The redefinition of Grade Two cigarettes has had a significant impact on their marketing.

Before the change, the unit wholesale price of Grade Two Cigarettes was RMB50 to RMB100 per carton. Accordingly, the unit retail price of Grade Two cigarettes was RMB70 to RMB200 per carton. The market of cigarettes with a retail price of RMB70 to RMB100 is where competition among tobacco manufacturers is relatively intense. The segment is relatively large, and used to be monopolized by such traditional big brands as Mount Hongtashan, Yunyan and Baisha, each with an annual output of 50 billion cigarettes (1 million cases) or higher. After the consumption tax policy change, cigarettes with a retail price of RMB70 to RMB100 were redefined as Grade Three cigarettes. As a result, these traditional big brands now have to relinquish their monopoly over the market of new Grade Two cigarettes.

Take Mount Hongtashan for example. Variants such as Mount Hongtashan (Classic 1956) and Mount Hongtashan (Classic 100) are key members of the Mount Hongtashan brand family, with the unit retail price standing at RMB70 to RMB100 per carton. However, Mount Hongtashan does not have variants with unit retail prices of RMB100 to RMB200 per carton. Therefore, after redefinition of Grade Two cigarettes, Mount Hongtashan does not have new Grade Two specification products to offer the market.

As traditional big brands are currently absent in the Grade Two segment, products with a unit retail price of RMB100 to per carton, which have been redefined as Grade Two cigarettes, are attracting greater interest, with some registering rapid sales volume increases.

Official statistics for the January-June period suggest that of the new Grade Two players, Liqun, The Seven Wolves, Mount Huangshan, Pride, Nanjing and other brands are enjoying the biggest sales volumes. With a unit retail price of RMB130 to RMB170 per carton, they have actually become relatively competitive players in the Grade Two segment.

Take Liqun and The Seven Wolves as examples. In the first half of 2009, the sales volume of Liqun reached a total of 22.02 billion cigarettes (440,400 cases), an increase of 27.33% over the same period of 2008. In particular, the sales volume of Grade Two cigarettes alone accounted for 60.78% of the total. In the retail price range of RMB130 to RMB170 per carton, Liqun is highly competitive, boasting several highly marketable specifications including the RMB130 per carton Liqun (New Fashion); the RMB150 per carton Liqun (Old Fashion), Liqun (Blue Sky) and Liqun (Festivity) and the RMB170 per carton Liqun (Soft Blue).

From January to October 2009, the sales volume of The Seven Wolves reached 51.565 billion cigarettes, an increase of 14.5% over the same period of 2008. In particular, The Seven Wolves (Red) and The Seven Wolves (Soft Red) registered rapid sales growth. Presently, The Seven Wolves is relatively competitive in the retail price range of RMB130 to RMB170 per carton, boasting a number of highly marketable specifications such as the RMB140 per carton Seven Wolves (Red), the RMB150 per carton Seven Wolves (Soft Red) and the RMB170 per carton Seven Wolves (Festivity).

The redefinition of Grade Two conforms to the structural upgrading of cigarette products in China. Objectively, it has contributed to bringing about great development opportunities for cigarette brands or specifications with a retail price of RMB100 to RMB200 per carton. The Grade Two cigarettes segment can probably become an area of simultaneous development of both scale and efficiency for cigarette brands, something that all large tobacco manufacturers have always attached great importance to. Since the consumption tax policy change, many tobacco manufacturers have been rushing to convert Grade One specifications into Grade Two ones, and to convert Grade Three specifications to enlarge the capacity of Grade Two cigarettes, in desperate efforts to grab market share in the Grade Two segment.

At this point, traditional big brands that used to monopolize the Grade Two segment, such as Mount Hongtashan, Yunyan and Baisha, are showing no weakness at all, and have all adopted countermeasures. In the first 10 months of 2009, Yunyun, while registering a year-on-year increase of 19% in the sales of Grade One cigarettes, succeeded in gradually increasing its Grade Two market shares. In the 10-month period, the Hongyun-Honghe Tobacco Group – the manufacturer of Yunyan – defined its new Yunyan (Soft Purple) as a leading variant in the Yunyan luxury cigarette product family, further consolidating its market shares in the segment.

Hongta Group strategy is to turn Mount Hongtashan (Classic 150) into a key specification for upgrading the structure and improving the economic efficiency of its Mount Hongtashan brand family.

Changsha Cigarette Factory – the manufacturer of Baisha cigarettes, has also developed a series of three new Baisha Grade Two products, Baisha (Noble Class White), Baisha (Noble Class Blue) and Baisha (Noble Class Golden), with unit retail prices of RMB130 per carton, RMB150 per carton and RMB170 per carton respectively

Presently, of the newly defined Grade Two cigarette products, those with a unit retail price of RMB100 per carton are seeing favorable growth while those with a unit retail price of RMB130 per carton, RMB150 per carton or RMB170 per carton are also registering very rapid development.

The global financial crisis has seen Chinese consumers downtrading from higher grades to lower grades since the second half of 2008. Some consumers that were previously consuming Grade One cigarettes have chosen to consume similarly priced Grade Two cigarettes instead,. This has contributed to directly stimulating the growth of Grade Two cigarettes sales. For example, cigarette products with a unit retail price of around RMB170 per carton have become new points of growth. Meanwhile, medium-grade cigarette consumption has continued to grow, contributing to stimulating the growth of Grade Two cigarette sales.

While seeing the growth of the Grade Two cigarette market we should also realize that new Grade Two cigarette products are encountering increasingly serious competition from foreign brands that are similarly priced. For example, BAT’s flue-cured 555 brand sold in China is similarly priced to their Chinese counterparts, with the unit price ranging between RMB120 and RMB180 per carton. Other world-famous brands including Marlboro, Kent, Davidoff and Mild Seven are also similarly priced to China’s new Grade Two cigarette products.

It has been barely six months since the tobacco industry of China redefined its Grade Two cigarette products. In this period, fierce competition among tobacco manufacturers to grab greater market shares of Grade Two cigarettes has started unfolding. It is foreseeable that under the impacts of the general economic situation, changes to consumption patterns and challenges from popular competitive foreign brands, competition in the new Grade Two segment will become increasingly intense. The future structure of Grade Two cigarettes in China has yet to stand the test of time and will be determined ultimately by the choices made by consumers.