Interfax-Ukraine's exclusive interview with General Manager of Imperial Tobacco in Ukraine Rastislav Cernak
According to the global report of the company for 2019, the Ukrainian market last year had one of the largest drops in terms of production of cigarettes in Europe. Ukraine’s contribution to general 4.4% decline of the European market was 1.5 percentage points. What is the reason?
Last year, Ukraine produced 51 billion cigarettes, which demonstrated, compared to European countries, the faster decline in the cigarette market. According to our data, the market decline was 15% compared to the year before. In 2011 – 2017 the decline was less significant than we witnessed in 2019. There are several objective reasons for the fall.
First, excise tax has raised! In 2018, the increase in cigarette excise tax was 30%, in 2019 we had two increases – 20% in January and additional 9% in July. A significant increase in excise tax led to the increase in the price of a pack of cigarettes that caused the growth of illegal trade.
Over the past few years, the level of illegal trade has doubled. According to TNS Kantar research, in 2019 the level of illegal trade reached 7%, the growth trend was observed from 2017. This level of smuggling and counterfeiting in Ukraine is the highest for the period since 2013.
Among other reasons the reduction in the number of population in Ukraine due labour migration can be mentioned. According to various estimates, for several recent years, 4 million people or 10% of the population have left Ukraine. Accordingly, we see the decrease in the number of consumers.
But the biggest problem is still illegal trade!
Do you forecast the current pace of the cigarette market decline in Ukraine in 2020? What is your forecast for the illegal trade?
Everything will depend on the legislative and regulatory aspects. If the increase rate of the excise tax does not slow down and a fixed trade markup is introduced, which inevitably affects the price of production, in 2020 legal cigarette market will be reduced at least to 43 billion cigarettes. But the level of illegal trade will increase to 20%.
We hope for rational excise tax and predictable regulatory environment. From January 2020, there has been an increase in excise tax by 20%, which was not surprising for us, but I would like to hope that we will have no other increases.
Back to the issue of fixed trade markup, or the so-called trade margin, which was passed by Parliament in October 2019, I want to emphasize that in the case of the law implementation, it will have an impact on the price of a pack of cigarettes of 7 UAH! Accordingly, it will be an additional burden for the consumer. we strongly oppose this initiative. As of today, this dubious bill (No. 1049) is awaiting the President’s signature, and we hope that it will be vetoed.
We had a discussion with the members of the government, we met with Volodymyr Zelenskyi, which resulted in the creation of the working group and signing the Memorandum of cooperation with the Cabinet of Ministers. Our company sees the above as a positive step towards solving the problematic issues, so we are optimistic about 2020. We expect both parties to adhere to the agreements.
If 2020 is more favourable for the tobacco industry in the sense of predictability and openness in government interactions with the tobacco producers, there is a chance to keep the market volume at 48 billion cigarettes and to reduce the share of the illegal market. Of course, such an optimistic plan is possible, provided that an excise tax will not rise dramatically but more cautiously and slowly – not exceeding 10% per year. And the state will actively facilitate the fight against illegal market.
This bill that establishes a fixed margin seems to be the industry’s sword of Damocles. All the deadlines for the signing of bill No. 1049 have passed.. Are there any assurances that in the near future this issue will be resolved?
We hope that this bill will not be signed. We do not know for sure what is going on in the power corridors, which discussion are in progress, but we expect for a constructive settlement of this issue as soon as possible. For us, the fixed trade margin is unacceptable. We do not support it in whatever light we view it. We know no market in the world with such a margin legislation. The Ukrainian market knows no other product with the fixed trade margin. Basically, it is weird even to have such a proposal The authorities assured us that this issue will be settled and the trade margin will not be implemented.
In the Memorandum of cooperation with the government, we agreed on the main principles and directions of our work: these are the issues of development of competition in the distribution market of cigarettes, countering illegal trade and overall regulatory framework of the tobacco industry.
But we understand that the problem of illegal trade cannot be solved within a few days, it is a much longer process.
In late January the government adopted the action plan for the implementation of the Strategy in the sphere of combating illegal production and turnover of tobacco products. To what extent does it meet the agreements in the context of the Memorandum?
