Gallaher Group Plc Business Information, Profile, and History

Company Perspectives:

The Group's strategy is to maintain and develop strong market positions, capitalising on its proven ability to build brand equity.

In the key UK cigarette market, Gallaher aims to defend vigorously its leading position in the high margin premium sector and to continue to increase its share of the growing low price sector.

Gallaher's international strategy is to continue to develop a balanced portfolio of interests in established and emerging markets with growth prospects--either independently or through strategic alliances or acquisitions. The Group's core international sales concentrate on building brands for local smokers.

Innovative advertising and creative marketing initiatives have built up brand recognition and loyalty with Gallaher's consumers over many years. This brand equity and superior marketing skills enable the Group to meet, and anticipate, changing trends, and to continue to develop new markets, with new brands and line extensions.

History of Gallaher Group Plc

Gallaher Group Plc is the second largest tobacco company in the United Kingdom, with manufacturing operations throughout the world. Its best known premium brands of cigarettes include Benson & Hedges and Silk Cut. Until 1997, Gallaher was a wholly owned subsidiary of American Brands, Inc., of Old Greenwich, Connecticut, in the United States. Since being divested from American Brands in 1996, Gallaher has undertaken a substantial overseas expansion program, acquiring cigarette manufacturers in Russia and Austria, and entering a strategic partnership with Shanghai Tobacco in China.

The Early Years

Gallaher was founded by Tom Gallaher, who in 1857 started his own business in Londonderry, making and selling pipe tobaccos. Within 16 years, he had prospered enough to move to larger premises in Belfast. Toward the end of the 1870s, Tom Gallaher crossed the Atlantic for the first time in order to personally supervise the buying of his company's tobacco leaves. He visited Kentucky, North Carolina, Virginia, and Missouri, and following his first trip the expedition became an annual event. Gallaher rose to become a notable figure in trade on both sides of the Atlantic.

During the first half of the 19th century, the pipe had gradually given way in popularity to the cigar. The military was credited in large part with this shift, as British soldiers returning from the Crimea campaign of 1854-56 introduced an item they had adopted from their French and Turkish allies--the cigarette. Smoking fashions in Britain underwent a change that Gallaher was astute enough to exploit. Soon other tobacco manufacturers also began to cater to this change in tastes. By 1888, he was producing flake tobaccos and cigarettes, which, included in the full range of Gallaher products, were displayed at the Irish exhibition in London during that same year. The expedition also saw the opening of Gallaher's first London premises, just inside the famous "square mile" of the city, at 60 Holborn Viaduct.

The first London factory was opened the following year at Clerkenwell Road to increase production, and in 1896 the Belfast factory moved into larger quarters. That same year, the company was incorporated as Gallaher Limited. An important development two years later was the discovery of a yellow and white burley leaf. Gallaher started to use it immediately, and in 1908 completed a transaction important to the history of the industry by purchasing the entire Irish tobacco crop.

The social history of smoking in the late Victorian and Edwardian ages was marked by the triumph of the cigarette. To that point in time, tobacco manufacturers had employed manual labor to make cigarettes as required, but soon cigarette-making machinery sped up production and thus satisfied the rising demand. It became acceptable for women to smoke, and new types of cigarettes were created to serve that market as well. By the outbreak of World War I in 1914, the cigarette had established its dominance over all other forms of smoking; it was considered vital to the welfare and morale of the armed forces and a valuable means of exchange.

Production increased significantly, and Tom Gallaher was the master of a thriving business when he died in 1927 at the age of 87. He had maintained an active interest in the company until the time of his death and had achieved great civic respectability as a governor of the Royal Victoria Hospital in Belfast. He also was credited with being the first person in the tobacco industry to introduce a 47-hour working week and annual paid holiday.

The Mid-1900s: Gallaher's Expansion Efforts

Smoking, and cigarette smoking in particular, enjoyed a continuous popularity throughout the 1930s and 1940s. The anxieties of World War II were a further stimulus to tobacco consumption. In the 1950s, however, evidence was produced that not only linked smoking to lung cancer and heart disease, but also suggested that long-term cigarette smokers might be more susceptible to lung cancer than pipe or cigar users, or nonsmokers. These findings seemed to do no harm to Gallaher Limited, however, which was looking to expand in 1955 and succeeded in acquiring the U.K. and Irish interests of the prestigious Benson & Hedges company.

