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50755 6078 STRATEGIC OVERVIEW Object ive To describe the longer term forces that affect the performance brands/companies. Relate learning to RJR's 1990's strategies.

50755 6079 STRATEGIC OVERVIEW Outline I. Market Dynamics A. Longer Term Trends B. Importance of YAS/Switchers C. Brand Performance D. Company Performance II. Strategic Issues Facing RJR III. YAS Programs A Un t i B. Marketing. Strategies I.I;i

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50755 6086 During the 1980's, brands and Savings STRATEGIC OVERVIEW Market Dynamics the largest growth brands have brands. been YAS LEADERS IN SOM GROWTH BRAND 1981 1988 Diff. Type of Brand Marlboro 18.3 24.9 +6.6 YAS 3.4 +3.4 DORAL Savings Newport Cambridge 2.2 4.4 +2.2 YAS Savings Source" MSA

STRATEGIC OVERVIEW Market Dynamics 50755 6087 Stability in longer term performance of brands is due to the mechanics of how shares change. Two market dynamics cause SOM change: Aging is the result of new 18 yearold smokers replacing older smokers who quit. Brand switching occurs as smokers change UB. Xq

50755 6088 STRATEGIC OVERVIEW Market Dynamics YAS are the only source of replacement smokers. government studies show that... Repeated Less than one-third of smokers (31%) start after age 18 Only 5% of smokers start after age 24 On an annual basis, about 800M (1.7%) adult smokers are new YAS. Conversely, about 1,500M smokers quit each year.

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STRATEGIC OVERVIEW 50755 6090 Market Dynamics Marlboro's share among smokers 18-20 is 63% while their 50 plus share is only 8%. As a result, Marlboro gains volume/share via the aging dynamic. New YAS provide 4.3 billionunits Quitters cost them only 1.45 billion units Aging benefit each year is... - 2.82 billion units - 1.02 share points Ind. Marlboro Volume I Volume 1988 Smokers 541.84 i--> 24.89 134.86 <--1 New YAS ~i~~-~ ...... ~.~-~83334.271.45 Older guitter .i.__>.=2_~.4 1989 Smokers . ~ 137.68 <

STRATEGIC OVERVIEW Market Dynamics 50755 6091 Marlboro has owned the YAS market for many years and their share is growing. This has provided a total aging gain of 7.64 share points since 1981. Marlboro Share Group 1982 1983 1984 1985 1986 1987 1988 Smokers 18-20 42.4 47.6 52.2 55.1 57.5 60.6 63.3 ~okers 50+ 5.6 6.3 6.9 7.2 7.3 7.8 8.4 Impact on SOM .87 1.52 .82 .99 1.16 1.08 1.20

50755 6092: STRATEGIC OVERVIEW Market .Dynamics Switching also has an impact on a Brand's performance, however, it is more difficult to measure. The number of switchers depends on the definition and time interval used. Switching Definition Purchase UB 90%+ Claimed UB Time Interval Month 1 vs. Month 6 Month I vs. Month 6 3..5~ 7.8% Claimed UB Any Change The tota] number of;~o~e~FW~ll~i~.__:~l~ss e i .... is probably between 1.87MM (4~)

50755 6093 STRAT EG I C OVERVI EW Market Dynamics The impact of Switching on a particular Brand's performance is usually small because its gains are nearly the same as its losses. Key reasons are: Switchers have different wants More than 70 Brands compete PERCENT OF SWITCHERS WINSTON 1984 1985 1986 1987 1988 Total Gain 12.5~ 12.1~ 11.3% 10.6I 10.1g Loss 9.3 11.2 12.2 11.6 12.6 Diff. +3.2 + .9 - .9 -1.0 -2.7 Switching -.02 -.04

STRATEGIC OVERVIEW Market Dynamics The number of potential switchers is larger than the number of New YAS. However... YAS Switchers Size 800M 1.87MM - 3.74HM Wants Similar Dissimilar Brands 2 70 Brands/Prospect 400H 27M - 53M Since Switching is hard to define and generally has less impact on performance than.Agi1., i --"-.. u..~ ..... Net Switchlng-~ To~aiIS~nge-~g~~ng

STRATEGIC OVERVIEW Market Dynamics 50755 6095 All of MarIboro's growth in the 1980's was due to its ability to attract new YAS. | Marlboro lost business as a result of switching. SOM Market Dynamic 1981 1988 Change Aging Switching Marlboro 18.32 24.89 I+6..571 1+7.(;41

