‘You’ve come a long way, baby’
Philip Morris redefines the tobacco company in an anti-smoking age

by Jack Milligan
for Virginia Business
April 2007

Ask American Cancer Society lobbyist Wendy Selig who her staunchest allies are in the battle to give the Food & Drug Administration control over tobacco products and she probably wouldn’t mention Philip Morris USA, the nation’s largest cigarette manufacturer.

In fact, Henrico County-based Philip Morris has backed tobacco regulation legislation in Congress since 2004 — a position that would seem to make as much sense as a fox calling for safer chicken coops. But Selig hasn’t forgotten that Philip Morris and other tobacco companies once challenged FDA regulation all the way to the U.S. Supreme Court. Therefore, she’s a little wary of the company’s change of heart. “Philip Morris has its own reasons for doing this,” she says. “They’ve made some sort of business decision that this is in their best interests.”

Philip Morris’ support for FDA regulation is just one example of how it’s charting a different path from the rest of Big Tobacco. The longtime tagline for its Virginia Slims cigarettes now aptly describes the company, “You’ve come a long way, baby.”

As anti-smoking sentiment has grown across the country in recent years, many workplaces, restaurants and hotel chains have banned smoking, and the public has no patience with tobacco companies that don’t acknowledge the harm that cigarettes cause.

Under Michael E. Szymanczyk, its chairman and chief executive officer, Philip Morris has done more to bring its practices in line with society’s changing attitudes than any other U.S. tobacco company. In so doing, the company is conducting a delicate balancing act, trying to avoid a public backlash that could cripple the cigarette industry as it moves toward the development of safer tobacco products.

Americans’ shifting attitudes toward cigarettes is evident even in Virginia, the company’s home state. Tobacco became Virginia’s first industry nearly 400 years ago when John Rolfe developed a commercially viable crop and helped rescue the fledgling Jamestown colony. Tobacco leaves, in fact, are painted on the ceiling of the state Capitol. That legacy, however, didn’t prevent the General Assembly from raising Virginia’s lowest-in-the-nation cigarette taxes in 2004 or stop Gov. Timothy M. Kaine from banning smoking in state buildings last year. Now the city of Alexandria plans to use its zoning authority to eliminate smoking in restaurants.

This anti-smoking fervor, however, does not mean that Philip Morris has lost its economic clout in Virginia where it has produced cigarettes in Richmond since 1929. The company remains one of Virginia’s largest employers, with more than 6,000 workers statewide. And it has reasserted its prominence in Richmond after slipping behind Capital One Financial Corp. in the 1990s as the area’s top employer. In recent years, Philip Morris USA moved its headquarters from New York to Henrico, invested more than $300 million in its cigarette plant in South Richmond and now is completing a $350 million research center in the Virginia BioTechnology Research Park downtown. “Philip Morris is known as an employer of choice in [Virginia’s] manufacturing sector,” says Greg Wingfield, president of the Greater Richmond Partnership, an economic development organization.

Still a profitable business
Philip Morris USA remains the dominant player in an industry that’s highly profitable despite a blizzard of lawsuits during the past 20 years and a declining percentage of smokers among American adults (down to 20.9 percent in 2005 from 42.4 percent in 1965). The company held a commanding 50.3 percent market share of the cigarette business last year, and its Marlboro brand alone controlled 40.5 percent of the market. Philip Morris USA, which is a division of New York-based Altria Group Inc., earned $4.8 billion on revenues of $18.5 billion, a modest increase over 2005. (Philip Morris International — which is based in Lucerne, Switzerland, and handles tobacco sales outside the United States — earned $8.5 billion on revenue of $48.3 billion last year.)

“Tobacco is an outstanding business,” says David Adelman, a securities analyst with Morgan Stanley & Co. Inc. in New York. “It’s outstanding because it has high profit margins and a high degree of consumer loyalty.” Tobacco companies also benefit from having relatively modest capital investment needs, and the retail trade establishments that sell their products have relatively little leverage over them. “It’s not like selling 20 percent of your product through Wal-Mart,” says Adelman.

