Anyone aware of the consequences of corporate consolidation of the telecommunications industries will realize that the recent $27.4 billion merger deal between Reynolds American and Lorillard means bad news for consumers and small business. I’ve previously expressed concerns about Big Tobacco’s influence on the e-cig industry here, but it seems even Forbes is critical of Big Tobacco’s recent moves judging from the following op-ed by Forbes staff writer Daniel Fisher:
Reynolds-Lorillard Merger Will Create Just The Kind Of Monster Tax Authorities Love
It also raises antitrust concerns, since the takeover will join the No. 2 and No. 3 U.S. tobacco companies, with brands like Camel, Pall PLL -0.54% Mall and Newport. They’ll all operate under the control of Britain’s British American Tobacco, which will own 42% of the combined company. Imperial Tobacco will buy a number of brands including Kool and Winston and take over Lorillard LO -10.49%’s U.S. distribution network.
In any other industry this concentration of market power would send Justice Department economists scurrying for their calculators to tot up the resulting Hirfendahl-Hirschman Index. But tobacco is no ordinary industry. It’s already a virtual cartel, by design, thanks to the Master Settlement Agreement that the state attorneys general negotiated in 1998. The $200 billion-plus settlement was engineered to keep cigarette prices high to discourage consumption – and to keep money flowing to state tax authorities, private lawyers and even the AGs’ own professional organization.
The profoundly anticompetitive deal was a boon for Altria (then known as Philip Morris) as well as Reynolds and Lorillard, since it largely insulated them from lower-cost competitors by forcing new entrants into the cigarette industry to pay the same amount per stick as the settling companies. Soon after the ink dried, Philip Morris’ share of the U.S. cigarette market climbed past 50% and its pretax profit per pack jumped 85%. Bennett LeBow‘s Liggett Group took advantage of its status as an early signatory with lower settlement rates but the same protection against competition to pump out half a billion dollars in dividends.
So far the deal has survived multiple challenges on multiple grounds. Would-be competitors have sued to get out of paying for a “settlement” of legal claims that arose before they even existed. The Competitive Enterprise Institute tried to bust it up by citing the Compact Clause of the U.S. Constitution, which supposedly prevents the states from signing economic treaties among themselves. The effect of the agreement, one set of opponents argued in a brief before the U.S. Supreme Court, was to force “competitors to increase the price of their products to consumers in order to protect their profit margins, thereby protecting the market share of the major tobacco companies.”
One especially pernicious element, those critics wrote, was the clause that required each state to pass a law binding not only current legislatures, but all future legislatures, to the virtual nationwide system of cigarette taxation, at the cost of losing all that revenue if they refused. The Supreme Court refused to take the constitutional bait, however, denying certiorari in 2011.
While the settlement was an unqualified financial success for the tobacco companies, they have continued to exploit its terms for more gains. One of the more curious provisions the AGs allowed in (aside from the hundreds of millions of dollars a year in fees that still flow to politically connected private lawyers who participated in the deal) lets the big manufacturers reduce their payments if they lose market share to low-priced competitors.
They’ve held back billions of dollars from the states as they sue for reductions, and last year a panel of arbitrators held that six states including Maryland and Pennsylvania failed to diligently collect payments from smaller competitors. The ruling means those states will collect $370 million less than they expected from the four biggest tobacco companies, casting a pall over “tobacco bonds” some sold on the premise of continued high settlement payments. The tobacco companies are still suing for similar reductions for the years 2004 to 2012.
So if the Lorillard/Reynolds merger raises prices, could the government possibly object? Imperial Tobacco seems to think it can ease the process by diluting the combined company’s concentration in the menthol and e-cigarette markets by taking Reynolds American’s Kool and Lorillard’s Blu e-cig brands for itself.
And then there’s the money factor. The stated premise behind the tobacco settlement, as well as Food and Drug Administration regulation of cigarettes, is to restrict the marketing and sale of cigarettes because they are deadly. The reality is they are also one of the world’s most reliable sources of tax revenue, and tax authorities love the predictability of cartels. As the dominant companies’ continuing fight over how the settlement is enforced against new entrants shows, there is no incentive to let the unruly forces of market capitalism intrude into this industry.