Reports that Matter

United States v. Philip Morris USA Inc.: Amended Final Opinion

The Defendants Need Youth as Replacement Smokers

Section 72 of 129

The Defendants Need Youth as Replacement Smokers

  1. Every year, over 400,000 people die of smoking related diseases. In addition, there are a relatively small number of people who quit smoking each year. In order to sustain and perpetuate themselves, Defendants must bring in new smokers to replace those leaving the market. Each cigarette manufacturing company gains a small amount (less than 10%) of smokers through "switching" or changing brands. Only about 9% of adult smokers switch among Defendants' brands. Krugman WD, 154:31-158:5; see also 2045165002-5014 (US 38402). Defendants' own employees admit that brand switching rates are low and falling. According to David Beran, Executive Vice President of Strategy, Communications and Consumer Contact for Philip Morris, the brand switching rate for 1997 was 4.0%, Beran TT, 4/18/05, 19395:15-17 (Confidential) (closed court); (no bates) (JD 053375) (Confidential); was 6.3% for 2002, Beran TT, 4/18/05, 19322:16-25; (no bates) (JDEM 040331); and was 5.4% for 2003. (no bates) (JD053375) (Confidential); Beran TT, 4/18/05, 19394:25-19395:3. Switching, by definition, does not bring in new smokers to the industry as a whole.

  2. The only way Defendants can sustain themselves is by bringing in large numbers of replacement smokers each year. Carl Schoenbachler, current president and CEO of BATIC (a former parent of B&W Tobacco and holding entity for B&W Tobacco) acknowledged that although the company has a stated policy of not marketing to non-smokers, "it was a reasonable conclusion" that B&W would become unprofitable if non-smokers did not become smokers. Schoenbachler PD, United States v. Philip Morris, 5/21/02, 72:16-21, 73:13-22, 141:11-141:21, 152:20-25.

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  1. The majority of people who become addicted smokers start smoking before the age of eighteen, and many more before the age of twenty-one. Ellen Merlo, Senior Vice President at Philip Morris, admitted that she was aware that over 80% of smokers start smoking before they turn eighteen. Merlo PD, United States v. Philip Morris, 6/11/02, 42:22-45:15, 48:2-48:6. A 1989 RJR document titled "Camel Y&R Orientation" discussed the "strategic importance" of young adult smokers ("YAS"): "YAS are the only source of replacement smokers. Less than one-third of smokers start after age 18." The document further stated: "To stabilize RJR's share of total smokers, it must raise share among 18-20 from 13.8% to 40% . . . ASAP." 507241613-1838 at 1617, 1620 (US 20774). In a September 20, 1982 memorandum, Diane S. Burrows, RJR Marketing Development Department researcher, stated, "if a man has never smoked by age 18, the odds are three-to-one he never will. By age 21, the odds are twenty-to-one." 500582269-2272 at 2270 (US 20641).

  2. Moreover, smokers are remarkably brand-loyal. LeVan PD, United States v. Philip Morris, 6/25/02, 225:3-228:12, 229:4-230:11 ("premium tobacco brands and smokers are very highly loyal and . . . they don't switch brands very often."). Defendants realize that they need to get people smoking their brands as young as possible in order to secure them as lifelong loyal smokers. As Bennett LeBow, President of Vector Holdings Group, stated, "if the tobacco companies really stopped marketing to children, the tobacco companies would be out of business in 25 to 30 years because they will not have enough customers to stay in business." LeBow WD, 63:16-64:1.

  3. In internal documents, Defendants admit that stimulating youth smoking initiation and retaining and increasing their share of the youth market is crucial to the success of their businesses. For example, in a 1999 slide presentation, titled "ASU30 [Adult Smoker Under 30]

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Project," manager Rick Stevens analyzed BATCo's "ASU30 Performance 1998," stating that younger adult smokers were a "critical factor in the growth and decline of every major brand and company over the last 50 years." Furthermore, a slide, titled "Value of YAS," recognized that "[m]arket renewal is almost entirely from 18 year old smokers" and "[n]o more than 5% start smoking after age

24." 321539777-9806 at 9782, 9787-9788 (US 24084); see also 2041518797-8956 at 8819-8820

(US 23907).

