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507Z0 ~540 SMOKER DYNAMICS • MarkeL Overview • Perspective on Issues Ul D£Hr~= Xa oo3npoad CX 37-A

50720 0t541 MARKET OVERVIEW Ob~ectlve The purpose of the presentation ts to summarize research results that relate to Market Dynamics. The focus is.on: • Longer term strategic forces • How the market works • What issues are important INIgNVI , Ill ' _ CX 37-B _ ,.

5072'O 154Z HARKET OVERVIEN Outline Industry performance Factors affecting brand performance - AgtnglYAS - SwtLchinglExLernal Forces YAS Research/Programs External Forces Savings Segment Socia] Unacceptabl]Ity IN~IgNVI~ 3ZHf8 ~q pa3npoad CX 37-C

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50720~|545 HARKET OVERVIEW Industry Population Oygamtcs The growth of industry volume in the past was a direct dynamics. result of population The adult population Increased significantly as the baby bubble turned 18. The increases in populatlon were large enough to offset decllnes in smoklng incidence. • As lighter smokers left the market, average consumption rose. These dynamics produced a stable base of smokers and growth of Industry volume. INI DNVIA , tll CX 37-F

MARKET OVERVIEW Population Oynamic~ Industry Ave. 1965 1970 1975 1980 AdulL PopulakJon (NH) 124.6 135.3 148.8 164.0 + Smoking Incidence (~) 42.6 36.2 33.9 33.1 - 7.9 No. of Smokers (MM) 53.0 49.0 50.4 54.3 + 1.0 Rate Per Day 25.6 27,7 31.1 30.4 + 6.1 Industry Volume 495.7 495.5 572.5 601.9 + 6.9 INIgNVIN [II DZH.fH £q poanpoad CX 37-G

HARKET OVERVIE~ Industry Population Oynamtcs In the future, Indust.ry volume and the number of smokers w~11 decline. • Populatton growth w111 be slower because the youngest members of the baby bubble are now 18 or older. • Smoking Incidence wtll conttnue to decltne. • Rate per day ts expected to be stable. NI~)NVI~ 111 ~LHI"H/fq po:~npoad CX 37-H

,I HARKET OVERVIE~ Industry 1548 Popular|on Dynamics Adult Population (HH) Smoking Incidence (g) No. of Smokers (HH) Rate Per Day Industry Volume 1980 1985 1990 164.0 175.8 178.7 33.1 28.9 26.0 54.3 50.7 46.8 30.4 31.2 31.2 601.9 578.7 528.0 Pct Chg. 90 vs. 85 + 1.6 - 10.0 - 7.7 0.0 - 8.8 Nil DNiVIN [II D£HI'H ~fq poanpoad CX 37-I

MARKET OVERVIEW | 507:Z0 1549 Industry Key Trends The baby bubble is currently 27-41. cause the 35-49 age group to grow. During the next 5 years DIST. OF SMOKERS AGE 1980 1985 1987 18-24 18.3 15.3 13.7 25-34 23.6 26.8 27.9 35-49 31.1 29.1 30.0 50 PLUS 27.0 28.8 28.3 they will INIONVI~ DZHI'H Xq poanpoad, CX 37-J

HARKET OVERVIEW Key Trends Industry Females have become more important tn the cigarette market because smoking Incidence has declined less among women than among men. SMOKING INCIDENCE 1965 1970 1975 1980 1985 1987 Total 42.6 36.2 33.9 33.1 28.9 27.3 Males 51.4 42.1 38.9 37.1 31.2 29.8 Females 34.3 30.7 29.2 29.5 26.7 25.0 DISTRIBUTION 1965 1970 1975 1980 1985 1987 Male 58 56 55 53 52 52 Female 42 44 45 47 48 48 I I )NVIA[ tll 3ZHfH Xq paanpo:[d - CX 37-K

MARKET OVERVIEW Industr~ Key Tren.ds The |mportance of ethnic groups ts rapidly increasing. In 1990, Blacks and Htspantcs will represent 18~ of all adults and 25~ of all younger adults. PCT OF ALL ADULTS 1980 1985 1990 Blacks 10.6 11.0 11.4 Hlspantcs 5.5 6.0 6.___~8 Total 16.1 17.0 18.2 PCT OF 18-24 1980 1985 1990 Blacks 13.3 14.4 14.7 Htspantcs Total 20.7 22.5 24.8 LII DZHfH Xq paanpoad CX 37-L