If Altria’s stock price is any guide, Wall Street likes the tobacco business as well. Starting in March 2006, Altria’s share price climbed steadily from the mid-$70 range to a high of $90.50 in January before settling back into the mid-$80s as this article went to press. Indeed, news that Altria planned to spin off its Kraft Foods subsidiary to shareholders at the end of March — which intensifies Altria’s bet on tobacco — seemed to make investors like the company even more.

The 1998 settlement
Such a fortuitous outlook would have been hard to imagine in the mid-1990s when tobacco companies were being sued by many state governments trying to recover public health costs stemming from smoking. A watershed event for the industry was the 1998 settlement with the attorneys general in 46 states — called the Master Settlement Agreement (MSA). The MSA required Altria and most major U.S. tobacco companies to make an initial payment of $10 billion and pay an additional $200 billion to the states over 25 years. The MSA also restricts how cigarettes can be advertised and sold in the U.S. — and placed strict prohibitions against marketing to children.

Since 1998, Philip Morris USA has pursued what one might describe as a dual strategy. One part of the strategy has been to continue to defend itself vigorously against lawsuits. In mid-February, for example, the company won a big victory when the U.S. Supreme Court overturned a $79.5 million punitive damage award in an Oregon case, saying that it violated the due process clause of the U.S. Constitution by awarding damages to individuals who were not a party to the original suit.

But the other part of the strategy has been to adopt a far more conciliatory posture on the health effects of cigarettes. On its Web site, Philip Morris acknowledges that cigarettes can be harmful. “Philip Morris USA agrees with the overwhelming medical and scientific consensus that cigarette-smoking causes lung cancer, heart disease, emphysema and other serious diseases in smokers,” says one statement on the site. In addition, the company has given millions of dollars to fund smoking cessation research. While this has done little to mollify the anti-smoking lobby, it represents a remarkable about-face for a company that once debated whether any link existed between the use of its product and serious medical conditions.

While the MSA prohibits participating companies from misrepresenting the health effects of smoking, Philip Morris’ commitment to social responsibility seems to be driven by more than just the settlement’s requirements. Executives such as Szymanczyk clearly saw the need to change the company’s public position on smoking.

‘We had to do something different’
Unlike most of his predecessors at Philip Morris USA, Szymanczyk did not start out in the tobacco business. In 1971, he joined Procter & Gamble straight out of the University of Indiana, where he received a bachelor’s degree in finance. Szymanczyk eventually left P&G to join Kraft Foods and in 1990 moved over to Philip Morris USA to become senior vice president for sales.

The decision to adopt a more forthright stance on the health effects of smoking was not Szymanczyk’s alone, but it was largely his to implement. By the late 1990s, he says, it was obvious that a change was necessary. The industry’s battle with the states was intensifying, and the company had become a pariah in the minds of many people. The headline on a Business Week cover story in 1999 described Philip Morris as “America’s Most Reviled Company.”

“Almost every day you’d read a negative story about Philip Morris and the tobacco industry,” says Szymanczyk. “From my perspective, I knew we had to do something different.”

The MSA could be seen as a proxy for society’s new views on the dangers of smoking, and Philip Morris understood that tobacco companies which remained outside the boundaries of societal norms did so at their peril. “Society’s view of tobacco companies and what they were doing had shifted,” says Szymanczyk.

The 58-year-old CEO says that Philip Morris USA has enthusiastically embraced the terms of the master agreement — and in some instances has done more than is required. For example, the company doesn’t advertise in magazines even though the MSA does not prohibit that. Most of Philip Morris’ competitors, in fact, continue to run magazine ads. The company also provides information on its Web site for smokers who want to quit and has asked entertainment executives not to use its cigarettes in television shows and movies aimed at youth.

