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OBJECTIVE 5075~ I19~ THE PURPOSE OF THE PRESENTATION IS TO SUMMARIZE RESEARCH RESULTS THAT RELATE TO MARKET DYNAMICS. THE FOCUS IS: • LONGER TERM STRATEGIC FORCES How THE MARKET WORKS WHAT ISSUES ARE IMPORTANT

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BARKET OV, ERV IEW I I!DUSTRY 50753 1t97 POPULATION TRENDS FROM 1965-1978, INDUSTRY GROWTH WAS DUE TO THE BABY BUBBLE AS THE ADULT POPULATION GREW FASTER THAN SMOKING INCIDENCE DECLINED. THIS IS NO LONGER A FACTOR- As A RESULT, INDUSTRY WILL DECLINE BY i%-2% EACH YEAR. EST • LE__VEL 1965 19 70 lq 75 1980 ADIlLT POPULATION SMOKING INCIDENCE NO- OF SMOKERS RATE/DAY INDII,~TRY VOLUME 129.6 42.6 53~0 25.6 495.7 135.3 36.2 49.0 27.7 495.5 148.8 164.0 175.8 118. l 33.9 33.1 28.9 26.0 50.4 5~1.3 50.7 46.8 31 .I 30.q 31.2 31.2 572.5 601.9 578.7 528.0

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MARKET OVERVIEW ,INDUSTRY 50753 1199 POPULATION TRENDS THE BABY BUBBLE IS CURRENTLY 27-qi. DURING THE NEXT S YEARS, THEY WILL CAUSE THE 3S-~9 AGE GROUP TO GROW IN IMPORTANCE- IN I~.°~(], NEARLY TWO-THIRDS OF ALL SMOKERS WILL BE ~+- AGE DISTRIBUTION OF SMOKERS _1980 1985 1990 IR-24 18.3 15.3 13.1 25-34 23.6 26.8 22.5 35-49 31.1 29.1 32.3 50+ 27.0 28.8 32.1 PCT CHANGE -14 -16 +II +II -8-

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MARKET OVERVIEW INDUSTRY 50753 1201 POPULATION TRENDS THE IMPORTANCE OF ETHNIC GROUPS IS RAPIDLY INCREASING- IN 1990, BLACKS AND HISPANICS WILL REPRESENT 18% OF ALL ADULTS AND 2S% OF ALL YOUNGER ADULTS. PCT OF ALL ADUI.TS 1980 1985 1990 BLACKS 10-6 11-0 11-4 HISPANICS 5-S ~-0 ~ TOTAL 16.1 17-0 18-2 PCT OF 18-24 1985 BLACKS 14-4 HISPANICS ~ TOTAL 13.3 14.7 7.4 10-I 20.7 2~.s :z~. 8

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MARKET UVERVIEW I~IDUSIRY 50753 1203 SMOKER/NON-SMOKER DIFFERENCES INCOME AND OCCUPATION ARE RELATED TO EDUCATIONAL ATTAINMENT- ON AVERAGE, SMOKERS HAVE A LOWER LEVEL OF EDUCATION THAN CONSUMERS IN OTHER PRODUCT CATEGORIES. YOUNGER ADULT • FLS.RLBORO • MILLER BEER • KOOL • C~L ATTENDED TUPPERWARE .ZAYR! PA~TY • • SALEM @ GIG. I~S, RKET LOW EDUCATION ~O HOMF PE~IDSI ~ •PHILCO 'IV • WINSTON ~'- • • AOUA VELV~ OWN AVON • PRELL SILsJ~ INSTAMATIC Slb~}vPOO CAMERA • GENERICS OLDER @ V. SLIMS • PONDEROSA STEAK @ IIOUSE HARDEE' S VANTAGE D(~ESTIC 'OO CAR BUDWEISER • MICHELOB BEER MOLSON BEER • • $ HEIHEKEN BEER • II, rPORTED BEER FIARKET VIDAL SASSOON SIJAM~OO • STEAK & • • JACK DANIEL'S ALE • MERIT • ARAMIS • BEER HARKET • LIGIIT BEER HARKET BENSON & • HEDGES ESTEE LAUDER • CIIIVAS REGAL OWN CAR• GREEN FOREIGN GOURMET AHERICAN • SPECIALTY EXPRESS CARD STORE • OWN 35m~ CAMERA • MONTGOMERY WARD CREDIT CARD ! • WINE MARKET OSONY TV EDUCATION • MORE ~DULT • NON -12- • CARLTON

