CASES FOR DISCUSSION. Philip Morris s Troubles

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1 Note: the following case is copyrighted and may be copied and used only by current users and owners of the textbook, BUSINESS ETHICS: CONCEPTS AND CASES by Manuel Velasquez. CASES FOR DISCUSSION Philip Morris s Troubles Financially speaking, 1995 was an outstanding year for Philip Morris, a combination tobacco, food, and beer company. Total company profits before taxes increased by 15 percent over the previous year; in the tobacco segment of the company worldwide profits rose by 16 percent; profits in its food segment increased by 7 percent and the beer segment s profits increased by 8 percent. 1 Yet all was not well. As of the end of 1995 there were 125 lawsuits pending against the company for recovery of damages to health alleged to have been caused by the company s tobacco products. Its beer segment was under attack by several consumer groups claiming that alcoholic beverages imposed heavy costs on society including numerous deaths attributable to drunk driving. And activists were accusing the company of laundering the dirty money it had made in the cigarette business by using it to buy up clean food businesses, in effect protecting these funds from any potential liability that might strike its tobacco business. Philip Morris, with 1995 revenues of $53 billion, profits of $5.45 billion, and 151,000 employees, is both the nation s largest cigarette manufacturer and its largest food company. Philip Morris was already the largest tobacco company in the United States by the late 1960s when virtually all of its revenues were derived from tobacco sales. Then, accelerating a long-term strategy of diversifying away from the tobacco industry, (a strategy that would become common in the tobacco industry) Philip Morris used the huge cash flows streaming from its tobacco businesses to acquire Miller Brewing Company in In 1985 i t bought General Foods for $5.6 billion, setting a record for the biggest nonoil merger in history. Three years later Philip Morris paid $12.9 billion for Kraft, then the largest food company in the United States. In 1990 the company acquired Suchard, a Swiss coffee and confectionery company, for $3.8 billion making it the world s largest food company and in 1993 it purchased Freia Marabou, a Scandinavian candy company, for $1.3 billion. Among the company s well known cigarette brands are Benson & Hedges, Marlboro, and Virginia Slims. Its beer brands include Miller Genuine Draft, High Life, Lowenbrau, Miller Lite, and Milwaukee s Best. Food brands include Post Cereals, Kraft Jell-O, Birds Eye, Maxwell House, Velveeta, and Oscar Mayer. In 1995 the company s tobacco operations accounted for 50 percent of the company s revenues and 63 percent of its profits while food products accounted for 42 percent of revenues and 32 percent of profits. Beer brewing provided 7 percent of revenues and 4 percent of profits. The company s financial and real estate ventures accounted for the remaining 1 percent of revenues and profits. 2 Philip Morris s Marlboro brand, the world s best-selling cigarette, held 31 percent of the U.S. market in 1995 and the company s other tobacco products held an additional 16 percent of the U.S. market, for a total U.S. market share of 47 percent. The company had captured 12 percent of the market outside the United States and in some regions such as Germany, Western Europe, and Latin America, its market share was well over 20 percent. Total world sales of Marlboro cigarettes were estimated to be well over $10 billion. International sales accounted for 50 percent of the company s total revenues and 40 percent of its operating profits in The domestic beer market had been in the doldrums since going into decline in the early 1980s. In spite of a continuing overall contraction in the market from 180 million barrels in 1994, to 171 million in 1995, however, Philip Morris Miller had managed to increase its market share, doing so at the expense of Coors, Stroh, Heilman, and some smaller regional brewers.

