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Furthermore, entering _18-year-old smokers account for all of Marlboro's strength among total 18-24. Loyalty rates from the 1983 SDS (i.e., the percentage of smokers who smoked Marlboro at age 18 and still do) show that Marlboro loses about 28% of its 18-year-olds by age 20 and another 14% by age 24 -- a total loss of 42% over the six years between ages 18 and 24. Translating this to share points, Marlboro would be expect:ed to lose .3 points of its .8 points of 18-year-olds before they reach age 24. This is, in fact, about the annual total NFO switching loss found for Marlboro in recent years. (See Appendix C.) But, since Marlboro gained .8 by becoming their "first brand" at age 18, it can afford the .3 switching loss and still come out: .5 points ahead. C B„ THE COMPETITIVE SQUEEZE This steady influx of 18-year-old smokers causes the pre-existing smoker market to shrink in share value: smokers who were worth 100.0% of the market at the beginning of 1983 were worth only 98.4% by year end. Thus, a brand which had a 10.0% smoker share going into 1983 and did not attract any 18-year-old smokers would drop to 9.8% even if it kept every member of its franchise. This means that an brand/company which is underdeveloped among 18-year-olds must achieve net switching gains just to break even. As a company, Philip Morris held more than 60% of these 18-year-old smokers in 1983 versus RJR's 15-20%, yielding PM a.5 point in-going SOM advantage in 1983 due only to "new" smokers. The power of this advantage can be seen by the fact that RJR's total competitive switching gains have been twice as large as PM's during 1980-83 yet, during the same period, RJR has lost smoker share while PM has made significant gains (See Appendix D). Furthermore, PM's younger adult smoker advantage has been i.ncreasinp~dramatically: SHARE OF SMOKERS 18-24 AVERAGE ANNUAL 1979 1980 1981 1982 1983 CHANGE RJR 26.1 25.0 24.3 23.5 21.3 - 1.2 PM 44.8 48.8 51.5 54.0 58.4 + 3.4 Source: MDD Tracker C. MOMENTUM FROM AGING Once a brand becomes well-developed among younger adult smokers, aging: and brand loyalty will eventually transmit that strength to older age 1>rac ets. ~

C. MOMENTUM FROM AG1NG An analysis of Tracker shares from 1979-83 (see Appendix E) shows that, apart from short term fluctuations: • Incoming 18-year-old smokers and the movement of its existing franchise into older age brackets can exp].ain all of Marlboro's smoker share gains in the past four years. Among smokers 25+, all of_ Marl_boro's gains are attributable to this aging movement -- switching appears to have had no net long term effect. If Marlboro merely holds its share among younger adult smokers in the next five years, it is likely to gain at least 3 points of smoker share due to the aging movement of its present smokers (assuming its switching is no worse than in 1980-83). If Marlboro continues to gain share among younger adult smokers at its present rate, its overall smoker share could easily increase by a total of 5 points, from 19% in 1983 to 24% by 1988. • Newport's growth can also be entirely exp].ained by its younger adult strength and aging. Over the next five years, Newport is likely to gain .8 points of total smokers without any additional growth among younger adults. If its younger adult gains also continue, it could exceed a 4% total smoker share by 1988, a gain of about 1.5 points over 1983. These examples demonstrate the momentum younger adult smokers give a brand. Although a competitor could slow this momentum by attracting switchers, the "first brand" would hold the high ground of brand loyalty in such a battle. D. LONG-TERM DIVIDENDS -- RATE PER DAY Government and RJR studies spanning several decades have shown that smokers increase their consumption as they age. The chart below shows that smokers 25+ consumed 22% more than smokers 18-24 on average during 1980-82. RATE PER DAY (1980-82 AVG.) AGE % Increase Cigts. Vs. 18-24 Index vs. Total 18-24 26.2 85 25-34 30.6 + 17% 99 35-49 34.1 + 30% 110 50+ 31.2 + 19% 101 Total 25+ 32.0 + 22% 103 TOTAL 31.0 + 18% 100 Source: Incidence/Rate Report, Year 198 2. -4- -r..

