+1 862 207 3288 Reynolds American, Inc.
Deliverables:
1. Write five questions to which you believe the answers are necessary in order to create a thoughtful strategic position for the company. These questions should address information gaps in the case for the general, industry/competitive, and/or internal environments. What important information was left out of the case? Questions that contain the words “is”, “are”, or “does” might be good candidates for information gap questions.
2. One thoughtful discussion question for each section (see headings below) that you develop after reading and thinking about the material contained in the section. The answers to these questions should NOT be ‘Yes’ or ‘No’ or ones that can be answered from data presented in the case. For the discussion questions you should challenge assumptions, speculate about actions/decisions, or figure out how to elicit a deeper discussion of issues/information/actions presented in the case. DO NOT provide the answer to these questions in the case brief. Questions that begin with: “What should…..”; “What could……”; “Why do you think…..”; “How could….” are all good candidates for thoughtful discussion questions. For this section of the case brief you will write three questions, one for each of the major headings identified below. Please note that each major heading (identified by H1 in my printed copy of the case) may contain multiple secondary and lower-order headings under it. You may write a question related to any of these lower-order headings under the major heading.
Major Headings for Discussion Questions
1. Introduction
2. Company History (Mid 2000s to Current)
3. Getting to the Top
3. Answer to the case/strategic position. Outline what the company should do to address key strategic issues (and deliver customer value) and the reasons why you recommend what you do. These actions should be based on thoughtful consideration of information contained in the case (for the internal, industry/competitive, and general environments) or other information that you might have from any other source (including personal knowledge). I want to see what you think the company should do and the thought process behind your recommendations. The answer to the case SHOULD NOT restate the objective (increase sales, lower costs, increase profit) but rather should be based on WHY you think the action will achieve the objective. After reading the case you should realize that neither the company nor its products are well-liked. Put yourself in the position of the CEO and determine (and support) actions that would benefit the company by improving its strategic position (who, what, and/or how).
FORMAT REQUIREMENTS In the last section, begin each separate recommendation (WHAT they should do) with a bullet point. Underneath the bullet-pointed recommendation, on the left hand margin, type the word ‘BECAUSE’ and then list the reasons WHY you believe Reynolds should implement the recommendation. Number each supporting reason for the recommendation (see preceding instructions for 3) above). If space is an issue you can end one reason and begin discussing the next within the same line of text. This section should take up approximately 2/3 of the case brief. Case brief page limit is one side of one page (max.). Case brief should be typed (not written by hand). Use line spacing of at least 1.15 but use any font/margin size that you want. The online quiz for the case must be completed before the beginning of class. To receive full credit for the case brief it must be turned in at the beginning of class and you must be in class for the case discussion.
Reynolds American, Inc.
Corky Whipple
John Justice
Patricia Gainer
Christopher Johnson
Irene Alvidrez
Arizona State University
H1 Introduction
Every year, 443,000 people in the US die from health issues arising form cigarette smoking or exposure to secondhand smoke. Scientists and health researchers alike have been adamant for years about the harmful effects of smoking cigarettes and many experts state bluntly that tobacco products kill its users. These statistics and criticisms certainly paint a grim picture for the tobacco industry; yet every day, the CEO of Reynolds American Incorporated (herein referred to as RAI), Daniel Delen, must assess these conditions and successfully manage an organization devoted to selling tobacco products.
While the history of smoking goes as far back as anyone can remember and across every border of the world, the cigarette and tobacco market in the US has changed dramatically over the years. Carefully marketed, cigarette manufacturers captured the once-closeted female customer in the early to mid nineteenth century and cinema made smoking both on and off screen of movie stars—and thus impressionable average Americans—de rigueur.
But, as the suppliers to the once very open and highly advertised leisure activity, tobacco firms began to feel the squeeze of tightening restrictions in the latter half of the century. The first major mandate affecting business came down in 1965 with the Federal Cigarette Labeling and Advertising Act requiring manufacturers to place the Surgeon General’s Warning—“Caution: Cigarette Smoking May Be Hazardous to Your Health”—on every pack of cigarettes. With cigarette advertising banned from radio and television as of January 1, 1971, cigarette manufacturers were left to rely primarily on billboards and print advertising—venues that, as of 1972, were required to carry health warnings as well. In the first federal restriction of smoking in public places, in 1973, the Civil Aeronautics Board required that non-smoking sections be created on all airlines subsequently providing the first tangible division of smokers from nonsmokers and enlightening nonsmokers to the idea of advocating for smoke-free spaces. In response to the rash of litigation by non-smokers as well as smatterings of successful local legislation, the Clean Indoor Air Act was passed in 1985 prohibiting smoking in government facilities, museums, and office buildings and started a landslide of similar measures at state and local levels. Back in the friendly skies, by 1988, smoking on flights shorter than two hours was prohibited and on January 1, 1990, all smoking on interstate buses and domestic flights of less than six hours was banned.
Legislation designed to warn the general public about the dangers of tobacco products and curb underage use has continued with the Master Settlement Act of 1998, the FDA Trafficking Act of 2009, the Prevent All Cigarette Trafficking Act of 2010, and most recently, the Family Smoking Prevention and Tobacco Control Act that went into effect on June 22, 2010. The restrictions in place today seriously handicap the tobacco industry from employing the typical avenues used to promote and sell a product and yet, while the percentage of cigarette smokers was more than double what it is today in 1965, there has only been about a 5% decline in smokers since 1990 (Exhibit 1). Even so, tobacco firms will continue to rely heavily on product development, marketing techniques, and increased health standards to stay competitive in this environment.
