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PHIIIPMOR1tIS EEC REGION Portugal Q Germany ~ France ~ Italy ~ UK / Ireland ~ Belgium ! Luxemburg ~ Holland ~ Greece / Israel ® Spain No. 5. N cn n 0 a m ~ N ~ m

I I I I I I I I I I I I I I I I I I EEC REGION THREE YEAR PLAN 1992-1994 TABLE OF CONTENTS A. THE REGION'S HIGHLIGHTS B. MARKETS 1. GERMANY 2. ITALY 3. FRANCE 4. SPAIN - MAINLAND 5. BELGIUM / LUXEMBOURG 6. NETHERLANDS 7. DUTY FREE C. CORPORATE AFFAIRS D. OPERATIONS E. INFORMATION SYSTEMS F. PROGRESS IN 1991 PAGE 1-15 16-27 28-42 43-53 54-64 65-74 75-85 86-95 96-107 108-119 120-122 123-128 I

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I I I I I I I I I I I I I I I I I I I -1- A. REGIONAL HIGHLIGHTS % CAG OBJECTIVES RF OB 1991 1991 1992 1993 1994 -1994 Unit Volume (bio) 161.2 169.1 175.7 185.2 4.7% Operating Revenue ($mio) 7,845 8,171 8,956 9,726 7.4% Marginal Contribution ($mio) 1,976 2,080 2,309 2,590 9.5% Income from Operations ($mio) 899 1,034 1,179 1,388 15.6% Net Income ($mio) 673 818 875 1041 15.7% Using 1991RF as the base, the EC Region will add 24 billion units and $368 million in Net Income over the Plan period to top $1 billion in 1994. Unit volume growth will average 4.7% per annum, slowed by the situation in Germany. Although we have not assumed implementation of the ECOFIN excise tax proposal (the "57%" minimum), the VAT and excise tax increases that are assumed in the Plan will have a significant impact on retail prices. As a consequence, we expect total demand to decline nearly 15 billion units by the end of the Plan period in our major markets. This covers Germany, Italy, France, Spain, the Benelux, and Regular Duty Free. Our incremental volume in these markets is driven solely by our aggressive gains in market share. In the EEC markets in total, our share will rise 4 points to 29.2%. In our major markets, our consolidated share will rise over 6 points to reach 36.2% by 1994. To translate the average annual growth in Marginal Contribution from 9.5% to a Net Income growth of 15.7%, we have carefully constrained our marketing expenditures and strictly controlled our overhead expenses. The key issues for the Region over the Plan period are:- * Excise tax pressure, compounded by the threat of the ECOFIN proposals. * Achieving retail price increases in a rising tax environment with major competitors tempted to price cut. * Changing legislative environment: - marketing restrictions - smoking restrictions - product legislation - packaging legislation - product flow legislation - social legislation * Relationships with the monopolies * Manufacturing capacity

I I I I I I I I I I I I I I I I I I I -2- MAJOR MARKET OVERVIEW Unit Volume Income from Operations (billions) ($ millions) RF RF 1991 1994 CAG % 1991 1994 CAG % Germany 50.6 56.1 3.5% 359 465 9.0% Italy 38.3 48.1 7.8% 315 656 27.7% France/Corsica 25.1 29.5 5.5% 107 183 19.6% Spain 13.2 19.0 12.9% 23 70 44.9% Belgium/Luxembourg 4.3 5.6 9.1% 13 34 37.8% Netherlands 3.9 4.6 5.3% 23 40 20.3% Regular Duty Free 4.9 5.9 6.2% 46 68 14.3% German : Income from Operations is predicted to grow at an average rate of only 9.0% over the Plan period. As in other markets, anticipated increases in VAT and excise tax rates are a factor. However, in Germany, the impact of indirect taxation is compounded by the loss of the Berlin Preferences, and by the implementation of the national legislation requiring the recycling of packaging materials. Further, we are restricted in passing all such costs onto the consumer due to the significant threat that one of our competitors, all of whom are to suffer volume declines over the Plan period, initiates a pricing action to regain unit volume. As such, Germany accounts for 22% of the Region's incremental Income From Operations over the Plan period, while today it contributes 40% of the total. Italy: We shall maintain our growth momentum in unit volume as well as in market share, leveraging our competitive advantage to continue dominating the growing foreign segment, and indeed, will overtake Monital to become the largest competitor in the total market by the end of 1993. In addition to achieving more aggressive increases in selling prices, we also intend to restructure our manufacturing agreements with Monital to generate higher unit profitability than provided by today's license arrangements. The combination of volume growth, higher selling prices and the new manufacturing agreements will enable Italy to be the principal contributor to the Region's growth in Income from Operations over the Plan period. France: Increases in excises taxes, not fully off-set by the anticipated reduction in the VAT rate, will combine with improved manufacturers' selling prices to force up retail prices nearly 25% over the Plan period. While this will contract the total market, the continuing expansion of the international segment at the expense of local black cigarettes will enable us to achieve our volume objectives and gain 6.3 share points (from RF1991) over the Plan period. Thus, France will contribute 16% of the Region's overall gain in Income From Operations over the three year period. Spain: The continued expansion of the international segment combined with our 8.2 share point gain allows Spain to achieve the fastest PM unit volume growth among the major markets. However, there is a risk because excise tax and VAT increases will amplify the moderate increases assumed in manufacturers' selling prices into a total retail price increase of 44% on Marlboro over the Plan period. In addition to our predicted volume gains, the growth in Income from Operations reflects our objective to renegotiate our manufacturing agreements with Tabacalera to improve PM's share of the profit earned by our brands. Consequently, Spain also has generated the highest growth rate in Income From Operations among the major markets, to contribute 10% of the Region's incremental income over the Plan period. I