We support and welcome this decision. Our company is one of the most affected by illegal trade which causes huge losses for us as a company estimated 0.5 billion UAH per year and also for the state revenue - several billion UAH of the annual losses caused by illegal trade. Hopefully, the introduced action plan for the implementation of the Strategy will not be left in the table but will really be followed. In particular, we support the opening of the Register of purchased excise stamps. To our mind, it is a tool for independent control of the industry over the products which appear in the market. We will see the real number of excise stamps purchased by each manufacturer and importer and the way they are used. We believe this to be an effective mechanism for combating illegal trade.
What do you think of the idea of the Minister of the Cabinet of Ministers to apply the barcode on the usual excise stamps as an alternative to the implementation of electronic excise stamps?
There are different initiatives as for the establishment of the track and trace system for tobacco products. The world has presented best solutions in this direction. The application of bar code on the excise stamp means the change of the size, and consequently, the changeover of all production equipment, which means in its turn significant losses. Therefore, we believe that changing the size of paper excise stamps is not the best solution, and we would like to avoid this. The level of production of cigarettes in Ukraine continues to decline, our factory manufactures cigarettes for export as well – and some countries have their requirements as for the information to be put on the pack.
We will support the introduction of electronic excise stamps, but not in the format the government offers. We believe that we should move closer to the European experience because it is already implemented.
The illegal market has two components: unequal competition with other manufacturers and smuggling. What are the dynamics of these two factors? Can you say the Government manages these two parts of the problem?
You are right about the two components. In my opinion, the government and industry must cooperate to combat these phenomena, because they have a very negative impact on the economy. Now Ukraine knows what smuggling is, and how local production of goods for export can be marked as Duty free, but in fact remain in the local market. The latter phenomenon has doubled in recent years.
The TNS Kantar conducts researches every two months of every year which measure the share of illegal products. The Agency collects and studies the empty packs of cigarettes in all parts of Ukraine. According to the research, in 2019, approximately 7% of the cigarettes consumed in Ukraine are either illegally produced or smuggled.
I would like to note that we see a positive trend. In particular, the summer wave of the research for 2019 shows that the level of illegal trade was 8%, and in October it dropped to 6%.
How do you explain this positive trend?
I consider it, first and foremost, as the actions of the authorities – the media provided a lot of information about the detention of smuggled cigarettes at the border. The level of illegal trade in Ukraine is still high, and only systemic work can lower it. We hope that the government has taken the right pace to cope with it and will keep it. But the essential point to remember is that the growth of the illegal market is directly related to the fast increase of tobacco industry taxation. The higher the price for cigarettes is, the more profitable illegal business on illegal product becomes!
But the government again proposes to accelerate the rate of growth of excise tax. What stage has been reached in the negotiations? Is a compromise possible? Perhaps they can be dependent on the income, or on the level of smuggling?
This is a very important question, one of the most important in the tobacco industry. If we are talking about the plan, two years ago, the Government and Parliament approved the plan with a 20% increase in excise tax every year until the level of the EU. As I mentioned, this plan was immediately broken, and the growth rate of excise tax has been accelerated, and we expected the negative result which was not long in coming.
The idea of the Government was to increase revenues to the state budget. Let’s analyze the results of 2019. The growth of budget revenues was less than 1%, despite the tax increase for the tobacco industry twice in the year, first by 20% in January and then 9% in July In fact, the chasm of UAH 14 billion between what the government planned, and what actually received. Also, the level of illegal trade in cigarettes in the country increased.
We have already appealed to the government with a proposal to reduce the growth rate of excise tax from existing 20% to 10% with simultaneous extension of the schedule of increase until 2030. Ukraine will reach the EU level, but gradually. We believe that a balanced increase will bring more budget revenue than a sudden one-time increase. And the tobacco industry makes really significant contributions to the state budget. In particular, according to the results of 2019, our company took 10th place in the list of top taxpayers.
We understand that the government is interested in increasing the number of taxes paid by the tobacco industry. But in fact, as a result of the significant increase in the tax burden, the revenues have not increased.
But alongside budget revenue, the purpose of increasing the excise tax is to reduce smoking. How much will your offer to prolong the excise tax hike affect the market: it will shrink or be stable?
