Busting the China Tobacco Monopolies: Open Market or Open Season?

Big Tobacco has spent the last 20 years waiting on the sidelines in China, and BAT’s announcement that it will be allowed to build a factory to make 100 billion cigarettes per year is being hailed by the industry as the end of the central government’s efforts to protect the monopoly local weed processors have enjoyed for 52 years.

Ostensibly, the monopoly was protected on the basis that the market was already saturated (a claim that has been increasingly specious as Beijing allowed foreign access and investment to other “saturated” industries i.e. automobiles). Now, the reason given by the government for opening up is that foreign competition will help streamline an industry with over 150 factories and over 300 brands.

Such reasoning stretches credulity. The government could compel a rationalization of the market via regulation and the kind of micro-level involvement that drives observers of the telecommunications industry crazy. Despite a new administration and the accession of China to the WTO, the nations leaders still aggressively pursue a policy of industrial determinism that would make even Japanese officials blush.

This suggests that the central government’s reasoning is somewhat less simple than they are letting on. There are several factors in the market that may indicate other reasoning.

First, taking the “drive rationalization through foreign competition” angle to its logical conclusion, it’s fairly clear that the authorities aim to create domestic tobacco firms that can take on BAT, Philip-Morris, and Japan Tobacco on the global market. Some tightly managed foreign competition among the locals to cull the weak will be the first step in creating international players.

Second, it’s pretty clear that the government – prodded by the Ministry of Health, the WHO, and a host of other players – is beginning to recognize the long term social and economic costs of a population increasingly addicted to tobacco. This has likely been enough to make some policy makers uncomfortable with the government’s role as a commercial player (via the monopoly) in the industry.

Third, there is a backlash coming, and the government wants to sneak out of the cross-fire before the real shooting starts. As the dangers of smoking become more apparent to the population, the government cannot afford to have itself associated with the enterprises that sell the stuff. Imagine how queasy a Chinese lawmaker must feel at the prospect of a growing local anti-smoking lobby led by doctors and nurses all vilifying the government for not only allowing but supporting the effort to hook China on tobacco. Such a movement would make the uproar around the government’s handling of SARS disappear into insignificance by comparison.

But a wise government cannot only be concerned about the public outcry – after all, such movements can be managed. What is likely of equal concern is that consumer rights movement is growing in China, as is the consumer tort bar, both largely encouraged by the government as part of an effort to sustain a “popular” (i.e., driven by the people) aspect around its efforts to rein in the excesses of both local and foreign enterprise. There are early indications that China will become increasingly litigious, and that industries like tobacco are going to be some of the first targets of outraged consumers empowered by opportunistic lawyers. The government wants to ensure it is not a target in these cases, both for economic reasons and for the political reasons noted above. As such, commercializing the industry by bringing in foreign competition and cutting local producers loose from government protection adds another layer of credibility in the government’s argument against its being named as codefendant in future legal wrangling.

All of which suggests that BAT could be walking itself into a massive future contingent liability. China’s domestic manufacturers have reaped the benefits of 50-odd years of growth in the tobacco business, leaving the global players with the scraps of grey-market product entering the market. But when the time comes to litigate – and given current trends that time is likely within the next decade – the focus will be on the global players. For those policy makers in China who can see the trend, it must warm the cockles to anticipate multinational companies sharing the liability of China’s smoking habit with the local firms that have reaped the greatest benefit.

It is entirely possible that BAT has already thought about all of this, and has made the actuarial calculation that suggests that the potential benefits of a chunk of China’s market far outweigh collective risks of any and all future litigation. But there are two factors that need to be added into that calculus:

  • BAT will have to spend millions to gain market share in an already incredibly competitive market, in the face of already onerous and growing restrictions on how tobacco companies are allowed to advertise and market their products;
  • Counterfeit both local and foreign-branded cigarettes is already a huge business in China, and attempts thus far to curtail counterfeiting have failed utterly. With a significant portion of China’s 300 cigarette brands crushed by rationalization and foreign competition, many are likely to turn to the production of counterfeits. Even an optimistic projection suggests that BAT et al will face decades of battles in the streets and in the courts to battle this problem.

Congratulations, BAT, on entering China. It was a good battle well fought and hard won. But the real fight is just beginning.