Benson & Hedges had enjoyed development and success parallel to Gallaher Limited, though in a more elevated style. Richard Benson and William Hedges began their business in 1873. Benson & Hedges notably departed from the custom of dispensing tobacco by weight. Their tobacco was prepared as a blend or mixture and packed in a sealed tin. This assured the customer that his goods would reach him in the freshest possible condition and also had experienced no tampering. The business also benefited from the patronage of the bon vivant Prince of Wales, later King Edward VII, who asked Benson & Hedges to prepare and make into cigarettes a parcel of Egyptian tobacco leaf that he had acquired. They did this, and adapted the style to market "Cairo Citadel," one of the first Egyptian-type cigarettes to be made in Britain.

When smoking became popular with women during Edward's reign, Benson & Hedges produced variations of the cigarette designed to appeal to women, tipped with rose leaves or violets, for example, or on a miniature scale. Increasing demand led to the establishment of a separate factory, although the original shop remained at its location on Old Bond Street. During World War II, the shop was bombed and practically destroyed, but was rebuilt with the return of peace. When Benson & Hedges joined Gallaher, it brought not only its best-selling cigarettes, but also its Royal Warrant, which was first bestowed by Queen Victoria "to purvey cigarettes and cigars for use in her household," and later renewed by subsequent monarchs.

In 1962, Gallaher acquired J. Wix and Sons Ltd. of London, the makers of Kensitas, a well-known cigarette. The company's vendor was The American Tobacco Company, which made the transaction in exchange for a stake in Gallaher's stock. By 1968, American Tobacco had increased its holdings in Gallaher shares to 67 percent. American Tobacco had been a relative failure in its native tobacco market, but was now using a steady cash flow wisely to buy and diversify. In 1969, in recognition of its changing profile, it was renamed American Brands, Inc.

An American Brands Subsidiary: 1970s-80s

Meanwhile, Gallaher itself began to broaden its scope. An interesting and substantial acquisition in 1970 was the Dollond & Aitchison Group, whose main specialty was the supply of optical services and advice, spectacles, contact lenses, and accessories. Dollond & Aitchison possessed an extensive branch network throughout the United Kingdom. Also acquired was a small ophthalmic instruments manufacturing and distributing operation, called Keeler Limited.

Gallaher continued this diversification phase by making its first foray into retail distribution. In 1971 it established the Marshell Group, a retail franchise operation that sold mainly tobacco products and confectionery through concessions within major retail stores across the United Kingdom. Within 20 years the concessions numbered around 635, and the company also had more than 50 of its own retail outlets.

Two similar acquisitions followed in 1973. The TM Group, previously called Mayfair, was a company operating vending machines that dispensed cigarettes, drinks, and snacks in licensed and industrial catering outlets. Perhaps TM's best known manifestation in the United Kingdom was the ubiquitous Vendepac machine. Another purchase was that of Forbuoys plc, a chain of shops selling tobacco, confectionery, newspapers, and magazines, again with branches throughout the United Kingdom.

Using its standing as a subsidiary of a giant conglomerate, Gallaher was able to continue its expansion and diversification without severely troubling its balance sheet. Dollond & Aitchison's overseas expansion began in 1974 with the acquisition of the Italian company Salmoiraghi Vigano, which added the retailing of optical and medical instruments to the group's interests. The following year, American Brands finally controlled 100 percent of Gallaher's shares. It was arranged that the chairman and chief executive of Gallaher Limited would sit on the board of American Brands, while American Brands would have non-executive directors on the Gallaher board.