507~Z0 ~55Z MARKET OVERVIEW Industry Key Trends Smoking incidence is highest among downscale consumers and tt has also declined less among this grouP. Soclo-Economlc Status Smoking Incidence 1974 1980 1986 Lower 38 39 Middle 38 36 Upper 34 32 34 30 25 Education High School or Less 38 37 Some College Plus INI~)N~V~IAI 32 25 Source" Yanke|ovtch [|| CX 37-M

! ~07:~0 HARKET OVERVIEW Industry Key Trends The ctgarette market ts less educated than average and much more downscale than oEher produce caEegortes. The average smoker has Ehe same level of educatton as customers of Zayre, Hardee's, Aqua Velva, and Avon. • B&H smokers have same education as Sears customers. INI~NVIA~ ~ 111 : D~LHf~I ,(q paanpoad CX 37-N

5o7zb 1554 HARKET OVERVIEN INDUSTRY • HILL[S • U/NSTON • C~[L ATTENDED TUPPER~ARE . ~:ATRI PAPTV • O SAI,EH 9 ClC. HARK[I - / • • PII ! I.CO TV I IHSTJUIATIC SILAJ,oPo0 C~ERA ~ |[.[E HOLSOII REEl O • e IIEIllEEEII SEER • llg'ORTED JEER HAERET ,o v. SLIHS Igl)i~lSf.ll • VlDAI. SASSOOII SIIAI4POO • STF.~ & • • JAClL DANIEL°S • HER/T • ARAHIS • SEER O LICIIT BE[IL HAIILI[T O PO.DEROSA STEAK • • I|OUSE |[HSOil ~ FSTFIr LAUDrJ~ VAHTAGE • I~H • HOHTCOflERT VINE I)C~IF.ST IC WAR• CRI"DIT I~ANKL'T U• CAR CARD • CIIlVAS fECAL CR[[II FOILEIGH CAR• GOUIU~[T A)IERICAN • SrECIALTT [XrR[sS CARD STORE O O~ 3Sam CA/~IIA • • sotrf TV • -,, tl.l+ CX 37-0

MARKET OVERVIEW 507Z0 1555 Industry Marketing Relevance 1. With declining volumelsmokers, marketing resources will be staolel declining. 2. Each smoker will be more valuable and harder to reach. In 1965, 431 of adults smoked compared to 29~ tn 1985. This places a premium on... • Effective positioning • Targeted programs 3. R3R needs to be sensitive to the growing gap between well educated marketers/advertisers and the less educated smoker. INII NVIA[ UI DZHFH Xq paanpoad CX 37-P

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- 507Z0 f557 HARKET OVERVIEW Performance Factors Longer term trends tn the cigarette market are very stable. Examples: • WINSTON • Kool • SALEM • VANTAGE INI~NVIA 3&HFH Xq pa3npoad CX 37-R

507Z0 1558 14 12 10 6 4 2 0 1954 WINSTON CUMULATIVE SHARE 1959 1964 1969 1974 1979 INI 1984 III II CX 37-S

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J SALEM CUMULATIVE SHARE 10 8 6 4 2 0 , DJIIFH ~q po3npoad CX 37-U

4 VANTAGE CUMULATIVE SHARE 2 0 1970 1975 1980 INID NV~ 1985 [II DJ~~I.F~I ~fq paan-poad CX 37-V

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| 507Z0 1563 HARKET OVERVIEW Performance Factors YAS are the only source of replacement s~okers. sLudtes show that... Repeated government • Less than one-third of smokers (31g) start after age 18 • Only 5g of smokers start after age 24 On an annual basis, about 800M (1..7g) adult smokers are exactly 18. Converse]y about 1,500H smokers quit each year. INIDNVIA HI ZHfH po: npoad CX 37-X

NARKET OVERVIE~ Performance Factors Stabtltty in longer term performance of segments/brands ts due to the mechanics of how shares change. Two market dynamics cause $OH change: • Agtn~ ts the result of new 18 year old smokers replacing older smokers who quit. • Brand switching occurs as smokers change UB. Ul • D~L~I f~l ~q paanpo:[d CX 37-Y

_ _ _ II I III mull ...... • 50720 1565 HARKET OVERVIEN Performance FacLors Examples: HarkeL Oynam|c • Aging • SwiLchlng TOTAL Annual Impact on SON Pall Mal 1 Marlboro (.25) 1.01 (:36) .90 CX 37-Z-i

507Z0 |~ MARKET OVERVIEW Performance Factors Aging explains 75~ of all movement The impact of aging is highly predictable over many years. performance trends are so stable. in $OM ... IncIudlng: A11 of MarlborolNewport growth The bulk of the decllnes of older brands such as Pall Ma11, Viceroy, Kent, etc. This is why INIONVI Ul 3£ 1f I Xq pa3npoad I CX 37-Z-2 .....

