply with tax and trade regulations. The TTB also investigates illegal tobacco product trafficking.

Under federal regulations, permits or bonds are required for any person who manufactures cigarettes, cigars, chewing tobacco, snuff, pipe tobacco and rolling tobacco. Permits are also needed to manufacture cigarette papers or tubes. These categories exclude manufacturing for individual consumption or use. Any person who imports tobacco products as a business

or operates an export warehouse for tobacco products also needs permits.

Labeling and marketing The Federal Trade Commission enforces the Federal Comprehensive Smoking Education Act (1984) and the Federal Comprehensive Smokeless Tobacco Health Education Act (1986). These acts require certain warning labels to be placed on cigarette packages and smokeless tobacco packages. Under these acts, manufacturers and importers must also provide a list of additives used in each product. In 2001, the Federal Trade Commission mandated cigar packages to carry similar warnings. Furthermore, in 2010, the FDA passed the Family Smoking Prevention and Tobacco Control Act, which requires larger and more visible warnings on smokeless tobacco packages and advertisements. Under the same act, manufacturers are prohibited from using the terms “light,” “low” and “mild” as descriptors for tobacco products, regardless of the cigarette product’s tar level.

Master Settlement Agreement The 1998 Tobacco Master Settlement Agreement (MSA) requires the four leading tobacco manufacturers to make annual payments to 46 states for the recovery of tobacco-related healthcare costs. In return, the tobacco industry is indemnified from individual tobacco- related cases originating from any of the 46 signatory states. Present-day industry operators that were signatories to this settlement include Phillip Morris (Altria Group), Reynolds American Inc. (RAI) and Lorillard (prior to its merger with RAI). The fourth party, Brown & Williamson Tobacco Corporation, was acquired by RAI in 2004.

These settlement payments change from year to year based on inflation, sales volume of cigarettes and each company’s market share. Annual payments began at $4.5 billion in 2000 and must total a minimum of $206.0 billion by 2025. The

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Operating Conditions

Industry Assistance The US government imposes import quotas and tariffs on tobacco, which reduce the level of competition that industry operators face from imported products. Aside from direct assistance from the government, producers also receive limited assistance from a number of trade organizations suchas the Tobacco Merchants Association, Tobacco International, Friends of Tobacco and the Tobacco Vapor Electronic Cigarette Association (TVECA).

Tariffs Tariff rates charged for industry products depend on a number of factors including

the type of tobacco product, size and ingredients. For example, cigarettes containing tobacco and clove incur a tariff of 41.7 cents per kilogram and an additional 0.9%. However, cigars containing tobacco that are valued at less than $0.15 incur a tariff of $1.89 per kilogram and an additional 4.7%. Finally, smoking tobacco, whether it contains tobacco or tobacco substitutes in any proportion, which are sold to the end consumer in the identical form and package in which it was imported, incurs a tariff of about $0.33 cents per kilogram. Overall, these tariffs have helped keep industry imports low, with imports

Regulation & Policy continued

agreement also places certain regulations on these companies. For example, cartoons cannot be used in advertising or packaging, and there are bans on certain outdoor advertising to avoid the exposure of advertisements to youth. The proceeds of these settlement payments have been used to fund anti-tobacco advocacy groups and campaigns such as the American Legacy Foundation’s Truth campaign, which aims to reduce youth smoking. The MSA also forced the dissolution of three significant pro-tobacco institutions: The Tobacco Institute, Council for Tobacco Research and the Center for Indoor Air Research.

The Engle progeny cases The Engle progeny lawsuits refer to the aftermath of the verdict in the Engle vs. Liggett case, in which the jury sought $145.0 billion in damages associated with tobacco use in Florida, which is not a signatory state to the MSA. The tobacco industry appealed several times and the Supreme Court of Florida eventually dismissed the lump-sum verdict in 2006, ruling that individuals represented in the suit did not meet the criteria for class action but could seek claims against the tobacco companies individually. According to RAI, there are currently over

3,100 cases pending in federal and state courts by over 4,100 individuals, though 415 of these cases were settled in 2015. Nonetheless, these cases have and will continue to present significant litigation costs for industry operators.