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Marlboro (63%) smokers 18-20. STRATEGIC OVERVIEW Market Dynamics and Newport (12%) have dominant 50755 6097 positions among @ Marlboro is growing. Newport is flat at 12%. SHARE AMONG 18-20 1984 1985 1986 1987 1988 Marlboro 52.2 55.1 57.5 60.6 63.3 Newport 10.8 12.1 12.8 11.8 11.8 Total 75.1 Source: Tracker

STRATEGIC OVERVIEW Market Dynamics Newport is the dominant brand among Black YAS. its share over the past six years. It has doubled SHARE AMONG BLACK YAS BRAND 1981 1983 1985 1987 1988 Newport 22.4 36.4 45.0 47.8 54.4 Source: Tracker

STRATEGIC OVERVIEW Market Dynamics Newport's strengths in the Black YAS are highly regional. Dominant in NASA Growing in SASAIPMSA Weak in MCSA Area NASA SASA Newport SOS 18-20 '841'85. '871'88H 176.o 71.8..I Diff. - 4.2 40.0 71.4 1+31.41 NCSA 38.6 49.6 +11.0 MCSA MWSA PMSA 30.4 35.1 + 4.7 34.1 . .57.2 1+23.11 pa3 .poa.d 50755 6099

STRATEGIC OVERVIEW Market Dynamics 5O755 The driving force behind Marlboro and Newport's growth in the 1980's is Aging NOT switching. Key segment is the 800M New YAS Newport Switching gain may be geographic... New programs in expansion markets. SOM Market Dynamic Brand 1981 1988 Change Aging Switching Marlboro 18.3 24.9 +6.6 J+7.7J -1.1 Newport 2.2 4.4 +2.2 J+l.7J + .5 INIgNVI

STRATEGIC OVERVIEW Market Dynamics sozss 61oi. I DORAL and Cambridge have low shares among YAS and grow via switching. They have taken 5.2 share points directly from other Brands since they were introduced. SOM Brand 1981 1988 Change Market Dynamic Aging Switching DORAL - 3.4 +3.4 - 1+--~.41 Cambridge- 1.8 +1.8- 1+1.___81

The impact of Aging is STRATEGIC OVERVIEW Market Dynamics ~hanging for V. Slims and CAMEL. V. Slims used to gain via aging, but their share among YAS has declined. CAMEL lost business due to Aging in the early 19BO's, but it revised its YAS trend in 1988. Share Among Smokers 18-20 Brand 1982 1983 1984 1985 1986 1987 1988 V. Slims 6.6 5.3 4.7 5.2 3.9 3.6 2.3 CAMEL 3.2 3.3 2.6 3.3 3.1 3.2 Aging Impact

STRATEGIC OVERVIEW Market Dynamics Other major brands lose business due to both Aging and Switching. For R3R CORE Brands, about 43% of their volume loss has been due to their low appeal to YAS. SOM Market Dynamic Brand 1981 -1988 Change Aging Switching WINSTON 13.3 10.8 -2.5 -1.0 -1.5 SALEM 8.B 7.3 -1.5 - .6 - .9 VANTAGE 3.7 3.0 - .7 - .4 - .3 Sub-Total 25.8 21.1 -4.7 -2.0 -2.7 Merit 4.5 3.8 - .7 .0 - .7

STRATEGIC OVERVIEW The importance of during the 1980's. Market ing Dynamics Aging and Switching differed by Brand Aging was the driving force behind Marlboro's and Newport's growth. Key segment was 800M new YAS. DORAL and Cambridge took 5.2 share points directly from other Brands via Switching. Other Brands lost share because of Aging and Switching. Marl~or~ Ne~iort, DORAL Camb r i SALEM VANTAGE CAMEL Merit V. Slims SOM Change '88 Vs. '81 % Total Aging Switching Aging +6.57 17.641 -1.07 loo +2.18 11.6____9l + .49 78 3.35 - .04 1+3.391 0 1.75 - .03 1+1.781 0 -2.56 - . 97 -1.59 / -1.52 - .55 - .97 42% - .77 - .39 - .38 - .45 - .34 - .11 - .66 + .03 - .69 - .52 - .40 - .12 + .54 + .39 + .15 All Other -7.91 -7.03 - .88 82% CX II-Z-3 88M03302 R JR478876

5O755 COMPANY PERFORMANCE R JR VERSUS P. MORRIS

STRATEGIC OVERVIEW Market Dynamics 50755 6106 P. Morris has grown 10 share points among YAS over the past six years. All of this growth is due to Marlboro. Share Amon.,g Smokers 18-20 Company 1982 1983 1984 1985 1986 1987 1988 P. Morris 59.3 63.2 65.4 67.5 67.9 68.7 69.8 Harlboro 42.4 47.6 52.2 55.1 57.5 60.6 63.3 Other PM 16.9 15.6 13.2 12.4 I0.4 8.1 6.5

