Authors: Richard Kluger
But Miles was never to become an eager defender of smoking, beyond insisting on everyone’s right to do so without a busybody government or anyone else interfering. And he was anything but confrontational in his approach to tobacco’s embattled status, replacing the joyfully combative Guy Smith as PM’s top public-relations man. Even when the company might have generated some favorable publicity over a decision it made early in 1992 to placate its critics—the placement of health warning labels on all packs of cigarettes PM exported to the few remaining nations that did not require them on their domestic brands—there was no announcement; the press learned of the move from a disgruntled stockholder, a clergyman who had long urged the humane step on management and was apprised that it had finally been done. Miles was probably right in his the-less-said-the-better approach; to have trumpeted the change would surely have invited criticism of the company’s long delay in making it.
Once in office, Miles encountered difficulty almost from the first in gunning the company full throttle when the rest of the U.S. economy was mired in recession.
American business was feverishly cutting costs, bringing unprecedented layoffs in the white-collar sector, a growing sense of national economic insecurity, and a suddenly acute price consciousness among consumers about what they were paying for everyday products, food and cigarettes prominent among them. Philip Morris’s inordinate pricing power, based on its stable of more than 3,000 products, many of them household names, was now under siege by no-name generic and private-label rivals sprouting on store shelves at discount prices.
The problem was more pressing at first on the food side of the business, where Miles had already effected the easy “synergies,” his favorite buzzword for economies like central purchasing of advertising for all corporate products in order to obtain the lowest rates, and manufacturing efficiencies like saving a million dollars a year by reducing the size of the caps on Miracle Whip jars. Faced with narrowing margins due to price warfare on supermarket shelves and volatile commodity costs, Miles elected to follow the lead of Procter & Gamble and risk a loss in market share to gain higher profitability by slashing promotional outlays in the form of “placement allowances” to retailers for desirable shelf display and off-price couponing to appease consumers. The decision meant slowed growth, if any, for Kraft General Foods (KGF) brands, the prices of which were cut cautiously when at all, but margins slowly firmed up. Meanwhile, high-volume but thin-margin product lines were peeled off, like Birds Eye frozen fruits and vegetables and KGF’s 15 percent share of the U.S. ice-cream business, under the Breyers and Sealtest labels, being hard hit by specialty and regional competitors like Haagen-Dazs and Ben & Jerry’s. Unilever took the lagging ice-cream business off Miles’s hands for $115 million, and he turned instead to more promising projects, like building up KGF’s 11 percent share of the high-margin breakfast cereal market, a distant third to leaders Kellogg and General Mills, by paying debt-laden RJR $450 million for its venerable but somewhat faded Nabisco Shredded Wheat trademark. Miles was also determined to turn around KGF’s low-profit food-service business, catering to restaurants and institutional cafeterias with bulk sales of cheese, mayonnaise, and other staples.
Increasingly, Miles also had to face up to the constant and often costly complexities of the food-processing business. This meant keeping constant vigil over not only inefficient and outmoded plants but even state-of-the-art installations like the turkey-processing facility put up in California to replace the old system by which the birds, after they were decapitated and their feathers steamed off, got dunked into a cold-water bath to await evisceration and dismemberment; the result was a kind of “fecal soup,” in which bacteria proliferated. To eliminate this unsanitary birdbath, the company installed an expensive cold-air process developed by German technology and approved by the U.S. Department of Agriculture for temporarily storing the poultry. Unfortunately,
the system did not work. “It was back to fecal soup,” Miles somewhat grimly recounted later. But instead of constructing a whole new configuration of the plant at a time when the demand for turkey was on the wane, the installation was closed down as part of a $400 million KGF write-off during Miles’s first year in office.
Such setbacks were inevitable for PM’s huge $20 billion food business. But often when one sector slumped, another was likely to compensate. The same was true of Miller Brewing, where its leading brand, Lite, was losing its luster but Miller Genuine Draft continued to advance, gaining seventh place among all brands. Even in a struggling economy, then, Philip Morris was able to generate enough surplus cash flow not only to finish paying off the debt from its huge acquisitions in the food business but to continue investing in expanded facilities and new ventures. The chief difference was that now Miles spent more surgically and less spectacularly than his predecessor, and mostly overseas in much smaller moves.
