Indonesia: Cigarette Paradise No More?

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By Andrea Lianto, Research Analyst at Euromonitor International

The significance of Indonesia in the global cigarette industry cannot be overstated. In 2016, over 316 billion sticks of cigarettes were sold there, making it the second largest market after China. The country’s smoking prevalence is among the highest in the world, at 36% of the total adult population and a very high 68% of the adult male population. Indonesia has also been a key market for leading tobacco multinationals: Indonesia makes up 40% of Philip Morris International’s cigarettes volume sales in Asia Pacific and 12% of British American Tobacco’s.

For years, Indonesia defied the global cigarette trends. When global cigarette demand fell for the first time in 2010, Indonesia still recorded 4% growth. In the 2010-2015 period, when global consumption dropped by a 1% CAGR (compound annual growth rate), cigarette volume in Indonesia instead grew at a 3% CAGR.

However, that narrative changed in 2016. The market lost its resilience, and for the first time in nine years, cigarette sales in Indonesia declined.

The least stringent regulatory environment in Asia Pacific

The fall of cigarette consumption in Indonesia probably came as a bit of a surprise. Just like in the past, other than the usual increase in excise tax and minimum retail price at the beginning of the year, there were no particularly drastic measures taken by the government to curb smoking in 2016. The tobacco regulatory environment in Indonesia remains one of the least stringent in Asia Pacific, and possibly in the world. Direct tobacco advertising on TV and radio as well as the print media, while restricted to 21.30hrs to 05.00hrs, is still allowed.

Event sponsorship by tobacco companies is not restricted – Djarum backed Djarum Superliga Badminton and Gudang Garam once again sponsored We The Fest music festival in 2017. Even though there are smoke-free laws in certain public spaces and laws prohibiting promotional discounts and free distribution of cigarettes, enforcement remains relatively weak.

In fact, despite growing pressure from anti-tobacco organizations and the international community for Indonesia to do more, the government continues to be reluctant – or at least undecided – when it comes to imposing stricter control on the tobacco industry. This reluctance is not entirely inexplicable. According to the directorate general of customs and excise, the tobacco industry contributed over 96% of the state’s excise revenue in 2016, or IDR143.5 trillion (US$10.7 billion), a hefty sum for a country looking to advance its infrastructure development.

In addition, millions of Indonesians make up an intricate cigarette supply chain web. Taking too tough an action on the industry would inevitably affect the livelihood of factory workers and tobacco farmers, in addition to clove farmers who benefit from the popularity of kretek in the country. This all makes the tobacco industry a potentially touchy political subject in Indonesia.

To complicate the matter further, leading cigarette players have myriad corporate social responsibility (CSR) activities, from disaster relief to the education financial assistance scheme, which made them something of an integral part of Indonesia’s development plan possibly giving them lobbying power over regulations. To this day, Indonesia is one of the very few countries that has not signed and ratified the Framework Convention on Tobacco Control (FCTC), which has been ratified by 183 United Nations member states.

The state of the cigarette market in 2016

Despite the government’s unchanging stance on the industry and the absence of new groundbreaking tobacco laws, the year 2016 saw the unprecedented decline of all three cigarettes segments in Indonesia. The weak performance of hand-rolled kretek cigarettes (SKT) and white cigarettes (SPM) was not surprising; demand for SKT has been falling steadily for years due to shifting consumer preferences, and SPM was not that popular to begin with. What hurt the market, though, was the decline in volume sales of machine-rolled kretek cigarettes (SKM), which accounts for more than three-quarters of cigarette sales in Indonesia.

Why cigarette demand fell

As it turned out, the government’s seemingly pedestrian approach to tobacco control in 2016 was not as lukewarm as one might have thought. Based on ministry of finance regulation number 198/PMK.010/2015, excise tax was increased by 6-17% (depending on the type of cigarettes and the manufacturer’s production volume) with effect from 1 January 2016. SPM saw the highest excise tax increase at 13-17%, whereas SKM experienced an 11-16% rise in excise tax. The minimum retail price also increased by IDR45-290 per stick. While it does not sound like much at first, following the 2016 revision, the minimum retail price of big SKM brands (those with production volume greater than two billion sticks) crossed the IDR15,000 mark for a 16-stick pack and reached the IDR 20,000 mark for a 20-stick pack. Not only did the new regulation make cigarettes more expensive, but it also made cigarettes noticeably less affordable.

