Annual report 2010 - Imperial Tobacco Group

Principal Risk and Uncertainties continuedStrategy Performance Governance FinancialsRegulationOverviewThe tobacco industry is subject to substantial and increasinglyrestrictive regulatory practices worldwide. In many of thecountries in which we operate, there are regulatory restrictionsaffecting a wide range of matters, including where tobaccoproducts can be smoked and their development, content,manufacture, packaging and labelling, testing, data reporting,sale, distribution, display, marketing and advertising.Imperial Tobacco, along with all other tobacco companies,is often excluded from engaging with regulators on thedevelopment of regulatory proposals. Any future changesto regulation of the tobacco industry could have an adverseeffect on the demand for our products or increase the costsrelated to compliance and contribute to an increase inillicit trade.MitigationWe employ a number of senior and experienced CorporateAffairs specialists to manage regulatory risk and engage withregulators. We monitor proposals for new measures globallyand analyse them to identify their potential impact on theGroup and its products. External experts are consulted wherenecessary to provide advice and guidance regarding anyimpact. Active membership of industry bodies facilitatesconsistent engagement on key issues. We develop Companypositions and toolkits and provide training and guidancefor our markets to comply with regulation. We challengeregulation which is not based on sound legal foundation.Excise Duty and Illicit TradeOverviewTobacco products are subject to excise duty which, in manyof the markets in which we operate, represents a substantialpercentage of the retail price. Substantial increases in exciseduty and any unfavourable change in the tax treatment offine cut tobacco, if widely adopted, may have an adverseeffect on the demand for our products. Increasing levelsof excise duty are also likely to encourage consumers inaffected markets to switch from higher-priced cigarettesto lower-priced cigarettes and fine cut tobacco.Excise duty increases also encourage both legal and illegalcross-border trade from countries with lower levels of duty.Illegal cross-border trade can take the form of genuineproduct smuggled illegally, cheap whites (whereby a smallmanufacturer produces product paying minimal tax, for thepurposes of smuggling) and the production of counterfeittobacco products. Illicit trade may lead to erosion of ourbrand integrity, loss of potential earnings, and potentiallyimpact on our reputation.There is also a risk that illegal trading in our products mayresult in the Group and/or our employees being subjectto investigation or other proceedings by customs or otherauthorities which could ultimately result in penalties andfines being imposed against the Group. Although we haveimplemented procedures to detect and control illegaltrading of our products, such procedures can provideonly reasonable and not absolute assurance of detectingnon-compliance by managing rather than eliminating risk.MitigationAs part of our business planning process we conduct regularreviews of our product portfolio to ensure it is aligned toconsumer preferences in the context of the excise dutystructure in each market.We are committed to working with government authoritiesand international organisations around the world and wecontinue to invest considerable resources in working tocounter the illicit trade in tobacco products.In September we signed a co-operation agreement withthe European Commission and the Member States of theEuropean Union to jointly combat illicit trade in tobacco.Under the agreement we will work together with theCommission and law enforcement authorities acrossthe EU to tackle the smuggling and counterfeiting oftobacco products.We apply stringent controls to our customers as set outin our Group policies and standards, Code of Conductand product supply compliance processes and procedures.Our dedicated brand protection and security specialistsoperate internationally in conjunction with governmentsand customs and excise authorities to disrupt with a view toprevent the supply and sales of illicit product. These controlsare supported by sophisticated information collection andanalysis practices and complemented by developingtracking and tracing, know your customer procedures,product authentication and volume verification solutions.Key Market DependencyOverviewAny material decline in the performance of our key marketsmay impact on our future profit development. The continuedgrowth of the business is underpinned by our key marketsincluding the UK, Germany and Spain. Negative developmentin any of our key markets could have a material adverseimpact on the Group’s revenue or profits.MitigationOur international footprint and brand and product portfolioprovides an increasingly balanced exposure to mature andemerging markets, while our portfolio includes internationalstrength in cigarettes and world leadership in fine cuttobacco, cigars, rolling papers and tubes. This providesus with enhanced growth opportunities, continuing toreduce the percentage contribution of an individual marketto the Group’s adjusted operating profit.26