In European markets, where the tax burden is much higher, smoking levels are reduced by only 3-5% annually. If we talk about Ukraine, smokers stop buying our products not because they stop smoking, but because they switch to more affordable illegal cigarettes – those of dubious quality, origin, with unknown composition. Illegal cigarettes are more risky for health, and the state does not receive any taxes on the production and sale of such cigarettes.
There is another resonant bill No. 1210. Tobacco producers consider this bill in an ambiguous way. On the one hand, it sets the rules for the e-cigarettes market, and on the other it increases 4 times tax rates on heated tobacco products changing approach to the taxation of this category itself. What is your attitude to this bill?
Actually, this is a complex issue and it is associated with the transformation of the tobacco industry. What we are witnessing today, worldwide and not only in Ukraine, is the biggest consumer shift in our history, with many of smokers around the world transitioning to potentially less harmful alternatives to cigarettes. We want smokers to choose products with lower health risks and encourage them to make that change by providing a portfolio of high quality NGP products. We also need legislation and regulation to be rational and support that process. That’s why we think that the taxation of such products should be lower than of cigarettes. We do not support the point in bill No. 1210 which equalizes excise tax rates on cigarettes and on tobacco heating systems, because it reduces the harm reduction potential to the consumer and effectively penalise smoker for making potentially less harmful choice.
What is your strategy in promoting your latest products in Ukraine?
Our company has a large product portfolio in the international market. In the vape category we have our brand blu, and it is the market leader in Europe. In the category of tobacco for heating we have our heated tobacco device Pulze, which was launched last year in Japan, as well as the next generation of oral nicotine products. The company to date has no new generation products in the Ukrainian market. But we see high interest of Ukrainian consumers in new products, and some products are rapidly developing.
We are actively studying the possibility of displaying the newest products in the market of Ukraine, we are studying the environment, evaluating the return on our potential investment. In this context, the principle of predictability and rational regulation is important, since it is difficult to predict, if there will be any legal restrictions in the near term for the launched product or not.
But your competitors are already present in this market. Are you not afraid that it will be too late launch your products?
In some categories we see a very successful launches of products by our competitors. But if we talk about our products, then in order to have a positive trend of return of investment and be sure that this product is really affordable and worth launching in the market, we first of all should clearly understand the country’s regulation and taxation of this product. Now, in terms of what we have today in Ukraine, it is impossible to predict changes.
How do you assess the market of electronic cigarettes and systems for heating tobacco in Ukraine?
Objectively, it is quite difficult to assess the market of vaping products in Ukraine, since its major part is in the shade – a lot of minor producers and sellers, many illegal products that uncontrolled hit the market in the form of regular postal parcels from China, etc. However, according to our estimates vaping in Ukraine is used by about 530 thousand people, or 1.7% of the adult population of Ukraine (18+). The market for heating tobacco products is considered more organized and transparent, and its volume in 2019 is estimated at 2.3 billion sticks. However, from 2021, the growth dynamics can considerably change, because, according to the current legislation proposal, starting from January 2021 the excise tax on the sticks for heating tobacco compared to the excise tax on cigarettes will raise, so these products will be significantly more expensive. Such steps can damage the harm reduction potential of NGP category by reducing its affordability to smokers.
Getting back to AMCU fine. Are you planning to pay it? What are your next steps?
On 10 October 2019 the AMCU decided to impose an unprecedented fine in general amount of UAH 6.5 billion on four international manufacturers of tobacco products, including Imperial Tobacco, for anticompetitive concerted actions. The amount of a fine imposed on our company was UAH 460 million. The AMCU accuses manufacturers of an alleged conspiracy in favour of Tedis which led to the monopolization of the market for distribution of cigarettes by the latter.
The position of Imperial Tobacco regarding the AMCU decision is unambiguous and determined: all accusations against the company are pointless and ill-founded. Imperial Tobacco have committed no violations. Being an international company with strict internal rules, we faithfully comply with the legislation in force.
