Chapter 35, Part 1

By Frank Tursi, Susan E. White and Steve McQuilkin
JOURNAL REPORTERS
© 1999 Winston-Salem Journal

Here's how far the mighty have fallen: Not too long ago, a reporter called the public-relations department at Philip Morris USA to ask a simple question. When did Marlboro overtake Winston as the top cigarette in the United States? The woman at Philip Morris went to her reference materials.

''Who makes Winston?'' she asked finally.

Reynolds executives Paul Sticht (left) and Colin Stokes talk with Capt. Hendon Berger aboard one of Sea-land's containerships. (Journal File Photo)

What's that? The reporter said.

She repeated the question.

He told her.

''Oh,'' she replied. ''Now, where's R.J. Reynolds located?''

What's that? he asked again.

Again, she repeated the question.

He told her.

''Oh,'' she replied.

RJR once lorded over the tobacco industry from its fortress on Main and Fourth streets. When our series opened, in the 1950s, someone working for Charlie Wade in the company's public-relations department might have responded equally indifferently to questions about Philip Morris, an insignificant blip to Bowman Gray, Ed Darr and the other executives who strode the halls of the Reynolds Building.

Nowadays, there are people in the New York headquarters of the new king, Philip Morris, for whom R.J. Reynolds Tobacco Co. is nothing more than an afterthought.

Though many in Winston-Salem like to blame the company's downfall on F. Ross Johnson and the leveraged buyout he inspired, the reasons are much more complex, and some aren't very mysterious.

This equestrian statue of a young Richard Joshua Reynolds, as he first rode into town more than a century ago, stands at the corner of Second and Main streets. (Journal Photo By David Rolfe)

As this series has detailed over the past two months, RJR leaders believed in their greatness. What had worked in the past would work again in the future. Like many other successful executives of big corporations, they acquired the usual encumbrances of success -- among them arrogance and bureaucracy. So steeped were they in the company's culture that those who led RJR in the 1970s failed to react quickly to the storm over smoking and health that was gathering over their heads and was changing their industry.

Every child now knows that smoking can kill. The loud and often acrimonious debate about smoking has gone on so long that people tend to forget that there was a time when there was little or no debate. Smoking once was glamorous. Smoking was sexy. It was a rite of initiation into the adult world. When Lost Empire opened in the early 1950s, America was addicted to the cigarette. Nearly half of the adult population smoked, and RJR and the other tobacco companies supplied them with their daily fix of nicotine. Running a tobacco company back then, a former RJR executive said, was the easiest thing in the world. You couldn't make cigarettes fast enough.

That all changed as more smokers quit and fewer people took their place. Now, less than a quarter of American adults smoke. How RJR's executives responded to the growing health issue, how they conducted themselves in the battle that still rages over smoking's toll on society are major factors in understanding what happened to RJR. The company's executives still deny that smoking causes lung cancer or other ailments. Early on, they tried to hide internal research that tended to show otherwise. They put the fortunes of the company above all else.

Cigarette companies are fast moving into sponsoring concerts and shows at bars and clubs as a way of reaching smokers. Camel sponsors this drag show at a club in Indianapolis. (Photo By Jason Yoder)

What anti-smoking activists couldn't do, lawyers finally did. Much of this story played out in the courtroom, where industry and plaintiffs' lawyers are involved in a high-stakes game. Nice guys need not enter. The damning memos and internal reports that the lawsuits brought to light revealed a rather unsavory side of the industry, one that seemed to lie and deceive. As any good tobacco man knows, image is everything. For years they sold their cigarettes, not based on any real difference among brands, but with beguiling advertising images that made people think there was a difference. The company memos and reports that tumbled out of courtrooms made America think there was something suspect about this business. RJR, for instance, can deny all it wants that Joe Camel was designed to appeal to children. People think that it was, and no one wants you messing with their kids.

Branded as poisoners of children, their adult customers turned into social pariahs, their political allies running for cover, RJR and other once-proud tobacco companies were forced to the settlement table.

That agreement won't end the hostility and distrust that people such as Matt Myers have for RJR and the other tobacco companies. The settlement, he said, doesn't wipe out the years of denials.

''We're seeing the dawn of a new era in which the tobacco industry will constantly be under attack from one place if not another,'' said Myers, the executive vice president of the Campaign for Tobacco Free Kids. ''As soon as they put out a fire, there's every reason to believe that another will emerge. It's unrealistic for the industry to think there will be an easy out or a knockout punch on their side to solve all their problems.''

Forty years ago, Reynolds Tobacco was simply a domestic tobacco company. Then would come waves of diversification, investments in oil, shipping, fruit, cookies and liquor, and the creation of a cigarette business that spanned the globe. In 1989. it was sold to investors in a mammoth deatl that made a lot of people wealthy and crippled the company with debt. Then came the dismantling.

