1(a) The use of tobacco follows the law of demand as evident from the inverse proportion of prices of tobacco with the consumption of tobacco. As the prices go up, the consumption falls. The economic theory of tobacco demand assumes the presence of an individual’s function of utility. The utility for an individual from consumption of tobacco depends on the amount of tobacco consumed derived from the taste and satisfaction of the individual. The constrained maximization determines the tobacco’s demand function where the consumption of tobacco is related to the price of tobacco, prices of substitute products, individual’s taste and preference and income.
As specified in the case study, the supply of the cigarettes in the market has increase by 30 per cent in spite of reduction in demand. The demand for the cigarettes have dwindled by 5 per cent in the last ten years, majorly being the result of price increase of cigarette due to levy of high taxes. Government is levying high taxes on cigarettes to discourage the smoking practice as it leads to several health hazards and has social and economic cost attached to it. The total loss incurred due to tobacco related diseases in 1999 was US $6.5 billion far more than the income of US $737 million from export of tobacco and tobacco related products.
Figure 1: Supply Surplus for Cigarettes
Though the cigarettes market is in surplus, still the prices are not lowered by the companies as they understand the impact of the addictive nature of the tobacco products. The demand for tobacco product is not elastic like other consumer products and is in a way inelastic as the increase in the price of tobacco products reduces the demand moderately. A study conducted by World Bank in 2001 concludes that price elasticity of tobacco products in -0.48 which means that for every 10 per cent increase in price, the demand of tobacco product would reduce by 4.8 per cent.
1(b) The government has tried to control the consumption of tobacco by taxation and implementation of Cigarettes and other Tobacco products Act, 2003 which covers ban on advertising of cigarettes, public smoking and others.
Taxation is a major area through which government has tried to control the consumption of tobacco, though the taxation is concentrated on cigarettes industry in particular wherein the taxes are 132 per cent more than the value of the product. The taxes on tobacco are utilized for revenue generation however in recent years government has deployed it as the tool to discourage the consumption of tobacco. The increase in the taxes on the cigarettes leads to reduction in the consumption. This impact is measured by the price elasticity of demand and the price elasticity of demand for cigarettes is estimated to by -0.3 to -0.5 which means that for every ten per cent increase in the price of cigarettes, the consumption would reduce by 3 to 5 per cent (; ; .
The taxes levied by Indian government has also bought down the consumption of cigarettes from 19 to 14 per cent though it is also indicated that people have started consuming other tobacco products which are not taxed by government. The demand of cigarettes can be considered relatively inelastic as despite the reduction in demand, the companies are still making profit as they have increased the prices to compensate for the reduction in demand. This would therefore lead to conclusion that the people who couldn’t afford to buy cigarettes moved to other tobacco products and the individuals addicted to cigarettes have continued to smoke in spite of the increase in price. The taxes levied by the government on the cigarettes are passed to consumers by the company as the product is inelastic for smokers.
Figure 2: Inelastic demand of Cigarettes
Advertising has the diminishing marginal product economic aspect in play. Due to the diminishing marginal product, the response generated to advertising leads to no change in demand or flattens out at one point. The advertising of smoking or the public display of smoking causes the imitation by adolescents who are actually the target potential customers of the tobacco products. With the introduction of ban on the media and public smoking, the effect on the teenagers are negated and though it does not lower the existing demand of the tobacco product to a larger extent, it does help in curbing the creation of new demand.
Figure 3: Shift of Demand Curve due to Ban on Advertising
The vertical axis of the graph measures the consumption of the tobacco product and the vertical line measures the advertising. The increase in consumption caused due to teenagers in reduced due to ban on advertising.
2. ITC is a major private player in the Indian market and is a renowned company. The company’s primary business was production and selling of tobacco, however company has diversified in recent years to other products as well. The increasing corporate social responsibility of the company puts a pressure on the tobacco division as tobacco consumption leads to several severe health hazards. The company has to deal with the pressure to be socially responsible by indulging in several society welfare initiatives, yet at the same time the production and selling of tobacco which causes death of many people jeopardize the company’s reputation. The tobacco products cause serious diseases to both, the primary and secondary smoker. The company in order to grow further and expand its business has to take initiatives in the cigarettes industry which involves social costs and the resistance from government and NGO’s.