Despite the mounting roadblocks, RAI is steadfast in its business model. R.J. Reynolds Tobacco, the largest division of RAI, ranks as the second largest tobacco company in the US cigarette market (Exhibit 2). Reinforcement of its brand sustainability comes from its smokeless tobacco holding, American Snuff Company, with top products Grizzly and Kodiak. RAI has positioned itself to harvest growth through an increased presence in the smokeless tobacco market, investing $71 million in research and development (R&D) toward this end.
RAI considers itself the provider of the highest quality products and an innovative leader in the tobacco industry. The firm is divided into three core business units: R.J. Reynolds Tobacco Company (RJR), American Snuff Company, and Santa Fe Natural Tobacco. Due to the size of Santa Fe Natural Tobacco, RAI incorporates its financial data into its “All Other Business” segment. RJR’s revenue contributes approximately 85% of RAI’s total sales with American Snuff the second largest segment depositing approximately 10% of the firm’s total revenue, and All Other Business accounting for the remaining 5% revenue in the company’s portfolio.
Despite perpetually bleak forecasted sales, RAI has been strong financially, reporting overall net sales of $8.17 billion in 2010—up from $8.02 billion in 2009. Demonstrating the flexibility necessary for the firm to cut costs if the need arises, RAI boasts a gross margin of nearly 50%. Further growth indicators include a year-over-year 15% return on equity increase, indicating increased profitability and a competitive return on assets when compared to similar companies within the tobacco industry. (See Exhibits 3A-G for comparative data across companies.)
NOTE: Ram CT QUIZ QUESTIONS 1-7 WOULD BE INSERTED HERE
H1 Company History
H2 Early Years
RAI, founded as and by R.J. Reynolds in 1875, is a US held corporation headquartered in Winston-Salem, NC. It is principally engaged in manufacturing tobacco related products such as cigarettes, smokeless tobacco, additive free tobacco, and cigars, with nicotine replacement therapy products offered in certain markets. Having started in chewing tobacco, in the early 1900s, RJR correctly anticipated the smoking tobacco market would grow. By the mid 1920s, RJR was one of the most profitable corporations in the world. Incremental changes followed with the introduction of menthol, tips, and cellophane packaging. In the 1960s, embracing the intermittently successful conglomerate merger trend, RJR began diversifying into food and other non-tobacco businesses and became the well known firm—RJR Nabisco.
After its poor response following the market crash of 1987, CEO F. Ross Johnson put the company in play and became involved in one of the most infamous leveraged buyouts of its time. , In the end, Kohlberg, Kravis Roberts & Co. (KKR), a large private equity firm, won control of the company, turning it private. Even so, RJR began active trading again in the early 1990s with KKR fully divesting itself by 1995.7
With increasing pressure to eliminate the marketing of tobacco products to children, and after the American Medical Association established that children were attracted to ads featuring him, in 1997, RJR withdrew its advertising cartoon character, Joe the Camel. In 1999, RJR was spun off from R.J. Nabisco with then CEO Steven F. Goldstone explaining, “Cookies and cigarettes do not share distribution or marketing or even the same sales force. They are very, very different businesses.”
H2 Mid 2000s to Current
After several acquisitions and joint ventures, including the addition of Santa Fe Natural and Brown and Williamson (B&W), RJR’s parent company—RAI—was created in 2004. The organization’s reportable subsidiaries include R.J. Reynolds Tobacco Company (RJR) and American Snuff. The Santa Fe Natural Tobacco Company, Inc. and Niconovum AB (nicotine replacements products) subsidiaries are reported as “All Other” within the company’s financial statements. RAI focuses on the US segment with any foreign sales occurring via its B&W affiliates.
As the second largest tobacco company in the US, RJR produces, markets, and sells Camel, Pall Mall, Doral, Kool, Winston, and Salem—six of the ten best-selling cigarette brands in the US as of December 2010. RJR also produces Camel Snus and Camel Dissolvables, two types of smoke-free tobacco seeing increased use across markets. Camel Crush, a menthol selectable cigarette and Camel Sticks, Strips, and Orbs (the dissolvable products), are considered innovative products in the industry. RJR divides its cigarette product line into three segments: growth, support, and non-support. Growth brands are supported by strong marketing for future growth, while support brands receive limited marketing funds but are relied upon for long-term sustainability. Non-support brands continue to be manufactured and distributed based on consumer demand (see Exhibit 4 for RAI holdings and products). Camel and Pall Mall account for RJR’s growth brands and are responsible for approximately 55% of RJR’s cigarette sales. The company sells its cigarettes primarily to distributors, wholesalers, retail chains, and other direct customers.
The US cigarette market is forecast to decline approximately 4% in 2011, similar to the decline seen in 2010. RJR’s revenue is approximately 85% of RAI’s total sales and accounts for approximately 28% of the overall industry market.