Philip Morris also has given money to outside parties to conduct scientific research. In 2004 it made a $15 million grant to the Duke Center for Nicotine and Smoking Cessation Research at Duke University. And in February it gave $25 million to the University of Virginia to support research into ways to reduce the harm caused by smoking. The grant will also support research on preventing youth smoking and improving the effectiveness of smoking-cessation programs. “Has Philip Morris gone further than the other tobacco companies?” Adelman asks. “Yes, they have.”

Not giving up on cigarettes
Of course, many critics would argue that the most socially responsible thing for Philip Morris to do would be to quit the tobacco business altogether. To that suggestion, Szymanczyk replies that he doesn’t have the right to give the business away. The company belongs to its shareholders, he says, and they have made it clear that they’re happy investing in a cigarette manufacturer. “If that’s what you want, I can’t help you,” he says. “The reason why there’s a cigarette business is because people want them.” Walking away from that business is “a hollow suggestion,” he adds.

Within the tobacco industry, Philip Morris’ most controversial stand has been its support for FDA regulation — particularly after it joined other tobacco companies to beat back an earlier effort by the FDA to assume regulatory control of tobacco products on its own authority. In that case, the Supreme Court ruled against the FDA in a 5-4 decision that barred it from regulating tobacco without congressional authorization.

Now Philip Morris supports twin bills in the House and Senate that would place all tobacco products under the FDA’s purview. Under this legislation, the agency would have the authority to regulate nicotine levels in cigarettes, establish product standards that could reduce the harmful effects of cigarettes and take additional steps to discourage youth smoking. Also, cigarette makers would have to disclose to the FDA all of the ingredients in their products.

As currently written, the bills would not give the FDA the power to eliminate nicotine from cigarettes or arbitrarily pull them off the market. “This is not a back door ban on the product,” says Selig, the American Cancer Society lobbyist. She points out that about 50 million U.S. smokers are addicted to nicotine. To summarily ban cigarettes would be a source of considerable hardship for them. “Our agenda is not to ban this product,” she says.

Congress failed to pass similar tobacco regulation measures in 2004 and 2005, but Selig is optimistic that this time will be different because the Democrats now control both the houses. “Having the Democratic leadership behind the bills is very important,” she says.

R.J. Reynolds opposes legislation
The tobacco industry’s second largest cigarette manufacturer — Winston-Salem, N.C.-based R.J. Reynolds Tobacco Co. — opposes the bills as currently written. Company spokesman David Howard argues that by placing even more restrictions on the ability of cigarette manufacturers to advertise, the proposed legislation would greatly favor Philip Morris. “Basic business 101 will tell you that if companies can’t communicate with consumers about what makes their product better or preferable, they’re going to stick with their own brand,” says Howard. “That would make it very difficult for us to compete with the marketplace leader.”

In written testimony submitted to the Senate Committee on Health, Education, Labor and Pensions in February, Szymanczyk said the primary benefit of FDA oversight would be “a new framework within which manufacturers can refocus their efforts in reducing the harm of their products.”

One of the company’s highest priorities, Szymanczyk said, is the development of cigarettes “and other products” that are safer. “It will take some time, but if we are successful in finding ways of both reducing potentially harmful compounds and reducing smokers’ actual exposure to them under real-world conditions, we believe the FDA under this legislation will be in a position to evaluate whether our product development efforts are actually reducing the risk of tobacco-related diseases among current smokers,” he said.

There’s another reason why Philip Morris would welcome federal regulation of tobacco products. Gregory B. Fairchild, an assistant professor of business administration at U.Va.’s Darden School of Business, says regulation would confer a degree of legitimacy on cigarettes. “As with any controlled substance in the United States, once the government signs off [on a product], we believe that it’s safe for us,” he says.

