120 Park Avenue
Philip Morris has been guided for many years by a number of fundamental strategies that drive our growth, our profitability, and our vision for the future. Together, these strategies enable us to continue delivering on our promise: to invest in the development, retention, and motivation of our talented employees; to conduct our business as a responsible manufacturer and marketer of consumer products, including those intended for adults; to profitably grow our businesses; to reinvest in our businesses; to pursue a disciplined program of acquisition; to enhance shareholder value; to safeguard our credit rating; and to successfully manage our litigation challenges and play an active and constructive role in regulatory issues.
As a major player in an industry dogged by health concerns, a shrinking domestic market, and widespread investor fears about its future, Philip Morris Companies Inc. (Morris) continued to achieve record-breaking sales and profits during the 1990s, most of them thanks to the enduring appeal of the Marlboro Man. From a position of relative obscurity in the cigarette business in the early 1960s, Philip Morris has ridden Marlboro's success to leadership of the world tobacco market, while battling legal problems surrounding the entire tobacco industry. In 1999, one out of every six cigarettes sold around the globe was a Morris brand. Wanting to limit its dependence on its tobacco sales however, Morris continued to bolster its food-related sales throughout the 1990s and into the new millennium. As the second largest food concern in the world, the company added Nabisco Holding Inc. to its arsenal in 2000, and then led Kraft in the second-largest initial public offering (IPO) in history in June 2001. As litigation in the tobacco industry appeared to be slowing, Morris continued to gain market share in many of its product categories and investor confidence returned. In fact, share price rose over 90 percent during 2000, making Morris the best performer on the Dow Jones Industrial Average for the year.
The Early Years: 1847-1920s
In 1847, an Englishman named Philip Morris opened a tobacco shop in London's fashionable Bond Street area. When British soldiers returning from the Crimean War made the smoking of Turkish-style cigarettes--until then exclusively a habit of the poor--de rigueur, Morris was soon busy as a manufacturer as well as merchant of the newly popular product. He introduced a number of successful cigarette brands, including English Ovals, Cambridge, and Oxford Blues, and continued as one of the leading British tobacconists for many years. Morris's company eventually built a small but stable business in the United States, where its brands sold primarily on the strength of their British cachet. The U.S. market, however, was until 1911 all but owned by the American Tobacco trust, which enjoyed a monopoly in cigarettes comparable to that of John D. Rockefeller's Standard Oil in the oil business.
When the tobacco cartel was dissolved by court order in 1911, a U.S. financier named George J. Whelan formed Tobacco Products Corporation to absorb a few of the splinter companies not already organized into the new Big Four of tobacco--American Tobacco, R.J. Reynolds, Lorillard, and Liggett & Meyers. His first manufacturing acquisition was the maker of Melachrino cigarettes, a company at which Reuben M. Ellis and Leonard B. McKitterick had made names for themselves as outstanding salesmen. Ellis and McKitterick became vice-presidents and stockholders of Tobacco Products Corporation as Whelan considered their amicable relationships with the thousands of tobacco retailers in the New York area an invaluable asset. Whelan purchased the U.S. business of Philip Morris Company in 1919 and formed a new company to manage its assets: Philip Morris & Company Ltd., Inc., owned by the shareholders of Tobacco Products Corporation. Ellis and McKitterick thus became part owners and managers of the new Philip Morris brands.
Marlboro Debuts: 1925
While Whelan wheeled and dealed his way toward a financial collapse in 1929, Ellis assumed control of Morris in 1923, at which time the company posted a net income of about $100,000. Ellis's first important move as president was the 1925 introduction of a new premium--20 cents a pack--cigarette called Marlboro, which did well from the beginning and leveled off at steady sales of 500 million cigarettes a year. Industry leaders such as Camel and Lucky Strike sold more than 25 billion a year. Marlboro was originally marketed to women, the wealthy, and the sophisticated, in complete contrast to its 1955 cowboy-image reincarnation. After a seven-year absence, McKitterick rejoined Ellis in 1930 and the two men set about buying Morris's stock from their former employer, now in retreat from the tobacco business. Whelan sold off all of his tobacco interests, allowing Ellis and McKitterick to gain control of Morris by 1931. The company marketed cigarettes mainly under the names of English Ovals, Marlboro, and Paul Jones; handled a modest amount of pipe tobacco as well; and owned a single manufacturing facility in Richmond, Virginia. By any measure, it was a minor competitor in an industry dominated by the remaining pieces of the former American Tobacco trust.