Consumers began to think twice before purchasing a pack of cigarettes. The effect of the price increase was especially felt by consumers in the bottom income segment, who account for approximately 74% of Indonesia’s alcoholic beverages and tobacco value sales according to Euromonitor International’s consumer spending by income band model. For this consumer group, spending on cigarettes could hardly be increased further; even prior to the excise tax hike in 2016, alcohol beverages and tobacco (mainly tobacco) already took up 7% of their annual household spending.

Coupled with unfavorable economic conditions and price increases for basic necessities in 2016, a smoking habit became more difficult to sustain financially and many low-income consumers had no choice but to cut down on the number of cigarettes smoked daily.

To cushion the impact of the price hike in 2016, cigarette companies shifted their focus to economy products, most of which were sold in small pack sizes of 12 or 16 sticks – possible because there is no 20-stick-per-pack restriction in Indonesia. For instance, Bentoel Internasional Investama and Nojorono Tobacco Indonesia launched the new economy SKM brands, Lucky Strike Mild and Maxus, respectively, to attract low-income consumers. Meanwhile, leading player HM Sampoerna expanded the distribution of its economy brand U Bold Filter (sold in packs of 12 sticks) to bigger cities in Java and Sumatra, and Gudang Garam relaunched its Signature Mild brand in smaller packs of 16 sticks.

Nevertheless, these efforts were not enough to prop up cigarette demand, partly because there were other external factors dragging down industry performance. In 2016, a growing number of districts in the country began to impose regional bans on tobacco advertising in the mass media. Even DKI Jakarta took a firm stance and banned outdoor advertising of tobacco products in the same year. Consequently, cigarette companies did not have as much room to breathe in 2016.

Adding to this, some consumers began shifting to vapor products. Younger smokers especially are attracted to the “cool factor” of vaping as well as the wider flavor variety of e-liquids. In 2016, retail value sales of vapor products in Indonesia nearly quintupled to reach IDR321 billion (US$24 million). While vapor product sales are only a fraction of the total sales income of cigarette, the segment undeniably stole some share from cigarettes, as the majority of vapers would purchase fewer cigarettes.

Outlook for the cigarette industry in Indonesia

It is difficult to be upbeat about the future of the cigarettes industry in Indonesia. Even as of July 2017 there were signs that volume sales of cigarettes were suffering from further increases in excise tax, minimum retail price, and PPN (VAT or value-added tax) for tobacco products. According to Philip Morris International, sales of cigarettes in Indonesia in the second quarter of 2017 fell 12% year-on-year. Three publicly listed tobacco companies – HM Sampoerna, Bentoel International Investama, and Wismilak Inti Makmur – also saw a drop in net revenue in the first half of 2017.

Today, tobacco companies are trying to weather the decline of cigarettes through launches of economy products to attract low-income smokers – Djarum recently relaunched three of its brands in packs of 12 sticks and Bentoel released Lucky Strike Bold in packs of 12 sticks – but this strategy will soon cease to be effective. In the medium term, the government will again resort to an increase in excise taxes – at least to appease the growing anti-tobacco movement – since drastic measures, such as FCTC ratification and a national ban on advertising, are not feasible due to the sensitive nature of the industry.

Considering that the bulk of smokers in Indonesia come from the low-income segment and that they are price-sensitive (possibly even more so after 2016), further decline in sales is likely. In addition, with more smokers switching to vaping and others expected to drop the habit for health reasons, it is hard to imagine that demand for cigarettes in Indonesia will pick up. Perhaps Indonesia is no longer such a cigarette paradise anymore.