Managing Director Philip Morris Ukraine, Caucasus and Moldova: One day we will stop selling cigarettes
Exclusive interview with Managing Director Philip Morris Ukraine, Caucasus and Moldova Michalis Alexandrakis, for ‘Interfax-Ukraine’ News Agency
Mr. Alexandrakis, almost every company in the industry indicated it is working on innovative tobacco products with some potential to reduce risk. What does it mean for the future of the industry?
- Let me start by referencing the World Health Organization who estimates that by 2025 around one billion people will continue to smoke worldwide. We feel that we have an obligation to offer alternative products with potential to reduce risk comparing to conventional cigarettes. The fact is that people today are more educated, have better and faster access to information and are looking for alternatives. We are not alone! Industries from laundry detergents to fizzy drinks see these trends. Industries react accordingly and offer products which even got a class name of “reduced harm” or “reduced risk”. Just think about phosphate-free laundry detergents or sugar-free soft drinks. The demand is there, our ambition is to meet the challenge and lead the whole industry into the smoke-free future.
You were the first to offer a radically different product for smokers in Ukraine. But how can one smoke a “smoke-free” product?
- The technology that our IQOS product utilizes is called “heat-not-burn”. In a nutshell, a heating device is so smart that it makes tobacco heatstick hot enough to emit aerosol with nicotine from tobacco without actually putting tobacco “on fire”. Hence, there is no smoke and less toxicants comparing to smoking a combustible product.
How much effort did your Company put to develop this technology?
- We started this journey with IQOS many years back; with our first pilot about 12 years ago in Neuchatel (Switzerland). We introduced different devices but used the same technology – heat-not-burn technology. What we know is that most of the toxins in the smoke result from tobacco combustion that occurs at the temperature above 800⁰C degrees. So 12 years ago we started working on creating this heat-not-burn technology where tobacco is heated to 350⁰C degrees, hence avoiding combustion. Over 3 billion dollars were invested into the research and product development. In 2014 IOQS was launched in the first markets. Today more than 400 scientists continue working in Neuchatel. Developing the future generation of Reduced Risk Products.
What drove these tremendous efforts?
- Our vision is to create a smoke-free future by offering better alternatives to the legal age smokers around the world. This is the movement and in PMI we are proud to be part of the journey.
But why did you not just go along with the liquid-filled e-cigarettes which were present in many markets? Some of your competitors seem to favor them…
- Heat-not-burn is a hi-tech development. IQOS is the closest RRP product to the “ritual” of a cigarette. And this is very important because if we don’t give smokers something close to what they used to, it will be very difficult to switch, to adapt to something new. No matter how good product we have if we don’t have acceptance from the consumers. The impact on harm reduction will be close to nothing.
Actually, our innovation pipeline includes four product platforms that can meet the varying preferences of adult smokers. Among them there are not only tobacco heating systems, but also electronic cigarettes.
How does the World Health Organization reacts to such products of tobacco companies?
- In 2016 in India the WHO presented a report where electronic cigarettes and tobacco heating systems had been mentioned. This report recognizes the need of alternatives in front of conventional cigarettes to reduce the health risks. They appreciate the fact that there are some devices, that can be less harmful than cigarettes, but they are concerned with solutions come from the industry.
What is your response to such concerns?
- For us the most important response is our ultimate transparency. Anybody can see all the research results on our website, we work with a lot of scientific communities around the world, we take part in all conventions.
The Company invited scientists to come and do their own researches based on our innovative products, and tell us if we’re right or wrong! We involve scientists from different spheres – physicists, chemists, biologists, pharmacists, doctors with full transparency. We don’t ask to trust us rather validate what we discover. They also need to give the chance to legal age smokers to choose a potentially less harmful product comparing to cigarettes.
Has your company become the first in Ukraine to start selling IQOS heating systems? How prepared is a Ukrainian consumer for such kind of product?
- We started in February 2016. Ukraine became one of the first markets in the world, along with Japan, Switzerland and Italy, where IQOS™ became available to adult smokers.
The sales results of this product in Ukraine demonstrate a steady increase in the interest of smokers to products offering satisfactory taste, ritual and pleasure with less harmful compounds comparing to conventional cigarettes. Since the opening of the first IQOS Space in Kyiv in May 2016, we have significantly expanded our commercialization scope and the geography of the new device sales in Ukraine. Other 5 new IQOS Space boutiques were opened in Dnipro, Lviv, Odessa, and 2 boutiques – in Kharkiv.
The cost of IQOS is quite high compared to conventional cigarettes, and the average salary of a Ukrainian is not as high as in the EU. Why did you choose the Ukrainian market for launch?