Ellis and McKitterick were both veteran salesmen in the tobacco business, however, which in the 1930s meant that they personally had done business with many thousands of the tobacco jobbers and retailers up and down the East Coast. In a field not yet controlled by the rising mass marketers, such as supermarket chains, those years of handshaking had built for both men a powerful store of goodwill among those who would determine which cigarettes would be pushed at the retail level and which would be allowed to languish. When Ellis and McKitterick launched a new mid-priced cigarette called Philip Morris English Blend in 1933, they could count on the strong support of their jobber network to help them through the difficult introductory period. To further cement their alliance with jobbers, Morris executives let it be known that the company would refrain from selling to the new mass marketers directly, preventing the latter from retailing English Blend at less than the price of 15 cents set by the jobbers and dealers. The jobbers, already beginning to suffer from price competition with the big chains, readily agreed to Morris's plan--they pushed English Blend at 15 cents after Morris guaranteed that the same package would not end up on supermarket shelves at ten cents.
As experienced marketers, Ellis and McKitterick came up with several novel advertising gambits as additional support for their new product. Morris introduced the use of diethylene glycol as a moisture retentive in its cigarettes, adducing as proof of glycol's milder effect on the human throat a host of more or less scientific evidence gathered by bona fide researchers who were, however, paid for their work by the company. Ellis and McKitterick circulated results of the research among physicians, while settling in their advertisements for the general claim that "scientific tests have proven Philip Morris a milder cigarette." The company kept up this advertising slant for many years despite skepticism voiced by the Federal Trade Commission, among others. Morris's second advertising strategy was the revival of an earlier campaign in which a bellhop was told to fetch a pack of Morris cigarettes. The "call for Philip Morris," slogan used on posters as early as 1919, was updated for radio in 1933 with the recruitment of a bellhop named John Roventini to serve as a living representation of the ad. Roventini, under the name of Johnnie Morris, enjoyed many prosperous years putting in countless appearances in New York and other major cities, while his strident call could be heard every week on radio broadcasts.
Roventini soon earned himself a large fortune, by bellhop standards, and Morris began its long climb to the top of the cigarette world. Sales of English Blend were strong from its introduction in January of 1933, helping Morris to triple its net income--to $1.5 million--in a single year and by 1935 to challenge Lorillard as the fourth-largest cigarette maker in the United States. Ellis and McKitterick were both deceased by 1936, but under new chairman Alfred Lyon the company continued its rise, in that year selling 7.5 billion cigarettes and laying firm hold on the industry's number four spot. Morris was viewed as something of a phenomenon, its combination of marketing expertise and jobber loyalty enabling it to take market share from much larger and wealthier cigarette leaders such as American Tobacco and Reynolds. Lyon personally directed the construction of what quickly became the industry's largest and most effective sales force; although Morris's special relationship with jobbers did not last long--supermarkets proving to be the wave of the future--it remained a company fueled by its expertise in sales and marketing.
By 1939 sales had reached $64 million, and World War II soon put even more pressure on cigarette production. When Morris's sales doubled by 1942, Lyon and company president Otway Chalkey began casting about for some means to expand capacity, especially difficult given the fact that tobacco needed to be cured several years before its use in cigarette production. When Axton-Fisher Tobacco Company of Louisville, Kentucky, was put up for sale in 1945, Morris paid a premium price--$20 million--to win its large stores of tobacco and a second manufacturing plant. The move looked good until the war's end in August of that year precipitated a huge drop in cigarette consumption, a cut in sales made more painful by Morris's overestimation of peacetime demand. Many of the company's biggest orders in the fall of 1945 were left to grow stale on retail racks, and net income plummeted just as Morris was attempting to float a new bond issue at the end of the year. The company withdrew the offering and suffered a certain amount of embarrassment, but its underlying business was sound and Morris soon bounced back. A massive 1948 advertising campaign claiming that English Blend did not cause "cigarette hangover," a previously unknown disorder, led to a fresh gain in market share and profit.
Repositioning During the 1950s
Despite Morris's success with such advertising claims, the company somehow failed to foresee the most important new development in the cigarette business in many years: the introduction of milder and less harmful filtered cigarettes. Unlike Morris's version of mildness, filtered cigarettes were indisputably less damaging to the throat, and increased public awareness of smoking's real health dangers spurred a rapid shift to filters in the 1950s. Morris was slow to recognize the importance of this innovation, and it was not until 1955 that the company repositioned its old filter entry, Marlboro, as a cigarette with broad appeal by working the myth of the American cowboy into the product's marketing strategy. It took time, however, for the new Marlboro image to take hold, and by 1960 Morris had slipped to sixth and last place among major U.S. tobacco companies, its bestselling entry able to do no better than tenth among the leading brands. It appeared that changing consumer preference had left Morris well out of the new era in tobacco.
