The tax hike now hanging over the Japanese market like a fiscal sword of Damocles is big enough to have a seismic effect on the Japanese cigarette market. The Japanese government is planning to bump up cigarette taxes by ¥3.5 (US$0.4) per cigarette from October 1, 2010, raising the pack price by an average of ¥100 yen, or 33%, to ¥400. This will be the first tax hike for cigarettes for four years in the world’s fourth largest market by volume after China, the US and Russia. It will also be the biggest since Japan Tobacco Inc. was privatized in 1985.

The accepted price elasticity formula is that a 10% rise in prices means a 4% fall in cigarette volumes in a developed market. This would therefore mean a fall in volumes of over 12% in Japan. However the market has been falling in volume even in the absence of cigarette price rises, a fact which could magnify the effect of the price rise. Some commentators think the fall could be as high as 20%.

Euromonitor International (EI) forecasts 24% decline for volume sales over the next 5 years between 2009-2014. The planned tax increase is part of Prime Minister Yukio Hatoyama’s pledge to reduce smoking in order to curb health insurance costs as the population ages but also to help wipe out the tax revenue shortfall. Price rises are regarded as the primary instrument of tobacco control and Japan has, thus far, not been one of the more zealous signatories to the FCTC. This seems to be changing though: it was announced in February 2010 that Japan’s health ministry will urge local governments to introduce a total ban on smoking in public places, including schools, hospitals, offices and buses (though restaurants and hotels will be able to keep separate smoking areas as a temporary measure).

Even before the announcement of the big price hike, there had been big changes going on in the Japanese cigarette market. One factor has been the developing health and wellness trend reflected in falling volumes – down 17% from 2003-8 - but also a rush to lower tar cigarettes. Ultra low tar cigarettes posted the strongest growth in 2008, up by 4% to reach 85.2 billion sticks (equivalent to 34% of volume sales). Brands containing 1mg tar proved extremely popular and saw a large number of new product launches, including Mild Seven Impact One, Marlboro Filter Plus and Kent Mintek.

But, unusually for a developed market, not only have cigarette market volumes fallen in Japan, so have cigarette market values – from 2003-8 by 11% at current prices based on EI calculations. In most developed markets, although volumes have declined, the pricing power of the international companies plus the charisma of the flagship brands, has enabled product mix improvements and better margins to deliver higher sales (and company profits) even when volumes have been in sharp decline. The reason has been the weakness of prices in the Japanese market but now this seems about to change.

Other big changes have impacted the Japanese cigarette market over the last few years. In 2007, vending accounted for 43% of volume sales of Japanese cigarettes. Today it has plummeted to 25% of total sales due to the introduction, in 2008, of the TASPO age verification system for vending sales. Registration for a TASPO card requires the presentation of formal ID and the completion of an application form but this achieved only a 34% penetration rate in its first year of operation. The main impact has been on young people smoking, which could accelerate the rate of fall in smoking prevalence in Japan, a rapidly ageing society. According to a report by a Health, Labor and Welfare Ministry study panel, 61% of underage students who said they regularly smoked once a month or more reported it had become more difficult for them to buy cigarettes.

Cigarette volumes and smoking prevalence have been falling in Japan but the share of the premium price band has been rising. This was the key to the erosion of the market share of Japan Tobacco in the years prior to 2007.

International cigarettes dominate the premium price band - Philip Morris Japan KK (PMJ) and British American Tobacco Japan Ltd (BAT) have been on the rise while Japan Tobacco Inc. (JT), once dominant in its home market, has been fighting to recover its position and free itself from the mid-priced focus of its portfolio, with Mild Seven, Seven Stars and Cabin all retailing for ¥300 per pack of 20 sticks. Although dominance has not been recovered, JT has certainly succeeded in reversing the steady erosion of its market share.

Despite its loss of share over the past decade, JT remains the clear leader of the cigarette market, with a 65% volume share in 2008 according to EI. PMJ was in second place with a 24% volume share, followed by BAT with 10%. However the market action remains in the premium price band, and, with the price differential between premium and mid-priced brands standing at only ¥20 per pack, the mid-priced band suffered the biggest fall in its volume share during 2003-8, down from 74% in 2003 to 70% in 2008. But what will be the effect of the price rise? Band differentials and consumer attitudes may be about to undergo profound change.

Japan Tobacco is perhaps already setting out its stall for the new price environment The company’s announcement, in December 2009, of 15 new Mild Seven packing designs was heralded as the company aiming to achieve a third consecutive year of domestic market share growth. The redesign included the Mild Seven brand’s soft pack, box and 100’s box products. In addition, a new product labeled as Mild Seven Impact One Menthol Box is being developed with a flavor thread filter containing natural menthol flavor. The new designs and the new product were planned for early February 2010. This could be fortuitous timing because recent events suggest that the new Japanese pricing environment is not in the future – it has arrived.

At the beginning of March 2010, PMJ and BAT filed applications with the ministry of finance to raise tobacco prices by 20 yen per pack. PMJ’s application covers 73 products, including Marlboros, which sell for ¥320. BAT is looking to increase prices on 50 offerings - among them Kents currently selling at ¥300. Both companies state their wish to raise prices to make up for lost revenues stemming from weaker volume sales.

To most people’s surprise, but demonstrating the new attitude to price exemplified in the planned tax hike, the Japanese government almost immediately approved the ¥20 per pack price increase for PMJ, to be implemented in June. This is unprecedented, because, in the past, price increases have been allowed only when there has been a tax rise, and, even, then only on selected brands. The BAT ¥20 price rise, had not been approved at the time of writing but given the treatment of PMJ, this also seems likely to be approved.

This represents a major change in government policy, and all the more so because it comes before the huge tax-driven price increase in October 2010. Consequently, it is the view of EI that, from now on, the Japanese government will approve price increases without tax increases. As demonstrated in the table below, not only are prices low in Japan but the lack of variation between competing brands offers little incentive to trade down but plenty to trade up. This year will change all that: in pricing terms, the Japanese cigarette market has joined the 21st century.

Japan Tobacco Mild Seven Product Information