Gallaher continued to make acquisitions. In 1984, it purchased Prestige Group plc. Under the "Prestige" brand name, the company produced stainless steel cookware, pressure cookers, bakeware, and kitchen tools and accessories. Under another brand name, Ewbank, it also marketed carpet sweepers. Established in 1937, Prestige was the leading non-electrical housewares manufacturer in the United Kingdom. Following the Prestige acquisition in 1984, Dollond & Aitchison opened the first fast-service optical department store in Europe at Yardley near Birmingham, England. Additional stores, called "Eyeland Express," have followed since then.

In 1988, along with other companies in Northern Ireland, Gallaher was approached by the former Fair Employment Agency for Northern Ireland, which sought cooperation in a study to ascertain to what degree equality of opportunity was being afforded to Protestants and Roman Catholics. The agency had been advised of Gallaher's longstanding interest in the question, and the report concluded: "The efforts made by the company and the local Trade Union officials to introduce locally meaningful equal opportunity measures are positive and encouraging and the Agency is satisfied that the action taken is indicative of real commitment to provide equality of opportunity."

The following year, the section of Gallaher's business represented by Dollond & Aitchison suffered a setback when the British government abolished free vision tests for the majority of people, and spectacles and contact lenses for retail became liable for value-added tax. In fact, this severely affected the entire industry in the United Kingdom, but Gallaher remained confident, and continued as planned with the expansion of the Eyeland Express chain. Within two years, Dollond & Aitchison had virtually completed a major restructuring of its retail and service facilities. It became the largest optical group in Europe, with more than 500 outlets in the United Kingdom alone and strong and profitable overseas business.

The 1990s and Beyond

Gallaher Limited began the 1990s with a strategy based on diversification. Further strategic development of Gallaher's nontobacco interests continued with the acquisition of Whyte & Mackay Distillers Ltd., in February 1990. The company, as well as its three Scottish distilleries, was headquartered in Glasgow. One of those distilleries was a bottling company, William Muir (Bond 9) Limited, based in Leith, near Edinburgh. Its products were the blended whiskeys Whyte & Mackay Special Reserve and The Claymore, as well as the single malts The Dalmore, Tomintoul-Glenlivet, and Old Fettercairn. In April 1990, Whyte & Mackay reinforced its branded business and acquired the worldwide trademark rights to Vladivar vodka, the United Kingdom's second largest vodka brand. Other than scotch whiskey, vodka was the most popular distilled spirit in the United Kingdom.

Meanwhile, the tobacco business, managed by Gallaher Tobacco, remained a strong performer. In the declining U.K. cigarette market, Gallaher had increased its volume of sales and was making the three leading brands: Benson and Hedges Special Filter, Silk Cut, and Berkeley Superkings. Gallaher also manufactured the leading U.K. pipe tobacco, the leading cigar, and the second largest brand of hand-rolling tobacco in the United Kingdom. Gallaher International, the export arm, also was undergoing increased development in the early 1990s, and was well placed to take advantage of the trend toward low-tar cigarettes, pushing for markets in France, Spain, and Greece.

Since its inception, Gallaher had maintained considerable holdings in Northern Ireland, and by the 1990s was one of the largest manufacturing employers there. Operations included a warehouse complex for tobacco leaf at Connswater, East Belfast, and a sales distribution center on the outskirts of the city. Production took place at Lisnafillan, near Ballymena, County Antrim, in a modern factory complex handling cigarettes, pipe tobacco, and hand-rolling tobacco. Also at Lisnafillan was the company's research and development division, which was a particularly vital establishment to Gallaher's drive to keep its position as market leader in low-tar cigarettes.

Gallaher also continued to operate in the Republic of Ireland, where it was the second largest tobacco company. Cigarettes, pipe tobacco, and hand-rolling tobacco were manufactured in a factory just outside Dublin. On the British mainland, three top-selling cigarette brands and a wide range of smaller brands were made at the famous Senior Service factory at Hyde, east of Manchester, and cigars were produced at Cardiff and Port Talbot in south Wales.