Morris had at least three cards yet to play, however. One was the emergence in 1957 of a marketing tactician capable of resurrecting the glory days of Alfred Lyon. Joseph Cullman III took over management of the company in 1957 and guided its amazing growth over the course of the following two decades, much of it earned in the international market. Morris was perhaps the earliest, and ultimately the most successful, U.S. tobacco company to foresee the potential sales growth in the worldwide cigarette business. In 1960, Cullman appointed George Weissman as director of international operations; the company's second greatest resource, Weissman is generally credited with making Morris the United States' leading exporter of tobacco products. The company's ace in the hole was the Marlboro Man, who would prove in the long run to be one of the most successful advertising icons ever created. For whatever combination of reasons--nostalgia for the Old West, clever packaging, tobacco taste--Marlboro almost singlehandedly raised Morris from also-ran to industrial leader during the next quarter century.
While Cullman attended to Morris's resurgence in the tobacco business, he also began the first of many attempts to diversify the company's assets, thereby rendering it less dependent on a product that was gradually becoming known as a serious health hazard. In the mid-1950s Morris bought into the flexible packaging and paper manufacturing trades, and in the early 1960s it added American Safety Razor, Burma Shave, and Clark chewing gum, hoping in each case to use Morris's existing distributor network and marketing experience to sell a wider variety of consumer products. None of these early acquisitions proved to be of great value, with the possible exception of its packaging division, not sold until the mid-1980s. Then, in 1970 the company added Miller Brewing to its holdings. Miller was then only the seventh-largest brewer in the United States, but the combination of a repositioned High Life beer and the introduction of the United States' first low-calorie beer, Miller Lite, brought the company all the way up to number two by 1980. On the other hand, Morris's 1978 purchase of the Seven-Up Company for $520 million was little more than a disaster: after several failed advertising campaigns the soft drink manufacturer was sold in the mid-1980s.
Marlboro's Rise to Superbrand Status: 1960s-70s
In the meantime, the Marlboro Man was running wild, carrying Morris up the ranks of cigarette makers with astonishing speed. Throughout the 1960s Marlboro registered yearly leaps in popularity, especially among the growing segment of younger smokers. By 1973, it was the second most popular cigarette brand in the United States and accounted for roughly two-thirds of Morris's tobacco business. In 1976, it moved past Reynolds's Winston as the leader with 94 billion cigarettes sold that year, helping Morris to become the United States' and the world's second-largest seller of tobacco. In 1961, Morris had controlled 9.4 percent of the market; in 1976 that figure topped 25 percent and continued to rise. With all other competitors in a slump, Morris and Reynolds together controlled well more than half the market. The two leaders thus found themselves in a very comfortable position: growing health concerns about smoking made it unlikely that any new competitor would join the tobacco business, and the need for massive, effective advertising made it difficult for the current competition to maintain its position. The net result was abnormally large profits for the two leaders, especially as their dominance of the market really took hold in the 1980s and they were able to raise prices frequently without fear of being undercut.
Complementing Marlboro's success was the emergence of new fields for Morris. The 1975, introduction of Merit brand signaled Morris's entry into the new low-tar market, a category that would mushroom as U.S. smokers became increasingly concerned with the deleterious effects of inhaling cigarette smoke. The company also began to focus increased marketing dollars on its premium brands, which produced greater profits per pack sold. Meanwhile, under the guidance of Weissman, the company's international business greatly expanded. While the U.S. cigarette market was flat in the 1970s and in retreat by the mid-1980s, international business continued to grow rapidly, and Marlboro soon ranked as the world's bestselling cigarette. That trend would continue through the following decade under the leadership of worldwide tobacco vice president Geoffrey C. Bible.
Morris's response to increasing U.S. controversy over smoking was to sell cigarettes with lower tar, meanwhile promoting all of its brands overseas where relatively less sophisticated consumers cared little about the health risks involved. In 1993, it cut the price of its Marlboro brand in an effort to gain an increased share of a sluggish market. Unfortunately none of these strategies went to the heart of the company's fundamental problem: the association of tobacco with lung disease. By the mid-1990s Morris had become embroiled in the rash of product liability lawsuits spawned by fifth-ranked Liggett's settlement of a class-action legal action in March 1996. The company was plagued by allegations that it had knowingly suppressed the harmful side-effects of smoking from consumers, and repeatedly made headlines as several former employees--some of them scientists--accused Morris of suppressing knowledge of the addictive quality of nicotine, manipulating levels of the drug in its Marlboro brand, and deliberately courting teenage smokers. In 1996, amid reports of Morris's third-quarter combined tobacco earnings of $2.23 billion and the announcement of a 20 percent increase in its annual stock dividend rate, came the announcement that the FDA planned to regulate the tobacco industry and restrict tobacco-related advertising. While Morris responded with a countersuit in an attempt to block the FDA ruling, the late 1990s were marked by increased litigation and falling share prices as investors grew leery of the tobacco industry.
