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    Cheap Smokes on Rise

    Deep discounters' share of U.S. cigarette market growing quickly

    NEW YORK -- Facing burgeoning competition from cut-rate cigarettes, big tobacco makers have stepped up short-term enticements such as 2-for-1 deals, forcing category leaders Philip Morris and R.J. Reynolds to slash their 2002 profit forecasts, The Wall Street Journal reported.

    As a result of current discounting, the domestic tobacco unit of Philip Morris will see its profit per thousand cigarettes fall more than 50 percent in the fourth quarter to $15.85 from a year earlier. At RJR, the comparable figure will fall 70 percent, Merrill Lynch analyst Martin Feldman told the Journal.

    Big tobacco companies have seen discounts as a necessity since adult smokers, already hit hard with the economic downturn, have faced huge per-pack tax hikes in many regions as local and state governments look for ways to plug budget gaps. Formerly noted for unwavering brand loyalty, many smokers are responding to the higher prices by either quitting or switching to less expensive brands such as Rave, Hi-Val and Roger. Deep discounters now control 10 percent of the U.S. retail cigarette market - up from only 3 percent in 1997.

    "There is a certain segment of adult smokers that are shopping only on the basis of price," Ross Webster, vice president of trade marketing for New York-based Philip Morris USA, said in an earlier interview with Convenience Store News. "[Retailer] profitability, however, is still in premium brands; you have to sell a lot of cartons of lower-tier products to equal the profitability of one carton of premium products. So, we think that it's in the best interest of most retailers to focus on premiums, but to make discount brands available."

    Still, the increase in low-end manufacturers has reversed a 50-year consolidation trend in the industry, and as taxes continue their persistent climb and cheap brands become more widespread, it is difficult to assess whether smokers will continue to accept a premium price on premium brands.

    Philip Morris is currently predicting improvement as early as next year. An overall strengthening of the economy may encourage consumers to return to more expensive brands, and major manufacturers can expect significant financial relief in 2003 as obligations of the multibillion-dollar Master Settlement Agreement begin to expire.

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