The international business, built country by country in the 1970s and 1980s, was sold this year, after the company gambled and lost in the foundering economies of the former Soviet Union. And in June, RJR officially separated from Nabisco, cutting the final tie to a business strategy begun more than 30 years ago, when the company began plowing its profits into businesses other than tobacco. The remarkable company founded in 1875 by Richard Joshua Reynolds has come full circle.

Promising Future

Andrew Schindler isn't throwing in the towel. He says he thinks RJR and tobacco still have a promising future. ''My view, (is) the product, as long as it's legal, will be here,'' said Schindler, the chairman and chief executive of RJR. ''I don't know how big the industry will be 25 or 30 years from now. I don't know what percent of that will be smoking. I think it will be substantial. I think it will be a profitable business to be in.''

The industry is still mammoth. Every day, about 1.1 billion cigarettes are made for sale in the United States -- five for every person in the country. Domestic retail sales exceed $45 billion. Exports of tobacco products add another $7 billion. From farms >and factories to retail stores, the U.S. tobacco industry employs more than 650,000 people.

Reynolds Tobacco is a stronger company these days, Schindler said. He credits the $8 billion sale of the international tobacco company to Japan Tobacco. Much of the proceeds of that sale cleaned up RJR's balance sheet, erasing all but $900 million of the debt remaining from the leveraged buyout of 1989.

''It's a good feeling, at least going into this thing, to believe that you have that ability to think in those terms, as opposed to where we were before being very cash-restrained,'' Schindler said.

Investors don't yet share his optimism. When RJR went public June 15, its stock sold for $32 a share. It's down to $18, even with a $3.10 a share dividend, among the highest on Wall Street.

Shedding that debt also makes RJR less vulnerable to a crippling jury verdict, Schindler said. ''It's a different world now,'' he said. ''First of all, the AGs' (attorneys general) suits have been resolved. It came at a big price, but they are resolved. So there's not this uncertain risk of the AG suits. Plus, we're sitting on a whole different situation relative to debt, relative to balance sheet, relative to available cash. The bankruptcy question, in my opinion, is no longer relevant like it was a couple of years ago.''

By signing last year's 25-year, $206 billion national settlement, RJR and the other tobacco companies wiped out the remaining 46 state lawsuits, which were filed to recoup health-care money spent treating indigent smokers who were sick. Still, the agreement didn't protect the cigarette companies from private lawsuits. ''The global settlement put people in the state of mind that these guys have got a lot of money to give away,'' said David Logan, a professor at Wake Forest University's School of Law.

The fate of the industry might then hinge on how badly the states want to be paid. ''I don't think the lawsuits will drive them into bankruptcy,'' said Yancey Ford, a former longtime sales executive at RJR. ''They got 50 new stockholders -- big stockholders -- called the states.''

The tobacco companies, though, can't continue to operate under such a tumultuous legal landscape, said Phil Carlton, the Pinetops attorney who represented the industry during the state negotiations. If nothing else, there needs to be a limit on the amount of damages the industry would have to pay if it lost a smoking lawsuit, he said.

''That is still the missing element of this whole thing,'' he said. ''And that's why there's no future until they can get something there. You just can't be very excited about the future. It's just that simple. The country's mood is very obvious now. If the country wants the public policy to be to put them in bankruptcy then that's OK. But that's what they need to think about.''

The industry is awaiting the verdict in a landmark class-action lawsuit in Miami. A jury found in July that Philip Morris and other tobacco companies were liable for the injuries of as many as 1 million sick Florida smokers. The jury ruled that cigarettes are dangerous and defective, that they cause cancer and other diseases, and that the tobacco companies engaged in ''extreme and outrageous conduct'' in selling and marketing their products.

Some legal experts have estimated that the damages could approach $300 billion.

Other cases haven't gone the industry's way. A San Francisco jury in February awarded $51.5 million to a woman with inoperable lung cancer. It was the largest award ever granted to a plaintiff suing the tobacco industry until a month later when an Oregon jury awarded $81 million to the family of a dead smoker.

Though both awards were later reduced by half, they were still unprecedented. In 40 years of litigation, the tobacco companies had lost only three other trials, all of which were overturned.

The Florida case likely will not be decided before the end of the year. And come 2000, the industry will still be tied up with more than 600 lawsuits, including cases filed by labor unions, American Indian tribes, various cities and counties, and foreign governments. The U.S. Justice Department also wants a piece of the pie. It filed a lawsuit in September, charging the industry with fraud and deceit and seeking to recover the billions spent treating smokers since 1954.

