Saturday, December 7, 2019

Market Structure and Market Failures in Sri Lankan Tobacco Industry free essay sample

The number of registered tobacco growers rose during the 1980s and most of the 1990s, but fell sharply in 1998 and 1999. It is estimated that tobacco growing provides between 5,355 and 16,580 full-time equivalent jobs (the range depends on the labor requirements per hectare), which is just a fraction of one percent of the total labor force (0. 08-0. 25%). Employment in tobacco manufacturing has fallen since 1990, from 6-7% of all manufacturing employment to 4-5% (the lower number refers to employment, the higher number also includes others engaged in the sector). Production volumes were fairly steady averaging around 5. billion sticks between 1995 and 1999, with a marked fall to 4. 6 billion in 2000. An estimated approximately 3 billion bidis are produced annually as well. There is no information on illegal production of so-called white cigarettes†. Average salaries and wages in the tobacco industry are about half the level for all manufacturing, and have fallen slightly in real terms during the 1990s. Manufacturing sector indirect tobacco employment is estimated to be small, of the order of 150 people. There are about 41,000 retailers that sell tobacco products, which typically account for only a small part of heir total turnover. The Sri Lankan tobacco industry is dominated by the Ceylon Tobacco Company (CTC). The holding company of CTC is the British American Tobacco Company (BAT). BAT is the second largest tobacco company in the world. That is more or less a monopolistic situation in the island by the CTC. CTC contributed Rs. 31. 9 billion to the national economy of Sri Lanka in 2005. The increase of 14% over 2004 is mainly attributed to the increased excise rates on cigarettes and raids carried out by law enforcement authorities to minimize the presence of smuggled and illicit cigarettes in the market. The Company’s contribution totals 9. 5% of the country’s total revenue and 1. 49% of GDP. Sri Lanka continues to have the highest rate of taxation in the world on cigarettes at 80%. Export values of raw and manufactured tobacco have fallen, making Sri Lanka a net importer in tobacco trade, with a corresponding outflow of foreign exchange. 2. 0Sri Lankan Tobacco Market Structure Analysis Porter’s five forces model has been used to analyze the Sri Lankan tobacco market structure. Potential entrances †¢High due to high economies of scale. CTC produces in large scale of cigarettes where unit cost per stick has dramatically reduced. So new entrance cannot afford to offer this low price as CTC. †¢High product differentiation due to product branding. CTC offers various world class products such as Dunhill, John Player Gold Leaf and Benson Hedges. †¢Legal regularity government barriers. Banning of smoking in public places such as pubs, restaurants, public transports and all enclosed work places. Banned advertisement on television, radio, news papers and bill boards. High tax imposed by government that is more than 80% per stick. Furthermore the government policies such as â€Å"Mahinda Chinthanaya† are enforced to reduce the consumption of cigarettes. Bargaining power of buyers †¢Bargaining power buyers are more less reason being because it is a habitual product and more addictive. †¢On the other hand consumers show high brand loyalty. For example Gold Leaf smokers would consume same brand only. †¢Although the increase in taxes was passed on to the customers, demand for tobacco remained relatively high. Cigarettes distributed through very wide range of retail outlets, none with significant clout. Bargaining power of suppliers †¢Bargaining power of the tobacco leaf growers are low. Since subsidiary companies operate leaf growing programs through which they provide direct agronomy support to farmers if it is not otherwise available. So CTC has the direct control over the leaf growers. Even though the import option is als o available bargaining power of international suppliers also high due to huge demand worldwide. †¢When it comes to the tobacco leafs there exists low presents of substitutes. Threats of substitute †¢Threats of substitute are low †¢Herbal cigarettes, Weed, Marijuana, Cannabis, Nicotine Patches, Nicotine Gums, Nicotine inhalers are among the substitutes. †¢Since high impose of the regulations and taxes, increasing number of illicit cigarettes can be seen. Rivalry Among competitors †¢There is low concentration of companies therefore competition is very low, the fact that there is heavy branding and brand loyalty supports this. In fact CTC is playing the monopolistic role where it enjoys the abnormal profits with the high market share. 2. The Private and Social Costs of Smoking Smoking creates a difference between private and social costs and benefits. Cigarette consumers derive private benefit from smoking and their habit entails a private cost. But the act of consumption creates negative externalities so that the social cost of exceeds the private cost. It is unlikely the smokers consider the external costs they are creating when they ar e lighting up. Smoker may also suffer from the information failure. So that they are not fully aware of the long term damage created by their smoking habit. That is they are over estimating the private benefit that they get from smoking. If smokers fail to consider the externalities they generate then market failure will occur which will lead to loss of social welfare. Because of the impact on human life, many of these externalities are impossible to value accurately in monetary terms. 2. 1. 