Cuban Cigar Industry

Topic: BusinessEnergy
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Last updated: June 7, 2019

A Note on the Cuban Cigar Industry Synopsis The case renders an extensive picture of the Cuban Cigar Industry.

It attempts to provide us with an understanding of the Cuban history, tumultuous relationship with United States and the impact on the Cuban economy thereof, along with the process of cigar-making and the major players. The Cigar industry is an indispensible part of the Cuban culture and folklore with a major bearing on its economy. With Christopher Columbus discovering indigenous tobacco in 1492, Cuba became known for its tobacco production.The 1959-1962 Revolution saw outing of President Batista and Fidel Castro took over. He nationalized the Cigar industry and about $1 billion of US-owned property resulting in US blockade on Cuba. Most key players in the industry fled to other countries, with the remainder fleeing when President Kennedy initiated the trade and financial embargo in 1962, which prohibited the sale of Cuban cigars, among other items, in the US. Cuba, then, adopted command economy and became dependent on Soviet Union.

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With the collapse of the Soviet Union, Cuban economy went through a major economic crisis for almost a decade until the government implemented “Special period in Peace time” program. Still, industry infrastructure is poor and investment resources are in short supply and though Cuba’s economic recovery has started, there are still many problems to be tackled. Main Issues Following the Cuban revolution, many key players and workers fled the country. They took with them the Cuban tobacco seeds, knowledge, skill and expertise to cigar-making and production, opening doors to competition.Moreover, the US is one of the largest markets for cigars in the world today but the US embargo restricts the sale of Cuban products there. Though the industry has survived without the US market over the past forty years, whether it can sustain in today’s marketplace, in the light of Cuba’s political upheaval and fragile economy, requires a great deal of probing. Furthermore, the cigar industry is dominated by two firms: Altadis, the world’s largest cigar producer, produces cigars in the U.

S. , the Dominican Republic, and Honduras, and has a 50% stake in Corporacion Habanos in Cuba.It also makes cigarettes and Swedish Match, the second largest producer, produces cigars in Honduras, Belgium, Germany, Indonesia, the U. S. , and the Dominican Republic. Hence, we have to decide whether the Cuban cigar industry exhibits enough potential to warrant new investments.

If yes, will it be able to withstand these industry giants for sustainable profit? To decide, we need to analyze the macro-environment, the industry’s dominant traits and the competitive environment and perform SWOT analysis of the Cuban cigar industry. 1. PESTEL Analysis ? PoliticalThe political environment in Cuba is not very stable. Before the Revolution, the Cuban cigar industry was not centralized. Every manufacturer was free to produce as much cigars and as different packaging styles as they desired. After Fidel Castro came into power, all private businesses became property of the government and many key players had to flee. Also, US-Cuba relationship deteriorated owing to the nationalization of US owed property, which later culminated to President Kennedy imposing the embargo on Cuba. Hence, the country specific risk is high as US is the largest market for cigars in the world.

Economic Though 300 million cigars are smoked in Cuba annually, it is the foreign premium cigar exports that play the pivotal role in sustaining the economy. The imposition of US embargo badly upset the Cuban economy and Cuba adopted a command type of economy. The support from Soviet Union helped reduce its impacts to a certain extent but with the dissolution of Soviet Union, Cuba lost a major market along with a major source of foreign assistance.

In 2002, Cuba’s population was 11,224,321 with per capita GNP of merely $1700.Cuba faced problems like continuing trade deficit, foreign exchange problems and energy crisis. Despite all this, the Cuban economy is showing signs of improvement, following reform programs from government and the encouragement of foreign economic associations in areas like mining, tourism, tobacco, et cetera. Also, Cuba is getting assistance and investment from other countries like Spain and France that accounted for 42% and 33% of the total market share (2000) respectively. Thus, the economic environment is looking up and seems to be moderately favorable. ? Socio-culturalThe history of tobacco and Cuba are interwoven. Tobacco has been cultivated in Cuba indigenously from a long time back. The cigar industry is a part of the Cuban heritage.

Families have been involved in cigar production for long. The farms are small and communities work together during harvest. The private farm system there allows family secrets and traditions to be preserved and passed on. The local farmers are responsible for production required to meet the state quotas. Also, foreign ownership of land is not permitted under the socialist regime; so the responsibility for tobacco falls upon the local labor force.Thus, socio-culturally, the Cuban environment is highly favorable. ? Technological The shift in focus towards quality calls for high technology for delivering superior products. Cigars can be handmade, hand-finished and machine made.

