How the East Was Won: BAT and Big Tobacco's Conquest of the Former Soviet Union

by Anna Gilmore and Martin McKee

In their 1848 Communist Manifesto, Marx and Engels could have been forecasting the tobacco industry’s rapid entry to new markets almost a century and a half later. They wrote that when domestic capitalism ceased to progress or experienced a crisis, industrialists would respond “by the conquest of new markets, and by the more thorough exploitation of the old ones.”

What they would not have predicted is the collapse of the Soviet Union in September 1991, the resulting upheaval, including widespread economic breakdown and the stampede among the multinational tobacco companies to gain a share of these previously closed markets.

The 15 states that emerged from the ruins of the USSR inherited whichever parts of the Soviet tobacco industry lay in its territory but without the benefit of the centralized Soviet system of subsidies, inter-republic trade arrangements and distribution mechanisms on which it had relied. Cigarette shortages that arose in the late 1980s worsened, leading to protests in major cities, in what became known as the tobacco rebellion.

The stage was set for the entry of the multinationals, which saw the former communist bloc — then the world’s second largest cigarette market, with the Soviet Union alone the third largest market after China and the United States — as a golden opportunity.

“[T]he dramatic increase in the proportion of the world’s cigarette market now open to free enterprise [make these] the most exciting times I have seen in the tobacco industry in the last 40 years,” stated Patrick Sheehy, chairman of BAT Industries between 1982 and 1995, in October 1990.

British American Tobacco (BAT), the world’s second largest tobacco company, with the most extensive global presence, had in the 1980s expounded a policy of seeking new opportunities in markets hitherto the preserve of state-owned tobacco monopolies.

The importance of the former Soviet Union (FSU) in this policy was summed up by Tony Johnson, a BAT board member and regional lead for Russia and central Asia. In an in-house publication, in 1994 he described the opportunities there as “almost limitless.”

“The emerging markets of Central Asia and the former Soviet Union in particular have immense potential and are of crucial significance to BAT,” explained Johnson. “As the long-established markets of North America and Europe mature and contract — and they will continue to do so over the next five to ten years — it is vital that we find new markets to grow and expand our business. … [T]he real opportunities for growth lie in the former Soviet Union and this is where we will be focusing much of our attention over the next few years.”

Having recognized the opportunities available, a BAT five-year plan established the “[a]ggressive exploitation of the emerging markets in Eastern Europe” as central to BAT’s expansionist ideas. A Ukraine marketing plan asserted the need for “firm and aggressive strategies and plans to attack” specific markets.

This article draws on internal BAT documents, made public as part of the tobacco industry’s settlement of litigation brought by the U.S. states. It shows how the company created demand in the former Soviet Union for legally imported and smuggled products, and then worked to ensconce itself in the region. Its investments, in turn, created a bigger marketing and political presence for BAT that ultimately resulted in elevated cigarette consumption and a powerful domestic lobby against anti-smoking regulations.

Selling Addiction as Freedom

BAT first became interested in the countries of Central and Eastern Europe (CEE) and the FSU in the late 1980s. A BAT study undertaken to explore the way in which Eastern Europe could be opened up for the company noted that: “If the changes in society and economy which have been announced are in fact implemented, the preconditions in these countries could be better than in many of the underdeveloped countries in the Third World.”

Western cigarettes had built-in advantages in a region just beginning to shake off its communist past and embrace the West. Company analysts noted that “western cigarettes are seen as relatively inexpensive status symbols. Anyone who smokes foreign cigarettes distinguishes himself from the egalitarian doctrine of socialism and thus demonstrates more individuality or personal freedom on a small scale.” BAT made a priority of establishing its brands quickly to achieve a leadership position.

BAT viewed the FSU as a market ripe for exploitation, with the potential to provide immediate returns on investment. Documents comment on certain favorable features, including the undersupply of the market, the vast population and in some areas its young structure, and the already high male smoking rates. Although few women then smoked, like the young of both sexes, they were more likely to smoke international filter brands, and were seen as a massive potential market.

Marketing documents show that women, young people, “opinion leaders” and those living in urban areas were identified as key targets. One Russian marketing study noted: “Three factors are very clear: (i) Most young Russians aspire to western international F.M.C.G [fast moving consumer goods] brands and will forego ‘necessities’ in order to afford them. (ii) Those that can afford to consistently buy western brands are younger consumers who are involved directly or indirectly in private enterprise and, ipso facto, are the ‘opinion leaders.’ (iii) Consequently, advertising investment in brands now can establish a loyal core franchise on which to build a wider franchise as consumers’ disposable income rises.”

In Uzbekistan, BAT noted, “Historically, local products have been too strong to attract large numbers of female smokers. Female smoking is now more socially acceptable and females can be drawn into the market via menthol offers or lighter brands.”