Other regulations Smoking is banned on all US flights and locations that provide federally funded services to children. While these regulations do not directly affect operators in the Cigarette and Tobacco Manufacturing industry, they may reduce the frequency of smoking while traveling. Moreover, most states have enacted laws that ban smoking in public areas such as restaurants and workplaces while an increasing number of states or municipalities are placing further restrictions on smoking. In mid-2014, for example, New York City was the first major city to raise the minimum age to buy tobacco products from 18 to 21. More recently, the state of California and Hawaii have also raised the minimum age to 21. As of mid-2016, over 170 cities in over 13 states had drafted legislation that prohibits sale of tobacco products to adults under the age of 21.

Level & Trend The level of Industry Assistance is Medium and the trend is Decreasing

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Operating Conditions

Industry Assistance continued

estimated to satisfy only 3.0% of domestic demand for tobacco products in 2016.

Industry associations Cigarette and tobacco product manufacturers also receive some assistance, albeit very limited, from independent industry associations. The Tobacco Merchants Association (TMA) is a global organization comprised of 138 companies and supporting organizations. TMA provides information that pertain to the industry as well as forums for dialogue on issues including declining industry revenue, public sentiment towards the industry and government regulations. Running since 1886, Tobacco International is a trade journal with regular coverage of the industry’s growing, curing and wrapping activities. Other relevant trade associations include the Tobacco Vapor

Electronic Cigarette Association (TVECA) and the Smoke-Free Alternatives Trade Association.

The industry currently receives much less assistance from outside organizations and institutions than it has historically. The Master Settlement Agreement (MSA), reached in 1998 between the top four tobacco product manufacturers and the attorneys general of 46 states, disbanded several tobacco interest groups with historical significance, including the Tobacco Institute, Council for Tobacco Research and Center for Indoor Air Research. More information about the practices of these institutions prior to their dissolution is available from the Legacy Tobacco Documents Library, a digital archive maintained by the American Legacy Foundation (a nonprofit funded partly by the MSA) and the University of California, San Francisco (UCSF) Library.

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Key Statistics Revenue

($m)

Industry Value Added

($m) Establish-

ments Enterprises Employment Exports

($m) Imports

($m) Wages ($m)

Domestic Demand

Percentage of smokers

(People) 2007 45,903.4 19,657.3 109 79 20,135 1,278.9 668.4 1,338.3 45,292.9 509.0 2008 41,945.1 19,496.1 101 71 18,797 920.4 704.3 1,233.7 41,729.0 540.2 2009 40,811.5 20,191.9 103 75 17,093 543.5 699.5 1,156 40,967.5 438.2 2010 42,975.8 19,127.9 119 94 14,096 498.2 734.8 1,031.2 43,212.4 366.3 2011 42,225.3 18,468.0 118 95 15,055 525.7 768.6 991.9 42,468.2 374.7 2012 42,376.1 18,773.4 114 93 14,599 508.9 854.1 962.1 42,721.3 423.1 2013 41,772.0 21,036.2 120 100 14,355 503.8 948.8 898.6 42,217.0 429.7 2014 38,061.3 18,496.8 132 114 13,981 435.8 992.6 820.9 38,618.1 464.6 2015 38,005.9 20,041.1 156 139 13,923 429.1 1,119.1 817.4 38,695.9 460.9 2016 37,553.9 20,909.9 162 144 13,827 422.7 1,165.2 808.0 38,296.4 478.1 2017 36,706.6 20,357.1 162 144 13,415 401.7 1,191.5 790.5 37,496.4 497.2 2018 35,900.2 20,018.1 160 141 13,087 381.8 1,221.6 778.1 36,740.0 512.6 2019 35,064.9 19,811.7 156 138 12,656 362.5 1,249.9 737.4 35,952.3 534.1 2020 34,225.0 19,711.2 151 133 12,099 343.9 1,277.8 732.6 35,158.9 551.8 2021 33,320.3 19,353.6 146 127 11,634 325.5 1,303 716.1 34,297.8 567.9 Sector Rank 49/200 13/200 179/200 172/200 158/200 164/188 150/188 156/200 60/188 N/A Economy Rank 301/1556 160/1556 1267/1556 1225/1556 973/1556 285/525 225/524 909/1556 73/524 N/A

IVA/Revenue (%)

Imports/ Demand

(%)

Exports/ Revenue

(%)

Revenue per Employee

($’000) Wages/Revenue

(%) Employees

per Est. Average Wage

($)