In the mid-1990s, Gallaher continued to increase recognition of its name in its home market, through various types of sponsorship. Although it had withdrawn patronage of the Silk Cut Tennis Championship in 1990, the Benson & Hedges Cup at Lord's remained an important sponsorship. This cricket competition was vital to the Test and County Cricket Board during those years, as the sponsorship arrangement guaranteed the organization £3 million over a five-year period. Other sponsorships within the Benson & Hedges portfolio were the International Open Golf Championship at St. Mellion, Cornwall; the Masters Snooker Tournament at Wembley; the Silk Cut Showjumping Derby; and the Silk Cut Nautical Awards. In Northern Ireland, small business development was encouraged by the Gallaher Business Challenge Award Scheme, and the company was also the major private sponsor of the Ulster Orchestra.

As Gallaher entered the last few years of the century, the strength of its tobacco industry holdings was tested when the European Community (EC) banned all advertising of tobacco products on U.K. television. At the time the ban was instituted, Gallaher owned the United Kingdom's biggest cigar brand, Hamlet, but was fighting for continued market share dominance with Imperial's Castella brand. During the weeks preceding the ban, Gallaher ran most of its old and new advertisements on U.K. television in a last-ditch effort to maintain its edge. For years, the Hamlet television advertisements had been wildly popular with the U.K. public and had won 15 Lion awards at the International Advertising Film Festival at Cannes. Gallaher also produced a 30-minute video showcase of the best of the Hamlet advertisements over the years, which was then sold to the public to keep the spirit of the 27-year Hamlet campaign alive.

Within a year of the tobacco advertising ban, Gallaher introduced a new entry in the budget-priced sector of the cigarette market. The brand Mayfair was introduced, and it joined Gallaher's Berkeley Superkings brand, which was currently the best-selling brand in the budget-priced market. Mayfair was immediately given a poster advertisement campaign, which focused mainly on the low price of the product. Furthermore, Gallaher attempted to appeal to potential customers by lowering the cost of Mayfair by the same amount that the government had just added as duty to the cost of the cigarettes. Soon thereafter, Gallaher also introduced its Eclipse brand, which was classified as a "super luxury length" product and joined other cigarettes at the opposite end of the spectrum from Mayfair. At that time, Gallaher was producing the top three cigarette brands in the United Kingdom.

Gallaher continued to reap success, even despite criticisms and raised eyebrows from industry analysts regarding marketing and pricing decisions made by the company. By 1996, Gallaher had grown to account for more than 50 percent of American Brands' yearly sales figures. The following year, American Brands made the decision to spin off Gallaher. Prior to the spinoff, Gallaher had helped American Brands achieve $6.9 million in 1996 tobacco sales alone. Following the divestiture, American Brands changed its name to Fortune Brands, Inc. The new name more accurately reflected that corporation's holdings--ironically, "American" Brands had been responsible for numerous international holdings for years, including Gallaher.

Back in Business: Gallaher in the 21st Century

The years immediately following its spinoff from American Brands were an extremely busy time for Gallaher. Although the tobacco industry in Britain was in the midst of making a small comeback in the late 1990s, with companies like Gallaher and Imperial Tobacco gaining listings on the London stock market, an increasingly complicated marketplace posed a number of challenges to Gallaher. For one, high taxes on cigarettes in the United Kingdom were pushing many consumers toward cheaper brands. Although Gallaher's Benson & Hedges still dominated the market for premium cigarettes in Britain, the company had minimal background with cut-rate brands, making it vulnerable to Imperial in this rapidly growing sector. The challenge was to establish an inexpensive cigarette that could compete with Imperial's Lambert & Butler, which in itself claimed more than 10 percent of the overall cigarette market in the United Kingdom. Although Gallaher had introduced its own cut-rate brand, Mayfair, in 1992, it still accounted for only 2.1 percent of the total market as late as May 1997. Recognizing the need to become more aggressive, the company launched a second cut-rate brand, Sovereign, in late 1996. Bolstered by a huge marketing campaign, the move soon paid off, and by late 1997 Sovereign and Mayfair could boast sales growth of 89 percent over the course of only six months. By September 2000, Mayfair had become the third leading cigarette in the overall market.