This continuing expansion was more apparent on the tobacco side, where PM acted as aggressively as prudence allowed in the republics of the former Soviet Union and its lately freed Eastern European vassals as well as in countries like Turkey, where it spent $400 million for a large new plant and was soon selling more cigarettes than it did in Japan and France combined; in Brazil, where it had bought out RJR’s manufacturing operations and was now pushing hard to improve on its 17 percent market share, still far behind BAT’s 80 percent but at least a legitimate contender now; and in Vietnam, where by late 1994 PM became one of the first U.S. companies to open a manufacturing operation. The company was equally active in expanding on the food side abroad, where the KGF-Jacobs Suchard food empire was a mishmash of loosely federated licensees, distributors, and partners. Under Miles and Geoffrey Bible, structural coherence was sought along with what the latter termed “critical mass” by concentrating on three product lines: coffee, candy, and cheese. PM, already a major factor in the European coffee business, soon acquired top processors in Spain, Italy, and the Czech Republic; by 1994, it was selling twice as many roasted and ground beans as its nearest competitor on the Continent. In the confectionery business it moved more boldly by paying $1.5 billion for the biggest Scandinavian candymaker, Norway’s Freia Marabou, to gain 15 percent of the continental market, just behind Mars, and then closed in further by outbidding Hershey to win Terry’s Group, a leading British maker of boxed chocolates and toffee, for $320 million, gaining 6 percent of the candy business in a nation with a pulsating sweet tooth. Leading confectioners were shortly added in Eastern Europe.
In the beer business, where Miller ranked as the world’s second largest producer, PM acted to improve its puny overseas sales—Anheuser-Busch was grossing three times its foreign revenues—by buying up 8 percent of Mexico’s
leading brewer, makers of the Dos Equis brand, for $160 million and a 20 percent share of Canada’s top entry, Molson Breweries, including rights to its U.S. import of the Molson brand, third-ranking among foreign labels that held 4 percent of the American market. Holdings in both foreign companies were likely to be expanded at the earliest opportunity, along with other promising candidates to solidify its power in the worldwide beer and candy business, like the Dutch brewer Heineken and the giant British confectioner and soft-drink producer Cadbury Schweppes.
II
MICHAEL MILES’S
severest problem running Philip Morris turned out to be sliding sales in its most profitable line of business: the American cigarette division. After so many years of clear sailing and ever escalating margins, reaching a sublime 50 percent on premium brands by the early 1990s on the strength of incessant price increases of 10 percent a year, there had seemed to be no limit to what the consumer traffic would bear. Even when the discount sector of the market began growing, PM had responded by offering its own lower-priced entries yet increasing their prices at twice the rate of its full-priced line to keep profit margins presentable. The main challenge had been how to prevent Marlboro, with a quarter or so of the cigarette market, from being squeezed into about half that proportion of the available retail shelf space and having to rely on closely monitored turnover of the stellar brand.
By Miles’s first year at the helm, though, the good old days were plainly over in Marlboro Country. The brand had lost 2.5 percent of its unit sales between 1988 and 1990, as the discount brands were capturing 20 percent of the market. In 1991, the erosion grew more serious. The older generation of smokers, knowing that one brand of cigarette was very like every other, resented paying two dollars or more for a pack and was turning to the cheaper brands, while for younger smokers, Marlboro was losing some of its appeal—it was the brand their parents smoked, and cowboys were old-fashioned, like Western movies. Camel, with its fun-loving mascot, Old Joe, was attracting a lot of attention from novice smokers. For the first time, Marlboro was offered in Christmas giveaway promotions. But it was not only Marlboro that was going into decline; all premium-priced brands except Camel were hurting, in particular Reynolds’s Winston and Salem, which RJR tobacco chief James Johnston was trying hard to resuscitate with glossier packages, improved blending, more puffs per butt, and a tighter wrap to ensure freshness, none of which seemed to help.