3. I would choose for option 2 as it is in sync with the elements of triple bottom line approach envisaged to be adopted by ITC. ITC currently is the biggest buyer of the tobacco crops as it buys fifty per cent of crops. It gives good prices to the farmers and has practical and enduring relationship with the farmers. The company due to its large production of cigarettes has to buy tobacco crops in bulk. Moreover, the company uses crops produced in India and uses very little imported tobacco. This provides the sustainability for the farmers and the company both. The company in its R&D lab constantly upgrades the tobacco variety and shares them with farmers which fetches farmers a high price also.
The company is already profitable in cigarettes sector and enjoys 75 per cent market share. Quitting the market at this point of time would only provide competitive advantage to other companies and will not impact the demand of cigarettes. The company can make major improvements to make the cigarettes less harmful for the consumers while being a part of the industry. Company should invest in researching ways to reduce the harmful factors of the cigarettes which shall be easier as the company already has its own research and development department which researches on variety of tobaccos. The research to make tobacco less harmful would be an extension of the research and development already carried out by company.
The company also invests heavily in the farmers and their villages as a part of their CSR. It teaches new methods to farmers to grow tobacco, provides them the equipments, have established e-chaupal and many more.
Moreover due to its excellent connection with farmers and ITC being the largest buyer; it can actually motivate the farmers to grow tobacco as researched by ITC.
The cigarette business of ITC is promising for its shareholders also as it yields good return on the investment. The dominant share of cigarette market ensures that ITC protects the shareholders investments. The cigarette business of the company is responsible for about 47 per cent of total company revenue with the year on year growth of 9 to 10 per cent. The business is still profitable even after the introduction of VAT in several states, ban on advertising and public smoking and availability of illegal cigarettes in market which are less in price. The cigarette business of ITC is the cash cow for it in terms of BCG matrix as the company has to make very low investment and the product is self-sustained and leads to increasing revenue,
The company with its increasingly profitable cigarette business can invest in R&D technology as required to make cigarettes less harmful and also promotes its other businesses like FMCG so that the return on investment of shareholders is protected and ensured even if the government takes stringent action by levying further taxes or other measures to reduce the consumption of tobacco.
Hence, the company should focus to grow its tobacco section while meeting the responsibilities in triple bottom line approach as it has the obligations towards farmers who grow tobacco and can cause changes in the tobacco industry with introducing harmless tobacco.
4. ITC being the market leader in cigarette production can form a board with other cigarette producing companies to initiate the cigarette demand and supply regularization program. Moreover, they can also suggest government to increase taxes on other tobacco products to reduce the consumption of other tobacco products. The companies can also educate the consumers on the harmful effect of the filtered and non-filtered tobacco products. Since ITC has good relationship with farmers, it should support government to find other cash crops for farmers which keeps them in black and reduce the production of tobacco.
Bibliography
Chaloupka FJ and Warner KE. (2000). The Economics of Smoking. Amsterdam, North-Holland: Handbook of Health Economics.
Chaloupka FJ, Hu T-W, Warner KE, Jacobs R, Yurekli A. (2000). The taxation of tobacco products. (C. F. Jha P, Ed.) Oxford: Oxford University Press.
McGuiness T and Cowling K. (1975). Advertising and the aggregate demand for cigarettes. European Economic Review , 311-328.
Ojha, A. K. (2010). ITC LTD: Towards a Triple Line Bottom Approach. Bangalore: Indian Institute of Management.
Price Elasticity of Demand for Tobacco products. (2008). Retrieved July 11, 2011, from Tobacco in Australia - Facts & Issues: http://www.tobaccoinaustralia.org.au/
Puffing Profits. (2007, November 8). Retrieved July 11, 2011, from Financial Express: http://www.itcportal.com/about-itc/newsroom/press-reports/PressReport.aspx?id=354&type=C&news=Puffing-Profits
(2000). Reducing Tobacco Use. US Department of Health and Human Services.
Ross, H. (2002). Economic Determinants of Smoking Initiation and Cessation. Chicago: Health Reserch and Policy Centres.
Saffer H and Chaloupka F. (2000). Tobacco advertising: economic theory and international evidence. Journal of Health Economics , 19 (6), 1117-37.
Somvanshi, K. K. (2010, Feb 1). ITC to offer investors healthy return on investment. Retrieved July 11, 2011, from The Economic Times: http://articles.economictimes.indiatimes.com/2010-02-01/news/27580834_1_cigarette-business-fmcg-business-itc