The machine-made cigar market is US $10 billion the world over. Sometimes combination of machine and handmade is used to distinguish the product or specific brand. Manually, 100 to 150 cigars can be produced in a day but through the use of machines, the amount can go up to 10000 cigars a day, thereby providing economies of scale.Moreover, with increasing pressures to improve yields and prevent diseases like blue mould (since weak economy limits the purchase of sufficient pesticides), new strains of tobacco seeds are being engineered and tested to battle these problems.

However, the economic fragility and the lack of good infrastructures impede the use of high technology to a large extent. Thus, the technological environment is not entirely favorable. ? Environmental The Cuban cigar industry is in transition phase. Altadis has brought increased investment, stability and increased production capacity in to the Cuban industry.The initiatives towards maintaining originality as well as quality through new methods, improving relationship with other countries, et cetera indicate a moderately favorable environment. ? Legal Due to the socialist regime prevailing in Cuba, there are a lot of regulatory directives that the firms need to comply with. The Helm-Burton Act limits the trade that subsidiaries of US firms in other countries could conduct with Cuba.

It also allows US to impose sanctions on countries trading with Cuba. Also, it bans officials of corporations doing business in Cuba to enter US. So, legal environment is not favorable.PESTEL ANALYSIS TABLE: |Environment/Favorability |Low |Moderate |High | |Political | | | | |Economic | | | | |Socio-cultural | | | | |Technological | | | | |Environmental | | | | |Legal | | | | |Overall | | | | . Industry’s Dominant traits ? Market Size: The global cigar market is estimated at roughly 15 billion units. The Cuban Cigar Industry has a very large market size. It caters to the domestic market as well as the international market. ? Scope of competitive rivals: Altadis SA and Swedish Match dominate the cigar industry.

Apart from these, there is Altadis USA, that controls more than a third of the US cigar market and there are other small companies too. But the stiff competition rages between these major players only. Growth rate and cycle: The industry is in maturity stage. Cigar Aficionado, a magazine devoted to cigar lovers, was credited for transforming the US cigar market from a small blue-collar segment to an upscale market promoted in places like luxury hotels and golf courses. It presented cigars as symbols of a successful lifestyle. In 1990’s there was tremendous growth which resulted in increase of farmers from 25000 to 37000 and factories from 17 to 33. After the mid 90s, the demands have tapered off.

The markets have registered slower volume growth and higher value growth. ? Number of rivals and their sizes: The post-revolution exodus of key players opened the doors for many competitors, especially US companies. Over one hundred major export brands were discontinued. However, new reforms provided relief to many small producers and there are many small firms working in the Cuban Cigar Industry. The two major companies, Altadis SA and Swedish Match, separately dominate the Cuban export market and these are the two largest cigar producers in the world.

Number of buyers: The industry has both the domestic as well as foreign buyers. Despite 300 millions cigars being smoked in Cuba annually, the emphasis is on premium export quality cigars as they provide major support to the Cuban economy and the Cuban cigar exports has gradually increased with each year. ? Ease of entry and exit: The entry and exit from the Cuban cigar industry does not seem much easy.

The production in the premium cigar factories is under the direct control of Cuba’s Union of Tobacco Enterprises. The foreign ownership of land is prohibited.The foreign firms can enter through joint ventures and there are other many regulations under Helm-Burton Act that companies need to comply with, that directly/indirectly make the entry and exit hassle-prone.

? Technological changes: The Cuban cigar industry has slowly started incorporating technology in producing cigars. They are investigating new agricultural methods and technologies to improve yields and quality simultaneously. firstly it used to produce handmade cigars but now they use automated machines to produce it. With ?Degree of learning and experience curve: The incumbents of the Cuban cigar industry have a high degree of learning and the experience curve is shifting outward as they have been in the business for a long time. ? Low cost efficiency and product differentiation: There is high degree of product differentiation as each brand has different blend in the filter, different type of binder and wrapper to finish the product. Also, the companies that have been operating for a long time have been able to achieve economies of scale through improved methods to increase yields and high degree of learning. .