The Center for Research and Technology
The key to understanding Szymanczyk’s strategy may be Philip Morris’ gleaming new Center for Research and Technology in Richmond, scheduled to open in June. About 500 scientists, engineers and support personnel will work at the center, and some of what happens there will most likely determine the company’s direction. Some of its most important work would be to develop a safer cigarette under FDA guidelines, should a tobacco bill finally make it out of Congress.

Szymanczyk also is pursuing what he and others at Philip Morris refer to as an “adjacency strategy,” where they hope to develop tobacco products that don’t have the same health risks as cigarettes. The company is test marketing a smokeless and “spitless” product called Toboka in Indianapolis. The research center will focus much of its resources on looking for other new product ideas. “In order to have successful products, you have to start with a lot of ideas,” says John R. “Jack” Nelson, the company’s president for operations and technology. “You need a [new product] pipeline.” The new center will also be doing basic research into the health effects of smoking — including ways to make cigarettes safer.

Szymanczyk saw the results of an adjacency strategy at his former employer, Procter & Gamble. That company started out in the soap business but transformed itself into one of the world’s most respected consumer products companies. The strategy presumes Philip Morris will continue manufacturing cigarettes. “To be successful in an adjacency strategy, you need to leverage off your core strengths and knowledge,” says Nelson. “We know a lot about tobacco. If we go away from tobacco, it becomes a little more of a stretch.”

For his part, Szymanczyk expects that, 20 years from now, Philip Morris will still be in the cigarette business — “but that won’t be where the growth will come from.”

Not everyone is happy with the initial fruits of Philip Morris’ strategy. Adelman at Morgan Stanley wishes that the company was leveraging its strong Marlboro brand to develop a more traditional dipping tobacco product like Skoal or Copenhagen, both of which are produced by UST Inc. “[Toboka] is a product that no one’s ever heard of before,” he says. “And it’s for a product category that doesn’t exist today.”

Richmond’s stake in company’s future
Given the long-term decline in the percentage of Americans who smoke, Philip Morris USA has little choice but to make the adjacency strategy work. And Richmond has a big stake in the outcome.

Ironically, although Philip Morris has had deep roots in Virginia, its home office had been in New York City until its relocation in 2004 to the former headquarters of the Reynolds Metals Co. Szymanczyk says the move saved the company about $80 million a year. Plus, it shortens the lines of communication between its management, research and manufacturing teams. Although the company considered a number of locations for the research and technology center — including one in Albemarle County outside of Charlottesville and another in North Carolina’s Research Triangle — Szymanczyk says Philip Morris chose Richmond because it is so close to the company’s other important facilities.

The company’s move has pumped new life into Richmond’s Virginia BioTechnology Research Park. The addition of Philip Morris’ research and technology center will nearly double the park’s size — eventually boosting total employment there to 2,000. “You will find that most life-science research parks achieved success when they could point to critical mass,” says Robert T. Skunda, the park’s president and CEO. The research and technology center has also been something of a “magnet,” Skunda adds, since many of the personnel who will ultimately locate there are independent firms working for Philip Morris under contract and will use Richmond as their operational hub in the mid-Atlantic region.

Philip Morris’ expanded presence has also been beneficial for a city working to expand its economic base. Wingfield at the Greater Richmond Partnership says Philip Morris has given a huge boost to the region’s fortunes. “To have that validation is huge,” he says. It was an important factor in MeadWeastvaco Corp.’s decision to move its headquarters to Richmond from Connecticut. “Philip Morris is one of their largest customers,” says Wingfield.

The company’s expanded presence also gives Mayor L. Douglas Wilder bragging rights over other big city mayors — which he seems happy to claim. “You can’t imagine what it does when I go places and people say, ‘I hear Philip Morris has located in your town!’ ” Wilder believes that Philip Morris’ decision to concentrate so much of its operations in Richmond helps him when he tries to recruit other businesses, because it lends credibility to the city’s economic resurgence. “It sends a big message,” says Wilder.