The levels of cigarette advertising that resulted were phenomenal. By the mid-1990s, the industry reported that up to 50 percent of all billboards in Moscow and 75 percent of plastic bags in Russia carried tobacco advertising, and in at least four of the newly independent states the tobacco multinationals ranked among the top three advertisers.

Advertising practices have in turn been reflected in smoking prevalence patterns — recent surveys in the region show higher rates of smoking among women than previous surveys and far higher rates of smoking among younger than older women, suggesting that female smoking is a relatively new phenomenon. Moreover, recent surveys in the region show that the strongest determinant of smoking in women is urban residence. Women living in the largest cities are up to 12 times more likely to smoke than those living in rural areas, a finding thought to reflect the industry’s targeted marketing.

Individual country smoking rates also appear to reflect industry activity: countries that were recipients of major tobacco company investments in the early 1990s and the focus of their marketing efforts now have higher female smoking rates than those that were not.

Smuggling Strategy

Smuggling was also an important component of BAT’s marketing strategy, and paved the way for its takeover of local firms, the company’s internal documents show. Smuggling acts as a market softening technique by creating demand for the (often highly desirable) smuggled product before a domestic manufacturing presence is established. This undermines local firms (which can then be more easily and cheaply acquired), and makes it easier to argue the need for local manufacture on the basis that the demand for quality products led to the illegal supply and reduces government revenues. Smuggling also ensures a ready supply of cheap cigarettes, thereby encouraging consumption by undermining public health efforts to moderate demand through price controls.

At high-level meetings, BAT executives discussed plans “to pursue several channels in parallel.” While some company documents mention a number of import channels and operators, the legality of which is difficult to establish, other documents suggest that smuggling was a key market entry strategy. BAT staff used euphemisms such as “general trade” and “transit” to refer to smuggling in their documents, while clarifying that transit “is essentially the illegal import of brands from Hong Kong, Singapore, Japan etc. upon which no duty has been paid.” The BAT UK and Export Limited Company Plan 1993–1997 outlines how, in Central Europe, high import duties make the export environment unattractive but that “GT [General Trade] opportunities exist.”

BAT Industries’ 1993 draft tobacco strategy document suggests that BAT was prepared to condone smuggling where excise policies were unfavorable: “We will seek to persuade governments to operate sensible excise and import policies, such that transit trade is reduced or eliminated, recognizing that where there is an imbalance, market forces will operate. Rationale: Transit trade is volatile and disruptive to the orderly operation of markets. It is in BAT’s interest that markets are legal, taxed and controlled. However our primary responsibility is to meet consumers’ demands as profitably as possible.”

In the former Soviet Union, the multinationals were undoubtedly aided in their smuggling efforts by the notoriously corrupt state customs committee and its poorly paid officers. As expected, the widespread avoidance of import duties had a clear impact on government treasuries at a time of major economic hardship.

The Race to Buy

Like the other major international companies, Philip Morris and R.J. Reynolds, BAT built its strategy in the FSU around the acquisition of the extensive tobacco manufacturing firms suddenly on the privatization block.

Investment in new markets, particularly those in the Eastern bloc countries, was such a priority within BAT that it led to the creation of a new, dedicated unit and a major company restructuring. At a series of high level meetings in the early 1990s, BAT Chair Patrick Sheehy, BAT Industries Managing Director Ulrich Herter and others agreed to establish a New Business Development unit (NBD) to maximize BAT’s opportunities in emerging new markets. The unit was described as “a central team to co-ordinate the identification and assessment of investment opportunities, to prepare proposals and to be responsible for the negotiations leading up to investments in eastern Europe and the USSR.” Yet this unit alone was insufficient to deal with the many opportunities available and a further significant company restructuring was undertaken in January 1993.

The competition to acquire assets was intense. In Uzbekistan alone, a series of letters of intent were signed for the establishment of a joint venture with the Tashkent Tobacco Factory between 1991 and mid 1993. Even by late 1993, as BAT was finalizing a deal to acquire this factory, Uzbek government offices were being “deluged with letters from various consultants fronting for PMI [Philip Morris International], RJR [R.J. Reynolds] and Rothmans.”

At one of the earliest meetings on new business development, BAT officials noted that the first priority for the NBD team would be to travel widely in the region and establish contacts at the highest level. It would be assisted in this task by consultants “who had good connections with the leading industry and political figures in the country” and accredited representatives who would “maintain contacts with national authorities.” BAT’s use of political contacts was absolutely key and fundamental to its effort to acquire local companies.

To “build up the trust of the relevant governments,” BAT emphasized the benefits of privatization and transnational investments in general, while promoting itself as superior to its rivals.

