Examination of Witnesses (Questions 300-319)
MR BEN STEVENS, MR NIGEL NORTHRIDGE, MR GARETH DAVIS AND MR DAVID DAVIES
12 JANUARY 2005
Q300 Norman Lamb: With traceability.
Mr Davies: With traceability and
with enforcement, because once you have established that distribution
chain and one attaches to that requirements through licensing,
for example, then you have to protect the legitimate supply chain.
That requires enforcement, obviously. However, there are measures
that can aid enforcement. One could, for example, make it unlawful
for a licensed retailer of tobacco products to sell more than
a certain quantity of cigarettes on any given day to an unlicensed
purchaser. That system actually does exist in Spain, for example.
If one is selling more than, shall we say, 1,000 cigarettes on
a daily basis to a purchaser, there is ample reason to suspect
that is not for personal consumption. If one were to make the
possession of a licence dependent on commitments and responsibilities
to sell responsibly and not to sell irresponsibly, I think that
would do much to address the problem of the losses to revenue
that this government and other governments suffer as a result
of the confusion around cross-border sales. Yes, one has to harmonise
government policy in relation to protection of the internal market.
However, today in Latvia the tax is 16 euros per 1,000 cigarettes
and here in the United Kingdom it is 268. If one were to have
a pure internal market for cigarettes, no one would buy cigarettes
in the United Kingdom; they would buy them all in Latvia. That
does not promote policy within the UK for revenue protection,
the prevention of fraud, or the promotion of public health policy,
in terms of using taxation as a measure to reduce consumption
of cigarettes. So I think that you have to look at the issue holistically;
not seize on one issue. You have to look at how one can accomplish
a secure distribution network, with obligations attached to every
player within the supply chain, which will ensure that there is
no infiltration of that network; that there is no diversion from
it and no circumvention of it.
Q301 Mr McFall: In your submission, Mr
Davies, you said that we need "the creation of a secure distribution
network". That is why Philip Morris support "the licensing
of tobacco product, manufacturers, importers, exporters, warehouse
proprietors, transporters, distributors and retailers. Any person
trading . . . without a licence would be subject to severe penalties.
Any licensed person trading in genuine non-domestic or counterfeit
cigarettes upon which UK taxes have not been paid should be subject
to the same penalties, as well as forfeiture of their licence".
On a superficial basis, that looks very much like a watertight
situation. First of all I would ask why we have not moved to that
and, second, would everyone at the table agree that we should
have such a licensing system? Mr Davies, could you answer first?
Mr Davies: It is a solution but
it also requires enforcement, obviously. That is why we advocate,
as part of the structure of a secure distribution network, the
issuance of licences, with severe penalties attached for violating
conditions. Conditions can include an obligation to maintain appropriate
records; an obligation to permit government to audit movement
of goods and to audit shipments to customers; an obligation on
retailers not to sell product that is not lawfully tax-paid product;
an obligation on retailers not to sell to young people. There
is a whole range of measures, but it clearly requires enforcement.
Smuggling depends on a willing marketplace and a distribution
network. To the extent you have an unregulated distribution network,
you are encouraging and facilitating smuggling.
Q302 Mr McFall: But if I could take Mr
Northridge's point, from what you said earlier on it was the breakdown
of the distribution network that caused the problem. So if we
had a licensing system which included proprietors, transporters,
distributors and retailers, that would be an almost foolproof
system, and the problem that arose with Gallaher would not arise
in the future.
Mr Northridge: I would not disagree
at all, Mr McFall. I just do not believe that, while that is a
fantastic vision, in a practical or administrative sense you would
be able to get to it. As Mr Davies said, it requires huge amounts
of buy-in from everybody, right across the whole of Europe. We
cannot get tax harmonisation at the moment. To ask for this kind
of vision would be even more difficult that getting tax harmonisation.
Q303 Mr McFall: So it is a pipe dream
then?
Mr Northridge: No. It is a new
concept to us. I have only heard of it in the last few weeks.
I just believe that it would be very difficult. I believe that
the BAT-driven initiative of the export bond guarantee is a step
in the same direction, without the same degree of difficulty.
It will not be easy because, again, it will require a lot of government
and Treasury buy-in but, ultimately, I think that it is a more
practical solution.
Mr Stevens: There are a number
of different issues that we are talking about here. I think that
licensing the supply chain can help in some circumstances. For
example, if you are trying to stop traders selling products to
children, then licensing them and withdrawing the licence can
be very helpful. The situation in the UK is slightly different.