Share of the Economy

(%) 2007 42.82 1.48 2.79 2,279.78 2.92 184.72 66,466.35 0.13 2008 46.48 1.69 2.19 2,231.48 2.94 186.11 65,632.81 0.13 2009 49.48 1.71 1.33 2,387.61 2.83 165.95 67,630.02 0.14 2010 44.51 1.70 1.16 3,048.79 2.40 118.45 73,155.51 0.13 2011 43.74 1.81 1.24 2,804.74 2.35 127.58 65,885.09 0.12 2012 44.30 2.00 1.20 2,902.67 2.27 128.06 65,901.77 0.12 2013 50.36 2.25 1.21 2,909.93 2.15 119.63 62,598.40 0.13 2014 48.60 2.57 1.14 2,722.36 2.16 105.92 58,715.40 0.12 2015 52.73 2.89 1.13 2,729.72 2.15 89.25 58,708.61 0.12 2016 55.68 3.04 1.13 2,715.98 2.15 85.35 58,436.39 0.13 2017 55.46 3.18 1.09 2,736.24 2.15 82.81 58,926.57 0.12 2018 55.76 3.32 1.06 2,743.20 2.17 81.79 59,455.95 0.11 2019 56.50 3.48 1.03 2,770.61 2.10 81.13 58,264.85 0.11 2020 57.59 3.63 1.00 2,828.75 2.14 80.13 60,550.46 0.11 2021 58.08 3.80 0.98 2,864.05 2.15 79.68 61,552.35 0.10 Sector Rank 2/200 174/188 183/188 3/200 198/200 43/200 82/200 13/200 Economy Rank 199/1556 464/524 506/525 24/1556 1536/1556 129/1556 573/1556 160/1556

Figures are in inflation-adjusted 2016 dollars. Rank refers to 2016 data.

Revenue (%)

Industry Value Added

(%)

Establish- ments

(%) Enterprises

(%) Employment

(%) Exports

(%) Imports

(%) Wages

(%)

Domestic Demand

(%)

Percentage of smokers

(%) 2008 -8.6 -0.8 -7.3 -10.1 -6.6 -28.0 5.4 -7.8 -7.9 6.1 2009 -2.7 3.6 2.0 5.6 -9.1 -40.9 -0.7 -6.3 -1.8 -18.9 2010 5.3 -5.3 15.5 25.3 -17.5 -8.3 5.0 -10.8 5.5 -16.4 2011 -1.7 -3.4 -0.8 1.1 6.8 5.5 4.6 -3.8 -1.7 2.3 2012 0.4 1.7 -3.4 -2.1 -3.0 -3.2 11.1 -3.0 0.6 12.9 2013 -1.4 12.1 5.3 7.5 -1.7 -1.0 11.1 -6.6 -1.2 1.6 2014 -8.9 -12.1 10.0 14.0 -2.6 -13.5 4.6 -8.6 -8.5 8.1 2015 -0.1 8.3 18.2 21.9 -0.4 -1.5 12.7 -0.4 0.2 -0.8 2016 -1.2 4.3 3.8 3.6 -0.7 -1.5 4.1 -1.2 -1.0 3.7 2017 -2.3 -2.6 0.0 0.0 -3.0 -5.0 2.3 -2.2 -2.1 4.0 2018 -2.2 -1.7 -1.2 -2.1 -2.4 -5.0 2.5 -1.6 -2.0 3.1 2019 -2.3 -1.0 -2.5 -2.1 -3.3 -5.1 2.3 -5.2 -2.1 4.2 2020 -2.4 -0.5 -3.2 -3.6 -4.4 -5.1 2.2 -0.7 -2.2 3.3 2021 -2.6 -1.8 -3.3 -4.5 -3.8 -5.4 2.0 -2.3 -2.4 2.9 Sector Rank 152/200 24/200 15/200 14/200 120/200 96/188 76/188 135/200 153/188 N/A Economy Rank 1394/1556 413/1556 255/1556 267/1556 1268/1556 339/525 252/524 1343/1556 449/524 N/A

Annual Change

Key Ratios

Industry Data

SOURCE: WWW.IBISWORLD.COM

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Jargon & Glossary

BARRIERS TO ENTRY High barriers to entry mean that new companies struggle to enter an industry, while low barriers mean it is easy for new companies to enter an industry.

CAPITAL INTENSITY Compares the amount of money spent on capital (plant, machinery and equipment) with that spent on labor. IBISWorld uses the ratio of depreciation to wages as a proxy for capital intensity. High capital intensity is more than $0.333 of capital to $1 of labor; medium is $0.125 to $0.333 of capital to $1 of labor; low is less than $0.125 of capital for every $1 of labor.