Given the legal uncertainties, G. Dee Smith is less sanguine about RJR's survival as a publicly owned company. ''I think they'll probably always stay in existence,'' said Smith, a retired RJR executive. ''But I think their profitability will be so small that it won't be a viable company much longer.''

A Strong No. 2

Philip Morris began its meteoric rise in the mid-1960s and overtook RJR as the country's leading tobacco company in 1983. Put aside for a moment all the moralism about tobacco marketing and look at Philip Morris just as a competitor within an industry. It is one fearsome company -- a brand bully much like an Anheuser-Busch or even a Microsoft. Philip Morris has increased its domestic market share to just under 50 percent, while Reynolds, its nearest competitor, has dropped to 24 percent. About one out of every three cigarettes sold in the United States is a Marlboro.

Schindler concedes that the race is over. ''I don't even think about that,'' he said. ''They have one brand that is 12 share points bigger than this whole company. . . . You got to recognize where you sit in the game. Three years ago we said our strategy was to be a strong No. 2, and some people in the company didn't like that. They wanted to be No. 1. Well, if the company became No. 1 some day, fine. But this isn't about being No. 1. It's about being competitive. It's about increasing your earnings, being strong in the marketplace, rewarding your shareholders and all that stuff. The problem with aspiring to be No. 1 with a situation like this is you start doing things you shouldn't be doing. You're looking for silver bullets and all that sort of stuff, and I think it's dangerous.''

That's not to say that RJR will roll over. It and two other tobacco companies won a preliminary injunction against Philip Morris in June after complaining in U.S. District Court in Greensboro that the company was trying to monopolize prime retail space with a program that encourages retailers to prominently display its brands. Philip Morris is appealing.

Domestic volume plummeted this year to about 420 billion cigarettes, about 9 percent below 1998, as cigarette companies raised prices to help pay for the tobacco settlement. Reynolds' volume will be about 105 billion, and there's a good chance that production next year will fall below 100 billion, the lowest level in 45 years. As volume continues to drop, the company has said that cigarette-making may stop at Whitaker Park, which opened in 1961 to meet the demand for Winston and Salem. A year ago, it laid off 1,300 employees to cut costs and bring its work force in line with cigarette deman.

Despite that forecast, RJR hasn't given up on increasing its market share. Its top brands -- Winston, Salem, Camel and Doral -- are what it calls ''investment brands.'' The others -- including Vantage, More and Now -- are the second-tier products. Schindler and his management team have struggled to stabilize the big four. Camel's market share is up. Doral and Salem are holding steady. Winston stopped a 25-year slide in 1998 with its ''No Bull'' ad campaign, but slipped a little this year.

''The question of whether you can grow market share has to do with the power of the idea,'' Schindler said.

Saying Thanks

RJR's ideas take a lot of different directions, but most revolve around two basic themes: keeping its customers loyal and targeting its marketing toward today's smokers, who tend to be less-educated and more blue-collar than society as a whole.

This September, for example, it sponsored a Doral Homecoming at its Tobaccoville factory, a big party to say thanks to the smokers who've made Doral RJR's top brand. The road into Tobaccoville is called Doral Drive. Camel, Winston and Salem may have built the company, but a discount brand with a 6.3 percent market share now calls the shots.

Some 3,000 people from across the United States showed up to eat hamburgers, tour the factory and hear Alabama play country music. As one appreciative smoker said: ''You've got to die of something. Might as well enjoy it. I look at it like this, they're giving me some of my money back.''

A few weeks later, RJR helped sponsor a very different event: the 1999 National Miss Gay USofA At-Large Pageant in Indianapolis. It was four days of drag queens, courtesy of Camel, and underscores the battle being waged at bars and nightclubs around the country. In many major cities, Philip Morris, Reynolds and Brown & Williamson have formed alliances with different clubs, helping with advertising and promotions. It's all part of an effort to find smokers where they smoke, and keep smoking a hip, cool past-time of young adults.

Philip Morris' Marlboro campaign is still about cowboys and wide-open spaces. RJR's advertising is edgier, and more irreverent. It shows the influence of being the underdog in second place. The smokers in the Winston ads aren't cowboys who looked like they walked off a Ralph Lauren shoot. They're average folks, looking for a little honesty in the world and, hopefully, their cigarettes. Camel's ''Mighty Tasty'' campaign made fun of lawyers and snooty rich people. The current campaign focuses around the theme ''Pleasure to Burn.'' One ad features a sultry woman wearing a skimpy dress and holding a cigarette in one hand and a TV clicker in the other.