The American Snuff segment, approximately 10% of RAI’s revenue, is experiencing high single digit growth annually. It is the second largest smokeless tobacco product manufacturer in the US, consisting of the moist-snuff brands—Grizzly and Kodiak. American Snuff was acquired in 2006 for $3.5 billion (known at the time of its sale as Conwood) and considered a key strategic move for RAI as its purchase provided entry into the smokeless tobacco business. The American Snuff segment holds approximately 31% of its target market but competition in this segment is high. RAI attributes increases in this segment to Grizzly’s lid redesign and strong product value.
The premium Santa Fe cigarette brands (Dunhill, State Express 555, and the no additive Natural American Spirit), in addition to the Niconovum business, account for RAI’s remaining 5% in revenue. Santa Fe, though small, delivered double-digit growth in 2010 on earnings and volume. While some analysts see RAI’s customers as an older demographic, Santa Fe branding could act as an entry to a younger, premium customer base.
Delen, President and CEO since March 2011, has continued the business strategy of outgoing CEO, Susan Ivey. Ivey was a 30-year veteran of the industry, previously CEO of Brown and Williamson, and assumed the CEO position when RAI was created in 2004. During this transition, RAI separated the Chairman of the Board from the CEO. RAI has de-emphasized private label brands to reduce complexity, increased prices, continued other factory and operating improvements (such as an ERP system), and remains committed to achieving an 80% payout target that will go hand in hand with a very hefty dividend of about 5.4%. As an industry less susceptible to market risk with a beta of .68, RAI is making it attractive for shareholders to care about supporting this $22.9B entity in its future ventures.
H1 The Black Sheep of America
While a lagging economy presents grave concerns to many industries, compared to the other challenges of the tobacco industry, it is likely the least of its worries. Easily usurping the majority of the time and attention of RAI executives are federal regulations and ongoing litigation. On June 22, 2009, the US government passed the Family Smoking Prevention and Tobacco Control Act. Most notably, this act significantly increases taxes on the sale of tobacco products and grants the US Food and Drug Administration (FDA) unprecedented control over the manufacture, sale, marketing, and packaging of tobacco products. Among other things, this act requires tobacco companies to disclose ingredients used in manufacturing including nicotine yield, limits flavor additives such as menthol and wintergreen, and places further restrictions on advertisements (including no logos or ads on t-shirts, caps, or other apparel) and smoking in public places. Were these restrictions not challenging enough for a company attempting to advertise, private industry has also taken the initiative to ban advertisements of cigarette products. Microsoft and Google both have policies banning tobacco promotion on their advertising networks and the Motion Picture Association of America threatens films depicting gratuitous smoking with higher ratings.
H2 Altria Group
Altria group was incorporated in Virginia in 1985 and is the holding company for Philip Morris USA and UST, which includes US Smokeless Tobacco Company LLC (USSTC). Cigarettes and smokeless products accounted for almost 95% of total income for Altria Group in 2010, with approximately 82% from cigarettes and 12% from smokeless products. Altria focuses on promoting brand equity, anticipating and responding to consumer preferences, competing in lower-priced markets, and enhancing margins through cost savings or price increases.
Philip Morris USA is the largest tobacco company in the US. Its most popular brand, Marlboro, has been the leading cigarette brand in the US for over 30 years and accounts for 87% of Philip Morris’ cigarette sales volume. Overall, Philip Morris products claim 49.8% of the total US cigarette market.
Altria acquired USSTC, the leader of the smokeless tobacco market as determined by retail share, on January 6, 2009. Copenhagen and Skoal are the most notable brands offered by USSTC and combined account for 83% of total smokeless tobacco volume within the company. Copenhagen retains 25.6% of the US retail market share while Skoal accounts for 22.4%. With all its smokeless tobacco products, USSTC controls over 55% of total US market share.
H2 Lorillard Tobacco Company
Lorillard Tobacco Company was founded in 1760, making it the oldest continuously operating tobacco company in the US. With corporate offices located in Greensboro, NC, Lorillard ranks as the third largest cigarette manufacturer in the US. In a similar fashion to RAI, Lorillard sold all major trademarks outside the US in 1977 and now produces cigarettes exclusively for the premium and discount segments of the US market. Lorillard’s primary brand is Newport, which accounts for roughly 90% of total company sales. Additional brands include Kent, True, Maverick, and Old Gold among many others. The Newport brand owns almost 11% of domestic market share, with Newport’s menthol product holding a strong 35% share within the menthol segment. As a company, Lorillard reported earnings of $1.725 billion in 2010.
Lorillard relies on in-store price reduction programs to promote the sale of its products. According to CEO Murray Kessler, Lorillard’s long-term growth depends on the strength of the Newport brand. Despite a FDA report stating that the “removal of menthol cigarettes from the marketplace would benefit public health in the US,” Lorillard is committed to the protection and growth of its core menthol cigarette business. Lorillard also directs its focus to enhancing internal capabilities to control operational costs as well as marketing efforts designed to penetrate strategic US markets.
H2 The Disappearing Smoker?
Consumers in the US spent about $90 billion on tobacco products in 2006 with roughly $84 billion of that total spent on cigarettes and $3 billion on smokeless tobacco. At that time, 23.6% of the adult (18 or older) American public actively smoked and 25.8% of the youth population smoked. Interestingly, the consumer base outside of the US does not face the volume reduction challenges faced here however, RAI has limited itself to the US market, so this is a unique disadvantage it faces compared to several of its competitors—especially Philip Morris.