Michael Porter’s Five Forces Model of Competition ? Intensity of rivalry: Since the late 1800s, Cuban cigars have been a commodity that is valued by cigar lovers the world over. The industry is in maturity stage and though the size of market has not been growing much in terms of volume, there has been growth in terms of value. The market players are few. Brand identity has a major impact on the consumers’ perception. There is substantial product differentiation.

The consumers’ cost of switching is almost non-existent.Habanos SA, the official owner of all the Cuban brand names, is now emphasizing on quality of their cigars as their competitive strategy. This move can intensify the competition. So, there is moderate Intensity of rivalry in the Cuban cigar industry. ? Threat of new entrant: The success of the two major companies, Altadis SA and Swedish Match, and the huge revenues they are earning is attracting many new firms (domestic as well as international) into the cigar industry.These companies not only have the advantage in terms of cost, experience and huge capital, they also have advantage of having the most popular brands in the world under their control and access to distribution channels.

To compete with these firms, the new companies need to have huge capital. Moreover, there are different government policies pertaining to domestic, foreign firms in terms of registration, access to raw material et cetera. So, there is moderate threat of new entrants in the Cuban cigar industry. ? Power of buyers: The power of final buyers is low in this case.Even though the buyers are large in number compared to the existing firms in the industry, majority of them are small buyers. The industry has few large companies.

Also, there is no close substitute available in terms of the brand image and the quality the Cuban cigars command; so the buyers do not have much bargaining power. The quality is the point of differentiation and Cuban cigars are renowned for their quality. The consumers’ switching cost is almost non-existent. ? Power of suppliers: The power of the suppliers is high in the Cuban cigar industry.

The cigar quality tobacco is unique to Cuban seeds and after the revolution that brought Fidel Castro into power, only the government is allowed to buy tobacco from small firms in Cuba. Hence, the power of supplier is high. ? Threat of substitutes: Though there is not much information about it in the case, we can say that the threat of substitutes is relatively lower in the Cuban cigar industry as the cigar smokers tend to be very particular about their preferred brands in general and they are hard-core loyals as well in majority of the cases.Keeping in mind the hold Cuban cigars have over cigar lovers, the threat of close substitutes is low. |Competitive Forces/ Rate |Low |Moderate |High | |Intensity of rivalry | | | | |Threat of new entrant | | | | |Power of buyers | | | | |Power of suppliers | | | | |Threat of substitute | | | |Overall, the competitive environment seems to be moderately competitive. 4. SWOT Analysis Strengths I. Cuban cigar industry is a part of Cuba’s culture.

II. Cuban cigars are celebrated for their high quality. III. Brand identification. IV. It is a very profitable industry.

V. Vuelta and Semi-vuelta areas in the Pinar del Rio region: Soil and the micro climate that is ideal for producing finest tobacco in the world. Weaknesses I.

Apart from large companies, no quality control and more emphasis on volume. OpportunitiesI. Gradual shift in focus towards quality. II. New reforms allowing growers to buy land through governmental loans and then pay in kind through tobacco harvests. III.

Foreign investments through joint venture. IV. Very large market size domestic as well as international. V. Possibility of embargo being lifted. Threats I. High country specific risk due to political upheavals and low favorability of law.

II. Stiff competition from Altadis SA and Swedish Match in terms of brand value, capital, experience and market share.II. Inability to take advantage of the technological innovations due to weak economic condition. III. Health risks posed by cigar-smoking and people gradually moving towards healthier lifestyles.

Conclusion The PESTEL Analysis points out that the Cuban cigar industry is moderately favorable. Despite current political and legal issues, the economy is looking up. The other environmental factors are quite favorable.

Increased investments and assistance from other countries has started Cuba in the road of improvement.Also, increasing condemnation of the US embargo and the visit of US president Jimmy Carter shows the possibility of easing of the embargo’s restrictions. The competitive analysis shows moderate results. Hence, there is potential in this industry as the market size is huge and the returns on investments seem to be pretty high. Furthermore, it is possible to compete with the industry giants if it enters the industry through joint venture agreement with another established company but the emphasis has to be on the quality of the products.Hence, it is advisable to invest in this industry but from the SWOT Analysis, we can see that the immediate threats are comparatively greater than the opportunities available. Thus, it would be better if John Hernandez waited for some time before making the investment.

The potential of this industry is significant enough to warrant an investment as of today but it is advisable to wait for some time until the investment environment becomes more favorable.

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