Wednesday, 2 May 2012

Plain-Packaging For Cigarettes - A Few Cigarettes Short Of A Pack

On April 17, four tobacco consortiums initiated legal action against the Australian Federal Government over Labor’s world first laws requiring all cigarettes to be sold in plain generic packages. The hearing took place at the High Court of Australia over three days and has been closely watched by other countries and tobacco firms who are concerned the Australian plain packaging legislation may set a global precedent.

The latest anti-tobacco legislation represents the final blow to an already heavily regulated Australian industry which, in the past few years, has experienced tax hikes, the compulsory provisioning of graphic health warnings on tobacco products and restrictions preventing retailers from displaying cigarette products. Not to mention the restrictions that have been placed on smoking within many public areas around Australia.

However, the issue in this case is that the High Court will give limited consideration to the effectiveness of the laws in reducing the incidence of smoking uptake and cessation, rather its ruling will be based on whether the destruction of the tobacco consortium's goodwill is constitutional. This is a little disturbing because this legislation has been passed and is currently being challenged without due consideration of the consequences.

So in the absence of due consideration lets blow the dust of our economic text books and prosecute the consequences of this legislation? Economic theory assumes that consumers know what is best for them. This concept is known as 'consumer sovereignty'. According to this economic framework, if smokers freely and willingly consume tobacco with full information about the health consequences and addictive potential, and if they also bear all the costs and benefits of their choices, then the market could be described as operating efficiently and there would be little grounds for the government to intervene.

Economists and most people within the wider community agree that this is not the case due to three market failures: information failure about the health risks of smoking; failures resulting from the addictiveness of smoking; and the external costs of smoking or externalities i.e. passive smoking and health costs.

Without going into the detail, previous laws have been effective in addressing these market failures. And like the preceding laws, generic packaging is aimed at reducing external costs by reducing the utility (level of satisfaction) and subsequent demand of the product and increasing the awareness of adverse health effects while reducing misleading perceptions around branding, e.g. the misconception that Marlboro gold is less harmful than higher strength cigarettes.

Despite the good intentions of the legislation it has been implemented when the impacts of generic plain packaging on tobacco cessation and uptake are not fully understood, meaning the legislation may not be effective in achieving it's intended economic objectives. The most recent literature review produced by the Cancer Council of Australia brings together 24 studies over two decades. Yet, the studies are mostly from different countries and are experimental in nature, hence the impact has only been tested on samples at a specific point in time.

Virtually all the findings of the studies converge on the following conclusions.

“Plain and generic packaging of tobacco products (all other things being equal), through its impact on image formation and retention, recall and recognition, knowledge, and consumer attitudes and perceived utilities, would likely depress the incidence of smoking uptake by non-smoking teens, and increase the incidence of smoking cessation by teen and adult smokers”.

But as mentioned above, the caveat attached to the results is that, “this impact would vary across the population. The extent of change in incidence is impossible to assess except through field experiments conducted over time”.

It seems ludicrous that no one considered that the population and tobacco market within Australia is considerably different to samples from international studies during the development and provisioning of this legislation. Politicians and the public have been hoodwinked by the Cancer Council, which has effectively created an argument around equivocal evidence with limited relevance in an Australian context.

Firstly, the experiments do not consider the ‘no display policy’ within Australian retail outlets that supply tobacco. When a smoker purchases a product from a store they are unable to see their preferred brand or label. Hence, a generic pack may not cause a further reduction in utility for current smokers because they cannot actually see the packaging at the time of the purchase. Subsequently, it would be expected that there would be no further impact on the incidence of smoking cessation within current smokers.

Secondly, while the removal of brands may reduce the utility attached to specific brands for new smokers, it will not reduce the utility of smoking. To get this concept across picture the scene from Pulp Fiction where Vincent and Jules are arguing about the meaning and pleasure of a foot massage –  "touchin' his wife's feet, and stickin' your tongue in her Holiest of Holies, ain't the same fuckin' ballpark, it ain't the same league, it ain't even the same fuckin' sport". Likewise, a cigarette achieves a certain state of mind and happiness which is not comparable to the utility achieved by any other alternative good or service. A person can not, and will not, substitute to three cans of coke, Mc'donalds burgers, or whatever because it 'aint the same fuckin' ballpark'.

However, the most significant aspect that has been overlooked within the research is the battle which would take place between incumbent tobacco consortiums and oligopolist supermarkets – Coles and Woolworths. In supermarkets and subsidiary petrol stations, the sales contribution of tobacco is equal to approximately 7 and 30 precent respectively. According to Richard Dennis of the Australian Institute, an independent think tank, this in conjunction with the generic packaging was the incentive needed for Coles and Woolworths to vertically integrate within the tobacco industry and increase profits. But first Coles and Woolworths would need to ensure generic labelling laws were passed.

So it would come as no surprise that in August 2010 Coles and Woolworths both withdrew funding from the tobacco industry’s war chest which was creating awareness about the ineffectiveness of plain packaging via commercials in what can only be viewed as a direct attack on tobacco consortiums.

Around this time, Coles began importing home-brand-style packs of 25 cigarettes at around $11, almost $4 a pack less than Australian-made Winfield and other leading brands.

The strategies implemented by the supermarkets so far are exactly reminiscent of a typical new firm entering an oligopoly. It is hard to see how government and the Cancer Council over looked it. But, they blatantly did, in fact they did not even consider it. Anita Dessaix from the Cancer Council of NSW was shocked when she heard the news that Coles was selling their own line of cigarettes, "this is sneaky and disappointing," she said.

So in lieu of the Cancer Council anticipating anything, what should we expect in terms of firm behaviour if the High Court rules in favour of the legislation? In a typical market, tobacco consortiums could use their goodwill to compete with Coles and Woolworths and possibly force them out of the market. But in a generic labelled marketing environment, it is likely only existing smokers would stick with brand labels. The opportunity for Coles and Woolworths lies in producing cheap cigarettes for new smokers that have not been exposed to tobacco brands and smokers that have a price elastic demand function, that is customers struggling to buy cigarettes after the tax increase.

This strategy will be complimented with a strategy that aims at promoting their own products, which is akin to a pharmacist offering generic labels. And by the looks of things, this has already been implemented. A Coles employee, who preferred to remain anonymous said "when customers came in and complained that their usual cigarettes are too expensive we suggest they try one of the new ones, like Tradition".

The rational strategy for tobacco consortiums would be only to slightly discount well known brands because these will still produce revenue within the medium term on the back of current smokers. It is also likely that they will reduce the price of other cigarettes to compete with Coles, and Woolworths if it enters the market. Some of you may be asking, wouldn’t the rational strategy of the tobacco consortiums be an all out price war? But a price war would be dubious because the government would just increase taxes to negate the adverse increase in quantity demanded. Secondly, it is likely big brands will still maintain customers into the medium term based on the ‘no display’ rationale discussed previously.

In a nutshell, Australia will act as a petri-dish for the rest of the world on the back of equivocal evidence. Effectively there is likely to be a negligible impact in the incidence of cessation and an unknown impact on the incidence of smoking uptake, especially because particular brands will be heavily subsidised by the supermarkets. Meanwhile, the law will propagate the supermarket oligopoly, which we are already concerned about within Australia. Not to mention the economic risk surrounding the provisioning of a Band-Aid policy such as a price ceiling, which would have a number of adverse impacts.

The irony of all this is that generic packs have been provisioned to rectify imperfect information, yet this law has been developed and provisioned on the back of a body of research, which is a few cigarettes short of a pack.

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