Consumers recognize the financial and health constraints that tobacco use imposes. During 2000-2004, consumers suffered an estimated $193 billion in health-related losses due to the effects of tobacco consumption. These additional medical costs contribute to an average of $10.47 per pack, on top of already soaring prices. With the lagging economic pressures, increased awareness of the effects of tobacco use, and the burdensome cost to the consumer, the trend away from smoking is likely to continue.
Perhaps making the biggest impact to the decline in smokers however is the social stigma of being a smoker—particularly a smoker amongst friends and family that have quit. With increasing restrictions on where one can smoke, smokers report feeling increasingly harassed and ostracized. A person is 67% less likely to smoke if they have a spouse that quit smoking. In addition, smoking is disproportionately becoming a habit of the lower classes—the less educated, the less wealthy, and individuals with mental illness and/or addiction issues. The fact that smoking within the more elite circles is now taboo has prompted many to quit rather than risk trying to rub elbows only to find a cold shoulder.
However, while smoking has been cut in half since 1965, the percentage of adult smokers has stalled at just above 20% for several years. While the decline is credited to several socio-cultural factors including a fall in the social acceptability of smoking, increased awareness campaigns regarding the health concerns related to tobacco use, and increased pressure from anti-tobacco organizations, there is no clear evidence to explain the apparent limits of the efficacy of these efforts.
H2 Tobacco Producers
Tobacco growers worldwide supply the industry with tobacco. The largest supplies come from China, Brazil, the US, and Zimbabwe. In almost all tobacco producing countries, the government influences the production and trade of tobacco. This influence typically extends to supply management and subsidies aimed at maintaining stable prices. Tobacco is a significantly more profitable crop when compared to others thus providing developing countries with the opportunity to trade internationally with substantial margins. For example, in Zimbabwe, tobacco is nearly seven times more profitable than the next best crop.
Tobacco growers have organized to protect their interests and leverage their collective voice with both national and international organizations. In the US, one such group is the US Tobacco Cooperative, which exists “to enhance the livelihood of [its] members…” Internationally, member countries have organized the International Tobacco Grower’s Association. Like other cooperatives, this group is focused on sharing information between tobacco growers, creating strategies to stabilize supply and prices, and protecting the legitimate interests of tobacco growers.
H2 The Smoking Gun – Nicotine, or rather the smoke?
Two separate issues face smokers trying to quit. The first is kicking the habit of smoking—the places and times that a smoker ritualistically has a cigarette—and the second is kicking the physical addiction to nicotine. With the majority of smoking related health issues tied directly to smoking and not nicotine, it would seem a fairly simple proposition to replace the nicotine delivery method to something less lethal than smoking, thus curing every smoker.
New advances in technology for nicotine delivery support this trend away from using tobacco products. Products such as nicotine patches and chewing gums have been in use over the last decade as an alternative to tobacco use. Prescription medications have been created and, in recent years, the advent of the electronic cigarette, or e-cigarette, has provided smokers with an experience similar to smoking purportedly without the harmful effects associated with burning tobacco. And, as mentioned previously, new sticks, strips, and orbs packed with nicotine are hitting the marketplace. All of these products have siphoned away profits from tobacco companies as users work harder at conforming to societal expectations, saving money, improving their health, or all of the above.
And yet despite these advances, the fact remains that 74% of smokers report they have tried and failed to quit. One additional factor in the ability to quit seems to lie in the age that smoking starts. Smokers that pick up the habit after the age of 21 are far more likely to quit successfully—a factor that has not escaped the notice of tobacco companies and likely drove the underage-geared marketing that received such considerable attention in the latter part of the last century.
NOTE: Ram CT QUIZ QUESTIONS 8-18 WOULD BE INSERTED HERE
H1 Getting to the Top
With 86% of its revenue coming from its RJR segment, the dominant business of RAI is cigarettes. American Snuff contributes 8% of all revenue, while All Other Business contributes the final 6%. Because of this revenue split, RAI strives to maximize the profitability and market share growth of RJR, while simultaneously nurturing growth within American Snuff. RAI uses the profits associated with the All Other Businesses to fund the promotion and growth of its two primary segments. Similar to other corporations with this type of structure, RAI makes decisions, allocates resources, and assesses the performance of each segment individually. In addition, RAI has a subsidiary, known as RAI Services Company, which provides support functions such as legal services, information management, and human resources. By keeping each segment operating independently, with support functions provided via a subsidiary, RAI is able to choose which segments receive greater resources and growth efforts.
RAI’s goal is to strengthen individual brand identity and in doing so, persuade consumers to switch from whichever competitor’s brand they may currently be buying. The marketing necessary to do so demands that RAI keep a constant surveillance on changes in customer behaviors and values. To increase its market share, RAI has split its products into two main categories: price-value and premium. The price-value brands are targeted to the price-conscious consumer, while premium brands are targeted to quality conscious consumer segments. While American Snuff bases its diversification almost entirely on this two party consumer system, RJR goes a step further. Within its price-value and premium product segments, RJR has developed brands aimed at smaller consumer segments.