STRATEGIC OVERVIEW Market Dynamics Marlboro is the driving force behind total P. Morris success. PM barely broke even on Switching. As a company, Company growth due to Marlboro Aging gains. Cambridge gains offset the switching losses of other PM brands. SOM 1981 1988 Change Market Dynamic Aging Switching P. Morris 31.8 39.3 +7.5 l+7.3l + .2 - Harlboro 18.3 24.9 +6.6 [+7.____~l-1.0 - Cambr i dge - 1.8 +1.8 .0 I + 1 .____8 - Other PM 13.5 12.7 - .8 - .3 - ..5

STRATEGIC OVERVIEW Market Dynamics 50755 6108 RJR's share has declined among smokers 18-20 during the 1980's. However, it held flat in 1988 due to CAMEL's gain. Share Among Smokers 18-20 Company 1982 1983 1984 1985 1986 1987 1988 RJ'R 20.2 17.7 16.4 14.5 14.0 13.5 13.8 CAMEL 3.2 3.3 2.6 3.3 3.1 3.2 SALEM WINSTON Other 8.3 7.2 6.4 5.1 4.2 4.1 ~. 011Nt~)N" ~IA~~ ~.~ ~.~ ZHfH Xq po npoJd 4.1 1.6

50755 6109 STRATEGIC OVERVIEW Market Dynamics RJR SOM declined slightly during the 1980's. The switching gains of Savings Entries were not large enough to offset the aging losses of Full Priced Brands. DORAL/CENTURY more than covered theswitching losses of other RJR Brands. Based on switching alone, PMwould no__~t have caught RJR in SOM leadership. The biggest problem is Aging losses for FP Brands. Most of our FP volume loss was due to Aging since DORAL covered much of the FP Switching loss. 1981 1988 Change Market Dynamic Aging Switching RJR 33.1 31.8 -1.3 -3.2 +I. 9 - Full Priced 33.1 27.6 -5.4 -3.0 -2.4 Sav i ngs

50755 ~110 STRATEGIC OVERVIEW Market Dynamics (Back-Up) Brand WINSTON SALEM VANTAGE SOM CHG Market Dynamic '88 Vs '81 Aging Switching -2.56 - .97 -1.59 -1.52 - .55 - .97 - .77 - .39 - .38 CAMEL - .45 - .34 - .II DORAL +3.35 - .04 +3.39 CENTURY + . 77

507=35 6111 STRATEGIC OVERVIEW Market Dynamics Conclusions Aging and Switching are both important. Their importance depends on the Brand and the circumstances. Brand Time Market Dynamic WINSTON 1954-1964 Switching SALEM 1956-1962 Switching Kent 1957 Switching Marlboro 1965-Present Aging Kool 1963-1975 Aging Newport 1975-Present Aging VANTAGE i ~.7I~.~-V ~ Switching Merit Switching DORAL 1984-Present Switching Cambridge 1986-Pr~e~t Switching

STRATEGIC OVERVIEW Market Dynamics Conclusions (Continued) 2. For R3R, YAS and Switchers are important for different reasons. A. YAS • Reason for ROR's decline from 1981-88 • Main source of Full-Priced volume 50755 6112 B. Switchers • R3R gained share via switching in the 1980's • DORAL is most successful Brand at Switching YAS are better prospects for Full Priced Brands because A. No Full-Priced Brand has gained via switching...not even Marlboro B. There is less competition for YAS C. The only suc~e§stpu~..~;R~i.~.!~n~.~rpnds have been • Based on r~'=~ =~"~'~=~'', elnnlaIIo~ ~ • Favored By Externa~ ~ac~ors " || I

STRATEGIC OVERVIEW Key Issues 50755 New Strategies are needed to be successful in the 1990's because the Old Strategies weren't good enough. We lost share despite | | Very Strong Performance By DORAL Competitive Advantages From - Direct Marketing - Promotion Based on Market Dynamics and Knowledge of the Business, three directions offer the best opportunities. 1. R3R must build its share of smokers 18-20 from 141 to 40% ASAP. 2. DORAL must retain its leadership of the Savings Segment. 3. New TechnologieI~ e]~ t ced Sw Opportunities~=.~ ~.I~~ ~.~~I Pri itching - Established Brands - New Brands