MARKET OVERVIEW INDUSTRY 50753 1204 SMOKERS HAVE MANY QUALITIES THAT SET THEM APART FROM NON-SMOKERS AND PRESENT POTENTIAL POSITIONING OPPORTUNITIES. NON-SMOKERS ARE MORE LIKELY TO HOLD RIGID BELIEFS ABOUT HOW PEOPLE SHOULD LIVE. ON THE OTHER HAND~ SMOKERS TEND TO BELIEVE THERE IS NO RIGHT OR WRONG WAY TO LIVE~ ONLY PERSONAL CHOICES- SMOKING ]NDE.X, VALUE AGREE DISAGREE LIBERAL SEX ATTITUDE SOCIAL PLURALISM SOURCE: YANKELOVI CH, 1979-1987 123 57 216 122 58 210 -13-

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! | CX 15-Q 87M03335 RJ~484244

MARKET 0VER~I,E.~ PERFORMANCE FACTORS 50753 1209 ~VER THE PAST FIVE YEARS, THE ONLY GROWTH BRANDS HAVE BEEN: • SAVINGS BRANDS • YOUNGER ADULT SMOKER BRANDS L.EA.D.ERS I N. _S.0M .GROWTH 1987 BRAND 1982 (.ES, T. ) MARLBORO ~[0.23 23 -67 DORAL --- 3 .I[I GENERICS .95 3.85 NEWPORT 2.42 4.00 CAMBRIDGE --- I CENTURY --- • 76 RICHLAND --- VIRGINIA SLIMS 2.(19 3.0~I PLAYERS LTS. -'- SOURCE: MSA DIFF • [I .~4 3.1[I 2.90 1.58 1.20 • 76 .55 .30 -18-

50753 1210 MARKET O,V.ERV IEW FACTORS AFFECTING PERFORMANCE AGING/YOUNGER ADULT SMOKERS SWITCHING/EXTERNAL ISSUES -lq-

MARKET OVERVIEW PERFORMANCE ,FACTORS 50753 1211 STABILITY IN LONGER TERM PERFORMANCE OF SEGMENTS/BRANDS IS DUE TO THE MECHANICS OF HOW SHARES CHANGE- TwO MARKET DYNAMICS CAUSE S0M CHANGE: • ~ IS THE RESULT OF NEW 18 YEAR OLD SMOKERS REPLACING OLDER SMOKERS WHO QUIT. • BRAND SWITCHING OCCURS AS SMOKERS CHANGE UB. EXAMPLES: MARKET DYNAMIC ANNUAL IMPACT ON S0M PALL MALL MARLBORO • AGING (-25) 1-01 I SWITCHING "_~ TOTAL (,36)

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MARKET OVERVIEW PE REORMANC I~ .FACTO RS 50753 %Z14 MARLBORO (51%) AND NEWPORT (14%) HAVE DOMINANT POSITIONS AMONG SMOKERS 18-20. THEY ARE FORCING OTHER BRANDS TO COMPETE FOR A LIMITED SUPPLY OF SWITCHERS- SHARE A~QNG 18-20 1ST HALF IST HALF 1987 I984 1985 !986 ,, 1987 TOTAL SMOKERS MARLBORO NEWPORT TOTAL RJR • CAMEL • WINSTON • SALEM SOURCE: TRACKER 52.2 55.1 57.5 60.6 23.3 63.0 67.2 70.3 /4.2 27.3 16.~ Iq.5 14.0 12.q 31.8 2.6 3.3 3.1 2.4 4.0 4.q 3.6 3.6 4.1 I0.1 6.4 5.1 q-2 3.8 8.5

