Reynolds’ strategy: Transformation through innovation

Reynolds American Tobaccoville Plant

WINSTON-SALEM, N.C. — The future of Reynolds American Inc. could not look much brighter than it did Tuesday as the company announced plans – from a stout position of financial and innovation strength – to acquire Newport, the nation’s No. 2-selling cigarette brand, according to the Winston-Salem Journal.

Reynolds’ top executive, Susan Cameron, beamed about being within reach of federal regulators’ approval of assembling her “dream” brand portfolio of Newport, Camel and Pall Mall.

Cameron spoke of the $27.4 billion deal for rival Lorillard Inc. as the culmination of a 10-year journey in which the “transforming tobacco” mantra became Reynolds’ calling card. It has dedicated a website – www.transformingtobacco.com – to the initiative.

She pointed out with pride to analysts, investors and employees the 2006 buying of Conwood (now American Snuff Co.) that allowed Reynolds to take a major stake in moist snuff with the top-selling brand, Grizzly.

She talked about the stunning decision in 2009 to buy Niconovum, a Swedish manufacturer of smoking-cessation products.

She touted the decision to become the first of the Big 3 U.S. manufacturers to internally develop an electronic cigarette, Vuse, which led to the 2013 formation of its R.J. Reynolds Vapor Co. subsidiary. A product Cameron and Reynolds is so confident in that it agreed to sell blu eCigs, Lorillard’s top-selling e-cig, to Imperial Tobacco Group PLC as part of a $7.1 billion deal.

“We will continue to transform our industry by driving innovation throughout our businesses, redefining enjoyment of adult tobacco consumers and reducing the harm caused by smoking,” Cameron said.

Understated in the transforming tobacco strategy is the hard reality that Reynolds really didn’t have any other choice if it wanted to survive.

Societal change, job losses were inevitable

To understand and appreciate Cameron’s triumphant tone requires going back to 2003, to when Reynolds was a wounded competitor facing a grim future as a traditional cigarette manufacturer.

Reynolds was being squeezed financially between discount cigarette manufacturers unencumbered by the landmark 1998 Master Settlement Agreement (MSA), and a larger rival, Philip Morris USA, with deeper pockets.

In February 2003, Reynolds announced an unthinkable decision – to end its top sponsorship of Winston Cup Racing after 32 years – to reduce its marketing expenses. It came to fruition in June 2003 when Nextel took over the role for the 2004 season.

At that time, the Winston-Salem Journal cited several causes for the decision: the slumping economy in 2001-03, higher state excise taxes affecting profits; societal changes spurred by anti-tobacco groups; expensive legal battles that include the MSA’s tighter restrictions on marketing options; a changing corporate culture; and NASCAR’s expanding television package.

Former Charlotte Motor Speedway promoter Humpy Wheeler said in February 2003 that Reynolds “has got some significant issues that have changed the dynamics of what they’re doing as a company.”

Whatever the cause(s), the decision proved to be the canary-in-the-coalmine moment for the company and the community.

In September 2003, five months after launching an internal restructuring review, Reynolds said it would eliminate 2,600 jobs, including 1,700 locally, in the latest of several employment blows since the mid-1980s.

The decision to cut 40 percent of its workforce – the largest in corporate history – also included the decision to sell its packaging division, which had another 1,000 employees.

Andrew Schindler, Reynolds’ chairman and chief executive at the time, said the announcement “does not mark the end of this process. We will be continually evaluating and refining our marketplace strategy and tactics. In addition, continuous cost improvements will be an on-going strategic initiative.”

Forsyth Commissioner Gloria Whisenhunt said at the time that “I think it’s one of the saddest days in the history of our county. We’ve always relied on Reynolds for good jobs for our citizens, and they’ve been a support system for the entire community.”

Yet, apprehension remained that the worst was yet to come.

Rumors of a deal with Brown & Williamson Tobacco Corp. had been circulating for months, like those recently about Reynolds buying Lorillard.

Only in this instance, the betting person was more likely to have placed bets on Brown & Williamson – the U.S. subsidiary of global powerhouse British American Tobacco Ltd. – being the buyer, and Reynolds becoming just another bought corporation sent to history’s dust bins.

However, Brown & Williamson was experiencing similar competitive challenges as the No. 3 manufacturer.

That reality led Martin Broughton, then BAT’s chairman, to engage Schindler in negotiating a deal in which Reynolds would be the surviving entity. Broughton already wanted to limit BAT’s exposure to U.S. litigation risks.

Key in the negotiations: Cameron, who was Brown & Williamson’s chief executive, was chosen to run the merged company. She was known as Susan Ivey then.

That proved fortuitous because of Ivey’s recognition of Reynolds’ need to diversify its product mix toward smokeless tobacco and innovative smoke-free products. The local community gained about 800 Brown & Williamson jobs to put some salve on its economic and psychological wounds.

Portfolio of brands is right mix

Cameron acknowledged the decision to focus Reynolds on four key brands – Camel and Pall Mall in cigarettes, Grizzly in moist snuff and Natural American Spirit in additive-free tobacco – “made a lot of people nervous.”