Another problem confronting Gallaher during this period involved the alarming rise in sales of "bootleg" cigarettes in England. High duties were an invitation for smugglers to try to seize a portion of the U.K. market, and 1998 saw the share of overall cigarette sales commanded by bootleggers rise from 2 percent to 3 percent in only six months. In light of the price differentials between legitimate and contraband cigarettes--a pouch of Golden Virginia hand-rolled tobacco could be sold by smuggler for around £3, compared with £7.95 in a tobacco shop--it was not difficult to understand Gallaher's concern. Heavy lobbying for government intervention did begin to show results by the year 2000, when increased vigilance by customs agencies caused the rate of decline in duty-paid cigarette sales to go down from 12 percent to slightly more than 2 percent. The bootlegging situation, however, also prompted Gallaher to look elsewhere for ways to offset the decline in profits. Although a strong British pound during the late 1990s had already cut into Gallaher's overseas revenues, the company continued to view international expansion as critical to its sustained growth. Toward this end, Gallaher set out on an acquisition spree in the five years after it was divested from American Brands, a strategy that raised its operating profits by 20 percent over a two-year span and expanded its overall annual cigarette production from 33 billion to 60 billion. Gallaher's purchase of Moscow-based Liggett-Ducat in June 2000 gave the company control of nearly 17 percent of the Russian cigarette market. More significant, the deal nearly doubled the company's production capacity, while simultaneously placing it in an ideal position to begin marketing cigarettes in Eastern Europe and Central Asia. The Liggett-Ducat acquisition was followed by a joint venture with state-run Shanghai Tobacco in China in February 2001, and in June 2001 Gallaher successfully outbid rival Imperial for Austrian Tabak, paying $2 billion for a company responsible for 90 percent of cigarette sales in Austria. By 2002 the company was competing for control of German cigarette manufacturer Reemtsa, the largest private tobacco company in the world, while also eyeing possible entries into cigarette markets in the Middle East and Africa. With U.K. profits diminishing, Gallaher was clearly looking abroad to build the foundation for its future success.

Principal Subsidiaries: Airton Cigar Sales Limited; Benson & Hedges, Ltd.; Benson & Hedges (Dublin) Ltd.; Cope & Lloyd (Overseas) Ltd.; Cope Brothers & Co., Ltd.; Gallaher (Dublin) Limited; Gallaher (Ukraine) Limited; Gallaher Asia Limited; Gallaher Asset Finance 1998 Limited; Gallaher Asset Finance 2000 Limited; Gallaher Austria (Holdings) Limited; Gallaher Austria Limited; Gallaher Benelux Limited; Gallaher Canarias SA; Gallaher Finance and Distribution Limited; Gallaher Finance Limited; Gallaher Finance Overseas Limited; Gallaher France EURL; Gallaher Group plc; Gallaher Hellas SA; Gallaher International Limited; Gallaher Kazakhstan LLC; Gallaher Limited; Gallaher Overseas (Holdings) Limited; Gallaher Overseas Limited; Gallaher Pensions Holdings Limited; Gallaher Pensions Limited; Gallaher Quest Trustees Limited; Gallaher Services Limited; Gallaher Spain S.A.; J.R.F. Realty, Inc.; Roughburn Forestry Limited; S.N. Farms Limited; S.N. Woodlands Limited; Silk Cut (Dublin) Limited; Silk Cut SA; The Galleon Insurance Company Limited; The Schooner Insurance Company Limited.

Principal Competitors: British American Tobacco p.l.c.; Imperial Tobacco Group PLC; Philip Morris International Inc. (U.S.A.).

Chronology

• Key Dates:
• 1857: Tom Gallaher begins making and selling pipe tobaccos.
• 1873: Benson & Hedges is founded.
• 1896: Gallaher Limited is incorporated.
• 1955: Gallaher acquires the U.K. and Irish interests of Benson & Hedges.
• 1962: Gallaher acquires J. Wix and Sons Ltd.
• 1969: The American Tobacco Company is renamed American Brands, Inc.
• 1996: American Brands spins off Gallaher Limited.
• 2000: Gallaher acquires Russian cigarette manufacturer Liggett-Ducat.