Regulatory Proposal for Reducing Fire Risks from Cigarettes

Chapter 2

2.1 Introdution

The Canadian tobacco industry consists of tobacco growers, intermediate tobacco marketers, cigarette and other tobacco-product manufacturers, wholesalers and distributors, and importers.  This chapter provides a general overview of the industry, with primary emphasis on the tobacco products industries and particular focus on cigarette manufacturers.

This chapter also presents a baseline model of the cost structure of a representative cigarette manufacturer.  This model will serve as a basis for subsequent analysis of the cost of complying with a cigarette ignition propensity standard.

2.2 Industry Structure

The tobacco products industries group includes manufacturers of cigarettes, cigars, fine-cut tobacco and tobacco leaf.  In 2002 and 2003, cigarettes accounted for approximately 85 percent of the industry group's domestic shipments. ⁵  During calendar year 2002, cigarette manufacturers produced approximately 41.3 billion cigarettes, and sold roughly 40.7 billion.  Of this total, 38.2 billion, or 94 percent, were sold domestically; the balance was exported or sold duty-free. ⁶

Tobacco-product manufacturing represents a very small portion of domestic employment, but is a high value-added business with relatively well paid employees.  Exhibit 2-1 shows that industry employment was 2,135 persons in 2001, or approximately one percent of total manufacturing employment in that year.  Production workers in the industry earned average annual wages of more than $66,000, or approximately 80 percent more than the average manufacturing worker.  Non-manufacturing employees in the tobacco product industries earned around 41 percent more than their industry counterparts, with average salaries of more than $81,000 per year.

Exhibit 2-1 - Tobacco Product Manufacturing Principal Statistics ($CAD in Thousands, unless otherwise noted)

	Tobacco Product Manufacturing (1)	Total Manufacturing (2)
Number of establishments	14	54,031
Sales of manufactured goods and other revenue	$2,755,751	$580,281,471
Cost of materials and supplies	$564,909	$318,555,697
Cost of fuel and electricity	$9,665	$13,937,118
Cost of materials, supplies and goods for resale	$581,288	$343,985,294
Total value added	$2,149,778	$222,403,704
Total value added as a percent of sales (%)	78%	38%
Production workers (persons)	1,768	1,602,958
Production workers wages	$117,628	$59,089,359
Wages per production worker	$66,532	$36,863
Non-manufacturing employees (persons)	367	373,147
Non-manufacturing employee salaries	29,963	21,541,627
Salaries per non-manufacturing employee	$81,643	$57,730
Total employees (persons)

Source:  Annual Survey of Manufactures - 2013, Table 301-0003 for Canada in 2001; (1) NAICS 312220; (2) NAICS 31-33.

Exhibit 2-2 (next page) depicts the industry graphically. In addition to the tobacco growers, several other industries supply cigarette manufacturers with inputs for cigarettes, including reconstituted tobacco products, paper, filters, chemicals, packaging supplies, and machinery.  The cigarettes manufactured domestically, along with imported cigarettes, are then sold to wholesalers that ship the product to various retailers throughout the country.  Each of the major sectors relating to cigarette manufacturing is described in more detail in the following sections.

Exhibit 2-2 - Canadian Tobacco Industry

Enlarge image

Sources:  Rothmans Inc., 2002,  Full Annual Report 2002, online at http://www.rothmansinc.ca/eng_annual.asp;
Health Canada, Canadian Tobacco Company Market Share in Canada (in percent), 1980-2001, available online at http://www.cctc.ca/cctc/EN/industrywatch/faqs/canadian-tobacco-company-market-share-canada-1980-2001/view?set_language=en&cl=en;
Physicians for a Smoke-Free Canada,  The Retailing of Cigarettes, available online at http://www.smoke-free.ca/Business/business_retail.htm;
Industry Canada,  Employment: Tobacco Manufacturing, available online at http://www.ic.gc.ca/canadian_industry_statistics/cis.nsf/idE/ cis3122empE.html

2.2.1 Tobacco Growers

During the 1990's, Canada produced an average of 71,700 tons of tobacco per year, and imported an average of 9,880 tons of tobacco per year.  Tobacco exports averaged 25,380 tons per year between 1991 and 2001.⁷ However, recent figures indicate that Canadian tobacco production dropped to 49,000 tonnes harvested in 2002⁸.

Exhibit 2-3 - Tobacco Production

Source:  Statistics Canada.

Ontario is Canada's largest tobacco producer, accounting for approximately 90 percent of Canadian tobacco production (see Exhibit 2-3).  Quebec and Prince Edward Island produce most of the remaining tobacco.⁹  The majority of this tobacco production consists of flue-cured varieties, but Ontario produces a small amount of dark tobacco as well.  This dark tobacco is blended with the other varieties to provide the mild flavour that is unique to Canadian cigarettes.¹⁰

2.2.2 Tobacco Marketing Boards

Three tobacco marketing boards act as intermediaries between Canadian tobacco growers and tobacco manufacturers:

• The Ontario Flue-Cured Tobacco Growers Marketing Board
• The Ontario Black Tobacco Growers Association
• L'Office des Producteurs de Tabac Jaune du Quebec.

