In February 2001, the Government of India (GoI) announced a ban on advertising by cigarette companies

and restrictions on the sale and consumption of tobacco products.

The proposed Tobacco Products (Prohibition of Advertisement and Regulation) Bill 2001
prohibits smoking in public places and the sale of tobacco products to people under the age of
18. According to the Bill, no tobacco related business would be allowed to advertise in any type
of media. Even surrogate advertising, like sponsoring sports and cultural events, by such
companies was to be banned. International brands, however continued to advertise on satellite
TV channels. Naturally, this put the domestic players at a disadvantage. To make matters worse,
tobacco companies had already been badly affected by rising excise duties and competition from
smuggled products. In fact, the number of cigarettes sold declined between 1997 and 2002, and
major cigarette companies saw a decline in sales volumes.

The declining sales of cigarettes, the proposed ban on advertising, the increasing anti-tobacco
campaigns and the experience in developed countries seemed to suggest that tobacco would no longer
be a profitable business in the future. Consequently, ITC decided to diversify into non tobacco
businesses. ITC made its first foray into a non-tobacco business long back in the 1970s, when it entered
the hotel industry.

Since then the company has diversified into a variety of other businesses- sportswear, greeting cards,
ready to serve packaged foods, confectionery and branded staples- to reduce its dependence on its
cigarette business. ITC diversified into retailing and merchandising of sports goods and premium apparel
under its cigarette brand, 'Wills' and ran holiday packages under another cigarette brand, 'Gold Flake'.
These businesses helped keep alive the existing brands. However, so far ITC hasn't been able to earn
significant profits through any of its non-tobacco businesses. ITC's core business, cigarettes, contributes
almost 85 per cent to its revenues, while almost all the other diversified businesses put together
contribute only 15 percent. Analysts feel that ITC's ability to grab a sizable share of the markets it has
entered and progressively make profits is doubtful, because it has diversified into areas where there is
intense competition.

A Note on Cigarette Industry

In the late 1990s, the cigarette industry in India was facing many challenges. The share of
cigarettes in the total consumption of tobacco was declining steadily. The demand for cigarettes,
which was at its peak at 104.2 billion sticks in end-March 1998, had declined marginally each
year to settle at 97.8 billion sticks in March 2001.

In March 2002, volumes fell to 87.8 billion sticks (Refer Table I). While the volume of filter cigarette sales
increased between 1998 and 2001, non-filter cigarette sales saw a significant decline of 30%. The
increase in excise duties over the years (Refer Table II), which got reflected in higher prices, eroded the
competitiveness of non-filter cigarettes vis-à-vis beedis.1 Higher excise duties made the lower end (non-
filter) cigarettes manufactured by the organized sector much more expensive than the beedis
manufactured by the unorganized sector. The organized sector also had to cope with stiff competition
from the grey market. According to industry sources, the growth rate of smuggled cigarettes was at over
25 percent annually.

Major Players

ITC was the market leader in the cigarette business with a share of over 78% in 2001 (Refer Table III).
The three major players, ITC, Godfrey Phillips India Ltd (GPIL), and Vazir Sultan Tobacco (VST), together
accounted for over 95% of the cigarette market.

VST was an affiliate of British American Tobacco (BAT), which held 30% equity in VST. In 2001, VST had
9.41% share of the cigarette market. The company's products, which were targeted at the low end of
the market, dominated the small sized (< 60mm) segment. GPIL was the third largest producer of
cigarettes in India. Philip Morris (US), the largest shareholder in GPIL, had a 36 per cent stake in the
company. The K.K. Modi Group, the Indian promoter of GPIL, increased its stake in the company from 32
per cent in 1998 to 36 per cent in 2002. GPIL was the dominant player in the northern and western parts
of the country. The company was planning to increase its presence in the western and southern
markets. Cigarettes constituted more than 90% of GPIL's turnover...

Background Note
ITC was established by UK-based tobacco major BAT. It initially set up the Peninsular Tobacco
Company (Peninsular), a cigarette manufacturing, tobacco procurement and processing unit. In
1910, it set up a full-fledged sales organization named the Imperial Tobacco Company of India
Limited (Imperial). To cope with increasing demand, BAT set up another cigarette
manufacturing unit (in Bangalore) in 1912.

To procure the necessary raw material (tobacco leaf), a new company, called the Indian Leaf Tobacco
Company (ILTC), was incorporated in July 1912. By 1919, BAT had transferred its holdings in the
Peninsular and ILTC to Imperial. Following this, Imperial replaced Peninsular as BAT's main subsidiary in
India. By the late 1960s, the GoI began putting pressure on multinational companies to reduce their
holdings. Imperial divested its equity in 1969 through a public offer, which raised the shareholdings of
Indian individual and institutional investors from 6.6% to 26%. After this, the holdings of Indian financial
institutions were 38% and the foreign collaborator held 36%. Though Imperial clearly dominated the
cigarette business, it soon realized that making only a single product, especially one that was considered
injurious to health, could become a problem...

ITC's Recent Diversifications

ITC has been constantly making efforts to de-emphasize its tobacco business. Its corporate
strategy aimed at creating multiple avenues of growth based on its core competencies.
In line with this strategy, ITC's diverse strengths were being leveraged across three product groups -
Lifestyle Retailing, Greeting Cards & Gifts and Branded Packaged Foods. The company aimed at
generating 40 percent of its total revenues from such diversified businesses. To achieve this, it planned
to invest around Rs. 26 billion to Rs. 28 billion in various ventures by 2006. Analysts felt that ITC's
diversification, especially into areas such as branded garments, aimed at improving its brand image,
which, in turn, may help it grow its core business.

Wills Lifestyle

In 2000, ITC extended one of its most valuable cigarette brands, Wills, to fashion retailing. The product
was called Wills Sport (Refer Exhibit IV)...

The Challenges Ahead

In 2001, ITC invested around Rs. 5 billion in its non-tobacco businesses. This investment was
expected to increase to Rs 20 billion in the next five years.

By May 2002, there were 44 Lifestyle stores in India. The gross turnover from these stores was
over Rs. 200 million, but due to their heavy start up costs, they were still not considered
profitable. Expressions greeting cards, which were sold through 10,000 outlets in 180 Indian
cities, were yet to bring in revenues. According to company reports, losses are on the rise in its
branded garments, greeting cards and packaged foods ventures. Losses in businesses such as
'Aashirvad' wheat flour, Expressions greeting cards and Wills Lifestyle accounted for five per
cent of pre-tax profits in 2002 and continue to be higher than the revenue generated by them. If
losses continue to rise over the next few quarters, it may adversely effect the overall profit
growth...