- There are some journalists who have asked for several times if the IQOS is a product for the rich people. The fact that we launched it in UA proves that this is not the case. Ukraine, as you know, is one of the less affluent countries in Europe. We launched IQOS also in Palestine, which is not a rich country as well. We try really to see the feedback of consumers with different background. Legal age smokers choose IQOS with different reasons. For lots of legal age smokers the most important element is that it’s potentially less harmful comparing to conventional cigarettes and others chose to use it because it’s a nice and trendy device.
It reminds me of the smartphones proliferation Ukraine…
- Absolutely! People spend their two-months salary to buy a top-line gadget. Why? It changes your life for the better.
Apart from IQOS, PMI has other products with reduced risks. Are these also sold in Ukraine?
- We have four different product “platforms” as we call them that can meet the varying preferences of adult smokers and hence help them to switch.
Two of them use heat-not-burn technology. We also have two nicotine-containing products that are closer to e-liquids. In Ukraine we start with our flagship IQOS as we believe that this is the right product to introduce this new category and educate the consumers.
What portion does Ukraine take in the total sales of PMI? What result will the company achieve in 2017 financial year and how satisfied are you with it?
- Though our parent company does its reporting based on the regional level, I can say that Ukraine is important for PMI.
In 2017 PMI closed the year with roughly 30% share of market of the Ukrainian market.
The market for conventional cigarettes continues a decline trend mainly due to demographics and the big increases on the retail prices due to the tax increase. Illicit products are also getting more attractive due to sharp increase on taxes.
What sources are used to finance the company operations in Ukraine? Is this company sources or do you raise loans?
- Unfortunately, tobacco business in Ukraine is very demanding of working capital. Unlike in all developed countries, the Ukrainian legislation provides the prepayment of excise tax upon excise stamp purchase. Usually, excise is tax on consumption. But in Ukraine we are obliged to pay it when cigarettes even are not yet produced!
The good news is that situation is being slightly improved over 2016-2017 years. We started with 5 days and from January 1 have 15 days to pay the excise after the stamps purchase.
This year the government has agreed on an eight-year plan to raise excises to the European level. How do you assess the prospect of such an increase in Ukraine?
- It has been a very pleasant surprise to know your tax rate for the next year at least two weeks in advance. I am not joking! In the past MPs kept it until almost the New Year’s eve to make a decision on tax rates!
What is important is a fixed eight-year rates evolution plan adopted by MPs. Ukraine has to to reach a 90 euro excise rate from current rate of roughly 20 euro. Price-wise it means a jump from 26 UAH per pack to 100! This is quite a big jump and it needs to be implemented with certain smoothness!
One of the big “stories” this year had been the cigarette distribution disruption back in early 2017 as a result of the blocking of Tedis accounts. How is the situation today?
- Tedis Ukraine is the largest distributor of cigarettes in Ukraine. In particular, it is the distributor for all four major tobacco manufacturers, including us. I want to stress that we are satisfied with our collaboration with TEDIS.
According to our estimation, PMU lost roughly 10% of the volume during the disruption. This figure is quite moderate only because of availability of cigarette stocks at sub-distributor and retail levels. This stock allowed to satisfy most of the market demand.
At what stage is the tax-related dispute with the State Fiscal Service of Ukraine? You are accused of the failure to pay proper taxes. What are the differences in interpretation of the law by you and the State Fiscal Service of Ukraine?
- We are challenging in court the additional tax charges of the State Fiscal Service. The dispute we have is around the Inward Processing Regime that we used two years ago after obtaining all relevant permits and approvals from the authorities. We are at the appeal stage now. The Court has requested Bokarius Forensic expertise institute to analyze the documents related to the Internal Processing Regime that we applied.
The SFS Head Mr Myroslav Prodan met with us and the Swiss Embassy who is aware of the proceedings. A task force has been established to look into the matter.
Do you continue to export your products? Has the decision of the courts affected the workload of your factory in Kharkov?
- The situation described above poses a significant threat to predictability of the business environment and investment climate in Ukraine as well as puts a risk on other businesses operating in a similar model.
The first reaction to the court's decision was to stop exports. We export around 40% of our production. Big chunk of our exports are cigarettes that are exported to Japan. We also supply our products to Moldova, Georgia and Armenia. Last year we began to supply the market of the Saudi Arabia. Export sales create working places and bring revenues in foreign currencies to Ukraine
Ukraine has a huge potential and I hope the government will continue with the reforms needed to unleash this potential and improve the life of Ukrainian people and the business environment in order to be able to attract more investments.