2. MARKET SHARE -- THE "F1RST BRAND" ADVANTAGE D. LONG-TERM DIVIDENDS -- RATE PER DAY (Cont.) Thus, the 18-year-olds who were worth 1.6 points of smoker share in 1983 were worth only 1.4 points of market share, since their consump- tion was below average (index of 85). However, by ages 35-49 they will be worth 1.8 points of SOM -- a 30% dividend on their original market share value. This consum tion increase is the difference between having smokere 35-49 and having smo ers who will age to 35-49. E. EXTENDED BRAND LIFE CYCLE The combination of brand loyalty, aging, and increasing usage tends to provide "life insurance" for brands which skew, or have skewed, younger adult. For example, Marlboro relies heavily on 18-year-olds for its share growth. But if, from_1_984 on, no 18-year-olds ever smoked Marlboro a ain, aging could let Marlboro almost hold its market share throu h ]~90. The left side of the table be ow s ows the contribution each age group makes to Marlboro's current smoker share and what that- contribution would be in 1990 if Marlboro got no more 18-year-olds and merely moved its franchise smokers to older age brackets. On the right side of the table, the smoker share contributions are translated to market share, by factoring in rate per day differences. The bottom line shows that, even after seven years without 18 year-olds, aging could allow Marlboro's market share to hold within one point of its 1983 level. SMOKER SHARE CONTRIBUTION MARKET SHARE CONTRIBUTION 1983 TRACKER 1990 PROJECTION 1983 EST. 1990 PROJECTION 0 6 6 < 0 0 18-24 6.8 <---- 0. . . 25-34 6.5 6.8 6.8 7.2 35-49 3.8 7.9 4.6 9.6 50+ 1.8 2.2 2.1 2.5 TOTAL 18.9 <-- 16.9 *20.2 19.3. *Jan.-Dec., 1983 MSA. Thus, even if a brand falls from favor among younger adult smokers, , the younger adults it attracted in earlier years and their increasing:: consum tion can carry the brand's market share for years, signifi- cantly extending its overall life cycle. -5-

3. SWITCHING OPPORTUNITY Younger adults are more likely to switch brands than any other smoker group, i.e., they are a concentrated switching target. Their very high propensity to also switch st:yles within their brand suggests the latent potential for even higher rates of brand switching. PROBABILITY OF SWITCHING IN 6 MO. BRAND FAMILY STYLE IN BRAND X INDEX X INDEX 18-24 16.6% 126 21.5% 78 25-34 13.4 102 12.8 106 35-49 12.1 92 10.4 86 50+ 13.2 100 11.1 92 TOTAL 13.2 100 12.1 100 Source: NFO, 1981-1983 (first half). Younger adult brand switchers (who then remain loyal) can also contribute the major portion of their aging benefits, including increased usage, to their second brand. Thus, switching by smokers 18-24 can yield a sij.ni.ficant part, but not al.l, of the share advantages associated with a "f:irst brand". Older switchers confer less, or none, of these benefits. -6- ..r. . . .. _ ... . . .~ .. ... .._ __. . . _ a . . ... . . . .. . Y'..... . ..

T}iE IMPORTANCE OF YOUNGER ADULT SMOKERS SUMMARY Though decreasing in number, younger adult smokers are a key market for RJR becaus;e improved RJR performance among younger adult smokers could contribute more to long term profitability and positive share momentum than could be achieved from gains in any other age group. 1. Younger adult_smokers are the only source of replacement smokers. More than a share point of 18-year-old smokers enter the market every year. These offer a significant growth opportunity and also shrink the share value of smokers already in the market. 2. A"first brand" strategy has significant share advantages. • Optimum ability to capitalize on the influx of 18-year-old smokers. This gave. PM a .5 point in-going advantage over RJR in 1983. •"First brands" compete from the high ground. They do not need switching gains to grow and can afford some switching losses. Brands which rely on older smokers must achieve net switching gains to break even on share. • Strength among younger adult smokers will ultimately yield growth in older agee brackets. Aging has been contributing all of Marlboro's and Newport's smoker share gains among smokers 25+. • Aging of loyal younger adult smokers creates disproportionately large gains in market share, due to their increasing consumption. This does not accrue from gains among older smokers. • Younger adult strength, past or present, will tend to extend the lifecycle of a brand. 3. Younger adult smokers offer the most concentrated switching opportunity. • Smokers 1.8-24 are more likely to switch. • Switchers aged 18-24 can provide more share advantage from aging/ increasing consumption than switchers 25+.