1985: The General Foods Acquisition
Meanwhile, to ensure its own safety, Morris had begun to diversify its holdings away from tobacco. In 1985, even as it passed Reynolds to become the largest domestic cigarette manufacturer, the company paid $5.75 billion for General Foods Corporation, the diversified food products giant. General Foods was large enough to offer Morris a significant source of revenue apart from the tobacco industry, and its reliance on advertising and an intricate distribution system was similar to Morris's core business; but General Foods was a rather lackluster company in a mature industry, and the acquisition did not kindle great enthusiasm among business analysts. They compared it unfavorably to Reynolds's purchase of Nabisco Brands at about the same time, and predicted that the move would not be sufficient to free Morris of its tobacco habit. In 1987, for example, two years after the General Foods purchase, Morris's total revenue had reached $27.7 billion and its operating income $4.1 billion. The lion's share of that income--$2.7 billion--was earned by the domestic tobacco division, where the slackening of competition allowed a luxurious rate of return on its $7.6 billion in sales. By contrast, General Foods's $10 billion contribution to revenue netted only $700 million in operating income, meaning that it was fully five times as profitable to sell a pack of Marlboros than it was to sell a box of Jell-O or a jar of coffee from General Foods. Indeed, 60 percent of Morris's total profit for 1987 was generated by Marlboro's popularity both at home and abroad.
In 1988, the company took a more decisive step toward reshaping its corporate profile. For $12.9 billion it acquired Kraft, Inc., an even larger and more dynamic food products corporation. Morris chairman Hamish Maxwell merged his company's two food divisions into Kraft Foods, Inc. Under its chief executive officer, Michael Miles, Kraft underwent a successful program of labor cuts and efficiency measures designed to raise its earnings level to something approaching that of the tobacco division. With $27 billion in sales by 1995, and more than 2,800 different product offerings, Kraft ranked as the world's second-largest food company. Within this conglomeration was Post which, as the third-ranking U.S. producer of breakfast cereal, instigated a cereal price war in mid-1996. In a bold attempt to gain market share and stay the rising consumer boycott of pricey breakfast cereals, prices on Post brands were slashed across the board in April, pushing number one producer Kellogg to reluctantly follow suit.
A low inflation rate coupled with an increasing consumer demand for low prices characterized the first half of the 1990s. Such a combination prompted downsizing, loss of jobs, and a search for new markets on the part of many in the food industry. Paralleling its success in expanding its tobacco market, Morris extended its food merchandising infrastructure worldwide. Under its Kraft Foods International division, new markets were established in Europe, South America, and the Asia/Pacific region. Morris also expanded its holdings overseas, buying Jacobs Suchard, a Swiss maker of coffee and chocolate for $4.1 billion in 1990; four years later it purchased confectionery companies in Russia and the Ukraine, as well as making inroads into the Chinese market through several joint ventures. By 1995, international revenues--$32 billion--exceeded North American revenues--$31.4 billion--for the first time in the firm's history.
A World Leader in Packaged Consumer Goods: The 1990s
The success of Kraft and Miller, coupled with Morris's still highly profitable tobacco market, has made Morris the world's largest producer and marketer--as well as the largest U.S. exporter--of packaged consumer goods. In fact, by the early 1990s, substantially more than half of the company's revenue was generated by non-tobacco products. One of the contributors was Miller Brewing's $3.5 billion in sales. Retaining its spot as the second-largest competitor in its field, Miller managed to successfully hold its market share in the face of a changing beer market and a 100 percent increase in the beer tax levied by the U.S. government in 1991. The rise in the number of small-scale "craft" breweries and changing demographics caused a slump in the beer market nationwide; along with number-one ranked Anheuser-Busch and number three-ranked Coors, Miller responded by entering the microbrewery market with its Red Dog and Icehouse brands, as well as by purchasing shares in small breweries in Maine and Texas. Despite heavily marketing its "lite" beers to the Baby Boomer market, Miller's 3rd quarter 1996 income fell 1.7 percent and the company responded by cutting operating costs.
