Profit and sales

The issue that keeps coming up regarding plain packaging is “Why the tobacco firms care?” Why if the policy has resulted in greater tobacco consumption do the major firms care? Indeed, why didn’t they voluntarily adopt plain packaging themselves?

Good questions.

The important thing to remember is that the tobacco firms – like all other firms – don’t want to maximise sales or consumption of their good per se, they want to maximise their own profit.

So what impact could plain packaging have? Well here is (anti-smoker) Harry Clarke and David Prentice explaining:

An immediate effect of plain packaging is to reduce product differentiation thereby making cigarette brands closer substitutes. This reduces prices and increases consumption.

Here is Christian Kerr indicating that this is exactly what has happened:

Plain packaging laws, which came into force in December 2012, have instead boosted demand for cheaper cigarettes, with reports of a more than 50 per cent rise in the market for lower cost cigarettes.

What impact overall does this have?

Step up the Baumol sales maximisation model:

Baumol Sales Maximisation

The TR curve is the total revenue curve and the TC curve is the total cost curve. Firms that profit maximise set output and earn revenue where the first derivatives of these two curves are equal (the slopes of the curves are parallel). That is at the Xm point. A firm that is maximising output (or sales or consumption) is at X* – but the level of profit for that firm is reduced. While total revenue is higher than the profit maximising level of output, costs are even higher.

Contrary to the policy intent we see an increase in smoking (although it isn’t clear if existing smokers are smoking more, or new smokers have taken up the habit), and a decrease is profitability. How this can be described as being a welfare enhancing policy is unclear.

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10 Responses to Profit and sales

  1. Andrew

    So a Gillard policy that makes EVERYBODY worse off? Sort of like the WBCT but without the Green carbonbagger subsidies.

    Do they have actual economists who get consulted about new policies? Or does this get handles by Health, A-G etc with the economist depts only involved if specifically asked?

  2. Anne

    It’s also dramatically increased the sale of cigarette cases 🙂

  3. Craig

    Once again Labor has shown they cant do policy work without it going pear shape. Fucking.hopeless.

  4. Tim

    More revenue from excise the more cigarettes sold, regardless of the price or profits for the companies. So it is all win for the government.

  5. James B

    I’m sick of this boring debate.

    How about: it’s not up to the government to tell people what they can consume.

    Period. Whether plain packaging results in lesser or more smoking is utterly irrelevant. People are and should be allowed to smoke.

    Remove ALL the excise, remove plain packaging, remove the graphic health warnings, repeal the ban on cigarette advertising and leave people who just want to smoke in peace the fuck alone.

  6. Dr.Sir Fred Lenin

    It is logical in a business sense that plain packaging eliminates the need for expensive advertising,thus enabling companies to reduce prices without profit loss,Also cheaper prices will increase sales,
    It would seem that the alp/green health Nazis have no conceptionof basic business principles,their basic education is sadly lacking ,instead of studying Narxism,they should have basic economics taught,I mean not everyone can be employed by the government,someone has to do the real workand pay their wages.

  7. Milton Von Smith

    I dont think you need to move to a revenue maximisation model to explain what is going on.

  8. Graham Dash

    As a tobacco seller there are other aspects to reported minor sales increase and excise collection. In the past there was always run up in sales prior to the twice yearly indexation of tobacco by buyers but more predominantly by increased inventory by tobacconists and other retailers. Purchases by them would slump for a month or two as the excess inventory passed through the system . The excise on tobacco is due for a 12.5% increase on 1st September ’14, ’15 and ’16 plus gst. The 1st September is also the time for the indexation of tobacco products based on the movement of average weekly earnings. This guaranteed price rise equates to a more than an 8.5% return on investment in inventory held after those dates. A rational response to this price signal is to build inventory (tobacco companies are fiddling around with purchase caps andrationing at the moment) to cover forward purchases. Yes there is still 6 monthly indexation occurring on 1st April 2015 but that is minor. The bringing forward of purchases to stock excess inventory will explain the apparent increase in consumption.

  9. Junican

    @Graham D
    But are not the data about quantity of sticks actually sold to the public rather than wholesale figures? True, some individuals will stock up while prices are a little lower than they will be tomorrow (in the same way that people often fill up their tanks with petrol an the eve of budget day), but would not that effect ‘equalise out’ over a full year? If that were true, then people would have to ‘double stock up’, so to speak, for any effect to take place.
    Just a thought.

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