1Private Costs and Social Costs of Smoking If you consider the private consumption costs as follows, A 20 a day smoker will spend about Rs. 131400 year on cigarettes. People on low income spend proportionally more of their income on tobacco than wealthier people. Cigarettes are products with negative income elasticity of demand. So the health costs to the private consumer is about half of all regular cigarette smokers will be eventually killed by their habit from lung cancer, chronic obstructive lung disease and heart disease. Increased health insurance costs with high premiums for smokers. Costs to the national health system of treating smoking related diseases are very high. Smoking itself is regarded as a major source of health inequalities. Lost output/productivity from working days lost and absenteeism caused by smoking related illnesses. Increased pressure on the welfare state/benefits system to finance those unable to work because of long term illness, plus the benefits paid to dependents of those who die young. Costs created by household fires linked to smoking. Cigarettes are major source of street litter and it will create cleaning and building maintenance costs dramatically. 2. 1. 2Explaining the Market Failure Consumption of cigarettes creates external costs. Therefore the social cost exceeds private cost. Private optimum is where marginal private cost (the cost of an extra unit consumed) equates with the marginal private benefit (the satisfaction from an extra unit). Social optimum takes into account the social cost. Without intervention, the self interest of smokers will lead to cigarettes being over consumed and under priced by the market. So without a marker for pollution smokers can continue to pollute without penalty. Following figure 1 illustrates the market failure due to smoking. Figure 1: Illustrating market failure 3. 0Taxation and Regulations If cigarettes and other related products are classified as demerit goods then market failure can occur. In this case there is an economic rationale for some form of government intervention in market mechanism. Different intervention strategies are possible as follows, †¢Use of Taxation of cigarettes products. †¢Command and control through regulation. †¢Education Health awareness to alter demand. †¢Increase government spending on behavioral treatments and pharmacotherapy (nicotine replacement and non-nicotine medications) in order to reduce tobacco dependence. In each case we need to consider the effectiveness of each form of intervention, related issue of equity (fairness) to different groups. 3. 1Command and Control of the industry Sri Lanka has the highest tobacco taxes in the Asian region. Over 80% of the final retail price is tax (VAT, green taxes and excise duty). The average tax composition in other nations is around 55 percent. The aim of higher taxation is to increase the real cost of purchasing and consumer cigarettes. Higher prices should control demand by reducing the real incomes of cigarette smokers and increasing the opportunity cost of continuing to smoke. Lower consumption rates reduce output towards the social optimum reducing the extent of market failure. Taxation is also justified on the grounds of making the polluter pay for the external costs that are created. Extra revenue from taxation can be used to find improvements in the health care (e. g. the concept of an ear-marked tax) Can impose following regulations, †¢Legal restriction on consumption. oBanning smoking in all sort of public places †¢Legal bans on the importation of cigarettes in Sri Lanka. †¢Health and safety at work act oIncluding an obligation on employers to protect. Employees from passive smoking. Creating separate smoking areas in the work place. †¢Regulation on tobacco products labeling. †¢Legal restriction on advertisement. Banning direct advertisement on public media such as TV, radio, print media, internet etc. Even there is a ban on indirect advertisement such as sponsoring sports like cricket Benson Hedges tournament. Government directives †¢Sets maximum upper limit of tar, nicotine and carbon monoxide for cigarettes sold. †¢Health warnings must occupy at least 30% of the front surface of the pack and 40% of rear. †¢Directive bans words such as light or mild as part of a brand name. †¢Taxes on cigarettes should represent a minimum of 80% of the final retail price. Formulation of Government Policies †¢Ã¢â‚¬ËœMahinda Chinthanya’ is the good example as it addresses ways and means to reduce cigarette consumption by 2012 under ‘Mathata Thithak’ programme. 3. 2Indirect Taxes and Price Elasticity of Demand Figure 2: Indirect taxes price elasticity of demand The figure 2 shows the impact of increases in tax depends on the price elasticity of demand for cigarettes. Price elasticity (responsiveness) will vary across different groups of consumers that are younger and older smokers, males and females. 4. 0Problems and Future Forecast 4. 1Problems Demand tends to be price inelastic therefore high rates of taxation are required to alter demand to any great extent. The burden of the tax tends to fall most on low income consumers suggesting that cigarette taxes are regressive. As the real value of taxation rises, so too does the incentive to smuggle in cheaper imports leading to increases tax evasion. People are motivated to use inferior quality products due to high price of legal products. The tobacco industry point to the many thousands of jobs at risk in tobacco manufacturing, distribution and retailing that might be lost if taxation reaches a penal rate. Education and health awareness campaigns: Market failure can be caused by information failure. Consumers may be unaware of the short and longer term health risks associated with smoking. If education and health awareness programs are effective, some consumers may revise their estimated benefit from consumers may revise their estimated benefit from consumption. Information shocks such as the publication of research studies with significant new information on the health effects of smoking, and health warnings have the effect of reducing demand. Following figure 3 shows this effect more clearly. Figure 3: Reduce of demand with the health awareness 4. 