tlARKET 0VERY IEW PERFORMANCE FACTORS 50753 1215 ~INLESS RJR Is ABLE TO IMPROVE PERFORMANCE AMONG YOUNGER ADULT SMOKERS, IT WILL BECOME INCREASINGLY DIFFICULT TO ACHIEVE VOLUME/EARNINGS GROWTH- ON AN ANNUAL BASIS, RJR LOSES ABOUT 0-3 SHARE POINTS DUE TO LOW APPEAL AMONG 18 YEAR OLD SMOKERS. SHARE NUMBER POINTS* SMOKERS AGE 18 RJR FAIR SHARE (33%) RJR ACTUAL SHARE (12%) LOST OPPORTUNITY BASED ON S0 MM SMOKERS 800 M 1.60 26q M 0.53 96 M 0.19 168 M -2,-

MARKU OVERVIEW PEREORMANC.E FACTORS 50753 1216 IN ORDINARY CIRCUMSTANCES, BRAND LOYALTY IS THE DRIVING FORCE AFFECTING BRAND PERFORMANCE. HOWEVER, EXTERNAL EVENTS HAVE MAGNIFIED THE IMPACT OF SWITCHING- • S&H PUBLICITY • 1983 FET -25-

MARKET OVERVIEW PERFORMANCE,FACTORS 50753 1217 MAJOR CHANGES IN S0M OF CONCERNED SEGMENT BRANDS HAVE OCCURRED DUE TO EXTERNAL S&H PUBLICITY- • KENT WAS NAMED LOWEST IN T&N BY READER'S DIGEST IN 1957. • CARLTON CITED AS LOWEST BY READER'S DIGEST AND GORI IN MID 1970'S- THE S0M OF THESE BRANDS QUICKLY INCREASED. RECEIVED LITTLE BENEFIT- BEING LOWEST WAS ALL THAT COUNTED SINCE #2

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MARKET OVERVIEW PERFORMANCE FACTORS 50753 1220 IN lqR3, THE FET DOUBLED PROVIDING SAVINGS BRANDS WITH A SALES BOOST. SINCE iq83, PRICE INCREASES HAVE CONTINUED TO FUEL GROWTH FOR SAVINGS BRANDS-

MARKET, 0V.ERV IEW PERFORMAN.CE~ FACTORS 50753 1221 I NTERP RETAT I ON NORMALLY, THE LEVEL OF SWITCHING IN THE MARKET IS QUITE LOW- NEARLY ALL SMOKERS ARE SATISFIED WITH THEIR UB- IN THIS SITUATION~ LOYALTY DRIVES BRAND PERFORMANCE AND YOUNGER ADULT SMOKER BRANDS BUILD THEIR EXTERNAL EVENTS DRAMATICALLY MAGNIFY THE SWITCHING INTEREST AND RELEVANT BRANDS QUICKLY CAPITALIZE- ONCE THE PUBLICITY STOPS, SWITCHING FLOWS RETURN TO NORMAL. IF EXTERNAL EVENTS RAISE ISSUES THAT NO EXISTING BRANDS CAN ADDRESS~ THEN SWITCHING , INTEREST BUILDS. THE FIRST BRAND TO ADDRESS THiS WANT TAP~ ~HIS PENT-UP SWITCHING POOL- -30-

MARKET OVERVIEW PERFORMANCE FACTORS OTHER EXTERNAL FACTORS HAVE THE POTENTIAL TO AFFECT THE CIGARETTE MARKET. SMOKING RESTRICTIONS SOCIAL UNACCEPTABILITY

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MARKET OVERVIEW PERFORMANC~ FACTORS 50753 1225 IN THE PAST~ EXTERNAL EVENTS HAVE MAGNIFIED SWITCHING OPPORTUNITIES THAT EXIST IN THE MARKET- RJR NEEDS TO HAVE CONTINGENCY PLANS TO ENSURE THAT IT IS NOT ADVERSELY AFFECTED BY EXTERNAL FORCES. INCLUDED ARE: • S&H PUBLICITY • PRICE INCREASES • SOCIAL UNACCEPTABILITY

