The counterintuitive economics of smoking

ONE HUNDRED dollars invested in the tech-heavy Nasdaq index in January 2024 would now be worth $160. If you had bought American tobacco companies, you would now have even more: some $165. The share-price boom in part reflects a strange economic phenomenon. In recent years, the operating margin on a cigarette sold in America has grown from about 50% to about 60%. This year cigarette- and cigar-makers are expected to make $22bn of operating profit in the world’s largest economy.

Not bad for a dying industry. In the past decade the number of American adult smokers has fallen by 20m or so. The number of cigarettes sold in the country has fallen by more than a third. And industry insiders expect the decline over the next decade to be even steeper (few Gen-Zers smoke cigarettes). Normally, when customers vanish, an industry suffers: just look at video-rental stores or local newspapers. So how is the tobacco industry thriving? It is, in part, because cigarette manufacturers have read their economics textbooks. They understand price elasticities.

When lots of people smoked, there were many “price-elastic” consumers. In plain English, they were sensitive to increases in the cost of a cigarette. As more people have quit, however, only the most committed smokers are still puffing. These people are price-inelastic. Companies have responded to the changing composition of their customers by raising prices at an ever-quicker pace. Over time, our analysis of official data shows, tobacco-price inflation in America has steadily increased relative to overall inflation. In 2017 the price of a packet of Marlboros rose by only a little more than overall prices (2.9% versus 2.1%). Last year overall consumer-price inflation was 3%. But the price of Marlboros rose by more than 7%.

The companies know exactly what they are doing. “[W]e can continue to take pricing to offset volume declines,” boasts Imperial Brands, which produces everything from Davidoff cigarettes to Rizla rolling papers. In recent results British American Tobacco, of Lucky Strike fame, said that in America “price/mix more than offset volume decline.” Manufacturers cannot perform this trick indefinitely: at some point even the most determined smokers will die, quit or switch to black-market cigs. For now, though, the industry’s prospects are as rich as a cloud of Davidoff smoke. ■