2Future Forecast Even though tobacco industry in Sri Lanka will face increasing higher tax rates and regulations with other nongovernmental pressure groups, the industry is still very profitable despite current regulations. Also, there are other very promising markets such as Africa, Asia and East Europe. However, there will be a question mark on the future of the tobacco industry if these markets also start restricting tobacco sales. It is also known that global and local cigarettes demands are declining as a whole specially in urban markets. 5. 0Recommendations The image of the tobacco company is very important since they are dealing with the very controversial product. It is a well know marketing fact that a companys image plays a vital role in marketing its products. It is well known that there are various ill effects associated with tobacco consumption. Furthermore, the tobacco industry is banned from direct promotions through various media. Therefore, it is important to such companies to find alternative ways to increase their market share. Due to this reason Tobacco Companies can take the following measures to enhance their public image. †¢Can conducted best agro practices with the Ministry of Agriculture †¢Can donated funds to be used to for the benefit of the flood victims Tsunami house reconstructions. †¢Can sponsored the National Quality Awards and Productivity Awards †¢Can contribute to develop rural information communication (ICT) infrastructure by building Information Technology centers. †¢Can back up the artists exhibiting or supporting a book publication Investigate on possibility to develop new types of cigarettes, which actually do not have any medical implications while providing the relevant satisfaction to the smoker. That is potential non smoking safe nicotine sources. More than six percent of the total production of tobacco is smuggled causing losses in revenue and taxes, it might be necessary to form a strategic alliance with the local governments to combat this issue. Ultimately tobacco companies should work to increase the market share since the overall decline in the tobacco market. They should be competitive on quality and price and deliver what the customer demands. They could incorporate good management practices in the reduction of cost. One of the major tasks of companies is to drive productivity (good management practices in the reduction of cost). The three pillars that we work on in order to do this are concentrating on both acquisitive and organic growth, productivity and responsibility because we are marketing a controversial product. Increase advertisements in growing markets in other regions where there are no heavy regulations and restrictions on tobacco industry. Can use more subliminal advertisement in movies. Industry can continue using colored packaging that is each brand has its own color like Benson Hedges are doing advertising indirectly; Gold Leaf is selling in red colored packages. The tobacco industry can also use other products like clothes shoes and caps carrying the brand names of the companies. Smokers Clubs: Companies can sponsor pipe and cigar smokers clubs. This will consist of reserving special times for the clubs to meet and affording them the chance to sample new tobaccos and cigars. This will provide them with a unique opportunity to draw in these high-end customers as there are no such clubs in the metro area. Newsletter: A bi-monthly newsletter can be sent out to interested customers. This newsletter will provide details on new magazines and tobacco products as well as special promotions. For example CTS’s Social Report. New Product Announcements Postcards announcing new additions and features will be mailed out to interested customers as a supplement to the newsletter. It is highly likely that smokers already pay the social cost of smoking given the high level of current tax. Therefore the best argument for increasing taxes is the normative judgment that smoking is bad for people and the government should intervene to reduce demand. In Sri Lanka, BAT has promoted its brands by sponsoring lavish discos at which young, attractive women (called golden girls) work the crowd, handing out cigarettes and encouraging customers to smoke them. Numerous door prizes are given away: key rings, shirts, caps, etc. While young Sri Lankans groove to the latest dance music, a laser light writes Benson Hedges on the walls. BAT also sponsors pop music magazines and rock groups in Sri Lanka, and manages to skirt a ban on cigarette advertising on the radio by underwriting a Golden Tones Contest on the English-language radio station that has a large teen audience. When indirect methods of sports and entertainment sponsorship do not seem to be enough, the companies can always use more direct appeals. In Kandy, Sri Lankas second largest city, BAT has paid to paint the logo of one of its most popular brands on the front wall of a prestigious girls high school and the scoreboard of an exclusive boys high school. BAT also hires young women (at five times the average salary of a university graduate) to drive around the country in bright red Gold Leaf cars and jeeps, giving out free cigarettes and promotional items on college campuses, shopping malls and other places where young people gather.

No comments:

Post a Comment

Note: Only a member of this blog may post a comment.