Listening to some industry analysts, people can get the perception that cigarettes, because of the marketing restrictions imposed by the settlement, will become a commodity. Big brands will lock in their market share for good. That was also the theory heard 29 years ago, when the TV ban took effect, and RJR found out the hard way what nonsense it was.

''It doesn't make sense that there will be no more innovation, no more opportunity to intervene and get market share for somebody,'' Schindler said. ''I think it's there. I think it's obviously tougher than if you were in a normal category, and you have access to all different media. My view is that the product will be around. I think, going forward, there will be innovation in this category. . . . It's hard for me to believe that 10 years from now this product will be exactly the same in the future as it is today. I think that represents an opportunity.''

By ''innovation,'' he's talking about a technological breakthrough that would allow RJR to produce a demonstrably less-hazardous cigarette. The company, for instance, recently announced a program to help farmers change the way they cure tobacco to reduce nitrosamines in flue-cured tobacco. The chemical compound in high doses causes cancer in some lab animals. It isn't likely that this shift will give Reynolds a marketing edge; other companies are following suit.

RJR hasn't given up on its ''safer'' cigarettes. Premier was a flop when it hit test markets in the late 1980s. Its successor, Eclipse, is currently being tested in limited markets. Both generate virtually no tar and a small fraction of the hazardous compounds in tobacco smoke.

RJR was careful not to make any health claims for Eclipse or Premier. Doing so would have invited a review by the U.S. Food and Drug Administration, which has asked the Supreme Court to determine if it has the power to regulate nicotine as a drug. RJR and the other tobacco companies have fought FDA regulation.

''Their long-term opposition to any federal regulation means that any effort to innovate, whether sincere or not, is going to take place in an atmosphere of open hostility, where neither side trusts the other, neither side is willing to believe the other,'' Myers said.

The Future

So where does all this go? Myers agrees with Schindler on one point: Cigarettes will be with us for some time. Nearly 50 million Americans still smoke, despite more than 40 years of warnings about the hazards of their habit. Banning cigarettes, Myers knows, isn't practical. ''I used to say to the industry people during the negotiations, which I'm sure they loved, `Maybe you can produce a product that kills, maybe you can produce a product that addicts, but you can't produce a product that both kills and addicts,''' he said.

In Myer's view of the future, the cigarette industry will be regulated by the FDA much as the drug industry is today. The federal government would force the tobacco companies to make safer, low-tar and low-nicotine cigarettes. The companies would have severe limitations on advertising. The idea, Myers said, is ''to encourage the creation of and bring to the marketplace products that might kill many, many fewer people, with marketing restrictions so they wouldn't turn into the next generation of low-tar cigarettes more designed to attract many new people to the marketplace.''

Banning tobacco isn't part of Donald Shopland's vision of the future. The co-author of many of the surgeon generals' reports on smoking for the U.S. Public Health Service, Shopland is disturbed by the steady rate of smoking among America's teen-agers. Though adult smoking in the United States has steadily declined, smoking among youngsters under 18 has just started to slowly fall after rising in the early 1990s. Still, more than one-third of high-school students are smoking by the time they graduate.

Shopland had hoped by now to see the smoking rate among American adults fall to single digits. ''But what we want to do is get the rates down as far as you possibly can to where it (smoking) becomes a social custom practiced behind closed doors,'' Shopland said.

Sneaking a smoke in the house like some drug addict isn't what Charles Blixt or the 8,000 other RJR employees have in mind. ''The people who work for this company and work for this industry work under a constant daily assault,'' said Blixt, RJR's general counsel. ''They have a lot of pride in what they do. They believe in the product they sell. They believe that people ought to have the right to use this product and get awfully tired after a while for being continually condemned for it. This is a product that has a long history in this country. It's something that people get enjoyment out of using and we're committed to providing the best tobacco products that we can.

''People really feel good about working for this company. They're committed to this company and it's a real travesty that they get castigated for being a part of what has been characterized as this cabal and that they can't go to work every day and feel good about what they do.''

Schindler is more introspective. He is . . . , and when he retires, he would be satisfied knowing that he left a strong company whose employees weren't afraid for their jobs.

The history and past glory are just that. Reynolds used to be atop the industry. ''So what?'' he said. ''You have to be careful about that.''

Schindler is a link to that past at Reynolds, the first executive to run the tobacco company in more than 20 years who came up through the ranks, the way it used to be done. He never sold underwear, or toothpaste or liquor. Except for a year with Nabisco in 1988, he's never worked for a company Reynolds bought with the profits from tobacco.

''This grand experiment officially began in April 1970, when they formed R.J. Reynolds Industries. So I've been here for 25 of this almost 30-year experience. I like to say I'm the last senior person in the company who lived through the whole thing.''