Abstract
This is a classic case concerning a long-standing debate in the history of management: Does the firm exists for shareholders’ wealth maximization or for stakeholders’ value creation? The case begins with the effect of levying additional cess on the FMCG product, cigarettes, on the share price of the company; and anchors around the argument—is the bare minimum meeting of regulatory mandate of the Government good enough for an organization to acquire favourable perceptions from their stakeholders; or are there other factors which impact legitimacy?
Issues Regarding Different Stakeholders
Poverty
In a country where (almost) one-fifth of the population lives below national poverty line, a significant amount of wealth goes up in smoke. The fact that the percentage of per capita GDP spent for purchasing cigarettes of the most popular brands is highest for India among BRICS nations, which is an alarming concern.
Money Spent on Health
One of the reasons for high use of tobacco among people is the marketing effort that the tobacco industry invests in to push its products into the blood of the consumers. The hazards due to tobacco are not limited to the people who consume it. It has negative externalities—it spreads to the farmers who cultivate the crops and has detrimental effect on the environment—use of pesticides and deforestation.
Preventive Efforts
Mandated laws by the government to warn smokers about hazards of smoking and the current television policy to reduce tobacco the hazard are some of the current preventive initiatives. WHO recommends active coordination between government, academia and civil societies to overcome the tobacco epidemic.
Profitability of the Industry and CSR of ITC
The P/E ratio and P/B ratio for the cigarette industry is pretty high, the minority investors invariably pay a premium for the shares of the firms in this industry. ITC has tried to maintain balance between the competitiveness and its social values. It has shown sensitivity by being carbon positive and by recycling water and solid wastes. It has reduced its dependency on fossil fuels. ITC has taken various initiatives in empowering women via SHGs and imparting skills and vocational training to the youth. It has also contributed to the sanitation drive by contributing in the Swachh Bharat initiative.
GST
ITC, while carrying out its economic activities, has negative externalities on unrelated parties, for example, deforestation, pesticide use, passive smoking and cigarette butts disposal. This externality cost is borne by the society, which is not calculated in the financial sheets of the firm. GST is not the only solution for curbing the epidemic. Addition of taxes shall deter the consumer to smoke less while MPOWER shall increase awareness of the consumers and act as a catalyst.
SWOT Analysis of ITC with Regards to Industry
Strengths
Market share of 76.10 per cent in retail FMCG cigarettes and presence in other FMCG products such as hotel industry, paperboard, specialty papers, agribusiness and information technology, help ITC leverage its distribution channel and acquire economies of scope.
Weaknesses
Though ITC spends considerable amount on CSR in areas, such as establishing women self-help groups, vocational training, sanitation, use of carbon neutral fuels, it has clearly failed to sustain the shocks of external environment (e.g., impact of tax regime). The financial health of ITC is dependent mostly upon its FMCG product cigarettes (61.32% of total revenue of ITC and 80.6% profit before tax).
Opportunities
The correlation of announcement by GST council of additional cess on cigarettes and dip in the stock price led analysts wondering if there would be any further impact of such events on the stock price. There is an opportunity to strike a balance between shareholders’ wealth maximization and stakeholders’ value maximization by being proactive in preventing ‘green tobacco sickness’ by asking children not to work in tobacco fields, even before a regulation strikes in. Other opportunities include leveraging its competence of special paper manufacturing in packaging cigarette and other nicotine product. ITC could also achieve economies of scale as cigarette boxes are light in weight but occupy large volume; the firm can leverage the additional benefit by using the excess weigh space for delivering products which are high on weight and low on volume.
Threats
A total of 5 per cent increase in an ad valorem tax (₹1591 per thousand sticks). As ITC has 79.10 per cent market share (retail volume—2016), ad valorem tax and cess will hit them the most.
Industry Threats (Porter, 2008)
Rivalry Among Competitors
The rivalry in the industry is less intense in retail with ITC in 2016 holding 79.10 per cent share in retail volume. And the rest 21 per cent is divided among Godfrey Phillips India Ltd, VST Industries India Ltd and Philip Morris India Ltd.
Threat of New Entrants
Sale of cigarettes is forbidden by law, which has grown to 22.7 per cent of legal sales in 2016. The understanding among consumers that imported cigarettes are lesser evil also offers threats. Finally, smuggling of international brand cigarettes to avoid taxes is yet another threat.
Bargaining Power of Suppliers
Suppliers have power when they extract more value for themselves and play off players in the industry against one other. The raw material supplied is not differentiated and are not credible enough to create forward integration in the industry. As the suppliers are distributed throughout, the bargaining power of supplier is low.
Bargaining Power of Buyers
The power of buyers in this industry is low, with ITC grabbing more than three-fourths of the retail market share of cigarettes.
Threat of Substitute Products
Consumption of nicotine in other forms such as chewing tobacco (49,511.70 tonnes) and e-cigarette (USD 3 billion-market size) are potential substitutes for ITC products.
Concluding Thoughts on the Case
The case poses a very imperative thought—provoking a question—Why do firms exist? Perrow (1991) argued that organizations shape the lives of the people in a subtle and unobtrusive way, such that what community used to contribute to the society is now been contributed by the today’s organizations. In a way, the organization has consumed the society. Large organizations employ a large amount of society’s population and provide medication, school facilities, recreation facilities and so on. The other smaller organizations exist to satisfy the needs of these large organizations. In short, large organizations dictate what the small organizations do. Individuals and their families depend on firms for their wages and externalize social costs to coordinate activities. From the lens of transaction cost economics, existence of organizations reduces the incurred costs if society co-ordinates its activities.
Given this, our assertion is that ITC has to be socially responsible. Doing business in sin goods gives perception that the company is more interested in filling pockets of the shareholders at the cost of the society. Being socially responsible acts as an insurance for the firm. The cost of smoking is also borne by people who are smoking passively and the government has to bear the cost of medical treatments. Overall, the shareholders’ maximization is at the cost of stakeholders’ value creation.
Though ITC is contributing to the society, the effects of having favourable perceptions among shareholders is not achieved. ITC should achieve a balance by increasing positive externalities to the society apart from contributing to SHGs.