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CONFIDENTIAL w ~. Fi LIP MORR S r, 197ft1982 r ~ DETAILED PLANS BY DEPARTMENT ~ 0 ~. ~ w N

NOTE After the enclosed plans were prepared some minor revisions to the sales forecast were deemed necessary. Therefore, the sales and production volumes used in the Department Plans differ from those reported in the PM-USA Five Year Plan submitted to Corporate. This difference is also reflected in certain unit cost information, particularly in fixed expenses per thousand cigarettes.

BUSINESS CONDITIONS 2o2s31'71'75

BUSINESS CONDITIONS THE ECONOMY Economic Trends The post recession recovery appears to be running out of steam. While it is doubtful that a severe recession is at hand, economic growth will be sporadic with real GNP (the most general economic bellwether) growing at a slow annual rate. The Administration may try to stimulate the economy in 1978 by tax reforms, but it is likely these measures will have only a transitory affect. This scenario affects Philip Morris USA's tobacco operation most directly through its impact on personal income and price inflation. Per capita disposable income is projected to increase at an annual rate of eight percent. Since the Consumer Price Index is expected to increase at an average rate of six percent per year, this income forecast implies a steady increase in real purchasing power. Inflation Outlook Even under the best of economic circumstances, broad inflation indices such as the Consumer Price Index (CPI) will show little improvement in the, next five years. This is due to extensive implementation of Cost of Living Adjustments and "indexing" agreements which have built an underlying six percent inflation rate into our economy. The impact of the recently signed minimum wage law and the President's Energy Plan are factors which will also have an adverse effect on inflation. We expect costs in the cigarette industry to rise faster than the Con- sumer Price Index. Support prices of flue-cured and burley domestic tobaccos are expected to rise at a seven percent rate over the next five years. On the other hand, the price of oriental tobacco will continue to decline until production and inventories have been reduced. Overall, we are projecting an annual inflation rate of 7.5 percent on our total operating expenses over the next five years.

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BUSiNESS CONDITIONS iNFLATION RATE SUMMARY 1977 - 1982 Expected Average Annual Rate Variable Manufacturing Expense 7.3 Fixed Manufacturing Expense 7.8 Shipping 7.7 Marketing 7.7 General & Administrative 9.9 Research & Development 8.0 Overall Operating Cost 7.5 ENERGY At this point, the energy situation is mixed. Short-term supplies of residual oil are good and (barring supply interruptions) should remain so until the early 1980's. With the opening of new western mines, coal producers appear poised to meet the record output required by the National Energy Plan. On the other hand, a Federal Power Commission report on natural gas estimates future winter supply shortfalls of 20 to 25 percent as opposed to the 27 percent experienced in the winter of 1976. Energy inflation continues to be a problem. The price of residual oil is forecast to advance at a seven to ten percent rate through 1982. While the price of coal should moderate in 1978, it will probably advance at a seven per- cent annual rate after that. Price inflation on natural gas will be determined by the National Energy Plan. CIGARETTE DEMAND FACTORS Trends in. the Industry The base used in forecasting unit sales has been revised for technical reasons, primarily an overstatement of American Brands' volume. This results in a lower estimate of industry sales but higher market shares for PM-USA and other companies. Unit sales are forecast to increase by a total of two percent over the next five years - less than a third the rate of growth since 1972. 1-2

CIGARETTE DEM AND EACTDRS PER CRP I T9 PVERRDE RETR I L DISPOSFIBLE INCOME PRICE PER PPCK 6D 75 -I e 50, c ~ U 45 40 -{r.._ Current Dai.Lars 35-I 1972 DaOlars I 30 1973 (974 1975 1976 1977 1978 1979 1960 1981 1982 CIGARETTE CONSUMPTION 1972 - 1982 4200 4175 4150 4125 4100 4075 4050 4025 4000 3975 -3950 3925 3900 i F 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982

