For the half-year to 30 June 2015, the IPKat's regular team is supplemented by contributions from guest bloggers Suleman Ali, Tom Ohta and Valentina Torelli.

Regular round-ups of the previous week's blogposts are kindly compiled by Alberto Bellan.

Sunday, 26 August 2012

I'd walk a mile for an unbranded cigarette

If she were a cigarette, apparently your Katonomist would be a clove cigarette (this has ruined her hipster aspirations as she had hoped to be an American Spirit.)  If she were in Australia, she would soon be "olive green... with stark health warnings."  Given the debate over Australia's new law, it is time to have a look at the economics of cigarette packaging.

Economists have done a fair amount of work on the economics of tobacco and cigarettes.  A lot of the research is in the last century as a number of major economies enacted changes to their regulation of tobacco products.   The research argues various points as it examines the role of advertising on cigarette consumption.

McGuinness and Cowling wrote in 1974 that cigarettes function as a commodity.  This suggests that differentiation between cigarettes is less about quality and more about branding.  (I'm sure that smokers would disagree.)  They also investigated the purpose of advertising in cigarettes as it is very difficult to find causation between advertising and decision to purchase.  The authors calculated that 95% of the positive effects on demand from advertising carry over from one quarter to another.  They also found that a 10% increase in advertising correlates to a 2.8% increase in sales (which means that cigarette spending on advertising enjoys the Katonomist's second favourite economics term, diminishing marginal returns.)

In the late eighties, Tye, Warner and Glantz looked at the industry (they also have a very handy overview of the earlier literature.) They make an interesting observation that the tobacco market is both mature and a growth market.  Mature in the sense that total sales are stagnant.  However, the tobacco market suffers from a high attrition rate which requires growth to compensate. At the time, this meant that "to replace smokers who quit or die prematurely, the industry must attract approximately two million new users per year [in the U.S.]"  Most of these replacement smokers were children or adolescents.

Cigarette smokers are also very loyal. Tye, Warner and Glantz note that only ten percent will switch brands in any given year.  This switching is typically between brands owned by a single company and thus does not generate additional revenue for the company.  This suggests that advertising by the industry is more defensive rather than increasing the number of consumers.  However, the authors also note that there  are conflicting reports of the effects of advertising on demand.

Internationally, various restrictions on cigarette advertising have had mixed effects. A great example is Italy where cigarette consumption increased despite a ban on advertising.  However, in true Italian style, companies chose to treat government fines for flouting the ban as merely an additional cost of doing business.  In Norway, a ban decreased sales by 15%.  However, in Taiwan an increase in cigarette taxes in resulted in only a short term decrease in consumption.

A more recent work, by Harris and Chan, looked at cigarette smoking in relation to price amongst young Americans, and found that cigarette consumption is inversely related to the price of premium brands, but surprisingly not for discount brands.  Instead, low income, young smokers make actually view discount brands as giffen goods. This could have interesting implications for the Australian market if it holds true for other populations.  What happens when consumers are less able to differentiate between premium and budget cigarettes?

IPKat readers will particularly like the 1995 paper by Cunningham and Kyle which looks specifically at the case for plain packaging in cigarettes.  They point out that cigarette packaging performs the same promotional role as advertising in general.  In addition to having some great cartoons, they look at various economics arguments.  Plain packaging removes the status signals associated with the cigarettes.  It also reduces the impact of foreign advertising, sponsorships and shelf displays.  They argue that plain packaging will reduce the number of products available as the market will not sustain the the variety of brand variations.  Finally, they point out that plain packaging is relatively cost free for governments with the added bonus of reducing smuggling. On the flip side, plain packaging might make counterfeiting easier.  It may also result in job losses in the packaging industry and make inventory control more difficult. Among other concerns, the authors also highlight problems with the restriction on the use of trademarks without compensation as discussed by Kats here and here.

Finally, Warner again looked at myths and realities in the economics of tobacco.  A key economic argument in favour of discouraging tobacco use is the potential savings in health care costs. While smoking related illness is expensive, the shorter lifespan of smokers balances out this expense at least slightly by reducing the number of years of healthcare.  However, premature deaths also mean less tax paying citizens! He argues that there really isn't much data on the subject and the effect is likely modest.  He also notes that, despite years of economic research, the relationship between advertising and sales is still debated.

Overall, it looks like the research suggests that less advertising via packaging may reduce demand for cigarettes overall.  However, the research is far from reaching a consensus.  <Insert pun about blowing smoke here.>  <And a further pun about economists not coming a long way, baby.>


Andy J said...

Many years ago, in politically incorrect days, those serving in the Royal Navy were able to purchase tax-free cigarettes when their ship was outside territorial waters. These cigarettes came in plain white packets, with a large 'RN' and the words 20 Cigarettes on them. Even the least artistically inclined were able to use a black ball-point pen to insert a 'U' in front of the 'RN', an 'I' in the middle and an 'E' at the end to produce an amusing little logo which apparently had no effect on the habits of smokers.

Andy J said...

re my previous comment, see this link for an image of the cigarette pack

Subscribe to the IPKat's posts by email here

Just pop your email address into the box and click 'Subscribe':