  1. Defendants know that marketing their cigarettes to youth is essential to each company's success and longevity, and for that reason create marketing campaigns designed to increase youth consumption. VXA1240104-0567 at 0272 (US 64316) (2000 Surgeon General

Report noting that "considerable evidence" demonstrates that "advertising and promotion recruit new smokers"). As United States marketing expert Dr. Robert Dolan explained:

The trend in tobacco companies' spending on marketing has continued to increase dramatically. Tobacco industry spending of $2 billion on advertising and promotion in 1980 reached $4 billion in 1988 and then $6 billion in 1994. After four years around the $6 billion mark, spending shot up [to] $11.2 billion by 2001. In 2002, the last year for which data is available, the tobacco companies spent $12.47 billion, an increase of 11.61% over 2001. The fundamental dynamic of the industry has not changed though. The tobacco companies knew that brand loyalty is a key phenomenon and if someone doesn't start smoking as a teenager, he or she is unlikely to start. . . . Defendants still represent that the only objective of marketing is impacting brand choice while they implement marketing programs which increase the value potential customers see in smoking -- attracting people including teenagers to the market and deterring others from quitting.

Dolan WD, 147:10-148:18; 2070802707-2770 at 2728 (US 89172).

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  1. In a February 29, 1984 memorandum, titled "Younger Adult Smokers: Strategies and

Opportunities," to Martin Orlowsky, CEO of Lorillard, Diane Burrows, market researcher at R.J. Reynolds, stated:

Younger adult smokers have been the critical factor in the growth and decline of every major brand and company over the last 50 years. They will continue to be just as important to brands/companies in the future for two simple reasons:

[1] The renewal of the market stems almost entirely from 18-year old smokers. No more than 5% of smokers start after age 24. [2] The brand loyalty of 18-year-old smokers far outweighs any tendency to switch with age. . . . Marlboro and Newport, the only true younger adult growth brands in the market, have no need for switching gains. All of their volume growth can be traced to younger adult smokers and the movement of the 18-year-olds which they have previously attracted into older age brackets, where they pay a consumption dividend of up to 30%. A strategy which appealed to older smokers would not pay this dividend. . . . Younger adult smokers are the only source of replacement smokers. Repeated government studies . . . have shown that: Less than one-third of smokers (31%) start after age 18. . . . Thus, today's younger adult smoking behavior will largely determine the trend of Industry volume over the next several decades. If younger adults turn away from smoking, the Industry must decline, just as a population which does not give birth will eventually dwindle.

503049069-9072 at 9069 (US 20711); 501431517-1610 at 1519 (US 20680); 506653291-3348 at

3291, 3296 (US 85235).

  1. In an April 13, 1984 RJR letter, R.C. Nordine stated that "[i]t is relatively easy for a brand to retain eighteen-year-old smokers once it has attracted them. . . . Conversely, it is very difficult to attract a smoker that has already been won over by a different brand." 502033156-3157
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  1. A March 1988 report, titled "Younger Adult Smoker Opportunity," discussed "RJR's most critical strategic need -- Younger Adult Smokers." The report stated: "Improved younger adult development is a key Corporate priority . . . -- Necessary for core brand revitalization (#1 Corporate priority) -- Lack of younger adults responsible for total Company volume trend." It indicated that RJR's "[m]arketing department [was] refocusing efforts against younger adult smokers." The report indicated the importance of unrestricted advertising for reaching these younger smokers and stated that a possible advertising ban "would severely limit RJR's ability to introduce [a] new brand or attract younger adult smokers." The report also stated that "[y]ounger adult smokers drive the growth of two major competitors" -- Marlboro and Newport -- which were "capturing an ever increasing share of younger adult smokers." Finally, the report explained that young smokers were crucial to the continuing survival of RJR because teenagers remain loyal to their brand of choice as they age and because teenagers smoke an increasing volume of cigarettes as they become adults: "[Y]ounger adult smokers are the key to future growth for any company or brand for several reasons: (1) Aging explains 75% of SOM [Share of Market] growth. (2) Benefits of younger adult smokers compound over time as a result of brand loyalty and the increase in rate per day as smokers age." In summary, the report stated, "RJR must begin now to capture younger adult smokers: -- Volume decline inevitable without YAS -- Potential for future advertising restrictions -- Marketing department restructured to address the issue." 506664499-4558 at 4499-4500, 4506-4507, 4557 (US 20763) (emphasis in original).