50753 1226 MARKET OVERVIEW BRAND FAMILY MARKETING -35-

MARKET OVERVIEW ~RAND FAMILY. 50753 1227 IN THE LONG TERM, PERFORMANCE DEPENDS ON THE TOTAL BRAND FAMILY RATHER THAN INDIVIDUAL STYLES. BRAND FAMILIES GO THROUGH LIFE CYCLES OF GROWTH~ MATURATION~ AND DECLINE- THESE CYCLES ARE VERY RESISTANT TO CHANGE~ INCLUDING LINE EXTENSIONS- LINE EXTENSIONS CAN: SPEED GROWTH • EXTEND PEAKS • SLOW DECLINES

50759 1228 WINSTON CUMULATIVE SHARE 16 14 12 10 8 6 4 2 0 1954 1959 1964 1969 1974 1979 1984 -37-

50753 1229 12 KOOL CUMULATIVE SHARE 10 0 1950 1955 1960 1965 1970 1975 1980 1985

50753 1230 SALEM CUMULATIVE SHARE 1°t 0 1956 1961 1966 1971 1976 1981 1986

50753 1291 VANTAGE CUMULATIVE SHARE 5 2 1 0 1970 1975 1980 1985

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MARKET OV.ErV IEW B RAND FAM I SINCE BRAND FAMILY POSITIONING REQUIRES A LONG-TERM COMMITMENT, IT IS A LONG TERM STRATEGIC ISSUE- IN ADDITION, OTHER CONCERNS AND PRIORITIES CAN EASILY DIVERT ATTENTION FROM BRAND FAMILY GOALS. VOLUME BUILDING PROGRAMS DO NOT ALWAYS CONTRIBUTE TO BUILDING A BRAND'S IDENTITY- LINE EXTENSIONS DISTRACT ATTENTION FROM THE PARENT BRAND. AS A RESULT., MAINTAINING A STRONG EMPHASIS ON BRAND FAMILY POSIT.IONING STRATEGIES NEEDS TO CONTINUE TO BE A HIGH PRIORITY IN ALLOCATING MARKETING RESOURCES.

CX 15-Z-20 RJR48427~ 87M03363

MARKET OVERVIEW SAVINGS S~GMENT 50753 1237 THE SAVINGS SEGMENT HAS GROWN STEADILY TO AN 12% S0M IN NIELSEN FOOD STORES- AT THIS RATE (PLUS POTENTIAL FET INCREASE), S0M COULD REACH 20-25% BY 1990. 12 SAVINGS NIELSEN MONTHLY FOOD DATA S.~,LE$ UHITS SHARE 10¸ 4 1984, 198,5 1986. 1997 1988

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i :Z CX 15-Z-24 o -4 RJR484276 87M03367

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CX 15-Z-26 0 R JR484278 87M03369

MARKET OVERVIEW SAVINGS SEGMENT 50753 124~ INCOME TOTAL UNDER $15K $15K-$25K $2SK-$50K $50K PLUS EDIJ CAT I ON 1983 SAVINGS SEGMENT S0S 1984 198_____~5 1986 IST HALF 198/ 1.1 1.5 1.0 2.1 3.0 4.3 5.9 2.8 4.3 6.3 7.9 2.1 2.8 4.4 5.7 2.2 3.1 5.2 1.5 1.4 2.0 2.9 SAVINGS SEGMENT S0S 1983 1984 1985 1986 IST HALF 1987 TOTAL I .i 2.1 3.0 4.3 5-9 GRADE SCHOOL 4.5 6.3 8.7 1.1 2.3 HIGH SCHOOL 3.2 {I.7 6-5 COLLEGE i .0 I .8 2.4 3 -5 4-4 SOURCE : TRACKER