I I I I I I I I I I I I I I I I I I I -3- Belgium/Luxembourg: This will be the only domestic market to experience growth in unit volume sales over the Plan period due to the favorable shift in cross-border purchasing. The continuing trend from local to international blond cigarettes, and our strong position in the Premium and the Popular price segments enable us to gain 7.3 share points. By 1993, we shall become the market leader, overtaking Rothmans. Belgium/Luxembourg will generate the second fastest growth in Income From Operations, contributing 4% of the Region's incremental income over the Plan period. Netherlands: Holland also contributes 4% of the Region's incremental Income from Operations. Marlboro drives our 6.1 share point gain and continuing advances are achieved in our selling prices. We pass Rothmans in 1994 to become market leader. Duty Free: Although military sales in Europe are set to decline, higher sales in the other Duty Free sectors generate growth in the total market. Our 5.5 share point gain over the Plan period is at the expense of all other major competitors. Duty Free contributes another 5% of the Region's incremental income over the Plan period. COMPETITION By the end of the Plan period, PM will be the market leader in all major markets, except France and Spain, where the local monopoly's market dominance is under rapid erosion and where we are leading the attack. With the foreseen decline in nearly all total markets, our share gains mean declining volumes for most of our competitors as well as lower market shares. RJR is the only major competitor expected to experience any unit volume growth, and this will be limited to less than a total of 1 billion units over the next three years, compared to over 20 billion foreseen for PM. RJR's gain is dependent on the Camel franchise; which it prices below Marlboro in Germany and France - and which benefits from the underlying growth in the international blond segments in the three monopoly markets, in particular France, rather than from greater segment penetration. Camel is also expected to improve its position in the Benelux markets, although its growth in Belgium/Luxembourg is largely off-set by declines in its local blond franchise and in Winston. Indeed, the remaining stronghold for Winston is the Spanish domestic market and certain market niches in Spanish Seastores. BAT's Barclay and Lucky Strike brands present strong competition. Barclay is well-positioned to capitalize on the anticipated build-up of consumer interest in lower tar products, driven by EC legislation on tar ceilings, the printing of T& N deliveries on the pack and the stronger health warning labels. The elimination of the "1 mg." claim in the Benelux countries will likely lead BAT to line extend the family further with an Ultra offering. BAT i s putti ng cl ear emphas i s i n most markets on Lucky Stri ke, whi ch i t reinforces with a below premium price positioning. However, declines in its local brand portfolios in Germany, the Netherlands and Spain as well as the weakening Benson & Hedges family in France off-set the gains of Barclay and Lucky Strike. Further, Lucky Strike advances in France are to the benefit of SEITA, which currently controls the trademark under license, and in Spain must be shared with Tabacalera, its joint venture partner in the Canary Islands. Overall, BAT is expected to decline in unit volume and share terms. Among the non-monopoly players, Rothmans faces the most dramatic decline in its overall market position, and is expected to lose up to 5 billion units over the Plan period. This reflects loss of position in France and Benelux,

