Strategic management | Cuban Cigar industry | Professor Changwha Chung |

Introduction Cuban cigars are known as the symbol of upper echelon class even for an uneducated cigar smoker. They are highly reputed for distinct taste and feel; also 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. 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. Porter’s Five Forces Model (Appendix 1) 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. 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 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. 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. 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. 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 the distribution of Havana cigars and Cuban brand names worldwide. Investigation on current Cigar Industry

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: Competitive Force | Degree | 1.Rivalry among Competing Sellers | Moderate | 2.Threat of New Entrants | Low | 3.Other Industries Offering Substitute Products | None | 4.Bargaining Power of Suppliers | High | 5.Bargaining Power of Buyers | High | Considering tobacco industry as a subject for investment it we will start with evaluating the global trends and global factors that this industry depends upon. The Cigar themselves are not the first-need consumer goods, but they’re not as the high cost product as sport-cars or real estate. That means that overall demand for cigars may increase dramatically as the world-economy is going up, thus increasing the middle and upper class wealth is the main demand driver for cigars. However, on the other side it can decline significantly once the today’s economy is not doing well.

The most important change in the global cigar market happened in the middle of 1990s, when the overall wealth of Western countries spiked after the Soviet Union disappeared, the demand for cigars experienced the large revival, especially in the U.S.A.; the biggest cigar market worldwide. However, more than a decade passed, the tobacco industry adjusted for new production quantities and the demand growth rate is almost flat. This means that all mid-90s boom benefits are already enjoyed and there’s nothing left for us in 2013. (Appendix.2). On the other hand there are number of advantages that Cuban cigars have, the main one is when Habana is made properly. Cuban trade relationships are also not very close to ideal and not every region is explored by Cuban merchants, which leaves big space for them to expand operations. Moreover, as the main beneficiaries of Cuban manufacturers’ success are Cuban socialist government, Altadis group and local cigar distributor, we will target at one of these groups. Let’s take a closer look on them. Cuban government bonds, if issued, are not that attractive, because they represent all the risks of this small and economically weak country’s economy. And these risks aren’t likely to be covered by blossoming cigar industry. The local distributors are too scattered around the main consumer countries as well with the fact that they’re mostly privately held companies, which makes an outsider investment almost impossible. So Altadis Group may seem to be the most attractive investment considering Cuban cigar industry in particular. But, is the overall industry prospective good enough for the investing? There’s not enough evidence to answer this argument, as the Cuban industry doesn’t have an access to the world’s biggest market, which accounts to almost half of world sales of cigars. This is greater than Germany, United Kingdom and France combined. Obviously such a stable and big market with its demand is the best guarantee of the future business. (Appendix 3) At the same time the Cuba’s export volumes to all of the biggest European consumers (except Spain) are not as big as they could be. (Appendix 4)
All these facts show us that Cuban cigar industry is not the best target for investment, as it has no access to the biggest market and the market itself is in correction after mid-90s boom.

Decision change on the two assumptions

* The US embargo lifts. * Land ownership laws are reformed such that foreign investors could take minority equity positions in land with cigar growing capabilities. These changes are of crucial significance for Cuban cigar industry, because the US market, as mentioned before, is the most important market. The Cuban products have excellent brand recognition around the world; the U.S. is not an exemption. Land ownership may give foreign investors an opportunity to have more control over production rates, such as make the operations easier, cheaper and faster. However, it would be more beneficial for Cuban government, as it attracts an investment from abroad thus making its economy more attractive for foreign investors. The pitfall of this new law is whether how minor these equity positions would be and what kind of influence would foreign investors have. Basically the second scenario itself alone can’t make Cuban cigar industry more attractive; however it can significantly amplify the positive effect from US embargo lift. This means that we’re more likely to make or increase our investment in Cuban cigar industry if both or only first scenario happens. The second scenario alone is not enough compelling to make investors rush into the Cuban industry.

Appendix Appendix1

Appendix 2

Appendix 3

Appendix 4