The Ontario Flue-Cured Tobacco Growers Marketing Board is the largest of these organisations, representing approximately 1,000 producers.  The other two organisations represent roughly 100 producers and 60 producers, respectively.  L'Office des Producteurs de Tabac Jaune du Quebec is the sole intermediary in Quebec.

The tobacco-marketing boards regulate production of tobacco and provide a legal avenue via which growers may sell their crops. ¹¹  At the beginning of each growing season, these intermediaries agree upon a desired production level along with a target price for domestic sales.  In recent years, this domestic price has been set approximately 50 percent higher than the world market price. ¹²

Tobacco production declined throughout the late 1970's and early 1980's, but remained relatively constant in the 1990's (See Exhibit 2-3 above).  However, as noted previously, it has begun to decline once more, to 49,000 tonnes in 2002.At the same time, the price of tobacco has steadily risen over the years, as can be seen in Exhibit 2-4.

Exhibit 2-4 - Average Farm Price of Tobacco

Source:  Statistics Canada.

2.2.3 Other Suppliers

Cigarette manufacturing requires a full range of production factors, including machinery, labour, energy and materials.  Aside from tobacco, the main material components of cigarettes include papers, filters, chemical additives, flavourings, reconstituted tobacco products, and packaging. As is discussed in Chapter 3 and Chapter 4, for the purposes of analysing the impacts of a cigarette ignition propensity standard, the most important of these other inputs is paper.

Schweitzer-Mauduit International, Inc., an international corporation with headquarters in the United States, is a diversified producer of premium speciality papers, and is the world's largest supplier of fine papers to the tobacco industry.  Schweitzer-Mauduit supplies approximately 90 percent of the paper required by Canadian cigarette manufacturers.¹³  The company's main cigarette paper mill is located in Spotswood, New Jersey, while fibre operations that supply pulp to the Spotswood mill are located in Winkler, Manitoba.  Schweitzer-Mauduit produces PaperSelectä for reduced ignition propensity (RIP) cigarettes that are currently marketed in the United States by Philip Morris.  Not only does it have the capabilities to produce Philip Morris' RIP paper, but Schweitzer-Mauduit also has a patent of its own for RIP paper in both the United States and Canada. ¹⁴  Schweitzer-Mauduit's top competitor in the Canadian cigarette-paper market is the Trierenberg Group, which supplies approximately 10 percent of the Canadian market. Trierenberg has also developed RIP products. ¹⁵

2.2.4 Cigarette Manufacturers

Three Canadian manufacturers dominate Canada's cigarette market, accounting for more than 98 percent of domestic sales:

• Imperial Tobacco Canada Limited (Imperial)
• Rothmans, Benson & Hedges Inc.
• JTI-Macdonald Corporation.

Imperial is the largest manufacturer, holding close to a 70-percent share of the market.  Rothmans, Benson & Hedges Inc. and JTI-Macdonald Corporation have market shares of approximately 17 percent and 12 percent, respectively.¹⁶  Exhibit 2-5 depicts the market shares of the three major manufacturers. Other, medium-sized competitors include Grand River Enterprises, Tabac ADL Tobacco, and Bastos du Canada.  There are also several smaller competitors such as Lanwest Technologies, Dynasty Tobacco, Lepine, and Tabac Tabec that produce low-cost cigarette brands.

2.2.5 Distributors and Retailers

There are approximately 40,000 tobacco-product retailers in Canada. ¹⁷  These retailers include grocers, supermarkets, convenience stores, small independent shops, drug stores, and gas stations.  Distribution costs, which include the costs of wholesalers and retailers, account for 12 percent of total sales. ¹⁸  In total, retailers earn approximately $700 million a year in mark-up revenue, and wholesalers earn approximately $140 million a year, which translates to approximately $3.00 per carton and 60 cents per carton, respectively. ¹⁹

Exhibit 2-5 - Domestic Market Share of Major Cigarette Manufacturers

Source:  Health Canada.

2.2.6 Importers

Only a few companies import cigarettes for sale in Canada and these imports account for less than one percent of the Canadian cigarette market.  In 2002, this represented over 200 million cigarettes with a dollar value of close to $20 million. ²⁰  The most popular imported brands include Gauloise, Gitane, Davidoff and Fantasia.

2.2.7 Market Trends

The percentage of Canadians who smoke has declined over the years, as seen in Exhibit 2-6.  As of 2001, approximately 22 percent of the population smoked, including about 20 percent of the total female population and 24 percent of the total male population.

Exhibit 2-6 - Smoking Among Canadians 15+ Years Old

Source:  Statistics Canada.

Although cigarette sales have fallen in recent years, Exhibit 2-7 shows that the Canadian cigarette industry still produces between 40 and 50 billion cigarettes each year.²¹  Moreover, tobacco sales provide large revenues through taxation to the federal and provincial governments.  As seen in Exhibit 2-8, about 44 percent of the final retail price of cigarettes in 2003 was due to provincial taxes, while another 30 percent was due to federal taxation.²²

Exhibit 2-7 - Cigarette Production

Source:  Statistics Canada.