-4- I I I I I I I I I I I I I I I I I I I as well as in Germany. The only market in which Rothmans may improve its position is in Italy, where it is trying to maintain dominance of the growing superslims segment, which it pioneered in 1988. Rothmans' severe decline makes it the prime candidate to use price to regain volume, where further initiatives with 25s packs are a serious threat. Its truncated success with Golden American 25s in the former GDR further aggravates their predicament. Reemtsma's position in its home market is built primarily on price. Indeed, it trying to repeat its success of West in Germany in the Benelux markets, France, Spain and Greece. Reemtsma's making further use of price is a threat. The decline of the three major monopolies, SEITA, Monital and Tabacalera, are fueling the growth in the total international segment. The only monopoly brand franchise to show some potential is Gauloises Blondes, which SEITA is trying to roll-out in the other European markets. As market positions decline, manufacturing arrangements with the international companies and distribution will be the alternatives available to fill capacity and to provide income. They face additional pressure on margins from the anticipated increases in total tax incidence. They may come under further scrutiny by the EC Commission's Directorate for competition. BRAND PORTFOLIO Our strong portfolio of international trademarks is our fundamental advantage over the competition. Our five top international brand families (Marlboro, Philip Morris, Merit, Chesterfield and L&M) will represent 87.4% of our total portfolio in 1994, up 2.2 percentage points from the RF 1991 position. Marlboro Marlboro dominates the growing international segment in Europe and will be the engine which extends our market leadership position across the Continent. Its momentum, margins and potential for line extensions keep it our top marketing priority. High-perceived quality combined with its strong international image will enable Marlboro to maintain its price premium over most of the competition. Marlboro Red will provide 49.3% of the Region's total growth i n vol ume over the P1 an peri od, and wi 11 sti 11 account for 84.6% of the total family in 1994, versus 88.5% in RF 1991. Marlboro Lights will contribute an additional 30.5% of the Region's growth. Philip Morris The family is developing rapidly in Italy, France and the Benelux markets. The expected increase in the appeal of lower tar products will enhance the brand's attractiveness. In Italy, the family offers 8 variants; it is the only family with two 100s line extensions below 5 mg.; and with the end-1991 launch of Philip Morris Lights Extra, will have the lightest product on the market. The full flavor variant is a an additional volume generator in France, where it is priced in the International segment. We are revitalizing the communications campaign and are considering a launch of a 1 mg. product, PM No. 1 in Germany as well. In addition to its high-tech positioning, the family carries our corporate name, which supports a separate communication platform. The family will increase its weight in the Region's portfolio from 5.9% to 6.8% with its 9.9% annual rate of growth. 2500064234 I

-5- I I I I I I I I I I I I I I I I I I I Meri t The potential for Merit and Merit Ultra is still developing in its major market, Italy, where the LTN/SLTN segment will move from 26.9% of the market to 30.5% by 1994. The sailing campaign is our core communication, and may be considered for extension into France, where the Merit family is still small but growing well even with no support. A Merit Ultra line extension will be considered for this market. Chesterfield The Chesterfield franchise is aimed at the Camel and/or Lucky Strike smoker. It is growing well in Italy, Spain, and France. It is developing in Holland, although from a much smaller base. Chesterfield Lights has been launched already in Italy and France, and Chesterfield Mild is under consideration for Holland. Chesterfield will remain our fastest growing franchise, at 15.5% per annum. L&M This is a lower price offer, and is doing well in Belgium/Luxembourg as it draws from the local blond 25s soft pack smokers, making it the leader in the relatively new international box 25s segment. It will grow 13.4% p.a. over the Plan period to add over 1 billion units in volume. It is also one of the Region's candidates to respond to any aggressive pricing initiatives from our competitors, as in the Netherlands or in France. While, L&M was used successfully to contest the price war in Germany in the early 1980s, we would rather use the Lark family to respond to any price war erupting in this market. STRATEGIC ISSUES Pricing and Taxation The biggest issue for the Region is the pace at which governments are taking decisions to increase total tax incidence. The spectre of the ECOFIN proposal which would set total excise taxes in each member state at a minimum of 57% of the MPPC by January 1993 has already prompted some member states to take decisions today to comply. Thus, we are faced with tax rate hikes across most of our markets. VAT increases are planned in Germany, Spain, Belgium and Luxembourg, while in France we shall need a reduction in the VAT to off-set a major tax hike on excise. We have assumed that the ECOFIN proposal for excise taxation will be averted, but the VAT and excise tax adjustments already planned will constrain our ability to take aggressive increases in our selling prices. Further, the impact on demand of these tax-driven increases in retail price combined with declining share for our competitors may well incite one to undertake a pricing initiative to regain volume. Marketing Restrictions The EC initiative for an advertising ban appears to be blocked for the time being, but will certainly re-surface in a modified form. Meanwhile, a number of member states are pre-empting the EC legislation by imposing greater restrictions at the national level. The Royal Decree in Belgium came into effect in 1991; similarly, a Royal Decree is expected to pass in Spain imminently, and the total ban under the Loi Evin will come into force in France in 1993. Restrictions in Italy are being extended, and the Voluntary Advertising Code in Holland is coming under scrutiny, while I