MARKET OVERVIEW .SAVINGS SEGMENT 50753 1244 THE DIARY PANEL PROVIDED A MEASURE OF SHARE GROWTH (VOLUME) OF THE SAVINGS SEGMENT- SOURCE APR- MAY DIARY PANEL 7-9 8.2 S0M JUNE JULY AuG. ~ OCT. Nov. CHANGE 8.6 9.2 9-6 10.3 10-6 10-3 +2-4 SOURCE: 1986 DIARY PANEL

~ARKET OVERV |EW SAVINGS SEGMENT 50753 1245 ~N AVERAGE, 16~ OF ALL SMOKERS PURCHASED A SAVINGS BRAND EACH MONTH FROM APRIL TO NOVEMBER. THE PURCHASE TREND WAS FLAT. THUS, S0M Is CAPPED BY 16% BASED ON CURRENT PURCHASE DYNAMICS. APR- _MAY J U N_____~E JULY ~ SEP. OCT. NOV. PCT. RIIYING SAVINGS iR .2 15 .q 15 .q 15.9 16.3 15.8 16.2 14.6 SOURCE: 1986 DIARY PANEL

MARKET 0VERV IEW SAVINGS SEGMENT 50753 THE ,SAVINGS SEGMENT GROWTH HAS BEEN DUE TO BUYERS (16%) GENERATED MORE VOLUME (10%)- BONTH PCT BUYING SAVINGS INCREASED REPEAT APRIL 18.2 7.9 ~AY 15 .~I 8.2 JUNE 15 -9 8.6 JULY 15.9 9.2 AUGUST 16.3 9 .6 SEPTEMBER 15'-8 I0.3 OCTOBER 16.2 10 -6 NOVEMBER 14 -6 10 -3 PURCHASE- REPEAT 43.4% 53.2 54.1 57.9 58.9 65.2 65.4 ~.5 THE SAME NUMBER OF SOURCE; 1986 DIARY PANEL

MARKET 0VERY IF~ SAVINGS S EG_MENT 50753 1247 OCCASIONAL USE OF SAVINGS BRANDS CONTINUES TO BE HIGH- HOWEVER, THE SEGMENT'S GROWTH IS DUE TO CONVERSION TO USUAL BRAND (UB) STATUS. GROWTH POTENTIAL BY CONVERTING OCCASIONAL BUYERS EXISTS- OCCASIONAL USE VOLUME ALSO REPRESENTS A VULNERABILITY. SH~R~ POINTS TOTAL UB 0cc- ~ 0CCASIONA~ APRIL 7.9 3.0 4.9 63% MAY R.2 3.7 4.4 54 JULY 9.2 q .2 5.0 5tl AUGUST 9 -6 4 -6 5.1 53 SEPTEMBER 10.3 5.3 5.0 48 OCTOBER 10.6 5.7 4.9 .41 N OVEMBE R 10-3 S. 8 4.6 44 SOURCE: 1986 DIARY PANEL

MARKET OVERVIEW SAVINGS SEGMENT ~07~ REPEAT LEVELS FOR GENERIC PRICED BRANDS ARE CONSISTENTLY HIGHER THAN VALUE ADDED 25'S- THIS REFLECTS~ MORE SINGLE MINDED POSITIONING. • A MORE FOCUSED PROMOTION/MERCHANDISING STRATEGY. REPEAT* LEVEKS BRAN~ APR. MAY JUNE J.~LY AUG. SEe. OCT- Nov. DORAL 55 65 60 69 69 69 71 72 PRIVATE LABEL 5R 70 55 64 55 75 68 79 GENERIC 48 57 55 57 54 56 61 60 CAMBRIDGE 39 22 24 25 32 43 43 57 CENTURY 29 40 31 39 39 45 42 50 RICHLAND 24 28 24 30 29 34 34 q6 PLAYERS LTS 19 27 21 34 43 54 50 51 *SOM PURCHASE

