Examination of Witnesses(Questions 360-379)|
WEDNESDAY 19 JUNE 2002
360. My final question is to Mr Wells just to
ask you the question that Mr Davis wanted answering. What are
the other companies doing which Imperial is not?
(Mr Wells) I think the sorts of areas in which we
would have particular concerns are those that, again, my ChairmanRichard
Broadbent mentioned. They concern issues as to the commitment
to minimise the presence of brands in the illicit market, sharing
information on export sales, timeliness of information and accuracy
of information on tracking and tracing procedures, commitment
to terminate supplies directly or indirectly where there are concerns
about customers, and willingness to share data with us on understanding
of export markets and why particular volumes of exports go to
particular countries. As I think I should say again, my Chairman
did make clear that we do not receive no co-operation from Imperial,
we simply feel that there could be more co-operation. If the sorts
of trends that we have been hearing about continue we have made
it clear that we are happy to review the arrangement that we have
and to look at whether a Memorandum of Understanding could be
signed with Imperial Tobacco as with other manufacturers.
361. That is a fairly long list that has been
read out and I think I should give you an opportunity to reply
to it because that statement from Mr Wells seems to me a fairly
damning statement. Do you want to reply to that?
(Mr Davis) Yes, I would very much like to, Mr Chairman.
Those particular points were raised with us as recently as 16
April when for the first time I had a face-to-face meeting with
the Director of Law Enforcement. He said we were compliant but
there were areas where he thought we could be more co-operative.
These areas were subsequently enumerated in a letter three days
later. I wrote back and said at the meeting and I said in the
letter, "Now I know, there is no point in me being disappointed
about perceived lack of co-operation, that is not productive for
anybody. The issue, as far as I am concerned, is to make sure
that co-operation takes place and the perceived weaknesses Customs
see in co-operation are addressed". That particular procedure
has started. None of those things causes us any particular grief
or any real problem. I have a review meeting with Mr Byrne in
July. I think it is fair to say John and Bruce have had two meetings
with Customs so far which have been in Customs' words "open,
productive and very useful". So I think there is certainly
an era of greater co-operation taking place with Customs at the
moment. I am sorry if they felt in the past historically that
there has been a lack of co-operation vis-a"-vis other manufacturers
but we cannot put it right unless we know about it. We had no
meetings with Customs for 10 months.
362. I think Customs should have to reply to
that. There is an air of wounded innocence that the answer is,
"I do not know why you are saying all this because we only
heard about it on 16 April and we have been trying to be more
co-operative ever since and what is all this about?" Do you
want to reply to that? Permanent Secretaries of government agencies
or departments do pick their words extremely carefully. What is
your reply to this? Apparently you have only been informing them
of all your difficulties in lack of co-operation since 16 April.
(Mr Wells) Chairman, I think perhaps I can start where
I left off before. My Chairman, Mr Broadbent, said on 29 April
we are not suggesting that we have received no co-operation from
Imperial Tobacco but rather the co-operation that has been received
is less than we received from others. I think some of the things
we have been talking about today, the issues with tracking and
tracing, the issues around the share of the smuggled market occupied
by two of Imperial's brands, the volumes of exports going to particular
countries, are the sorts of areas that indicate where we have
had concerns. If, as Mr Davis has said, we are able to move forward
on that then I think that is exactly what we want to do. Again,
as my Chairman said, we do not want to have conflict or confrontation
with any tobacco manufacturer. We very much agree that the way
forward is to co-operate, that is what we want to do. We would
be delighted if the level of co-operation that we receive improves
in the way that I have outlined and if it does we are very happy
to review the situation and to move forward in a positive way.
Chairman: Thank you. Mr Geraint Davies.
363. Just following on from that, Mr Davis.
You said earlier in this hearing that you did not know what other
companies were doing, "tell us and we will do it" is
what you said. You just said you only knew on 16 April what they
were doing. Can I just ask again, Mr Wells, it seemed to me from
reading the documentation that we were listing what Gallaher does
that we think is satisfactory to provide a memorandum and you
are saying, as far as you know, that Imperial did not have that
list before 16 April so they did not act on it. Is that right?
I am a bit confused by this. I find it very difficult to believe
that we are in a hearing and have information from your Department
which criticises Imperial for not doing what Gallaher does and
Imperial is saying they did not know what they had to do. Is that
right as far as you are aware?
(Mr Wells) I think what Mr Davis was saying was his
first meeting directly with Customs was on 16 April. We have had
meetings for several years, indeed going all the way back. I think
there have been ten bilateral meetings between Customs and Imperial
back to 2000. Since the start of 2001 we have issued 15 red cards,
one of which we withdrew and that leaves 14, we have issued 14
red cards and four yellow cards to Imperial. We have had exchanges
of correspondence and we have also met bilaterally. Whereas it
is certainly true to say that the first direct meeting between
my Director of Law Enforcement and Mr Davis was on 16 April, there
have been a great number of meetings and exchanges of correspondence.
364. I have got the idea. That is what I thought.
Mr Davis, it seemed to me the statement you made was completely
incredible. I think you said "I did not know until 16 April,
now we will do whatever is necessary" but the reality is
executives in your corporation have regular dialogue and in the
view of Customs you have been relatively unco-operative. Not you
personally but corporately. Do you accept that?