RJR’s Misty brand is a good example of this. It is packaged and promoted to appeal to middle-class women. This type of segment-specific packaging and promotion is an effective tool for RJR’s smaller brands. RJR’s flagship brand, Camel, is packaged, promoted, and advertised in a more neutral, all-encompassing manner, thus ensuring its appeal to the largest market possible. These types of segment-specific products allow RAI to maximize its market potential.
RAI is able to maintain lower costs through a variety of activities and practices. Unlike a corporation dedicated solely to providing the lowest cost products of its industry, RAI’s variety of products allows them to price products effectively to maximize market share. The fact that RAI owns all of the manufacturing facilities for RJR and American Snuff products helps control prices. This vertical integration allows them to monitor raw material and production costs, and price its products accordingly. Additionally, to protect itself against competitors that may attempt to take market share through cost cutting, RAI has established various discount opportunities for retailers. By discounting at the retail level—wherein RAI makes payments to retailers to reduce the price paid by the consumer—RAI is able to keep its products priced competitively to ensure maximum market share. This type of pricing structure is especially important in industries with such intense rivalry. While its manufacturing price controls help with long-term pricing, only these real-time customer-level pricing strategies ensure that RAI can react to competitors’ attacks on market share via pricing.
H2 Ensuring Stockholder Support
Another corporate strength for RAI can be seen in its commitment to offer rising dividends, high yields, and steady earnings when it comes to its stock.
QUOTE The S&P 500 tobacco index of four stocks – Altria Group Inc., Lorillard Inc., Philip Morris International Inc., and Reynolds American Inc. – has gained 121% over the past five years to the end of March (2011), after factoring in dividends. Over the same period, the S&P 500 has risen a mere 14%.
For a corporation to grow and reach its optimum level of success, it must have outside investors purchase stock in the company. Public perception of tobacco companies and the products they offer leave some possible investors with a moral dilemma when it comes to investing. To counteract this, RAI leans on its strong financial record to recruit new and additional investments (Exhibit 5). It is important that RAI show strong returns and rising dividends to keep the faith of prospective and current stockholders. Due to the amount of legislation and litigation affecting tobacco companies, these large returns protect RAI from having its stock price fall due to fears about the future health of the company. However, for these strong returns and the benefits they cause to continue, RAI must continue to grow. RAI’s main efforts to grow overall sales and brand market share are conducted through marketing.
H2 Modern Marketing
The Master Settlement Act of 1998 changed the way tobacco companies were allowed to advertise and market their products greatly. This act focused on the perceived ability of tobacco providers to target advertising toward children. The highlights of this act included the banning of cartoons in tobacco advertisements, restricting brand-name sponsorship for events with significant youth audiences, and the banning of outdoor advertising.
This act led to drastic advertising and promotional changes within RAI. In anticipation of the act, Joe the Camel, a popular advertising caricature associated with the Camel brand, was preemptively pulled from all advertising and promotional campaigns on July 12, 1997. Additionally, RAI changed its overall approach to advertising and promotion. Blocked from using standard advertising avenues, RAI began utilizing direct mail, advertisements in newspapers and magazines not restricted by federal, state, and local law, and a renewed and expanded presence at organized adult events and venues. Due to the intense competition between tobacco companies and despite the extensive restrictions on marketing and promotions, cigarette companies still managed to spend $12.4 billion on advertising and promotional expenses in the US in 2006—more than double their expenditures in 1997. Where RAI had once used marketing to target new (i.e. younger) users, its new strategy was to strengthen brand image, build brand awareness and loyalty, and recruit adult consumers of competing brands to RJR and American Snuff brands.
h3 Growth, Support, and Non-Support Brands
To effectively employ its marketing approach of strong brand image, awareness, and loyalty, as well as entice other brand users to its products, RAI divides its products into different operational groups. While its brands fall under the premium or price-value product lines when it comes to the type of customer being targeted, RAI uses the terms growth, support, and non-support brands when it comes to its promotional strategies.
Growth brands include Pall Mall cigarettes, Grizzly and Kodiak moist snuff, and its flagship brand, Camel. The goal of these brands is long-term market share and growth in profits. RAI’s commitment to the growth of American Snuff is evidenced by the fact that both of its major brands, Kodiak and Grizzly, are seen as growth brands by RAI. In addition, the modern smoke-free products, such as Camel Snus and Camel Dissovables, marketed under the Camel brand, are targeted for long-term market share growth. While all of the brands under the growth umbrella receive a large amount of promotional funding, the majority of these resources are earmarked to promote Camel products.
Support brands are managed for long-term sustainability and profitability. These brands include Winston, Kool, Capri, Salem, Doral, and Misty and receive little to no promotional or advertising support. Together, these products form a solid platform of sustainable growth and profits for RAI, with essentially no funds allotted or necessary for their promotion or growth. Non-support brands are all other products under the RAI umbrella. The goal of these products is short-term profitability. These short-term profits are then used in the promotion and advertising of growth products. This system of grouping brands by marketing strategy has allowed RAI to defend its market share in the ultra-competitive tobacco industry, while also funding the initiatives necessary to steal market share away from the competition.
H2 The House that Reynolds Built
American Snuff has manufacturing facilities in Tennessee, North Carolina, and Kentucky. American Snuff owns all three facilities and began capacity upgrades and expansions in 2009. RJR also owns its manufacturing facilities and has recently consolidated completely to its Tobaccoville, NC location. Total product capacity for RJR is estimated at 160 billion cigarettes per year. As a result of this consolidation, RAI is seen as benefiting financially from economies of scale.