To check Marlboro’s decline, PM in mid-1991 rolled out its first major line extension in twenty years, since the introduction of Marlboro Light, which had
developed into almost as big a seller as original Marlboro Reds. Company marketers thought there might be a niche they could fill between the flagship Marlboro Red and Light, which had about two-thirds of the former’s tar and nicotine yield and appealed heavily to women. Why not Marlboro Medium, with yields slightly above Lights but offered in a package almost identical to the Reds and advertised in a slightly coyer fashion—without cowboys, only pictures of their boots or spurs to suggest a diminished strength to the smoke? The introduction was lavishly promoted through ads and incentives to wholesalers; the idea was to keep Marlboro buyers from defecting to rival full-priced brands or the discount sector, even if at the expense of Marlboro Red’s sales. Within a year, Medium had taken a 1.5 percent share of the market but succeeded only in slowing, not stopping, Marlboro’s overall slide.
Fresh thought was now given to revisiting the ultra-light sector of the market—brands yielding six or fewer milligrams of tar—and particularly the bottom end of it, dominated by American Tobacco’s Carlton and RJR’s Now, with yields of about one milligram; all together, this niche held barely 3 percent of the market. Philip Morris had virtually abandoned it after the failure of Cambridge as a minimal-yield entry a decade earlier. “We had other fish to fry,” PM-USA head William Campbell recounted. Merit Ultra Lights, with a 5-milligram yield, had done well and taken 2 percent of the market, but what if Philip Morris tried seriously now to stir smokers’ interest in a supermild brand, on the unspoken premise that it would be perceived as a safer product and stake out a good deal broader market than Carlton and Now held, if marketed with the old Philip Morris verve?
The scientific evidence in support of such a product remained sketchy but plausible. In the mid-’Eighties, Neal Benowitz and other investigators, measuring yields by trace elements of nicotine in smokers’ blood and urine (and taking into account any increase in their smoking habits due to compensation), found that users of ultra-low brands were experiencing a 50 percent drop in nicotine absorption and 30 percent less than the average yield of carbon monoxide. And in highly preliminary estimates by Wynder and others, smokers using or switching to low-yield brands showed a 25 to 35 percent reduction in their risk rate for lung cancer but no discernible gain in fending off heart disease. But whether these sizable drops were enough to sustain a significant or even measurable reduction in disease formation could not be authoritatively determined without a major epidemiological study, perhaps covering the entire smoking life of subjects who used only the weakest brands.
Even so, Philip Morris marketers, however much they preferred to believe that it was the growing social stigma of smoking more than health fears which were depressing sales, brought out Merit Ultima in 1992 in a sky-blue pack with a metallic finish and white lettering meant to suggest a mild product. It got pushed hard with futuristic ads using computer-like dot printing that hinted
at technological innovation and declared, simply, “Surpassing flavor at only 1 mg. of tar” (and 0.1 of nicotine)—the Carlton-Now rock-bottom dosage level. Nevertheless, Ultima, like Medium for the Marlboro line, slowed but could not halt Merit’s attrition.
Philip Morris might have prevented some of the continuing erosion of its full-priced sales if it had chosen to stop raising prices in the teeth of a recession and buyer resistance to costlier name brands. Or it might have even cut prices, as its KGF division had done with its Cracker Barrel cheese brand when faced with heavily discounted no-name house brands in the supermarkets. Instead, PM-USA opted to defend its aggressive pricing with premiums. These ranged from T-shirts with brand logos, given away by the millions per year for cutouts of the package bar code to prove purchase, to Virginia Slims’ new “V-Line” of women’s wear, which included a supple black leather jacket with a surplus of zippers (as a reward for a year’s worth of smoking at a pack-a-day rate), to the still more elaborate Marlboro Team Adventure promotion, offering outdoor gear like sleeping bags and insulated jackets bearing the brand imprimatur and giving contest winners a free trek through “Marlboro Country” in a four-wheel R/V, on a Whitewater raft, and, of course, on horseback.
Amid all this frenetic effort to defend a relentless pricing policy for its top brands, PM continued to guard its rear by accommodating customers who no longer could or would pay high prices for a name alone. It offered three brands at a mid-level discount—Cambridge, Alpine, and Buck—and the more deeply discounted Bristol and the supermarket black-and-white label, Basic. By the end of 1991, Philip Morris had actually seized the share lead from Reynolds in the discount sector of the market, which was now accounting for one out of every four packs sold.