Cuban Cigar Industry

Cuban Cigar Industry – Five Competitive Forces Model

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When anyone mentions the country Cuba, two products register in our mind – sugar and cigar. Cuban cigars are renowned for as the sign of upper echelon style and class even for an uneducated cigar smoker. They are highly reputed for distinct taste and feel and consider containing the world’s best tobacco. As a tropical region, Cuba’s land is possibly the ideal place to grow the finest tobacco and wrappers in the world. Even though cigars have been manufactured in other countries as well, Cuba’s cigars still hold the foremost choice of all cigar aficionados around the world. Cigar is mostly popular in United States as a symbol of class and posh lifestyle. This means that anyone would be tempted to invest in the cigar industry. However, the importation of the Cuban cigar to the United States is illegal. Due to the trade embargo imposed on Cuba by the Kennedy administration forty years ago, all economic trades between United States and Cuba are blocked. With the former U.S. president Jimmy Carter, the first U.S. president to visit Cuba following the embargo, there are speculations that the U.S. – Cuba relations would soften, leading to lifting the embargo restrictions. Obviously the potential slackening of the trade barrier would be an investor’s dream within this industry, but the reality of the situation is still very unpredictable. Forty years have passed since the embargo, and many cigar manufacturing industries have evolved around the world during this period, all contributing to U.S. cigar consumption. Even United States has its own cigar industries in Connecticut and Tampa. Anyone considering investing in the cigar industry as a possibility of alleviation of the embargo should identify the external environments forcing the shape this industry. This study identifies the Five Forces Model of Competition identified by Michael E. Porter: (i) Rivalry among competing sellers, (ii) Threat of new entrants, (iii) Other industries offering substitute products, (iv) Bargaining power of suppliers, and (v) Bargaining power of buyers. Consequently, the strength of each force is also identified.

Minesh Rajbhandari [#1311]

SAIM, EIA, Summer 2009

Cuban Cigar Industry – Five Competitive Forces Model

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1. Rivalry among Competing Sellers The strongest among the five forces is almost always the market maneuvering and tempting for buyer support, which induces rivalry among the competing sellers. The cigar industry almost held monopoly in Cuba until the Civil War in 1868. During and after the Civil War, many Cuban tobacco growers fled the country for United States, taking with them the prized Cuban seed. There the Cubans harvested the tobacco, thus spreading the secret of their cigars to other countries. The embargo during Fidel Castro’s regime was a major catalyst for worldwide competition, as Cuba saw a major departure of its key players in the industry. During the 1970s and 1980s many other cigar industries evolved around the world including the Dominican Republic, Honduras, Indonesia, Ecuador, Mexico, and Cameroon along with United States. Competition increased as new technologies were developed to manufacture machine-made cigars, reducing the price per cigar. However the merger between the cigar industry giants Spanish Tabacalera S.A. and French SEITA S.A. in 1999, forming Altadis S.A. eased competition. Altadis entered into joint venture with Habanos S.A., which is the marketing, distribution and export arms of all Cuban brand cigars. Thus, rivalry is moderate among competing sellers. Even though many countries harvest tobacco and manufacture cigars, Cuban cigars still landmark as the benchmark of the superior cigar in the world. 2. Threat of New Entrants The threat of new entrants intensifies if there are ample resources and the candidates have improved and better resources that would make them formidable market contenders. The cigar industry is dependent on the quality of tobacco, which cannot be harvested all over the world. Growing and cultivating cigar tobacco requires the soil and microclimate to keep the humidity ideal. Harvesting the tobacco is even a slow process, with the leaves to be hand picked at the right time, which is achieved through experience. Only some

Minesh Rajbhandari [#1311]

SAIM, EIA, Summer 2009

Cuban Cigar Industry – Five Competitive Forces Model

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countries, other than Cuba, have the climate suitable for growing tobacco. So the threat of new competitors entering the cultivation and harvesting tobacco is low. The cigar industry operates under sizable economies of scale, i.e. higher production volume mean a lower cost for each item produced, since fixed costs are shared over the goods produced. So new entrants in the cigar industry must also enter on a large scale, which can be a costly and risky move; or they can accept a cost disadvantage and consequently lower profitability. In either case, threat of new entrants is low. Moreover, two major corporations Altadis and Swedish Match control the distribution of Cuban cigar worldwide, increasing the barrier to entry. 3. Other Industries Offering Substitute Products A product can be considered to be a substitute product if it can be a replacement, and still satisfy the same needs of the consumer. Cigarettes can be considered as a substitute product for cigars, in terms of shape, production and method of consumption. However, consumers who smoke cigarette and cigar are totally different and don’t usually substitute one for another. People smoke cigars simply to show that they belong to the upper echelon class, while cigarette smokers do not. The quality and reputation of cigars are far better than those of cigarettes. Thus there are no threats of other industries offering substitute products. 4. Bargaining Power of Suppliers The bargaining power of suppliers is dependent on whether major suppliers can exercise sufficient bargaining power to influence the terms and conditions of supply in their favor. The production in the premium cigar factories is under the direct control of Cuba’s Union of Tobacco Enterprises and is completely separate from the Altadis-Habanos joint venture. Tobacco growers can buy land through government loans and then pay in kind through tobacco harvests. So the Cuban government is the only buyer of the output from the private firms, partly due to the Helm-Burton Act of 1996. This Act limited trade that subsidies of U.S. companies in other countries could conduct with Cuba, allowed the U.S. to impose sanctions on countries trading with Cuba, and it barred officials of corporations Minesh Rajbhandari [#1311]

SAIM, EIA, Summer 2009

Cuban Cigar Industry – Five Competitive Forces Model

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doing business in Cuba from entering the U.S. In a way, U.S. was trying to extend its embargo to other trading partners of Cuba. With these restrictions in action, Cuba could not trade with other suppliers rather than its own government, thus giving it a high bargaining power. 5. Bargaining Power of Buyers The bargaining power of buyers is dependent on whether some or many buyers have sufficient bargaining leverage to obtain price concessions and other favorable terms and conditions of sale. The cigar industry worldwide has two major corporations: Altadis and Swedish Match. These two entities control, through ownership or interest in other companies, the distribution of Havana cigars and Cuban brand names worldwide. Altadis is the result of a 1999 merger between Tabacalera and SEITA, both largest purchasers of Cuban cigars. Altadis went into joint venture with Habanos, which are the official official owners of all of the Cuban brand names. Only these exclusive dealers can distribute Havana cigars throughout the world and only these dealers have access to the cigar supply. Thus the bargaining power of buyers can be considered to be high. Conclusion The renowned Cuban cigar was examined under the Five Competitive Forces Model, depending on the environment it is operating on and the factors influencing it. The result of each force is summarized below: S. No. 1. 2. 3. 4. 5.

Competitive Force Rivalry among Competing Sellers Threat of New Entrants Other Industries Offering Substitute Products Bargaining Power of Suppliers Bargaining Power of Buyers

Degree Moderate Low None High High

So investing in Cuba is unfavorable as of today. The embargo has not yet been lifted and even if it does, the major supplier would still be the Cuban government. There are major companies which take over the supply and distribution of the cigar. Thus investing in Cuban cigar would turn risky if one does not have a strong political connection or high monetary investment to commit for advertising and sales promotion for brand loyal cigar consumers. Minesh Rajbhandari [#1311]

SAIM, EIA, Summer 2009