  2. Marketing reports prepared for RJR, under the heading "Decision to Smoke," included the following statement: "66% of all new smokers by age 18." The document also reported on the brand loyalty of smokers, indicating that "90% [of] smokers use only one brand," and that the

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"Implications for 90's" are that eighteen to twenty-four year olds will be "[c]ritical to long term brand vitality as consumption increases with age." Another report prepared for RJR, from approximately 1989, titled "Younger Adult Smokers," discussed the strategic importance of younger adult smokers, stating that "YAS are the only source of replacement smokers-[l]ess than one-third of smokers start after age 18." The report analyzed the differences between "FUBYAS" [First Brand Young Adult Smokers] (ages 18 to 20) and "Switchers" (ages 21 to 24), stating that "FUBYAS are in transition -- belonging to the FAMILY (secure) replaced by belonging to selected PEER GROUP (not as secure)." MBDOJ06953-6966 at 6955-6956, 6969, 6993, 6996 (US 59747) (emphasis in original).

  1. In a letter dated October 12, 1989, titled "Dollar Value of YAS Over Time," Burrows provided "estimates . . . of the value of capturing Younger Adult Smokers and holding them over time." The letter calculated the profits that RJR would gain "[i]f an 18 year old adopts an RJR full price brand" for 3 years ($1,359), for 7 years ($3,710), for 10 years ($6,148), or for over 20 years ($18,794). Burrows concluded:

Our aggressive Plan calls for gains of about 5.5 share points of smokers 18-20 per year, 1990-93 (about 120,000 smokers per year). Achieving this goal would produce an incremental cash contribution of only about $442MM during the Plan period (excluding promotion response in other age groups and other side benefits). However, if we hold these YAS for the market average of 7 years, they would be worth over $2.1 billion in aggregate incremental profit. I certainly agree with you that this payout should be worth a decent sized investment.

507181261-1261 (US 20007) (emphasis in original).

  1. An RJR document, titled "1990 Workplan Objectives," stated that "[t]he number one priority for 1990 is to obtain younger adult smoker trial and grow younger adult smoker share of market." In addition, the document asked "Why target the YAS market?" and answered:
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Each Year: -- 800,000 new smokers (18+) enter the market -- 1,500,000 smokers leave the market With about 50 million smokers, this means that each year there are: -- 1.6 share points of new smokers -- 3.0 share points of quitters At least 95% of all new smokers are 18-24. About 70% are exactly 18 (i.e., aged in the 18+ market). Each brand and company has a share of new smokers and quitters, which is reflected in their shares of YAS and older smokers. These shares drive long-term market performance.

513869196-9303 at 9197, 9198 (US 30058) (emphasis in original).

  1. Carl Schoenbachler, current president and CEO of BATIC (a former parent of B&W Tobacco and holding entity for B&W Tobacco), when asked if the statement, "The key to sustainable long-term profit growth in the U.S. is ASU 30," was accurate, responded: "Yes, I would say that's true." He explained that

there tends to be a great deal of loyalty in cigarette brands. So, just a natural mathematical equation would suggest if you -- if you don't have thirty-year-olds smoking your product, you won't have forty- year-olds and fifty-year-olds. It's a very brand loyal business.

Schoenbachler PD, United States v. Philip Morris, 5/21/02, 72:16-21, 73:13-22, 141:11-141:21,

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