2 Hurt by the recession of the early 1990s, the food industry had also not been doing well. 3 Nevertheless, by reducing its workforce, implementing cost reductions, and pushing aggressively into new international markets, Philip Morris had managed to raise its food income per employee by 43 percent between 1991 and 1995, raise food income margins to 15.3 percent in 1995, and increase 1995 food income by 7.5 percent. In 1991 Michael Miles became CEO of the company, the first nonsmoker to run the company. Under Miles the company continued to increase its share of the cigarette market in spite of a decline both in the number of cigarettes sold each year and in the number of Americans smoking. The average adult smoker in 1994 had consumed 2470 cigarettes, down 26 percent from 3370 in In 1995 U.S. consumers smoked 1.7 percent fewer cigarettes than in Nevertheless, although U.S. consumption of cigarettes had declined since the early 1960s, Philip Morris continued to increase both its sales and its market share. By 1994 Philip Morris held 45 percent of the market, followed by R. J. Reynolds with 27 percent, Brown & Williamson with 11 percent, Lorillard with 7 percent, American with 2 percent, and Liggett with 2 percent. Competition in the contracting industry was now extremely intense. Competition, however, was not Philip Morris main headache. In 1995, the Federal Drug Administration (FDA) had intensified its attacks on the industry with the announcement that 400,000 Americans died of causes related to smoking each year, more than 1000 deaths a day. An average of five and a half minutes of life are lost for each cigarette smoked. While smoking among adult men had been declining, smoking among children was rising rapidly. So many adult women had taken up smoking that lung cancer now killed more women than breast cancer. The FDA claimed that smoking illnesses accounted for 11 percent of the aggregate costs of all illnesses in the United States. For men between 45 and 64, 25 percent of disability days were associated with cigarette smoking. Indirect economic losses from reduced productivity and lost earnings were estimated at $37 billion per year, and total economic losses at $65 billion a year. Since the 1950s the tobacco industry had been buffeted by studies linking smoking with cancer. Large scale studies published in medical research journals in the early 1950s associated repeated cigarette use with high rates of lung cancer. In 1954 the widely read magazine Reader s Digest published a popular article summarizing the medical research that linked smoking and cancer intensifying the concern of the public. In spite of bitter protests from the industry, the Surgeon General of the United States in 1964 released its own report linking cigarette smoking to cancer. In 1966 Congress required health warnings to be placed on all cigarette packages, a law that it amended in 1969 to require sterner warnings and again in 1985 to require rotating health warnings indicating the relationship between cigarette smoking and lung cancer, heart disease, emphysema, fetal injury, and premature births. A new concern had surfaced in 1986 when the Surgeon General of the United States and the National Academy of Sciences reported that nonsmokers were at increased risk of lung cancer and respiratory illness when exposed to environments containing second-hand smoke. In 1994 the Food and Drug Administration turned its attention to the addictive nature of cigarettes. The Surgeon General had already issued a report in 1988 summarizing research that nicotine was addictive. The FDA now announced it was prepared to recommend that because of their addictive nature, cigarettes a nicotine delivery device should be regulated like a drug under the jurisdiction of the FDA. In 1994 Congress held hearings on the question whether the nicotine in cigarettes is an addictive drug and whether the cigarette industry was manipulating the nicotine levels of cigarettes. The executives of all the tobacco companies were called to testify. At the hearings, William Campbell, head of Philip Morris s tobacco unit, in a sworn statement, denied that nicotine was addictive and said that the company does not manipulate nor independently control the level of nicotine in our cigarettes.... [N]icotine contributes to the taste of cigarettes and the pleasures of smoking. The presence of nicotine, however, does not make cigarettes a drug or smoking an addiction. 4

3 On April 1, 1994, Congressman Henry A. Waxman announced that a committee he headed had found evidence that Philip Morris had suppressed a 1983 study by Dr. Victor DeNoble that had produced definitive evidence of the addictive qualities of tobacco in rats, and that Philip Morris had, therefore, known since that time that tobacco was addictive. Waxman stated that the discovery goes to the basic question that was raised in our hearing: Have the American people been manipulated into thinking that smoking is a matter of choice, or in fact is it a choice denied them because of the possible intentional manipulation of nicotine levels to keep them addicted? 5 Waxman s findings were corroborated when, on March 19, 1996, the FDA released sworn statements from two Philip Morris research scientists and a Philip Morris plant manager contradicting Campbell s testimony. 6 Jerome Rivers, the plant manager, outlined a sophisticated manufacturing process in which the levels of nicotine in tobacco were carefully monitored and during which tobacco whose nicotine levels were out of spec was pulled out and reprocessed. Ian Uydess, one of the research scientists testified that Nicotine levels were routinely targeted and adjusted by Philip Morris in its various products at least in part and that Dr. DeNoble s research on nicotine analogues was known in the company where there was a growing concern among Philip Morris management about the use of the term addictive and where internal reports were increasingly scrutinized by Philip Morris management. Dr. W. Farone, former director of the company s applied research also testified to the company s sequestering of much good science. Earlier an internal Philip Morris document written about 1992 by a Philip Morris employee had surfaced stating that people smoked mainly to deliver nicotine into their bodies and comparing nicotine to cocaine, atropine and morphine in its effects on the brain. 7 Jeffrey Wigand, a former manager for Brown & Williamson, one of Philip Morris s main competitors, had testified on November 29, 1995 that Brown and Williamson s CEO had also lied to Congress during the hearings when he had said I believe nicotine is not addictive. 8 The U.S. government now initiated a criminal investigation of U.S. tobacco industry executives to determine whether they had lied at the hearings and fraudulently concealed from the public the addictive nature of smoking nicotine products. Several class action suits were filed against Philip Morris alleging damages to health arising from the company s failure to warn of the addictive nature of smoking. The Food and Drug Administration announced in August 1995 that it was considering sweeping new rules to regulate the advertising and sale of tobacco particularly to minors. In addition, several states and two insurance companies had filed new suits seeking reimbursement of the medical costs alleged to have resulted from caring for citizens who had used the products of the tobacco companies. Philip Morris, together with the other cigarette companies, had responded that states were already compensated for smokers health costs through heavy excise taxes, that smoking imposes few costs on government and may save states money when sick people die early, and that once tobacco s contributions to the economy are factored in tobacco makes a positive economic contribution to a state s economy. A report released in late January 1996 by the Centers for Disease Control, however, calculated that the direct medical cost of smoking totals $50 billion a year, more than twice the $21 billion in state revenues from tobacco growing and manufacturing. 9 On the other hand, an earlier 1993 report by the Office of Technology Assessment claimed that in 1993 smokers paid $13.3 billion in excise and sales taxes but cost governments only $8.9 billion in health-care expenses. As of December 31, 1995, over 125 cases were pending against the company seeking compensatory and, in some cases, punitive damages for cancer and other health effects claimed to have resulted from cigarette smoking or exposure to cigarette smoking. While previously sued more than 300 times in court, cigarette companies had never lost a case. Among the defenses used in litigation by Philip Morris, was the argument that complying with the 1965 Federal Cigarette Labeling and Advertising Act, particularly as amended in 1969, protected the company from claims that it failed to warn smokers that cigarettes were dangerous, a defense that five federal courts of appeal had upheld. 10

