FALL FOR PHILIP MORRIS The company insists that cutting the price of Marlboros will make the brand more valuable. Wall Street says the move is a giant blunder. Who's right? Wall Street is.
By Patricia Sellers REPORTER ASSOCIATE Andrew Erdman

(FORTUNE Magazine) – RARELY has a single, simple statement destroyed so much wealth in so little time. When Philip Morris announced, on what became instantly infamous as Marlboro Friday, that it was cutting the price of perhaps the world's most profitable branded product by 20%, investors knew something large had happened. Worried that national brands had somehow lost their power on that April morning, they stomped on the stocks of RJR Nabisco, Procter & Gamble, H.J. Heinz, Quaker Oats, Coca-Cola, and PepsiCo, among others. They also knocked $13.4 billion off the market value of Philip Morris. Says an intrigued observer, Roger Enrico, chief of PepsiCo's giant Frito-Lay subsidiary: ''In the annals of business history, Philip Morris's action is bigger than New Coke. MBAs will study this decision for the next century.'' But what does it all mean? Did big brands die the day the Marlboro Man fell off his horse? The short answer is no. Sure, generics and store brands are strong, but that's an old trend. In some categories, such as soft drinks and beer, the market share of private-label brands has barely budged even through the recession. What really happened is that Philip Morris made an ill-conceived and foolishly executed decision in an attempt to recover from years of surprising mismanagement. The extravagant costs of the plan are largely unique to Marlboro. And that expense includes penance for past sins that management is loath to discuss. Philip Morris expects its U.S. tobacco operating profits to drop by as much as 40%, or $2 billion, as a result of the price cut of 40 cents from a pack that retails for $2.15. This is, as the tobacco managers admit, the company's jarring comeuppance for pricing too aggressively through the past decade: Marlboro's 10%-a-year increases were more than double inflation. But knowledgeable Philip Morris watchers are confused. Says Paine Webber analyst Emanuel Goldman, a veteran follower of Philip Morris: ''Two billion? Two billion? If they have to spend this much, it suggests there are real problems with the way Philip Morris makes its decisions.'' The $2 billion figure is difficult to fathom. If Philip Morris runs its discounting program through year-end, it will use up only around $1.2 billion. What accounts for the rest of the $2 billion drop-off? Most will apparently be the cost of cleaning up an inventory problem that has long been building at the company. FORTUNE last year disclosed that Philip Morris consistently entices wholesale customers to buy extra quantities of cigarettes before price increases -- a practice that puffs up its sales and earnings. Explains Gary Black, a security analyst at Sanford C. Bernstein: ''Philip Morris was shipping more than smokers were buying, and this was going to be a worsening problem.'' Once you start that practice, you can't stop without taking a big hit to earnings as wholesalers work off the extra inventory they've built up. That's what will happen now as distributors, with no price increases in sight, draw down their stockpiles. Conservatively, that means three weeks' supply, or more than $700 million in cigarettes they won't need to order this year. Philip Morris's forgone profits will approach $500 million. Considering the inventory troubles and Marlboro's flagging position -- its U.S. market share has dropped from 26% to 22% since 1989 -- Philip Morris management certainly needed to take bold action. The question remains: Will the $2 billion plan set the Marlboro Man riding high again? Not necessarily -- for the new program is panicky, hodgepodge, and undisciplined. THE DECISION to discount Marlboro was based on a single test market in Portland, Oregon. The four points of market share Philip Morris gained in that experiment sound impressive, but the test was only a month long, not enough time for rivals to respond. Philip Morris's competitors will retaliate against the national discount plan, believes wholesaler Greg Wellinghoff, president of Keilson Dayton Co. in Dayton, Ohio. Another distributor to whom Philip Morris managers recently pitched the program says: ''The plan seems poorly thought out. I asked them, 'Do you honestly think that this discounting is going to occur in a vacuum? What have your marketing people given you to work with in the event of a competitive response?' They said, 'Nothing.' They seemed pretty embarrassed.'' A further oddity of Marlboro's new price plan: Why now, in light of the Hillary factor? Hillary Rodham Clinton and her health care panel have been considering how large an increase in the federal excise tax they can slap on cigarettes to help pay for national health care, and many knowledgeable observers had projected a doubling of the current tax to 48 cents a pack. But now Washington could make that 88 cents, and the price of Marlboros -- and of all other brands that match the 40-cent reduction -- would still rise only 48 cents from current levels. Says analyst Goldman: ''Philip Morris's price cut is made to order for Hillary. Did they even discuss the fact that this now gives the government the green light to try to increase the tax an extra 40 cents?'' The tax issue was not discussed during the development of the Marlboro plan, says Philip Morris's senior vice president of planning, John Nelson: ''We focused on what is going on in the marketplace.'' If this decision turns out as badly as seems likely, who will take the heat? CEO Michael Miles is looking more and more like the corporate cowboy who wants to keep his boots clean. Generally aloof, he has declined to speak with % reporters or analysts about the new strategy or the damaged stock. On the day the price cut was disclosed, Miles appeared at a morning meeting with analysts, introduced chief financial officer Hans Storr, then inexplicably walked off-stage, not to be seen again. Two days earlier, at a Wednesday meeting of Philip Morris directors, Miles recommended that the board approve the pricing action on Marlboro. ''It got the board's blessing,'' says a Philip Morris spokesperson, unwilling to say how much the directors mulled their choice. A prominent executive who serves on several large boards maintains, ''There should have been a full-scale presentation and maybe two days of discussion by the board. The one thing that shouldn't have happened is that the decision was brought to the board as a fait accompli.'' The executive suffering slings and arrows is William Campbell, a lifelong tobacco man who is now chief of the domestic operation, Philip Morris USA. By all accounts he feels beaten, looks haggard, and is in danger of losing his job. Says a former Philip Morris executive who talks frequently with managers still at the company: ''There have been discussions about replacing Bill, but there's no obvious choice within the domestic tobacco company. And none of the food people are willing to come over to cigarettes and put their feet to the fire.'' With Marlboro, Philip Morris seems to have missed the major marketing trend of the Nineties -- value. By relying on endless price increases instead of better quality at reasonable cost, it got itself into a fix. To get out, it made a decision that the stock market and the industry consider dumb. No, big brands in general aren't dead or even close to it. But one in particular could be in big trouble.


-- Philip Morris's after-tax profits from U.S. tobacco will be as much as $1.5 billion lower than Wall Street had expected. That amount is about equal to the total net income earned by the eighth most profitable FORTUNE 500 company, Chevron.

-- Management's bad news knocked down Philip Morris's shares by $13.4 billion in market value, the largest one-day decline by a single stock since October 19, 1987, according to Wilshire Associates.

-- Philip Morris sold 124 billion Marlboros in the U.S. last year. Lined up end to end, they would stretch to the moon and back 27 times.

-- The Marlboro brand alone has more U.S. revenues than such well-known companies as Campbell Soup, Kellogg, and Gillette.