Selling the Benefits of Privatization

The core of BAT’s argument for privatization was that privatization and BAT investment would financially benefit governments. Notes on Patrick Sheehy’s visit to Uzbekistan and meeting with President Karimov, for example, outline how Sheehy emphasized that increased quality and exports of tobacco leaf plus import substitution could increase government revenues: “SPS [Sir Patrick Sheehy] mentioned to President benefit that would accrue to state viz: $20–25 mn value of leaf (improved quality and exports) $20–25 mn import substitution + others i.e. at least $50 mn p.a.” A hand written note next to this memo also indicates that Sheehy stressed the macro-economic benefit of investment.

Such claims were repeated publicly and made elsewhere. In Ukraine, Sheehy, again in direct contact with the President, Leonid Kravchuk, emphasized the importance of tobacco taxation revenue and suggested that, with BAT’s input, leaf imports could be reduced.

In relation to Belarus, which continues to resist calls for tobacco privatization, BAT argued in documentation prepared for Deputy Prime Minister Ling’s visit to the UK that there was an “urgent need for investment in Tobacco Factory Grodno to modernize and expand production facilities, to improve quality and quantity of cigarettes for supply to the Belarusian market and to replace imports coming into the country without duty being paid.” The company also emphasized the “increasing fiscal and excise revenues to the Belarusian Government” as one of the benefits of BAT’s investment.

The reality was, however, far different. BAT’s actions undermined the various FSU governments’ ability to reap economic benefits from their tobacco industries. BAT avoided competitive tenders wherever possible, acknowledging that tenders would increase the prices they would have to pay for assets in the region. BAT redesigned tobacco taxation systems to its advantage, in one instance halving the rate of excise tax, thereby undermining public health efforts to curb tobacco use while simultaneously reducing government revenue. Much needed revenues were further reduced through BAT’s extensive involvement in smuggling cigarettes to the region. In Belarus, for example, BAT continues to market its brands heavily despite having little official market share, a practice that can only be explained by a substantial presence in the illegal market thought to represent 40 percent of the total.

In countries receptive to privatization, BAT instead focused on selling itself as preferable to its competitors as a joint venture partner.

A simple tactic was to arrange for key players to visit BAT’s established ventures such as the Pecs factory in Hungary, its first joint venture in the region, to persuade them that “BAT are good and welcome foreign partners.” Other tactics included the promotion of BAT’s image as a responsible partner and selling BAT’s strengths.

In 1993, just as the competition for assets in the FSU escalated, the World Tobacco Symposium was held in Moscow and used as a venue to promote BAT’s image. In his keynote speech, Ulrich Herter attempted to sell BAT’s role as a tax collector and government partner: “Not only do we collect excise [taxes] but we also advise and set up schemes in many countries, that will deliver to their governments the revenues they need in a predictable and orderly way.”

Herter’s speech then went on to promote BAT’s charitable record: “[F]or me the most satisfying area is sponsorship of the arts. Our company has recently brought a young Russian musician to London to perform in a classical concert and, on a larger scale, next month we are bringing The Art of Holy Russia exhibition to London’s Victoria and Albert museum.”

Smoked by the Competition

Yet BAT’s stratagems suffered from a major flaw: as against its competitors, the tobacco giant was slow to capitalize on the opportunities in the former Soviet Union. BAT missed the first set of state import orders and its competitors established licensing arrangements first. BAT lacked experience in the region, was reluctant to pay market prices and was outbid at competitive tenders. Ultimately, its competitors were quicker to establish a manufacturing presence as they had been to meet import orders. R.J. Reynolds was the first to invest in Russia and Ukraine, in the latter despite BAT’s belief it could be first into the market. Philip Morris also acquired assets giving it a dominant share in Kazakhstan.

But BAT was certainly not shut out of the FSU, and the company’s efforts to acquire firms yielded considerable returns.

BAT gained a dominant position in Uzbekistan, with reports suggesting it spent more than $300 million on the country’s tobacco industry. By 1999, BAT had achieved a market share of over 70 percent in Uzbekistan, and as the country’s largest foreign investor, has been able to secure favorable treatment from the government, including a five-year extension of its preferential tax-exempt status.

In Ukraine, the company spent $65 million to establish a joint venture, the BAT Prilucky Tobacco Company, with the capacity to produce 16 billion cigarettes a year.

The Danish company, House of Prince (in which BAT has a significant stake) invested in Latvia.

Although the multinationals did not invest directly in Georgia after that country’s tobacco industry was privatized in 1998, BAT in 2001 spent a reported $15 million establishing a licensed production operation there.

And BAT, along with Rothman’s, the world’s number four tobacco manufacturer at the time BAT acquired it in 1999, has spent hundreds of millions of dollars on acquisitions and investments in four cigarette manufacturing facilities in Russia.