Strategy: Distribution Control

PM USA announces its 2006 Wholesale Leader Program

NEW YORK -- On September 30, Philip Morris USA announced its 2006 Wholesale Leaders Program, according to Citigroup tobacco analyst Bonnie Herzog.

In her most recent industry note, she said the new program will become effective Jan. 1, 2006, and it involves incentives based on term rates and cents-per-carton payments, which could result in cost savings for the manufacturer.

Before, it was just based on cents-per-carton payments, she said.

"This new program could effectively reduce costs for PM USA since [image-nocss] it makes it very hard for some wholesalers to meet certain criteria to obtain payments," said Herzog. "We believe these changes are consistent with Philip Morris's long-term strategy to reduce the number of direct buyers in its Wholesale Leaders Program, which will lead to lower costs and more control over the distribution of its brands. Basically, the changes should have the most effect on the smaller wholesalers, but should not effect pricing to the consumer."

She added, "If a wholesaler does not meet its performance objectives, it receives less money, thereby creating an incentive for the wholesaler and possible cost savings for Philip Morris; therefore, we don't necessarily consider this a price increase per se, but do believe it is an opportunity for Philip Morris to reduce costs."

The highlights of the PM USA's 2006 Wholesale Leaders Program include:

Performance levels for wholesalers are now defined as, Meeting or Exceeding Program Performance Target (Level 2) and Below Program Performance Target (Level 1). Wholesalers in Level 2 will receive $0.26 cents per carton and a 2.1% up front discount (unchanged for Level 2). Wholesalers in Level 1 will receive 1 cent per carton and a 1.7% up front discount (changed from 2005's program, where the lower-level wholesaler also received a 2.1% discount and potentially higher rate of cents back per carton). New program has 2 Levels versus prior program, which hadthree levels.

Herzog concluded, "We find it interesting that Philip Morris announced the changes to its Wholesale Leaders Program so early before it becomes effective; however, this may be because Philip Morris is basing its terms rates on wholesalers' share performance during the period October 2 through November 12. Could this be a push for more volume during [the fourth quarter]?"

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