Big Tobacco’s price games undermine tobacco taxation

Taxation is the most effective form of tobacco control, but the tobacco industry uses a variety of sophisticated pricing strategies to undermine tax increases.

When a government budget announces an increase on the price of a packet of cigarettes, the tobacco company just passes it on to the consumer, right? No, not quite, according to new research published in Tobacco Control.

Researchers at the University of Bath found that the tobacco industry uses a variety of sophisticated pricing strategies to undermine tax increases, which keeps the number of people addicted to smoking – and the industry’s profits – high. This is important because research shows that taxation is the most effective form of tobacco control.

Pricing strategies

The research team from the University’s Tobacco Control Research Group reviewed 37 publications (22 covering high-income countries and 15 covering low- and middle-income countries or LMICs) and identified six key strategies, listed here in order of frequency:

  • Differential ‘shifting’ of taxes between brands and products:
    • ‘overshifting’ – the company raises the price above the tax increase, so the increase (and more) is paid by the consumer
    • ‘undershifting’ – the company absorbs (some of) the tax increase to delay or prevent a price increase
  • Launching new brands/products:
    • new, cheaper brands, variants and products aimed at encouraging customers who can’t afford their regular brand to switch rather than quit
    • pricier products targeted at customers willing to pay more for ‘luxury’ brands
  • Running product promotions, or charging different customers different prices for the same products:
    • this tactic helps the company retain price-sensitive smokers while attracting new ones unaffected by high prices
  • ‘Smoothing’ prices:
    • to avoid a price hike straight after a budget – which might encourage smokers to quit – the company raises the price incrementally and regularly instead
  • ‘Shrinkflation’:
    • know how some chocolate bars seem smaller than when we were kids? Is it because we have grown or did the bar actually shrink? It is the same with cigarettes. Tobacco companies charge the same price per pack but reduce the number of cigarettes in it from, say, 20 to 19, 18 or even 17 to disguise the price rise
  • Changing the product or its classification:
    • tobacco tax rates are based on a product’s attributes (length, weight, type) and its means of production. Tobacco companies can exploit this system by changing a product’s characteristics or how it is produced so that it moves to a lower-tax category.

Different strategies for different markets

This analysis is the first to focus systematically on what happens in low-income countries and that’s important because that’s where 80% of the world’s smokers are.

It shows that the most popular strategy was differential price shifting, with overshifting more common in high-income countries (seen in 15 out of 22 studies), and undershifting featuring more often in LMICs (seen in 11 out of 15 studies).

The former included the UK, the US, Ireland, the Czech Republic and New Zealand. The latter included Bangladesh, Indonesia, Mexico, Pakistan, South Africa, Thailand, and Turkey. This suggests a deliberate choice by tobacco companies to prioritise expanding lower-income markets over maximising profits, at least in the short-term.

In the UK, Spain, and Thailand tobacco companies introduced new economy products, brand variants, and brands. In lower-income countries, they introduced new versions of previous brands – or new cheaper brands – targeted at women and younger people.

Targeted tactics and legislative loopholes

Evidence from six of the studies (covering the UK and the US) shows that the tobacco industry has developed targeted promotional tactics to encourage smokers to reduce their costs. These include coupons, cartons or gifts, or varying price by place or store type. This strategy boosts profits and has a disproportionate impact on low-income or price-sensitive consumers, like the young, who are more likely to take advantage of price promotions.

In the US, for example, smokers can avoid the full impact of taxes by buying cartons or by purchasing from lower-tax jurisdictions such as Native American reservations.

Previous research on the UK market has shown that cigars are a good example of changes to product classification because they are taxed at a lower rate than cigarettes and are exempt from some restrictions.

This review highlights how the tobacco industry took advantage of these legislative loopholes by launching economy cigars and low-priced, cigarette-like, filtered cigarillo products, some of which used existing cigarette brand names.

Research significance

Speaking about the findings, the lead researcher, Dr Zaineb Sheikh, said:

‘Given that the primary focus of this study was to assess the global literature on pricing strategies, we haven’t been able to assess the (relative) success of counter-taxation policies, either in terms of their impact on tax revenue or public health.

‘What we do know, however, is that taxing cigarettes is the most powerful and cost-effective way to reduce smoking because high prices encourage existing smokers to quit or cut down and dissuade young people from starting. So, it’s important to understand the strategies companies use to undermine and manipulate pricing and taxation.’

Economist Dr Rob Branston, a senior author on the paper, added:

‘The oligopolistic nature of tobacco markets with limited competition gives tobacco companies significant pricing power, especially since demand for their products is relatively inelastic, resulting in inordinate profitability. This profit and pricing power therefore gives them multiple ways to respond to tax increases, as we highlight in this paper.’

Source: University of Bath