R&D has traditionally been performed at the RJR facility where scientists and engineers focus on developing new products, new packaging models, hard reduction technologies, and FDA compliance. However, RAI is relocating the R&D segment to a new facility to further consolidate R&D efforts across all business segments. RAI’s R&D expenses were $71 million, $68 million, and $59 million in 2010, 2009, and 2008. Increases primarily reflect the development of harm reduction and smoke-free products for RJR.
H1 Financial Results
In 2010, RAI reported net sales of $8.6 million—a 1.6% increase over the reported $8.4 million in sales in 2009 (Exhibits 6A-B). This is important given that key competitors within the tobacco industry indicated significant decreases in 2010 net sales. Much of this growth can be attributed to increased sales within the American Snuff business segment as RJR only realized a 0.2% increase in net sales from 2009 (Exhibit 7). RAI 2010 net profit followed suit reflecting a 1.6% increase over 2009.
H1 Leadership
RAI key executive officers include Daniel (Daan) M. Delen and Thomas R. Adams. Delen became President and CEO of RAI on March 1, 2011. Delen previously served as President and CEO of reporting segment RJR from 2007 to 2010 and served as Chairman of the Board of RJR from 2008 to 2010 yielding a total of four years active experience with RAI. Prior to retirement in 2011, Susan M. Ivey preceded Delen, serving as President and CEO of RAI for seven years.
Adams has served as Executive Vice President and CFO of RAI since January 2008. Adams’ prior experience with RAI dates back to 2005 and includes leadership roles such as Senior Vice President, Chief Accounting Office, Senior Vice President-Business Processes, and Controller.
H2 Board of Directors
The RAI board of directors is made up of 12 board members, each serving a three-year term and divided into classes I, II, and III. Each class represents a year of staggered term end dates. Board members include a mix of inside and outside directors that help promote industry knowledge while fostering a greater degree of board independence. Board committees are crucial to the ongoing monitoring of top executives and as such, RAI’s board of directors has established the following three standing committees: Audit and Finance, Compensation and Leadership Development, and Corporate Governance and Nominating.
The current Chairman of the Board, Thomas C. Wainert, stepped into the role in November 2010. Relevant industry qualifications include having previously served as a Director of both RAI and RJR. Wainert has also held the CEO position in public and privately held firms. The Board of Directors meets a minimum of five times during an annual calendar year with meeting agendas developed by the Chairman, the CEO, and the Secretary of the Company. Board members may also provide recommendations for additional agenda items as deemed necessary. Finally, all Board members retain open access to RAI’s senior management.
RAI’s top executives, serving as agents on behalf of shareholders, share a combined total of over 150 years of direct experience with RAI and the tobacco industry (Exhibit 8). This provides RAI with an extensive amount of knowledge from which to leverage decision making. RAI has established proper checks and balances of executives by incorporating formal evaluations of leadership, including an evaluation of the CEO by the Compensation and Leadership Development Committee. Additionally, the Governance Committee monitors Board membership to ensure a diversity of perspectives, skill sets, and superior business and professional experience are represented. The Governance Committee also conducts an annual evaluation of the Board’s performance. These control mechanisms counter managerial opportunism (i.e. pursuit of non-approved product diversification) and provide assurance to stakeholders by ensuring decisions are made with the best interests of RAI in mind. Further evidence of sound internal controls is evidenced by executive Sarbanes-Oxley assertions within RAI’s audited financial statements.
H1 Maintaining Momentum
Analysis of the tobacco industry reveals tremendous pressure and key challenges facing the market—and RAI is no exception. Specific to the firm, these obstacles include a growing competitive base, slow economic recovery from the recession, severely tightened government regulation, and substantial societal obstacles. RAI faces intense strategic challenges as a result of this. Challenges such as product mix, differentiation factors, pricing, R&D investment, successful product placement, and marketing must all be addressed.
The tobacco industry is subject to a wide range of laws and regulations regarding the marketing, sale, taxation, and use of tobacco products imposed by local, state, federal, and foreign governments. One example of such regulation is the Family Smoking Prevention and Tobacco Control Act.
The health-conscious consumer also presents stiff resistance to RAI. From increased scientific studies and research on the influence of tobacco to innumerable anti-smoking groups, the obstacles are significant.
With heavy consideration given to these encumbrances, the management team of RAI must develop a very focused strategy to overcome these obstacles. Despite some difficult societal economic hardships, RAI has demonstrated consistent financial results. Considering the challenges within the industry, RAI’s approach to sustainability across its brands must be continued. With firm strategic initiatives and strong management leadership, RAI will continue to be a powerful company, capable of long-term success.