MARKET OVERVIEW Performance Factors 50720 1567 Har|boro (61X) and Newport (12~) have 18-20. They are forcing other brands switchers, dominant postL|ons among smokers to compete for a limited supply of Marlboro Newport Total SHARE AMONG 18-20 1984 1985 1986 1987 52.2 55.1 57.5 60.6 10.8 12.1 12.8 11.8 63.0 67.2 70.3 72~4 1st Half 1988 Total Smokers 23.5 4.2 27.9 RJR • CAMEL • WINSTON • SALEM 16.4 14.5 14.0 13.5 2.6 3.3 3.1 3.2 4.9 3.6 3.6 3.3 Source" Tracker HI 3ZHfH paanpoad CX 37-Z-3 31.4 4.0 10.3 8.8

507Z0 156~ HARKET OVERVIEW Performance Factors Newport |s the domtnant brand among Black YA$. over the past stx years. It has doubled it's share RJR's share of Black YAS has sl|pped from 22.4~ to 15.8X. SHARE AHONG BLACK YA5 BRAND 198__._~I 198~3 1985 198_~7 Newport 22.4 36.4 45.0 47.8 SALEM 19.2 13.6 12.2 10.5 Kool 30.8 21.8 16.1 11.6 RJR 22.4 17.5 15.2 15.8 Source" Tracker INIDNVIA~ Ul DJ~H I'H Xq pa:,npoad CX 37-Z-4

HARKET OVERVIEW Performance Factors On an annual basts, R3R loses nearly 0.6 .share points due to tLs development among YAS and large shares among older smokers. Smokers Age18 Qutts No. Share* No. Share* ToLal 800H 1.67~ 1,500N 3.13~ R3R Fatr Share 248 0.52 465 0.97 R3R AcLual 104 0.22 600 1.25 NeL Loss 144H 0.30 135H 0.28 * Based on 481~1 smokers [ii 3ZH.fH paanpoJd CX 37-Z-5

! 50720 |570 HARKET OVERVIEW Performance Factors Unless R3R |s able to improve performance among YAS, tt will become increasingly dtfftculL to achieve volume/earnings growLh. INIgNVI 111 -- , CX 37-Z-6 ..... , ,,,

'507Z0 I571 NARKET OVERVIEW YAS Programs Several research programs have been completed to |ncrease understanding of YAS. Included are: 1. YAS Studies Opportunity Analysts FUBYAS Presentation 2. Harlboro Analysis 3. SLrategic Inttlatlves • YAS • Hispanlcs • Blacks • ] t jc... DZHfH Xq paanpoJd CX 37- 7,- 7

HARKET OVERVIE~ ! 507Z0 157Z YAS Programs Harkettng programs have been Implemented to tmprove R3R's performance among YAS. 1. CAHEL, SALEH, and HAGNA 2. Pack Action Promotion 3. Special Harkets • Hispanlcs • Blacks 4. Project Delta IN[I~NIVIN 111 DZHFH ~(q paanposd CX 37-Z-8

MARKET OVERVIEW .! 507Z0 1573 In ordinary circumstances, brand.performance. Performance Factors brand loyalty is the drtvtng force affecting Smokers give 90% of their volume to their usual brand 58% of smokers buy only thetr U8 - not even one cigarette of a non-UB was purchased over 6 months. Hany smokers stay with thetr ftrst UB Current Age ~ Sit11 With First Usual Brand 18-24 48~ 25-34 32 35-49. 13 50 PLUS 10 33,HfH Xq pa3npoJd CX 37-Z-9

507Z0 1574 MARKET OVERVIEW Performance Factors Opportunities exist to attrack switchers stnce 3~-4~ of smokers swttch brand 1oyallttes tn a year. However... Many brands compete for switchers Substantial one-way switching flows are rare PERCENT OF SMOKERS WHO SWITCH* TIME PERIOD (MONTHS) 1 2 3 4 5 0.5 1.0 1.5 1.9 2.2 ProJ. 12 mos. 3~-4% Buy Brand X as UB 90% and switch to buying Brand Y as UB 90~. • 3£Hl" I Xq paanpoJd --' CX 37-Z-I0 ...................