Reynolds’ attempt to become a “total tobacco company” was met with steep skepticism, if not derision, by anti-tobacco advocates.

Undeterred, Cameron spurred Reynolds on to become an innovator or seller of products that could be less harmful to consumers than cigarettes.

When Reynolds paid $3.5 billion to buy Conwood, it was a signal in some ways of returning to its roots. It was founded in 1875 when Richard Joshua Reynolds started a chewing-tobacco operation in Winston.

In the following decades, Reynolds Tobacco rose to prominence and fortune by selling cigarettes, not chewing tobacco. In 1985, it sold 10 of its chewing-tobacco brands and stopped production of others.

But by the time Reynolds bought Conwood, the rate of adult smoking was declining, while the smokeless-tobacco business was gaining momentum through such brands as Grizzly, Skoal and Copenhagen.

Some analysts warned they thought Reynolds had overpaid for Conwood, but Grizzly took the top moist snuff market share in late 2010 and has been pulling steadily away since.

The most surprising innovative twist so far has been buying Niconovum, which Reynolds has kept mostly under wraps since the 2009 acquisition. It has had Niconovum’s Zonnic nicotine-replacement therapy gum in test markets in Des Moines, Iowa, and Omaha, Neb.

Camel Snus quickly became the top-selling snus product as national distribution began. Vuse was launched nationally in June after quickly gaining top market share in test markets Colorado and Utah.

It hasn’t been all success for Reynolds with its innovation strategy.

In January 2009, it put into test markets three dissolvable products – a film strip for the tongue, a chew stick and an orb – that drew enough mixed results from consumers that the company pulled distribution in 2012.

Yet, the strength shown by those four key brands and the innovative products helped produce the revenue necessary for Reynolds to be a more viable competitor to Philip Morris USA, as well as the confidence within Lorillard management that they could trust Newport in Reynolds’ hands.

It didn’t hurt that Cameron returned from a three-year retirement in May to direct what she calls “the final push” to get the deal done.

“The complementary nature of Newport to Reynolds’ core brands was not lost on Reynolds’ board and management team,” Murray Kessler, Lorillard’s top executive, said.

“They were able to come forth with a transaction that is able to deliver significant and immediate value to Lorillard shareholders through a (40 percent) cash premium, as well as the potential to participate in the upside potential of this amazing new company.”

Cameron said “successful integrations are something we’re experienced in and good at” – a point both companies hope is persuasive to federal regulators who analysts say traditionally are supportive of tobacco industry consolidation.

David Adelman, an analyst with Morgan Stanley, said he believes Reynolds is on the right size of the reward-risk proposition involved with buying Lorillard even as potentially tightened regulations on menthol cigarettes are being considered by the Food and Drug Administration.

“Although all together a high price for an excellent asset, Reynolds takes on the industry’s tail risks with menthol and an indemnity for Imperial and some Federal Trade Commission-related antitrust risk to closing the transaction,” Adelman said.

“We worried that the structural details would have been less favorable for Reynolds than proved to be the case.

“Perhaps the greatest antitrust issue is that the brands chosen by almost all new smokers – Marlboro, Newport and Camel – would only be owned by two firms, rather than three,” Adelman said. “We expect Reynolds and Lorillard to demonstrate that Camel and Newport are not prime competitors, but rather that both principally compete against Marlboro.”

Cameron said she is “very confident that this portfolio of strong, iconic brands lives together very well.”

Cameron committed to regional economy, jobs

Although Cameron was only able to stem the flow of job losses, at 600, during her seven-year first term with Reynolds, she slowed the pace compared with the loss of 12,100 jobs from 1983 to 2004.

It’s clear that maintaining, if not increasing, the local work force is top of mind for Cameron.

During the May 23 announcement of pledging to create 200 jobs as part of establishing Vuse production in Tobaccoville, Cameron hit on the transformation theme again.

“Transforming our community for the better is part of our overall commitment to transforming the tobacco industry,” Cameron said. “We’ve done that in a number of ways — through philanthropy, through the donation of properties and buildings to fuel economic development, and through employee volunteerism.

“But I can tell you, it sure feels good to be announcing new jobs and a major investment in equipment right here in North Carolina.”

Cameron stressed Tuesday that the proposed deal for Lorillard/Newport would not lead to any Reynolds job cuts. If the deal gains FTC approval, Reynolds has plans to shift Newport production from Lorillard’s plant in Greensboro to Tobaccoville, which is expected to lead to the need for more production jobs.

“It is a most remarkable deal that it satisfied the financial needs of four companies, yet kept employees at the forefront of the negotiations,” Cameron said, including the 2,900 Lorillard jobs that will be transferred to Imperial.

“I am absolutely confident that our journey to transforming the tobacco industry is enhanced by this transaction.

“After 139 years operating in the Triad, Reynolds American remains committed to the region and to continuing to be an engine for regional economic growth.”

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