NOTE: Ram CT QUIZ QUESTIONS 19-25 WOULD BE INSERTED HERE
Exhibit 1
Current Cigarette Smoking in Persons 18 and Older by Sex, Selected Years, 1965-2008
Source: American Lung Association publication, Trends in Tobacco Use – http://www.lungusa.org/finding-cures/our-research/trend-reports/Tobacco-Trend-Report.pdf
Exhibit 2
US Cigarette Market Share by Competitor
Source: Blashill, Graham. 2008. Implementing our strategy in the USA. Accessed 20 May 2011. http://www.imperial-tobacco.com/files/financial/reports/ar2008/index.asp?pageid=98
Exhibit 3A
Annual Net Sales Comparison
Source: see below 3G
Exhibit 3B
Percent Sales Growth Comparison
Source: see below 3G
Exhibit 3C
Gross Margin Comparison
Source: see below 3G
Exhibit 3D
Net Profit Margin Comparison
Source: see below 3G
Exhibit 3E
Return on Assets Comparison
Source: see below 3G
Exhibit 3F
Current Ratio Analysis
Source: see below 3G
Exhibit 3G
Inventory Turnover Comparison
Source: Reynolds American, Inc. Form 10-K for the fiscal year ended 12/31/2007. Form 10-K for the fiscal year ended 12/31/2008. Form 10-K for the fiscal year ended 12/31/2009. Form 10-K for the fiscal year ended 12/31/2010. Accessed 23 Feb 2011. http://www.reynoldsamerican.com/sec.cfm?DocType=Annual&Year=; Altria Group, Inc. 2007 Annual Report; Altria Group, Inc. 2008 Annual Report; Altria Group, Inc. 2009 Annual Report; Altria Group, Inc. 2010 Annual Report. Accessed 25 Feb 2011. http://investor.altria.com/phoenix.zhtml?c=80855&p=irol-reportsannual&src=top_nav; Lorillard 2007 Annual Report; Lorillard 2008 Annual Report; Lorillard 2009 Annual Report; Lorillard 2010 Annual Report. Accessed 24 Feb 2011; Vector Group Ltd. Form 10-K for the fiscal year ended 12/31/2007, 12/31/2008, 12/31/2009, 12/31/2010. Accessed 24 Feb 2011. http://www.sec.gov/cgi-bin/browse-edgar?type=10-K&dateb=&owner=include&action=getcompany&CIK=0000059440; Imperial Tobacco Group PLC. Annual Report and Accounts 2007, 2008, 2009, 2010. Accessed 24 Feb 2011. http://www.imperial-tobacco.com/index.asp?page=151
Exhibit 4
RAI Holdings and Products
Reynolds American Inc.
RJ Reynolds Tobacco Company (85%) American Snuff Company, LLC (10%) All Other (5%)
Cigarettes Smoke Free Snuff Non Snuff Santa Fe Natural Tobacco Company, Inc. Niconovum AB
Growth Support Non-Support Camel Snus* Camel Dissolvables* Cigars Loose Tobacco
Camel
Pall Mall Winston
Kool
Salem
Capri
Doral
Misty Carlton
Eclipse
GPC
Lucky Strike
Monarch
More
Now
Private-Label
Tareyton
Vantage Robust
Winterchill Orbs
Strips
Sticks Grizzly*
Kodiak*
Levi Garret
Hawken Winchester
Captain Black Bugler American Spirit
Dunhill
State Express 555
*additional growth brands
Source: Information compiled using http://www.rjrt.com/whoweare.aspx
Exhibit 5
RAI Financial Results
Source: Reynolds American, Inc. Form 10-K for the fiscal year ended 12/31/2007. Form 10-K for the fiscal year ended 12/31/2008. Form 10-K for the fiscal year ended 12/31/2009. Form 10-K for the fiscal year ended 12/31/2010. Accessed 23 Feb 2011. http://www.reynoldsamerican.com/sec.cfm?DocType=Annual&Year=
Exhibit 6A
RAI: Consolidated Statements of Income
For the Years Ended
(Dollars in Millions, Except Per Share Amts) December 31,
2010 2009 2008
Net sales (1) $ 8,170 $ 8,015 $ 8,377
Net sales, related party 381 404 468
Net sales 8,551 8,419 8,845
Costs and expenses:
Cost of products sold (1)(2)(3)(4) 4,544 4,485 4,863
Selling, general and administrative expenses 1,493 1,508 1,500
Amortization expense 25 28 22
Asset impairment and exit charges 38 — —
Trademark impairment charges 6 567 318
Goodwill impairment charge 26 — —
Restructuring charge — 56 90
Operating income 2,419 1,775 2,052
Interest and debt expense 232 251 275
Interest income (12 ) (19 ) (60 )
Gain on termination of joint venture — — (328 )
Other expense, net 7 9 37
Income from continuing operations before income taxes 2,192 1,534 2,128
Provision for income taxes 863 572 790
Income from continuing operations 1,329 962 1,338
Losses from discontinued operations, net of tax (216 ) — —
Net income $ 1,113 $ 962 $ 1,338
Basic income per share (5) :
Income from continuing operations $ 2.28 $ 1.65 $ 2.28
Losses from discontinued operations (0.37 ) — —
Net income $ 1.91 $ 1.65 $ 2.28
Diluted income per share:
Income from continuing operations $ 2.27 $ 1.65 $ 2.28
Losses from discontinued operations (0.37 ) — —
Net income $ 1.9 $ 1.65 $ 2.28
Dividends declared per share $ 1.84 $ 1.73 $ 1.7
-1 Excludes excise taxes of $4,340 million, $3,927 million and $1,890 million for the years ended December 31, 2010, 2009 and 2008, respectively.