The majority of the smuggled product being sold in the UK, as
far as I am aware, is sold in pub car parks and car boot sales.
It is bought, duty paid, in other European markets. A licensing
system will not really help you there. That is the problem we
have with it. On the other hand, it could cause the most enormous
administrative burden. To license the entire supply chain across
the whole of Europe, which is what you would be talking about,
would be extremely difficult. Therefore, I think that there are
advantages in having licensing, but I am not sure that we will
solve the problem we are debating today with it. That is my concern.
Q304 Mr Walter: Perhaps I could come
in on Mr Davies's point. We do not need a licensing system, because
any legitimate retailer is already subject to all that kind of
audit from Customs and Excise in his VAT return. We all know what
his turnover is—unless he is committing fraud. So we do
not need to go down the licensing route. Mr Stevens has a very
valid point there: that it is the people who are selling outside
the legitimate chain who we have a problem with.
Mr Davies: I think that we have
to create consequences. A licensing mechanism provides a unique
opportunity to create very serious consequences. I should also
say this. Let me come back to the issue of whether it is a pipe
dream and whether administratively the burdens can be overcome.
I do not think that it is a pipe dream— if there is a real
commitment on the part of government and on the part of those
involved in the trade to solve the problem, which is hurting all
of us. The Government is losing hundreds of millions of pounds.
We are losing hundreds of millions of euros in lost sales. If
there is a real commitment, it can be made to happen, and it can
be self-financing.
Q305 Norman Lamb: Just explain how you
are losing your sales.
Mr Davies: Because every time
someone buys illegal product—ours, for the most part, it
is counterfeit product—we are losing sales. Not only that,
we are putting our brand equity at enormous risk, because the
quality of those products does not match ours. Let me just say
this by way of analogy. The port of Rotterdam invested 14 million
euros in a scanner. Within the first six months they had recovered
20 million euros in lost duties. A licensing scheme, taking
the same sort of approach, can be self-financing in terms of the
recovered losses to both the government, manufacturers, and others
involved in the distribution chain.
Q306 Norman Lamb: Is there any precedent
for this in other products or other jurisdictions?
Mr Davies: Spain has a licensing
scheme, which includes limitations on the quantities of products
that retailers can sell. They enhanced those provisions in the
late 1990s. As this Committee is probably aware, through a combination
of significantly increased enforcement efforts and these changes
to the licensing system in Spain, we have seen a very dramatic
reduction in the levels of illegal sales of cigarettes within
the kingdom of Spain. I think that is a very good example.
Q307 Norman Lamb: Mr Northridge, you
refer in your submission to further research by Customs and Excise
in conjunction with other EU customs authorities, "to help
to establish more accurately the scale of smuggling from other
EU countries, thereby enabling supply routes to be focused upon
and controls to be put in place". Have you suggested this
to Customs? Is this something that is likely to be taken up?
Mr Northridge: Yes. With the opportunity
of meeting Customs at every level and with policy every six months
or so, they are aware of and they share our concern.
Q308 Norman Lamb: Because there is clearly
a lack of intelligence, is there not, about what is actually happening?
Mr Northridge: Yes, and I think
that the intelligence that existed for the tobacco products being
brought in from outside Europe allows us to turn our attention
to within Europe.
Q309 Norman Lamb: According to Customs,
large-scale, organised smuggling gangs, who supply most of the
illicit market, have increasingly switched their attention to
counterfeit product. As a result, there has been a significant
increase in the volume of counterfeit cigarettes seized, which
we have heard about. Do you measure the volume of counterfeit
cigarettes in the market, using your pack surveys, and what is
your estimate of the level of counterfeiting?
Mr Northridge: We started our
pack survey in 1998, where we interview—perhaps "interview"
is too strong a word—we get 500 or 600 people every month
to contribute towards that survey. It suggests that somewhere
around 2½% of the market—say, 2 to 3 billion cigarettes
currently being consumed in the UK—are counterfeit, and
it is growing.
Q310 Norman Lamb: Is that an estimate
that you share?
Mr Stevens: Of the BAT product
that is seized and given to us by Customs to look at, 80% is counterfeit.
So it is very significant.
Mr Davis: For us it is 93% that
are now counterfeit, and we go to some pretty grotty places to
do pack collections. We would estimate a little higher than Mr
Northridge: probably somewhere nearer to the Customs' estimate.
I think that their mid-range estimate is about 4 billion cigarettes.