4 Philip Morris also argued that the studies linking smoking to lung cancer were not conclusive. In particular, the company claimed that since not all smokers got lung cancer, there was no demonstrable cause-effect relationship between smoking and lung cancer. The company also argued that smoking was not addictive and, consequently, smokers were free to quit smoking any time they wanted. Smoking, the company claimed, was a matter of personal choice and all individuals should be left free to exercise their personal right to smoke when, where, and as much as they choose. Moreover, even if cigarette smoking were dangerous, the company claimed, the warnings on cigarettes required by the federal government gave smokers a knowledge of the risks associated with smoking and so it could not be argued that they did not willingly assume those risks. While escalating health concerns were creating a declining market in the United States, citizens of other countries who were not as educated about the risks of smoking were a rising opportunity. The governments of many countries, especially in the Third World, did not spend much money on antismoking campaigns, and many were reluctant to give up the tax revenues associated with cigarettes. As U.S. markets declined, therefore, tobacco companies, particularly Philip Morris, moved into foreign markets, especially into Third World and, more recently, into East European markets. The company was one of the first American companies to sell its cigarettes in China, and had expanded vigorously into Eastern Europe after the collapse of the Soviet Union in While United States per capita consumption of cigarettes declined by 25 percent between 1985 and 1994, U.S. tobacco exports rose by 367 percent, from 64 billion to 235 billion cigarettes. Much of the rise in exports was the result of U.S. government pressures that had forced the dropping of import barriers in Turkey, Japan, Taiwan, South Korea, Thailand, and the members of the former Soviet Union, all countries where American-blend cigarettes, especially Philip Morris s Marlboro brand, were becoming highly popular. Turkey was considered a key location since it borders the former Soviet Union and is a stepping stone to Asia. Moreover, Turks are heavy smokers and Turkish cigarette consumption was expected to grow 3 to 9 percent annually. Philip Morris s beer business was also under pressure. Growing awareness of the large social costs associated with alcohol consumption and drunk driving had been spurring lawmakers into passing a variety of alcohol regulations. The Alcoholic Beverage Labeling Act of 1988 already required all alcoholic beverages to carry warnings associating the consumption of alcohol with health problems, the risk of birth defects, and a lowered ability to drive a car or operate machinery. Even the company s forays into the food industry were being assailed by critics. Critics pointed out that Philip Morris was using the revenues being generated by its tobacco units to buy food companies. The company, critics alleged was in effect laundering its tainted cigarette money by transferring it into the food industry where it would be sheltered from the litigation threatening its cigarette division. QUESTIONS 1. Discuss the utilitarian, rights, justice, and care issues that are raised by Philip Morris s activities in the tobacco, beer, and food industries. 2. Both the tobacco and the beer industries have been characterized as sin industries. Comment on the extent to which virtue theory sheds light on the company s activities in these industries. 3. What, in your judgment, would be a morally appropriate course of action for the government agencies involved in the case? NOTES 1. Philip Morris, Annual Report, Philip Morris Companies, Inc., Securities and Exchange Commission Form 10-K, 1991, p. 1.

5 3. U.S. Department of Commerce, U.S. Industrial Outlook, 1994, (Washington: Government Printing Office, 1994), pp to Alix M. Freedman, Philip Morris Memo Likens Nicotine to Such Drugs as Cocaine, Morphine, Wall Street Journal, 8 December Philip J. Hilts, Philip Morris Blocked 83 Paper Showing Tobacco Is Addictive, Panel Finds, New York Times, 1 April 1994, p. A Tim Friend, New Heat on Tobacco Firm, USA Today, 19 March 1996, p. A1; Tobacco Industry Under Fire, USA Today, 19 March 1996, p. B2; Dough Henry, Whistleblowers Wreak Havoc, USA Today, 19 March 1996, p. B2. 7. Ibid. 8. Alix Freedman, Cigarette Defector Says CEO Lied to Congress About View of Nicotine, Wall Street Journal, 26 January, 1996, p. A1. 9. Does Tobacco Pay Its Way? Business Week, 19 February, 1996, p Philip Morris Companies, Inc., Securities and Exchange Commission Form 10-K, 1991, p. 4.