FTC Staff Stands by Its Analysis: Agency Says Tobacco Industry Critique of its Report on the Proposed Tobacco Settlement Is Unfounded

The staff of the Federal Trade Commission today said that tobacco industry criticism of its report on the proposed tobacco settlement is unfounded. According to the FTC staff, the industry critique of its report did not uncover any significant errors and the findings of the original report remain: that the antitrust exemption contained in the proposed settlement, as well as other features of the agreement, could permit the cigarette companies to coordinate more effectively, and that such coordination would be expected to generate dramatic increases in industry profits.

On September 22, the FTC released the staff report, titled "Competition and the Financial Impact of the Proposed Tobacco Industry Settlement." The report provides an overview of the U.S. cigarette industry and analyzes the effects of the proposed tobacco settlement on competition, prices, profits and public sector revenues. It demonstrates that industry profits could rise substantially, in part because of the antitrust exemption. Approximately two-thirds of any additional revenues generated as a result of increased coordination among the industry would go to the cigarette manufacturers as excess profits, the report says.

The evaluation of the tobacco industry analysis, as well as the report itself, were prepared by the staff of the FTC in response to several congressional requests. The evaluation of the industry's critique points out that "[t]he industry analysis does not address several key conclusions of the FTC Staff Report: that the antitrust exemption and other features of the proposed settlement could lead to enhanced industry coordination, that more effective coordination would allow the industry to increase prices more than necessary to simply 'pass through' to consumers the amount of the annual settlement payments, and that these price increases would lead to a substantial increase in industry profits."

According to the evaluation, the tobacco industry, however, does posit that the staff report figures for future cigarette prices are too low and that the figures for future industry profits are too high. In response, the FTC staff said that "[t]he industry's projections of future cigarette prices are much closer to [our] projections . . . than they appear" because the industry estimate of a $1.52 per pack price increase by the year 2007 "is given in nominal terms, which means that the effects of anticipated inflation are included in the estimate. Since the FTC staff analysis was conducted in real terms (i.e., in constant 1997 dollars), it is necessary to convert the industry estimate into real terms to compare it with the FTC staff estimate" of a $0.72 per pack price rise. When that conversion is done, "the industry's estimated $l.52 nominal price increase is equivalent to a real price increase of only $0.67 to $0.79." Use of real terms is important, the staff evaluation points out, because "[u]se of nominal prices would lead to an overestimate of the reduction in cigarette consumption. Since only real changes in price affect consumers' purchasing decisions, estimates of future demand must be calculated in real (i.e., constant-dollar) terms to control for the effects of inflation." If the settlement in fact achieved a "real" price increase of $1.52 per pack, the windfall from the approximate $0.70-$0.80 per pack increase would disproportionately favor industry according to the earlier staff report.

The staff evaluation also observes that when analyzing profits the "industry report adjusts some figures for inflation but not others, in effect mixing apples and oranges and leading to wrong conclusions." If the industry had used a consistent basis, it would support the staff conclusion that "manufacturers' profits would rise substantially under the FTC staff's scenario reflecting substantially more effective industry coordination."

Finally, the staff evaluation points out that the industry probably overstates the magnitude of the decline in future cigarette consumption. According to the evaluation, the industry uses estimates of the elasticity of demand that are higher than most published estimates and it assumes that even in the absence of prices increases there will be a substantial (2.5%) annual decline in cigarette sales. The Commission's vote to authorize the release of the staff evaluation was 3-0 with Commissioner Sheila F. Anthony not participating.

Copies of the staff evaluation, the staff report and Commission testimony on the proposed tobacco settlement are available from the FTC's World Wide Web site at: http:www.ftc.gov and from the FTC's Public Reference Branch, Room 130, 6th Street and Pennsylvania Avenue, N.W., Washington, D.C. 20580; 202-326-2222; TTY for the hearing impaired 1-866-653-4261. To find out the latest news as it is announced, call the FTC's NewsPhone at 202-326-2710.

(FTC File No. P859 912)