SECTION II SUCCESSFUL "F1RST BRAND" STRATEGIES OF THE PAST

11. SUCCESSFUL "FIRST BRAND" STRATEGIES OF THE PAST In the 1983 Segment Description Study (SDS), smokers of all ages were asked what brand they smoked when they were 18 years old. By using these responses to represent the younger adult market of the past, the rise and fall of key younger adul.t: brands over the last fifty years can be analyzed. By linking these brand trends in time to demographic/social/marketing changes, insights into the factors which affected those brands and might affect a younger adult brand today can be gained. This section traces every brand which has risen to a 10% or higher share among 18-year-old smokers since the 1930's. There have been only six, but they include the major brands of the last half century -- Pall Mall, WINSTON, Marlboro, Kool, SALEM, and Newport. BACKGROUND Although their rise cannot be traced, Lucky Strike, CAMEL, and Chesterfield were the giants of the cigarette market during the 1930's. Smokers who turned 18 in the 1930's seemed to favor Lucky Strike, but no brand skewed younger adult to the degree seen for the brands that would follow. 1930's AVG. SOM 18-YR-OLD SMOKERS ~ _ Share BDI . Lucky Strike 22% 32% 146 CAMEL 27 30 111 Chesterfield 27 20 74 A1.1 Other 24 18 75 PALL MALL: THE BRAND OF THE 1940'S AND 1950'S. The key trend for Pall Mall was younger adult female smokers, who were rapidly becoming more likely to smoke at: age 18. The SDS showed that females rose in importance from 30% of all 18-year-old smokers in the 1930's to 44% in the- 1950's. This gain was large enough to create a 6% increase in the number of younger adult smokers between the 30's and 50's, even t~'Fiougli there was a 15% decrease in the size of the younger adult population during that time. -8- .

"Extra length" Pall Mall King entered t.he market in 1937. Initially, it had a prestige positioning, but was soon refocussed to emphasize mildness and "easy" smoking. From the beginning, Pall Mall's development was about twice as high among younger adult females as males. This captured the rising trend of the younger adult smoker market and also ioade good strategic sense for ATC -- Lucky Strike skewed male and Pall Mall skewed female. Thus, Pall Mall was in tune with the demographics of the times and its company's mix. % 4 1956 IW 0 During the 1940's, Pall Mall's share grew to 10Y% among all 18-year-old smokers, to 18% among younger adult female smokers, and was still rising. But since Pall Mall attracted fewer older smokers, its market share was only 3% after a decade (1947). By the 1950's, though, the aging payoff was inevitable: Pall Mall's SOM soared to 15%, with a younger adult smoker share twice that high. PALL MALL IT11E TER7t ROU.1N0 RKR/IpE i/rMtE MAk1:F7 SHAriE - - 1B-YUR-OLD SkMU :4 a lOUCM 1/1I1Q1 N/Illl 1'rp iM1 as ~ C"oNl MIas T" ^AV o• ® Aildness is a Pleasure # with Pall Mall

But, Pall Mall became out of step with its times when the cancer scares of the mid-19'i0's created the filter boom. Pall Mall might have defended itself with a filter line extension, but it didn't try until 1965, when it had few younger adult smokers left to defend. After Pall. Mall peaked, its younger adult franchise began to skew male. Younger adult female smokers -- the rising trend Pall Mall had captured -- moved on. But the brand loyalty and aging benefits of the younger adult smokers who remained with Pall Mall bolstered its market share for another 10 years. PALL MALL SHARE A MONG 18-YEAR-OLD SMOKERS _ 1940's 1950-54 1955-59 1960-64 1965-74 Males 9% 16% 30% 22 4 I F'emales 40 C 18 30 13 2 _ TOTAL 10 >26 >30< 19 < 3 Source: 1983 SDS ATC's :leading position among younger adult smokers, first with Lucky Strike and then Pall Mall, pushed it to fi1 in the industry in 1940, when it passed RJR. However, since Pall Mall was ATC's last successful younger adult entry, the brand's downturn signalled the future performance of ATC as a company. AMERICAN T06ACC0 Sa 0 It o~ . A rnt 'c'* t'JL-!s +,vo,r.t P..d r_vxi- sF.. o.y ~ - - ;E_:R-0:D sRrS3 ! • • ~ 1950 1960 1970 1980 i01.~ 1~JGE.a W" A VC .lG: f00 r~ . . . . _ . . ._ _.. . . _ _... ad S Y~_E_•.L.

Key Points About Pall Mall: • Pall Mall's "extra length" was a product breakthrough in its day -- one that promised extra mildness. It caught on right away with younger adult smokers. • Pall Mall grew quickly among younger adult smokers because it was in tune with the 1940's, when the major trend in smoking was the rising importance of younger adult female smokers in the market. • Pall Mall.'s younger adult strength was a long lead-indicator of its rapid market share growth in the early 1950's. • Pall Mall's downturn among younger adult smokers was also a lead- indicator of the brand's eventual decline, although its market share held for another decade due to the loyalty and aging of the younger adult smokers it att:racted in earlier years. • Pall Mall became overdeveloped among males only during its decline. • Since Pall Mall was ATC's last major younger adult brand, its downturn was a leading indicator of ATC's decline. ~