CX II-Z-13 88M03312

STRATEGIC OVERVIEW 50755 6115 Key Issues Several research programs have been completed to understanding of YAS. Included are: increase YAS Studies | Opportunity Analysis i FUBYAS Presentation 2. Marlboro Analysis 3. YAS Resource Allocation Project 4. Strategic | | | | | Initiatives YAS Hispanics Blacks M ili tary iI.~" Anglo Interests

YA$ are a declining key segment is even STRATEGIC OVERVIEW Key Issues percentage of total smokers. smaller...÷he 800M New YAS However, the 50755 6116 Distribution of Smokers Age 1980 1985 1990E 18-24 18.3 15.3 13.1 25-34 23.6 26.8 22.5 3.5-49 31.1 29.1 32.3 50+ 27.0 28.8 32.1 To reach YAS, R JR mus ources.

STRATEGIC OVERVIEW Key Issues 50755 6117 Population Trends The importance of Ethnic groups is rapidly increasing. In 1990, Blacks and Hispanics will represent 181 of all adults and 25% of all younger adults. Blacks Hispanics PCT OF ALL ADULTS 198______0 1985 ~990 10.6 11.0 11.4 5.5 6.0 6.8 Tota] 16.1 17.0 18.2 Hispan ics 7.4 1 I0.1

STRATEGIC OVERVIEW Key Issues Targeted Marketing Programs have been developed for and Military YAS which will cover 30-35% of Total YAS. % OF YAS Hispanic 10% Black 15% Military 10% Ethnic YAS Targeted programs for Anglo YAS are currently based- " t . ......... segmenting them r~r.k.~. 1 ~ v .i;~[ being developed by • . ~} -- "

STRATEGIC OVERVIEW 50755 6119 Key Issues One of the most important differences between YAS and Older smokers is their purchase patterns For YAS, everyth~n.g is small. Fewer Cigarettes/Day Purchase Single Packs Use Convenience Outlets To effectively reach YAS, more emphasis is needed on: Pack promotion versus Carton Small Out

STRATEGIC OVERVIEW Key Issues YAS smoke 25 cigarettes/day compared to 311day for average smoker. the 50755 6120 RATE/DAY 1986 1987 YAS 25.8 25.7 TOTAL SMOKERS 31.2 31.1 1988 25.2 3~.7 | YAS are much more likely to buy by the pack. PACK CARTON YAS 71 71 72 2~ [ff 28 INDEX VS. TOTAL 163 50 p }3npo d

STRATEGIC OVERVIEW ' 50755 YAS tend to buy cigarettes outlets. OUTLET SUPERMARKETS Key Issues in small convenience oriented YAS 1986 1987 1988 19.6 21.2 18.9 CONVENIENCE STORES SERVICE STATIONS SUB-TOTAL 27.7 29.8 30.9 17.7 16.7 16.9 45.4 46.5 47.8 SMALL GROCERY DRUG STORES VENDING 5.6 5.8

STRATEGIC OVERVIEW Key Issues 50755 6122 The largest growth trends among smokers 18-20 are Non-Menthols packaging. The appeal for FF taste and 85MM length is.stable. SOS AMONG SMOKERS 18-20 and Box CATEGORY 1982 1983 1984 1985 1986 1987 1988 NON-MENTHOL 63.5 66.9 68.9 70.1 .72.2 73.0 76.2 MENTHOL 34.8 32.1 29.6 28.4 26.7 24.5 21.7 BOX 31.3 35.5 40.3 45.7 45.8 48.0 56.4 SOFT PACK 67.0 63.6 58.1 52.8 53.1 49.5 41.4 85MM 66.4 67.4 68.2 67.1 69.5 67.1 71.9 lOOMM+ 31.9 31.6 30.3 31.4 29.4 30.3 25.9 LT 44.4 ~3~~.~4~'~.~/~J. 43.4 44.0 55.4 42.4 Source" Tracker Xq po3npo . d

5O755 612~ STRATEGIC OVERVIEW Key Issues In order for SALEM to contribute to RJR's YAS strategy, reverse the decline of Menthols among smokers 18-20. it must 111 p anpo,td

STRATEGIC OVERVIEW 50755 6 ! 2V ,~ o-~. "1 Key Issues Marketing programs have been implemented to improve RJR's performance among YAS. 1. CAMEL, SALEM, and MAGNA 2. Pack Action Promotion Special Markets • Hispanics • Blacks • Military 4 New Brands To be successful, all resources must be integrated R JR' s YAS goals. "~I to achieve