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Y~EY ISSUES YOUNGER ADULT, .SI~oKERS 5075~ 125~ RJR NEEDS TO IMPROVE PERFORMANCE AMONG YOUNGER ADULT SMOKERS IN ORDER TO ENSURE IT CAN CONTINUE TO MEET VOLUME/EARNINGS GOALS IN THE FUTURE• RAT I ON ALE ITS LOW S0M (12%) AMONG SMOKERS AGE 18-20 EXERTS A STEADY DOWNWARD PRESSURE OF ABOUT 0.34 SHARE POINTS PER YEAR- As A REStlLT~ • SHORT TERM VOLUME PROGRAMS MUST OVERCOME THIS WEAKNESS• • DEMAND FOR RESOURCES HAS BEEN INCREASINGLY ALLOCATED TO SHORT TERM NEEDS. • LONG TERM PROBLEMS INCREASE. STRATEGI ES/ACT I 0NS i. RJR MUST ENSURE THAT SUFFICIENT RESOURCES ARE ALLOCATED TO YOUNGER ADULT SMOKERS PROGRAMS -- IDENTIFYING OPPORTUNITIES AND SUPPORTING THEM. MORE TARGETED OPPORTUNITIES AMONG YOUNGER ADULT SMOKERS MAY ALSO EXIST. SUB-GROUPS THAT ARE GROWING ARE: • LESS EDUCATED • HISPANICS • FEMALES • BLACKS KEY WITHIN THE EXISTING PLANS, THE BEST OPPORTUNITIES MAY BE: • IMPROVED SMOKING ENJOYMENT • AN IMAGE ORIENTED SAVINGS BRAND 0 CREATIVE USE OF PROMOTION • CONVENIENCE STORE PROGRAMS -62-

KEY ISSUES EXTERNAL EVENTS RJR MUST THOROUGHLY UNDERSTAND AND BE PREPARED TO CAPITALIZE ON EXTERNAL EVENTS WHICH COULD AFFECT THE BUSINESS- 50753 1254 RATIONALE: EXTERNAL EVENTS HAVE PROVIDED MAJOR NEW/ESTABLISHED BRAND OPPORTUNITIES IN THE PAST BY MAGNIFYING SWITCHING, MANY EXTERNAL CHANGES ARE EXPECTED OVER THE NEXT 5 YEARS INCLUDING: • SgH PUBLICITY • SOCIAL UNACCEPTABILITY • TAX INCREASES STRATEGIES/ACTIONS= I, STRATEGIC RESEARCH WILL MONITOR EXTERNAL EVENTS WHICH COULD AFFECT THE BUSINESS. 2- COMPLETE ACTION PLANS SHOULD BE DEVELOPED FOR EACH ;i! :.ii~ EXT~:RNAL ISSUE TO ENSURE THAT RJR CAN CAPITALIZE ON THEM IF THEY OCCUR, WE MUST BE .EJ__R.~..~.,

50753 1255 KEY ISSUES SAVINGS GROWTH RJR MUST ESTABLISH A STRATEGY THAT ENSURES THAT IT HAS A DOMINANT POSITION IN THE SAVINGS SEGMENT. RAT 10NALE: THE SAVINGS SEGMENT IS LIKELY TO GROW TO 14-16% AND IN THE EVENT OF ANOTHER FET INCREASE, ITS SHARE COULD EXCEED 20% BY 1990. DORAL WILL PROBABLY BE THE DOMINANT BRAND~ IF IT IS ABLE TO RESIST EXISTING COMPETITORS- LONGER TERM, DORAL WILL PROBABLY FALL IN A MID-PRICED TIER. IF NEW TECHNOLOGIES ARE DEVELOPED WHICH ALLOW MAJOR REDUCTIONS IN COST, A LOWEST PRICE TIER WILL PROBABLY DEVELOP. IF IMAGERY DOES BECOME A FACTOR~ IT WILL OCCUR AMONG YOUNGER ADULT SMOKERS. AS A RESULT, SHARE GROWTH OF SUCH A BRAND WILL BE A SLOW BUILD. STRATEGIES/ACtIONS,: 1. RJR SHOULD ENSURE THAT DORAL RETAINS ITS LEADERSHIP POSITION. NEW BRANDS SHOULD FOCUS ON: SUB-GENERIC PRICED ENTRY. IMAGE ORIENTED BRAND-

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