Q311 Norman Lamb: According to your submissions,
the root cause of tobacco smuggling is the fact that the UK has
the highest taxes on cigarettes in the EU, but the UK retail price
net of taxes is also the highest in the EU. In the UK it is £1.05,
compared to 68p in France and 54p in Spain. Do you accept that
your own pricing policies are also contributing to the problem?
Mr Davis: No, I do not. If you
look at the tax-exclusive prices in the UK as a percentage of
the retail price, you find the UK is one of the lowest in Europe
at about 22%.
Q312 Norman Lamb: Because the tax is
so high.
Mr Davis: If we look at Sweden,
it is 30%; Germany and Italy, 26%; the Netherlands, 29%. It is
only France, at 20%, that is lower.
Q313 Norman Lamb: Just going back to
the figures I quoted you—
Mr Davis: The absolute cash amount.
Q314 Norman Lamb: Why £1.05 in the
UK, 54p in Spain? You are making a lot more profit here than in
Spain.
Mr Davis: There are also some
significant differences in the market. In the UK, we have 191,000
points of sale to service. In Spain—one of my colleagues
may correct me if I am wrong—I think that it is around 15,000.
This is obviously higher absolute prices, so we have higher retail
margins—because of the higher insurance costs, because of
the higher tax-driven prices, higher property costs. Also in this
country, ourselves and the retailers have the cost of discounting—which
does not take place in other countries. If we put all those—
Q315 Norman Lamb: So you are saying the
figures that I quoted do not include what is happening in terms
of discounting?
Mr Davis: No, that takes place
after, as it were.
Mr Northridge: An interesting
point, I believe, is if you look over the last decade and strip
out inflation and the excise increases, in total the price of
Gallaher cigarettes over that 10 years, on a volume-weighted basis,
has only increased by 5.7%. Not per annum: in total, over 10 years.
Q316 Norman Lamb: But you are still making
more here.
Mr Northridge: Our margins have
increased because we have been able to take out costs, and we
have economies of scale; but, from a consumer perspective, it
has not had a huge effect.
Q317 Norman Lamb: You are still making
more on your packet of cigarettes here than you are in Spain.
Mr Northridge: We are. Absolutely,
yes.
Q318 Norman Lamb: Substantially more—double.
Mr Northridge: At the premium
end, yes. On our biggest selling brand in the UK, Mayfair, we
do not. It is about the same as we make in continental Europe,
but on the premium brands we do make more. But we have invested
far more, over many years, and they have a higher cachet in that
sense. We tend at Gallaher to be in the value end in Europe and
in the premium end in the UK, so we would expect the margins to
be higher. The important thing from the tax-driven, smuggling
perspective is that the retail price differential—stripping
out inflation and tax—has increased by only 6%. Even if
you took just the taxed price in the UK of, say, Benson and Hedges
at £3.77, it is still more than double the full margin price
in Spain. Even if we made them, sold them and distributed them
for free, it would still be more than double.
Norman Lamb: I am sure that you will
not do that.
Q319 Mr Beard: You have supplied us with
written evidence, setting out what you are doing to combat this
illicit trade in both genuine and counterfeit products. Can you
give us an idea of what resources you are devoting to combating
cigarette smuggling, say in terms of the number of people you
have involved in this sort of exercise? Mr Northridge?
Mr Northridge: We have a specific
brand detection team of around seven or eight people. The point
I have tried to make, more importantly than that but in that context,
is that we have a sales force of 300 in the UK and a global sales
force of 2,500 people, and our international trading policy, in
our submission, is really a way of life. It is implicit in the
way in which our commercial people do business. Everybody is charged
with ensuring that that policy is enshrined in the way they act,
feeding that information back up through the brand enforcement
team, through internal audit—which is good risk assurance—to
the board, where we identify it on a quarterly basis and debate
it, and then give all that information back to Customs. That,
I believe, is more relevant than the specific eight or nine people
who are in that brand detection squad. If you take that, plus
the market research, plus the external agencies that we also use,
plus witness statements, attending court sessions, et cetera,
we estimate that we spend in excess of £1 million in that
area. However, I want to reiterate the point I have made. It really
is a way of life. Everybody who is employed at Gallaher at the
commercial end understands that it is their responsibility to
do everything in their power to bring these people to justice
or to eradicate that business. In that sense, therefore, they
are all whistle-blowing.
Mr Davis: I concur with what Mr
Northridge has said. It is very much embedded throughout all of
our sales organisations worldwide.
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