Exhibit 2-8 - Retail Price for a Carton of 200 Cigarettes

Source: Statistics Canada.

2.3 Manufacturing Costs

To analyse the impact of an ignition propensity standard on cigarette manufacturing costs, a baseline model of the cost structure of a representative cigarette manufacturer was developed.  Exhibit 2-9 presents this model.

The figures in Exhibit 2-9 show that total manufacturing costs (i.e., before operating profits and taxes) for a representative cigarette manufacturer are approximately $5.70 per carton.  Of this amount, materials comprise the major cost factor, while labour constitutes a relatively small portion of costs, reflecting the largely automated nature of cigarette production.  Purchased leaf tobacco is the largest single cost input at $1.15 per carton, or more than 20 percent of total costs.  Handling, transport and storage costs for tobacco at the early stage of production are also significant, at approximately 17 percent of total costs.  Subsequent steps in the production process - tobacco processing, plug making, and cigarette making - together account for approximately 19 percent of total costs.  Packaging and shipping costs represent 14 percent of the total, while general business expenses (which include building depreciation and overhead) account for the remaining 30 percent.

The model estimates operating profits of $4.43 per carton.  Thus, operating profits represent approximately 44 percent of the before-tax wholesale price of a carton of cigarettes.  When taxes are taken into account, however, the price charged by manufacturers - an estimated $10.12 per carton - represents only 19 percent of the estimated wholesale price of $53.01 per carton.

Appendix A provides background information on the model's development.

Exhibit 2-9 - Cost Structure of a Representative Cigarette Manufacturer (2002 Canadian Dollars per Carton of 200 Cigarettes)

	Labour	Energy	Materials	Depreciation	Total
Purchased Leaf Tobacco			$1.152		$1.15
Handling, Transport and Storage					$0.98
Tobacco Processing			$ 0.0	$ .032	$0.22
Plug Making (1)	$0.081	$0.007	$0.326	$0.004	$0.42
Cigarette Making (2)	$0.148	$0.014	$0.253	$0.036	$0.45
Packaging/Shipping (3)	$0.220	$0.020	$0.511	$0.015	$0.77
Business Expenses					$1.71
Operating Profits					$4.43
Taxes (4)					$42.89
Total Wholesale Price =					$53.01

(1) Materials cost includes filter materials, adhesives, paper wraps and flavourings.
(2) Materials cost includes paper, tipping materials, starch, adhesives and ink.
(3) Materials cost includes packets, foil, plastic wrap, tear tape, adhesives, cartons and cases.
(4) Includes Provincial Tobacco Tax, Federal Excise Tax and Federal Excise Duty.

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⁵ Rothmans, Inc.  2003 Annual Report. Figures for the year ending March 31, 2003 calculated based on billions of sticks and equivalents shipped domestically.

⁶ Statistics Canada, "Production and Disposition of Tobacco Products," Catalogue no. 32-022-XIB, December 2002. Exports and duty-free sales are not reported separately for the entire year because of confidentiality requirements of the Statistics Act.

⁷ Agriculture and Agri-Food Canada, 2002,  Special Crops: Tobacco Statistics.

⁸ The Montreal Gazette, Tobacco growers doing a slow burn, Saturday, March 27, 2004 . Journalist: Nicolas van Praet.

⁹ Statistics Canada, 2001, Hay and Field Crops by Province, Census Agricultural Region, and Census Division.

¹⁰ Agriculture and Agri-Food Canada, 2002, Special Crops: Canada's Tobacco Industry.

¹¹Agriculture and Agri-Food Canada, 2002, Special Crops: Canada's Tobacco Industry.

¹² Ian J. Irvine and William A. Sims, 1997, Tobacco Control Legislation and Resource Allocation Effects, Canadian Public Policy - Analyse de Politiques, 23(3).

¹³ Health Canada Tobacco Control Programme.

¹⁴ Schweitzer-Mauduit International, Inc.

¹⁵ Health Canada Tobacco Control Programme and Tobacco Reporter, 2003, A Burning Issue.

¹⁶ Health Canada, Canadian Tobacco Company Market Share in Canada (in percent), 1980-2001.

¹⁷ Imperial Tobacco Declaration, Imperial Tobacco Ltd. vs. Attorney General of Canada, document no. 500-05-031332-974.

¹⁸ Ian J. Irvine and William A. Sims, 1997, Tobacco Control Legislation and Resource Allocation Effects, Canadian Public Policy - Analyse de Politiques, 23(3).

¹⁹ Physicians for a Smoke-Free Canada, The Retailing of Cigarettes.

²⁰ Health Canada Tobacco Control Programme.

²¹ Statistics Canada, Cigarette Production (in millions of cigarettes), 1946-2001.

²² Finance Department, Provincial governments, Finance Canada, 2003, Retail Price - by Province.