507Z0 1575 MARKET OVERVIEW Performance Factors External events have the ability to magnify switching interest in brand propositions that are relevant. S&H Publicity Price Increases Smok|ng Restrictions INIONVI~ 111 • D~LHfH Xq pa~npoad ,,, CX 37-Z-II .......

50720 ~576 NARKET OVERVIEW Performance Factors HaJor changes tn SON of concerned segment brands have occurred due to external S&H publicity. Kent was named lowest tn T&N by Reader's Dtgest tn 1957. Carlton cited as lowest by Reader's Digest and Gori in mid 1970's. The SON of these brands quickly increased. counted since #2 received l|ttle benefit. Being lowest was all that INI NVIA[ Ill D LHfH paanpoJd "' CX 37-Z-12

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50720 J57S HARKET OVERVIEW Performance Factors Interpretation Norma]ly, the ]eve] of switching tn the market smokers are satisfied with their US. In this sttuatlqn, loyalty drives brand performance and younger adu|t smoker brands but]d their SOH's. External events dramatically magnify the switching interest and relevant brands quickly capitalize. Once the publicity stops, switching flows return to normal. If exLernal events raise issues that no extsttng brands can address, then switching interest builds. The first brand to address this want taps this pent-up switching pool. INIDNVI Ill DZHfH Kq paanpoad CX 37-Z-15

507Z0 I~0 HARKET OVERVIE~ Savings Segment O O Sales Trends Demographics Purchase Dynamtcs INI~)NVI~ DZHFH ,Xq po;~npoad CX 37-Z-16

MARKET OVERVIEW Savlngs Segment 507Z0 |58| In 1983, the FET doubled providing Savings brands with a sales boost. Since, 1983 price brands. increases have continued to fuel growth for savings INIDNVIA~ [II D.LHFH Xq pa3npoad CX 37-Z-17

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MARKETING OVERVIEW .! 507Z0 1583 Savings Segment Nearly all ~f the savtngs growth is due to branded savtngs 20's. - DORAL - CAMBRIDGE Generics are declining. Value-added 25's are flatldecltn|ng. INIDNVIA[ DZHfH Xq paanpoad CX 37-Z-19

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507~0 ~586 HARKET OVERVIE~ Savtngs Segment The savings segmenL has grown among all demographic groups; however,, its largesL shares are among: • Older smokers • Downscale smokers ~ INI[)NVIA~ ~ ill : • ~£HfH ~q po.~npoad ...... CX 37-Z-22

Age Group Total ~8-24 25-34 35-49 ~0 Plus Sex Source" Total Male Female Tracker __ ,,,. _, J__ IIII II MARKET OVERVIEW Savings Segment Savings ,Segment SOS 1983 1984 1985 1986 1987 1.1 2.1 3.0 4.3 6.1 .4 1.1 1.1 1.6 2.7 .8 1.6 2.2 3.7 4.7 1.2 2.2 3.6 4.5 7.1 1.4 2.9 4.0 6.1 7.9 Savings Segment SOS 1983 1984 1985 1986 1987 1.1 2.1 3.0 4.3 6.1 1.1 2.2 2.9 4.0 5.6 ~.OlN~OD N,V-I~ [II 3ZH fH £q p~3npoad CX 37-Z-23 ! 507Z0 15e7

HARKET OVERVIE~ Savings Segment 50720 Income 1983 1984 Total 1.1 2.1 Savings Segment SOS 1985 1986 1987 3.0 4.3 6.1 Under $15K 1.5 2.8 4.3 6.3 8.5 $15K-$2,K 1.0 2.1 2.8 4.4 6.3 $25K-$50K ) ] 2.23.15.0 $50K Plus .7 1.5 1.4 2.0 2.4 EducaLion Savings SegmenL SOS 1983 1984 1985 .1986 1987 Source" ToLal Grade School High School College 1.1 2.1 3.0 4.36.1 ~ 1.1 ?2.3 4.5 6.3 9.4 3.2 4.7 6.6 Tracker ill 3£HFH poanpojd -- CX 37-Z-24 ............................