What did actually happen? The Antimonopoly Committee acting in the times of Yanukovych in 2010-2011 issued numerous permits for concentration s in favour of company Megapolis Ukraine (subsequently renamed as Tedis Ukraine) resulting in a consolidation of market for distribution of cigarettes by Megapolis. Meanwhile, we were receiving letters from our numerous distributors of cigarettes with information that they ceased their activities and sold their businesses to Tedis. It should be noted that at that time Imperial Tobacco did not initiate termination of contractual relationships with any distributor. The company could not influence this situation, our point of view concerning possible outcomes of monopolization of the distribution market resulting from those events and concentration was asked neither by the AMCU nor by any other authorities, and we had to take such a radical change in the structure of the market for distribution of tobacco products for granted - as formally, from the legal perspective, the whole market transformation was confirmed by the AMCU permits.
And what did the AMCU do in 2019 by imposing an unprecedented fine of UAH 6.5 billion on manufacturers? It factually intends to shift responsibility for all these events to us as manufacturers, like, it is not the AMCU who allowed market concentration by Tedis through its permits - it is manufacturers who allegedly conspired. Meanwhile, the AMCU accusations are not supported by any evidence or just grounded economic analysis. Our internal pricing and distribution policies were always independent and, for example, the facts of the rough competition between manufacturers resulting in “price war” in 2016 and substantial decrease in the market share of Imperial Tobacco are completely ignored (it would appeared to be a strange conspiracy, where we would decrease prices and lose market share). It is indeed a paradox - the major part of the AMCU arguments are based on the AMCU case from 2016 concerning monopolistic market abuse by Tedis, to which Imperial Tobacco did not have any relation.
By now, Imperial Tobacco brought a claim to the Kyiv Economic Court to challenge the AMCU decision. On 20 January the first preliminary case hearing was held - the presiding judge in this case reviewed procedural motions of the parties and, understanding complexity of the case and for the purpose of assisting the parties in the exercise of their procedural rights, has given us and the AMCU additional time for preparation of evidence and grounding of the legal positions. Thus, our legal team is working very actively on preparation to further court hearings, we involved the best economists and experts in antimonopoly law from Ukraine and the EU, and also specialists in the EU law for additional grounding of our defence position. Therefore, we are sure that the Ukrainian judicial system will solve this dispute in a competent and professional manner, duly perform its function and protect the company`s rights by making a legal and grounded decision. Besides, we are working on other available legal instruments of protection, in particular, on claims to International Investment Arbitration Tribunal
But anyway, there is a monopoly on the distribution market. What way do you see out of this situation? Do you discuss this issue at work meetings?
There is no monopoly today. Of course, the share of Tedis is quite high: at the level of 60-65%. But this is no longer a monopoly. I can only speak for my company, since 2017 we have partnered with 21 direct buyers. Of course, we sell products to Tedis, but we have 20 more buyers. For our part, we have updated our Distributor Collaboration and Selection Policy, but as before we do not set limits on volumes and do not create any requirements that allow to single anyone out. We have an equal, unbiased and non-discriminatory attitude towards all partners.
We do everything possible to reach the most competitive market of distribution of cigarettes in Ukraine. We expect from our distributor to deliver our products in a most efficient way to the end consumer, it is a business that requires a lot of investments: into warehouses, logistics, people, this is not possible to do in short time. And certainly, the distribution issues will not be solved by trade margin fixing.
In 2018, your companies in Ukraine made profit after a few years of small, but loss. Did you manage to maintain your position last year and what are your plans for this year?
The positive trend of the company continues. This was influenced by few factors: hryvnia stability, successful launches of new variants of our premium brand Davidoff’ and increase in our exports from Kyiv factory.
Do you somehow feel the increase in household income?
- We collect analytical data to track the behaviour of our products consumers. Before 2015, there were different excise duty rates on filter and filterless cigarettes, in 2015 they were equal. We had a large proportion of filterless cigarettes. To date, this segment has virtually disappeared. If we analyze the market segments, we can see that the price for the premium and the average segment products does not affect the market as much as the lower price segment products. That is, social segment consumers suffer most.
What is the company’s share in the Ukrainian cigarette market?