(Mr Davis) No, I think I would have to challenge the
365. You have given an undertaking today that
you will do everything that Gallaher does to co-operate with Her
Majesty's Government in order to try and secure more taxation,
is that correct?
(Mr Davis) Mr Davies, when we saw the Memorandum of
Understanding that was published between Customs and Gallaher,
the forward looking Memorandum of Understanding, we failed to
understand what the problem of co-operation was because all the
things that were enumerated
366. So the answer is yes, you do give that
(Mr Davis) Absolutely.
367. That is very helpful. So in terms of the
future perhaps it will be positive. In terms of the comments you
made about the triple-whammy, the three reasons why it is not
in your profit interest to manufacture all these cigarettes, the
answer is that 65% of Superkings and Regal cigarettes manufactured
by Imperial are in fact smuggled back. What I am interested in
is, firstly, whether the profit margin on these cigarettes you
are selling to Russia, Latvia, etc., is in fact more than the
profit margin of these brands when sold legitimately in the UK?
Is it more or less?
(Mr Davis) Generally it was less in the sense that
these were market entry strategies, as I said. We were trying
to develop our business internationally and very often when you
go into a market you have an investment phase where you make very
little money in the first few years.
368. Okay. You are adding in here the advertising
and market development costs?
(Mr Davis) And the pricing also.
369. What I am asking is if it is the case that
the tax in the UK is 90% on low value brands then obviously you
only make 10%. If you sold a pack of cigarettes for 20% of the
price in the UK shop you would get double the revenue and many,
many times the profit margins. Obviously there is a lot of money
to be made from selling into low tax areas and if they come back
it does not matter because what they are cannibalising is a product
that makes less margin. Are there examples of that anywhere?
(Mr Davis) No, I think it is completely the other
(Mr Dibble) Yes, totally the other way round. If I
may refer you to Appendix II, the profit margins are clearly set
out and that only compares to
370. You are talking about developed Western
markets in Appendix II. I was going to ask why you rip off British
consumers by making 89 pence for every packet of cigarettes which
generically are the same sticks on which you make 45 pence in
Spain. Given the price you start with in Spain is lower because
of tax, why do you not make it the same sort of margins that you
are charging British people?
(Mr Davis) That 89 pence is not just for us, that
is wholesale and retail margins as well.
371. I do not think that is completely acceptable,
but anyway. Mr Dibble, you were going to explain to me how it
is the case that if we are manufacturing cigarettes here and you
only get 10% on the retail price, it is 90% tax, how it does not
follow that if you charge the equivalent, say, 20% of that UK
price in a developing market at virtually no tax you would not
make much, much more money. Why is that the case?
(Mr Dibble) I think it is not the case because we
are talking percentages here and that seems to be confusing the
372. What I am saying, looking at Appendix II,
is if you are selling at 89 pence that is what you get back on
a packet of cigarettes sold in Britain
(Mr Dibble) What we and the retailers share.
373. The question is if you sold at, I do not
know, a pound a packet somewhere else which has zero tax obviously
you would make more money, would you not?
(Mr Dibble) No, we would not because it is not zero
tax elsewhere. If you take Latvia, there are taxes in every country
in the world. Even in the most lowest taxed country there are
taxes on tobacco.
374. What is the lowest taxed country?
(Mr Dibble) I do not know offhand.
375. What is the tax in Moldova? What was the
tax in Afghanistan before the troubles?
(Mr Dibble) The retail price is approximately 50 pence
and the tax one presumes is approximately 30 pence.
376. So you get 20 pence a packet?
(Mr Dibble) And the distributors and retailers. For
the sake of argument we make, say, 10 pence, which is one-ninth
of the tax exclusive price in the UK. If you say the retailer
is added to that, again we make four or five times more. There
is four to five times more profit between us and retailers in
the UK than there is in countries like Moldova.
377. So in all these countries, Latvia, Russia,
Kaliningrad, Afghanistan, Moldova and Andorra, when you sell these
cigarettes you are saying you get less after tax revenue than
in Western countries?
(Mr Dibble) Much less.
378. In terms of the brand managers of Superkings
and Regal in terms of hitting their sales targets, half their
production, more than half, about 65% of production, is in foreign
markets and half of that is smuggled back, is it not? In fact,
something like a third of the total production of these brands
is knowingly smuggled. You know it is smuggled rather, we know
you are making money out of that.
(Mr Dibble) We accept large quantities are smuggled
back to the UK, they are very low profit brands and even lower
profit brands for us once you take off the set-up costs of starting
to trade in those countries. So for many years we make nothing
going into new countries, therefore when they are smuggled back
that is why we are more than willing to stop supplying, it is
in our economic interests.
379. Mr Davis, one of the three reasons, and
it seemed to me odd, is that you are doing enormous volumes in
selling them and then saying you are not making money, that seems
to be strange. Why are you doing that? It is economies of scale
on production, is it not? It seems to me counter-intuitive.
(Mr Davidson) The reason we are doing it is the future
growth of the company has to come from international markets.
We have a substantial share in the UK, the overall UK consumption
is coming down, so