By the close of 1995 Morris's portfolio of brands included 68 that reported sales of over $100 million. Of those 68, six non-tobacco products--Kraft, Miller, Jacobs, Oscar Mayer, Maxwell House, and Post--passed the $1 billion mark. New marketing efforts included revised Marlboro and Virginia Slims merchandise catalogs and a sweepstakes for trips on the "Marlboro Unlimited," a luxury train scheduled to tour Marlboro country in 1998. Although the company's leadership continued to reject plans to divest Morris of its tobacco holdings, because of such successful diversification efforts, Morris planned to continue using the extraordinary cash flow generated by its domestic tobacco sales to finance further moves into the food industry, where the relatively low rate of return could be eventually compensated by means of sheer size.
A Shift in Corporate Image: Late 1990s and Beyond
Indeed, the company's foothold in the food industry continued to become even stronger during the latter half of the 1990s. Under the leadership of Bible--elected chairman and CEO 1995--Morris continued its growth while working diligently to clean up its corporate image. In late 1996, the company agreed to some of the restrictions in marketing and advertising set forth by the FDA, as long as the FDA agreed not to regulate the industry. At the time, the company was involved in nearly 180 smoking-related lawsuits.
The following year, the U.S. tobacco industry reached the Tobacco Settlement Agreement with 46 states in which $206 billion would be paid out over the next 25 years to cover Medicaid-related costs and tobacco-related claims and lawsuits. The settlement also included restrictions on marketing and advertising of tobacco products. In 1999, the company established its Web site on which it stated--for the first time--that smoking could cause lung cancer and various other diseases. The company continued to downplay its tobacco businesses in the media, instead focusing on its Kraft and Miller units. The United Press International commented on the strategy in 1999, stating that the moves were "seen as part of the entire tobacco industry's attempts to lessen their legal liabilities. There is an opinion that by admitting to smoking's risks in a public way, future plaintiffs cannot claim they were unaware of the potential dangers of tobacco use." Morris then announced in 2000 that it was pulling more than $100 million in cigarette advertising in more than 50 national publications that had an 18-and-under readership base of over 15 percent. In 1999, Morris accounted for nearly half of all cigarette advertising in magazines.
During the Clinton administration's last year, the Department of Justice filed a healthcare cost recovery suit against the tobacco industry, seeking restitution for expenses related to treating people with problems caused by smoking. In September 2000, however, a federal district judge dismissed a large portion of the case. In fact, when the Bush administration took office in 2001, many analysts felt that the litigation and frequent tax increases would lessen under Republican leadership. Morris also appealed the much-publicized Engle class action case in Florida that delivered a $146 billion verdict and was optimistic that the case would be dismissed due to errors made by the judge during the trial.
While Morris spent much of its effort cleaning up its tainted tobacco image, the company was making giant strides in the food industry. From 1992 to 1997, Kraft's profit margin had increased to 16 percent--one of the highest in the food industry. The unit also controlled 35 percent of the frozen food market, after the successful 1995 launch of DiGiorno Rising Crust pizza, and continued to be the market leader in many of its product segments.
Morris secured its number two position in the global food industry in 2000 with the purchase of Nabisco Holdings Corp. The $19.2 billion acquisition created a $34.9 billion food concern and gave Kraft an entrance into the fast-growing snack foods segment with products like Oreo cookies and Ritz crackers. Management also eyed the deal as a means of reducing costs related to purchasing, manufacturing, distribution, sales, and administration, and expected to save nearly $600 million by 2003. Kraft also acquired Boca Foods and Balance Bar energy and nutrition snack products that year.
In June 2001, Kraft began operating as a publicly traded company when Morris spun off 16 percent of the firm, retaining 84 percent ownership and 98 percent of its voting rights. The public offering generated $8.7 billion and was the second-largest IPO to date. Kraft became the largest publicly traded food company in North America whose brands could be found in over 99 percent of U.S. homes.
After the tough litigation problems of the 1990s, Morris appeared to be stronger then ever in the new millennium. The firm's share price rose over 90 percent in 2000--the best performance in the Dow Jones--signaling that investors who were once leery about the firm were now enticed by the company's strong performance. Morris continued to gain market share in many of its product categories, and while the American economy slowed, company management remained optimistic knowing that Morris had historically performed well during economic downturns. The firm's legal battles seemed to be slowing as well as fewer individual cases were tried during 2000 than in the previous year. As the company looked to be on track for future growth, Morris management remained confident that it would continue its market dominance in the years to come.
Principal Subsidiaries: Philip Morris U.S.A.; Philip Morris International Inc.; Kraft Foods, Inc.; Kraft Canada Inc.; Kraft Foods International, Inc.; Miller Brewing Company; Philip Morris Capital Corporation.
Principal Competitors: Anheuser-Busch Companies Inc.; British American Tobacco p.l.c.; Nestlé S.A.