Last year our share was 12.6% in Ukraine, it decreased by about 1.5 pp compared to the previous year. The main reasons for this are the significant increase in excise tax and illegal trade. We are probably the company most affected by the growth of illegal trade and unpredictable excise tax policy. As of now, we are the fourth player in the market.
Last year we produced approximately 10.1 billion cigarettes, of which domestic market realized 6.4 billion cigarettes, which is 24.5% lower than in 2018. The rest was exported. We supply products to more than 20 markets, the largest of which is Saudi Arabia. If it were not for the exports, there would be a question whether the factory could survive. Note that the annual capacity of the factory is estimated at 35 billion cigarettes.
During our meeting with the President, he showed interest in the issue of Ukraine becoming more export-oriented country. Our factory is ready to develop the export direction, we see its great potential.
How much did the company invest in production last year?
In 2019, the investments in production amounted to more than $2.5 million. The lion’s share of investment last year was aimed at establishing equipment for the export production, in particular, coding equipment for the packs for the UAE, and the products in the “fresh-lock” packs for the Middle East. Over 25 years, we have already invested in Ukraine $400 million. We are one of the largest investors. These investments are mainly made in production capacity.
The structure of Imperial Brands considers the Ukrainian factory as one of the newest. The products which are presented in the Ukrainian market are manufactured at the Kyiv factory.
Imperial Tobacco in Ukraine is part of Imperial Brands, we are mainly cigarette manufacturer, but, as already noted, we have other products, such as vapes, tobacco heating devices and nicotine containing products. Our global office is in the UK, in Bristol, our shares are listed on the London Stock Exchange. The company has strict requirements regarding the implementation of legislation in the country of operation and of international standards.
Imperial Brands employs 30 thousand people, the company is present in 160 markets and today owns 36 factories, one of which is in Kyiv.
In Ukraine the company is represented by two legal entities – the factory and the trade and marketing company. Together, the two companies employ about 700 people.
We have our own history in Ukraine. Our oldest brand is Pryma, it has a 65-year history, and though we have worked on its design, but nevertheless, until today it has been a popular brand. Our company does not produce Pryma in any other market. Only in Ukraine.
We implement social projects working for several years with the “KRAN” Charitable Foundation, providing in cooperation with it targeted financial assistance to ATO participants who need specialized neurorehabilitation after traumatic brain and spinal injuries. We also closely collaborate with the community of Holosiivskyi district of the capital, where our factory is located – we restored the crossing at the crossroads near the factory, which is considered one of the most dangerous in Kyiv.
Besides, the company Imperial Brands at the global level was included in the prestigious A list of companies by Carbon Disclosure project for making the greatest contribution to the reduction of environmental impact. About 8,400 companies submitted their data for this list and only 179, of which received the award, including our company. In 2019, our factory reduced air emissions by 20% and the amount of waste by 16%.
Is the location of the factory in Kyiv advantageous?
We believe that the advantage is primarily in the fact that we can attract good professionals, but, on the other hand, human capital in Kyiv is the most expensive. We have employed people not only from Kyiv. We have sales representatives in the regions and in recent years to find qualified people is a challenge, because many of them are offered to work abroad.
Where from does tobacco leaf come to you? Does the changing of the price affect the cost of the final product?
In the market there are various grades of tobaccos. Best are used for products in the premium segment. The company purchases tobacco leaf in the globa market on a centralized basis. Usually, these are countries in South America and Africa. Mind it, tobacco is a plant, which is affected by weather conditions, transportation, climate change and harvest and you never know what may turn up each next year, even if the tobacco is imported from the same country. The task of our experts is to ensure that the, regardles of the tobacco blend components the taste remains stable. Of course, they always remember that there are legal requirements as for the contents of nicotine, tar, etc., which we have to comply with.
And what about Brexit and leaving free trade area’s influence on you?
To be honest, personally I, as Head of the Ukrainian part of business, am more concerned with the stability and predictability of the regulatory fields in Ukraine. I truly hope that the plans of Volodymyr Zelenskyi and the members of the Cabinet of Ministers of Ukraine concerning the creation of favourable conditions for foreign investors will have a positive impact on the development of the tobacco market. And this, in turn, will provide the high income from tobacco industry to the state budget.