I I I I I I I I I I I I I I I I I I I -6- domestic legislation is increasingly being extended to apply to the Duty Free sector. While we lobby aggressively to avert these increasing restrictions, we must comply with those in place and prepare for those which are anticipated. Although tailored to each market situation, our strategy is to consolidate our brand communication to focus on core themes and messages, maximizing our exposure in the media that remain, and pre-empting competition in the media and channels that stay available. This raises the importance of the point of sale, and of building our trade relationships. We shall maximize our product availability and improve product flow management. Active vending programs will play a major role in many markets. We shall focus more of our marketing attention upon our event marketing and sponsorship programs, as well as on our trademark diversification ventures. Product Legislation The EC tar ceiling of 15 mg. for cigarettes becomes effective at the end of 1992, with a reduction to 12 mg. five years later. We expect the new ISO cigarette testing methodology to be in place. As the printing of T&N deliveries is contained in the EC labeling directive, we shall position our line extensions to meet consumer needs, and we shall introduce additional variants where needed to complete our product range. This is particularly the case in Italy. Distribution The advent of the free movement of cigarettes among the EC member states will likely lead to greater concentration in the distributive and retail trade in non-monopoly markets, while the preserve of the licensed retail systems in the monopoly markets may well be challenged as anti-competitive, particularly by the large food chains. We are actively evaluating the implications of such developments on our competitive position, and we are already investigating alternative distribution systems for the monopoly markets, as well as in Belgium/Luxembourg where our competitors' involvement in distribution touches some 40% of the product flow. We are also actively seeking means to achieve greater penetration in the vending machine channel, which accounts for approximately a third of the sales to consumers in west Germany and in Spain, and is a growing channel in east Germany and in the Benelux markets. Monopolies The three major monopolies of Italy, France, and Spain are each losing ground fast. We will continue to defend the de facto distribution monopolies and the licensed retailing systems as best serving our interests in preserving orderly markets. In Italy, we seek to increase the monopoly's dependence upon us to strengthen our ability to deal with the authorities and to influence Monital's operations. Accordingly, we are adopting the new, supplemental manufacturing agreement which will bring much needed volume into the monopoly's factories. In Spain, we are striving to break the contractual situation which hinders our profit growth. As part of the negotiating process we anticipate offering to leave production volume with Tabacalera, albeit under different arrangements. I

I I I I I I I I I I I I I I I I I I -7- Within France our objective is rather to deal with the Government and offer the bait of potential manufacturing investment with the aim of achieving progress towards our excise tax structure goals in France, and potentially therefore in the EC. Corporate Affairs The evolution of the EC and the advent of the Single Market are bringing a range of issues that will have significant impact on business in general; while the opponents of our industry maintain their relentless pressure and seek to exploit all opportunities to attack us. Fighting against rising excise taxes while seeking to convert structures towards specific systems will remain a priority - both at the EC and individual country level. The struggle against tightening marketing restrictions will similarly remain a high agenda item throughout the Plan period at both the EC and country levels. Emerging issues to be addressed concern the environment, particularly related to packaging waste, and the EC's Social Action Program. This program risks to constrain our management flexibility and to lead to increasing pressure on our labor costs. In addition to dealing with specific legislative programmes, we shall apply our resources to combat the drift in public opinion that continues to move against us and underpins much of the eventual legislation. ETS, and the related topics of smoker courtesy and accommodation, will receive special attention in this regard. Operations The immediate strain on our manufacturing capacity will be relieved by the planned expansions at Bergen op Zoom and Berlin. However, our continuing success in the marketplace will necessitate additional capacity, and we have taken the first steps to identify the site for an eventual green field factory complex for cigarette and sheet manufacture. The pressure on our prices forces even greater focus on our productivity increases and cost reduction programs. These improvements are built into our Plan, while quality enhancement remains an objective on which we shall not compromise. Information Systems We are concentrating our resources in those areas that hold the highest potential for cost reductions, greater productivity, and better decision making throughout the whole business chain. The manufacturing environment will receiving heavy support. Our study for "Factory Management" will review all factory systems from production planning through to conversion. At the other end of the chain, sales force management systems will be upgraded and implemented, taking maximum advantage where possible of EDI opportunities with our business partners, thus supporting the new thrust towards micro-marketing. W cn 0 0 rr ~ ~ w ~ I