BUSINESS CONDITIONS CIGARETTE INDUSTRY SALES 1972-1982 (Billions of Cigarettes) Year Unit Sales Annual Change Year Unit Sales Annual Change 1972 550 2.8% 1978 608 1.0% 1973 571 3.8 1979 614 1.0 1974 583 2.1 1980 617 0.5 11 975 591 1.4 1981 614 ( fl.5 .) 1976 597 1.0 1982 614 1977 602 0.8 This forecast does not include the impact on cigarette demand of major attacks against smoking. Our cigarette demand model indicates that one of the possibilities under consideration-a "media event" surrounding the new Surgeon General's report-could lower 1978 unit sales by as much as five percent. Other strategies which focus on making public smoking appear undesirable and anti-social would have a milder initial but longer lasting impact, which has been implicitly incorporated in our forecast. As shown below, the low tar category (defined as 15 milligrams or less) has grown very rapidly, and should continue to remain the fastest growing category over the next five years. It is reasonable to assume, however, that this category will be redefined at lower tar limits in future years. The menthol category will also continue to increase its share of market, but only at a third the rate of the previous five years. In contrast, the non-filter category's decline is expected to accelerate. .CATEGORY TRENDS Share of Market Unit Sales Gain , (Percent Change) 1972 1977 1982 1972-1977 1977-1982 80/85 non-menthol 44.3 43.1 41.8 6.5% (1.1)% 80/85 menthol 17.3 18.7 19.2 18.3 4.7 Tota180/85 61.6 61.8 61.0 9.8 0.7 100mm non-menthol 14.4 16.4 19.7 24.7 21.9 100mm menthol 7.2 9.3 10.8 41.4 18.4 Total 100mm 21.6 25.8 30.5 30.7 20.6 110/120 non-menthol - 1.0 1-0 - 2.0 110/120 menthol - 0.6 0-6 - 2.0 Total 110/120 - 1.6 1.6 - 2.0 Non-Filter 16.7 10.8 7.0 (29.2) (33.9) Low Tar 5.3 22.7 36.3 368.8 63.1 Total Menthol 24-5 28.6 30.6 27.8 9.1 I-3

BUSINESS CONDITIONS DEMOGRAPHICS A number of demographic trends wiil affect cigarette sales growth over the next five years. Changes in the age composition of the population (caused by high birth rates in the 1950's and very low levels in the sixties and seventies) are becoming less favorable. The growth of the "smoking age" group (persons aged 18-64) will fall to an annual rate of less than one percent by 1980. In addition, the number of persons aged 15-24, the ages in which most smokers begin to smoke, will decline slightly during the next five years, indicating that there will be fewer potential new smokers. However, the distribution of new smokers will vary among consuming groups. The proportion of black smokers is expected to increase over the n . ext five years. Recent data indicate that over 50 percent of black smokers prefer menthol brands. Moreover, when only blacks, 18-34 years of age are considered the level rises to over 75 percent. This category loyalty is in marked contrast to that of other smokers and, as we discuss later, presents us with a significant marketing opportunity. Southern and western states now have more than half the United States population, and will grow twice as fast as northern states in the next five years. This regional shift will have an important impact on our sales patterns, shipping and warehousing. In terms of our manufacturing locations, however, it is important to note that population in the "Tobacco Belt" states will grow at only about one percent a year. Many companies have found the area's relatively low labor costs an attractive incentive for locating new plants; however, increasing investment at a higher rate than population growth will place added pressure on the local labor force in a region where unemployment is already below the national average. COMPETITION The emphasis among cigarette manufacturers continues to be on low tar entries, both free standing and line extensions. Several of these recent entries have been successful. We can expect introductions of new brands to be predominantly low-tar in the next five years. In addition, the tar content of existing brands, including full flavor brands, will continue to decline. PM-USA and Lorillard are forecast to remain the only companies with growing shares of market over the next five years. This is consistent with our expectations since the demographic profile of Lorillard smokers is very close to that of our own. By 1982, Philip Morris' share of market is forecast to reach 32.6 percent, slightly higher than that of R.J. Reynolds.

Percent Market Shore PM-l1SR im RMER P.LOR. LM P.LOR. m BW BW w N) w w ~4 cn c~ cn 0 tn 0 cr 0 co BW f v N 1'' A10,WL" Z~WRMER. LM M AMER. P.LOR. PM-USFi RJR RJR ~T . =':l1RJR PM-USF1