-2 Includes Master Settlement Agreement, referred to as MSA, and other state settlement agreements with the states of Mississippi, Florida, Texas and Minnesota, together with the MSA collectively referred to as the State Settlement Agreements, expense of $2,496 million, $2,540 million and $2,703 million for the years ended December 31, 2010, 2009 and 2008, respectively.
-3 Includes federal tobacco quota buyout expenses of $243 million, $240 million and $249 million for the years ended December 31, 2010, 2009 and 2008, respectively.
-4 Includes U.S. Food and Drug Administration, referred to as FDA, user fees of $75 million and $22 million for the years ended December 31, 2010 and 2009, respectively.
-5 All per share amounts have been retroactively adjusted to reflect the November 15, 2010, two-for-one stock split. See note 1 for additional information.
Source: Reynolds American, Inc. Form 10-K for the fiscal year ended 12/31/10. Accessed 23 Feb 2011. http://www.reynoldsamerican.com/secfiling.cfm?filingID=950123-11-16932
Exhibit 6B
RAI: Consolidated Balance Sheet
December 31,
(Dollars in Millions) 2010 2009
Assets
Current assets:
Cash and cash equivalents $ 2,195 $ 2,723
Accounts receivable 118 109
Accounts receivable, related party 48 96
Notes receivable 34 36
Other receivables 10 15
Inventories 1,055 1,219
Deferred income taxes, net 946 956
Prepaid expenses and other 195 341
Assets held for sale 201 —
Total current assets 4,802 5,495
Property, plant and equipment, at cost:
Land and land improvements 89 88
Buildings and leasehold improvements 656 661
Machinery and equipment 1,700 1,759
Construction-in-process 157 87
Total property, plant and equipment 2,602 2,595
Less accumulated depreciation 1,600 1,570
Property, plant and equipment, net 1,002 1,025
Trademarks and other intangible assets, net of accumulated amortization (2010 — $672; 2009 — $647) 2,675 2,718
Goodwill 8,010 8,185
Other assets and deferred charges 589 586
$ 17,078 $ 18,009
Liabilities and shareholders’ equity
Current liabilities:
Accounts payable $ 179 $ 196
Tobacco settlement accruals 2,589 2,611
Due to related party 4 3
Deferred revenue, related party 53 57
Current maturities of long-term debt 400 300
Other current liabilities 1,147 1,173
Total current liabilities 4,372 4,340
Long-term debt (less current maturities) 3,701 4,136
Deferred income taxes, net 518 441
Long-term retirement benefits (less current portion) 1,668 2,218
Other noncurrent liabilities 309 376
Commitments and contingencies:
Shareholders’ equity:
Common stock (shares issued: 2010 – 583,043,872; 2009 – 582,848,102) — —
Paid-in capital 8,535 8,498
Accumulated deficit (547 ) (579 )
Accumulated other comprehensive loss — (Defined benefit pension and post-retirement plans: 2010 – $(1,446) and 2009 – $(1,376), net of tax) (1,478 ) (1,421 )
Total shareholders’ equity 6,510 6,498
$ 17,078 $ 18,009
Source: Reynolds American, Inc. Form 10-K for the fiscal year ended 12/31/10. Accessed 23 Feb 2011. http://www.reynoldsamerican.com/secfiling.cfm?filingID=950123-11-16932
Exhibit 7
American Snuff Brand Financials
For the 12 Months Ending
*Millions of Cans December 31,
2010 2009 2008
KODIAK 47.5 47.8 51
GRIZZLY 325.3 304.6 279.6
OTHER 4.5 4.1 4.5
TOTAL MOIST SNUFF SALES 377.3 356.5 335.2
Source: Reynolds American, Inc. Form 10-K for the fiscal year ended 12/31/10. Accessed 23 Feb 2011. http://www.reynoldsamerican.com/secfiling.cfm?filingID=950123-11-16932
Exhibit 8
RAI Leadership
Title Name Years of RAI Experience
President of Santa Fe (All Other Business, RAI) Nicholas Bumbacco 5
Executive VP and Human Resources Officer Lisa J. Caldwell 10
Senior VP – Public Affairs Robert H. Dunham 6
Senior VP and Treasurer Daniel A. Fawley 11
Executive VP – Operations and Chief Scientific Officer, RJR Tobacco Jeffrey S. Gentry 24
President and Chief Commercial Officer, RJR Tobacco Andrew D. Gilchrist 6
Executive VP, General Counsel and Assistant Secretary, RAI Martin L. Holton III 6
Executive VP – Consumer Marketing, RJR Tobacco J. Brice O’Brien 15
President of Niconovum USA, Inc. Tommy J. Payne 22
Senior VP and Chief Accounting Officer, RAI Frederick W. Smothers 8
President of American Snuff Co. Randall M. (Mick) Spach 9
Executive VP – Trade Marketing, RJR Tobacco Robert D. Stowe 6
Senior VP – Strategy and Business Development, RAI E. Kenan Whitehurst 22
Source: Reynolds American, Inc. Form 10-K for the fiscal year ended 12/31/10. Accessed 23 Feb 2011. http://www.reynoldsamerican.com/secfiling.cfm?filingID=950123-11-16932
Gorham, Philip, CFA; Morningstar Investment Research Center – Reynolds American, Inc. RAI Thesis 04-25-2011 http://library.morningstar.com/stocknet/MorningstarAnalysis.aspx?Country=USA&Symbol=RAI.
Endnotes
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