CONSTANT PRICES The dollar figures in the Key Statistics table, including forecasts, are adjusted for inflation using the current year (i.e. year published) as the base year. This removes the impact of changes in the purchasing power of the dollar, leaving only the “real” growth or decline in industry metrics. The inflation adjustments in IBISWorld’s reports are made using the US Bureau of Economic Analysis’ implicit GDP price deflator.

DOMESTIC DEMAND Spending on industry goods and services within the United States, regardless of their country of origin. It is derived by adding imports to industry revenue, and then subtracting exports.

EMPLOYMENT The number of permanent, part-time, temporary and seasonal employees, working proprietors, partners, managers and executives within the industry.

ENTERPRISE A division that is separately managed and keeps management accounts. Each enterprise consists of one or more establishments that are under common ownership or control.

ESTABLISHMENT The smallest type of accounting unit within an enterprise, an establishment is a single physical location where business is conducted or where services or industrial operations are performed. Multiple establishments under common control make up an enterprise.

EXPORTS Total value of industry goods and services sold by US companies to customers abroad.

IMPORTS Total value of industry goods and services brought in from foreign countries to be sold in the United States.

INDUSTRY CONCENTRATION An indicator of the dominance of the top four players in an industry. Concentration is considered high if the top players account for more than 70% of industry revenue. Medium is 40% to 70% of industry revenue. Low is less than 40%.

INDUSTRY REVENUE The total sales of industry goods and services (exclusive of excise and sales tax); subsidies on production; all other operating income from outside the firm (such as commission income, repair and service income, and rent, leasing and hiring income); and capital work done by rental or lease. Receipts from interest royalties, dividends and the sale of fixed tangible assets are excluded.

INDUSTRY VALUE ADDED (IVA) The market value of goods and services produced by the industry minus the cost of goods and services used in production. IVA is also described as the industry’s contribution to GDP, or profit plus wages and depreciation.

INTERNATIONAL TRADE The level of international trade is determined by ratios of exports to revenue and imports to domestic demand. For exports/revenue: low is less than 5%, medium is 5% to 20%, and high is more than 20%. Imports/domestic demand: low is less than 5%, medium is 5% to 35%, and high is more than 35%.

LIFE CYCLE All industries go through periods of growth, maturity and decline. IBISWorld determines an industry’s life cycle by considering its growth rate (measured by IVA) compared with GDP; the growth rate of the number of establishments; the amount of change the industry’s products are undergoing; the rate of technological change; and the level of customer acceptance of industry products and services.

NONEMPLOYING ESTABLISHMENT Businesses with no paid employment or payroll, also known as nonemployers. These are mostly set up by self-employed individuals.

Industry Jargon

IBISWorld Glossary

CIGARILLO A small and narrow cigar that is often wrapped in leaf tobacco (not paper)

CURING The process of regulating temperature and humidity conditions for freshly harvested tobacco leaves.

E-VAPOR A broad category of electronic nicotine delivery systems (ENDS) that includes e-cigarettes, larger vaporizers and their accessories.

ELECTRONIC CIGARETTE Electronic cigarette is a battery-powered device that contains a nicotine-based liquid that is vaporized and inhaled, simulating the experience of smoking a traditional cigarette.

MENTHOL A chemical derived from the peppermint or spearmint plants. Menthol naturally has a cooling effect, which can help reduce the harshness of tobacco smoke.

RECONSTITUTED TOBACCO Tobacco made from the pulp of mashed tobacco stems and other parts of the tobacco leaf that would otherwise be waste that are then sprayed with nicotine and other substances lost during processing.

SNUS A type of moist powder tobacco consumed by placing it under the lip for extended periods of time.

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Jargon & Glossary

PROFIT IBISWorld uses earnings before interest and tax (EBIT) as an indicator of a company’s profitability. It is calculated as revenue minus expenses, excluding interest and tax.

VOLATILITY The level of volatility is determined by averaging the absolute change in revenue in each of the past five years. Volatility levels: very high is more than ±20%; high volatility is ±10% to ±20%; moderate volatility is ±3% to ±10%; and low volatility is less than ±3%.

WAGES The gross total wages and salaries of all employees in the industry. The cost of benefits is also included in this figure.

IBISWorld Glossary continued

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