MARKET OVERVIEW Savings Segment During 1986, purchase of savings brands was stable at 16~ per month. However, the number of purchasers of savings brands has declined to 12~ in 1988. Pct Buying Savings 12 8 4 A M 3 J A S 0 N LIIM .l .l A S 0 N D .l 1986 1987 ~~ 3 L}I[ I. Xq pa3npoad F MAM 1988 -- ,,,, CX 37-Z-25

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MARKET OVERVIEW Savings Segment As brand loyalty to savings brands increases, volume due to occaslona| usage has declined. Currently, about 90% of savings brand volume is due to smokers with a savings UB. 70 6O ~0 40 30 • 20 10 Ill ' A M 3 3 A S.- 0 N M 3 3 A S 0 D 3 F M A H CX 37-Z-27

507Z0 159Z HARKET OVERVIE~ Savings Segment Summary 1. The savings segment has grown steadily since the 1983 FET. ,Hanufacturer prtce increases and state taxes have fueled the growth. • Segment skews o]der/downsca]e. • DORAL and Cambridge are leading brands. 2. The segment is expected to level out soon because... • Purchase levels fall between 12~ and 16~. • Increases in repeat purchase have driven SON growth. 3. An additional FET could increase potentta! to 20~. = INIDNVI~ , HI 3ZHI'H A;q paanpoad CX 37-Z-28

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HARKET OVERVIEI~ Restrictions Smoking Restrictions Laws that restrict publlc smoking have increased greatly and the support for such restrictions is also growing, especially since 1983. Strongly Approve 1977 1979 1981 1983 1985 1987 Ban in Supermarkets 37 37 36 38 44 50 6an on Air]tnes 30 34 32 40 46 Restrict at Travel ~ermtnals 43 40 44 40 42 50 Restrict in Restaurants 41 46 46 50 55 58 Restrict in Offices Source: Yanke]ovich II| DZHfH paanpoad CX 37-Z-30 38

MARKET OVERVIEW Restrictions 50720 1595 • Soclal Acceptabillty Only 33% of Americans over 16 years of age feel smoke cigarettes, in moderation, for enjoyment. years ago. 1975 1977 1979 1981 1983 1985 1987 % Agree 48 45 43 42 41 38 33 Even,among smokers, more than 1-out-of-3 feel smoking is not acceptable. Percent Acceptable 1981 1984 1987 it is acceptable to About half agreed 10 Total 16+ 42 < ........ 36 33 Source: CX 37-Z-31

507Z0 15S6 HARKET OVER¥IEW Industry Performance Summary Changes in population dynamics will result in decltnes in the number of smokers and industry volume. The demographic mix of the market w111 become older, more female, more ethnic, and more downscale. Marketing Relevance Marketing resources will be stableldeclining. Company an edge that has... This wtll gtve the • Effective poslttonings . ,argeted marketi~[~|r~.z~N, VN R3R must be sensitive to the dlfferences between groups and upscale marketers. III lower socto-econ~mtc • 3J HI"H pa:,npoad CX 37-Z-32 ....

MARKET OVERVIEW Summary Factors Affecting Brand Performance Aging results in 75% of all movement in market share. This includes • All of Marlboro'slNewport's growth Most of the dec|ines of older brands (e.g., Kent, Pall Mall) R3R's low share (13%) among smokers 18-20 produces a net loss of 0.6 points per year. Marketing Relevance Improving R3R's share among YAS is a major strategic issue since lt w111 become increasingly difficult to offset strategic decllnes with promotion ~ • CAMELISALEMIMagna • Pack Action Promotlc~ll • Specla] Markets • Project Delta D,L iJ'H Xq po npoad CX 37-Z-33

50720 ;598 MARKET OVERVIEW Summary Factors Affecting Brand Performance B. Switching Brand switching produces 25% of share change, including a11 of the growth of the savings segment. Switching opportunities are 1|mired because: • • Only 3~ to 4% of smokers change loyalties. Competition for switchers is high. Substantial net flows to one brand are rare unless the brand Is favored by external factors. ., The savings segment is currently favored by external factors. However, savings growth is expected to level out soon, barring a new FET. • Purchase ~el ~ |~.~~VI~ • Repeat rates are at 9o~ Restrictions on publ|c smo have grown and smoking has become less socially acceptable " Xq p p CX 37-Z-34

MARKETING OVERVIEW ! 50720 1599 Summary Factors Affecting Brand Performance B. ',Switching Marketing Relevance RJR is well prepared for switching based opportunities DORAL is leading savings brand Premier can capitalize on social unacceptability. If DORAL peaks out as purchase dynamics Indicate, then Improving YAS performance wtll become even more crttlcal since DORAL gains w111 no longer offset 0.6 potnt loss due to aging. 1 NI'~),NVIAI , Ill DJ, HFH Xq po:)npoad CX 37-Z-35 0