Counterfeit Cigarettes Force Tobacco Firms to Fight Back

The world’s biggest tobacco companies are under siege from counterfeit cigarettes, which threaten the industry with the loss of billions of dollars in revenue and the loyalty of millions of smokers.

It is an awkward situation for the companies. For years, they made money off the smuggling of genuine Marlboros, Winstons and Benson & Hedges as governments lost a fortune in taxes. Now crooks who once specialized in sneaking authentic brands past tax authorities are finding more profit in pushing cheap knockoffs instead.

Whether they actively encouraged the illicit sale of their products, as some charge, or simply turned a blind eye, big tobacco firms benefited because smuggling evades taxes and import restrictions that raise prices and smother demand.

Counterfeits are a different story. British American Tobacco Chairman Martin Broughton has called the counterfeiting of all goods a “social epidemic.” British American and the three other top tobacco multinationals -- Philip Morris, Japan Tobacco and Imperial Tobacco -- have committed millions of dollars and an army of lawyers and sleuths to the defense of their brands.

The anti-counterfeiting campaign aligns the interests of tobacco and government authorities as never before. But as stalwarts of law and order, cigarette makers come off to critics as hypocrites. As they seek closer ties with customs authorities, “the cigarette manufacturers recognize that their reputation is rather jaded,” said John Robertson, director of enforcement for the United Nations mission in Serbia’s Kosovo province, a longtime smuggling stronghold.

The companies deny they ever condoned smuggling, saying they have been innocent bystanders to crimes that result from tax differentials and weak border controls. Government investigations and lawsuits, however, allege that the companies supplied billions of cigarettes to intermediaries during the 1980s and ‘90s, with the clear understanding that the smokes would be slipped past customs authorities.

In the late 1990s, for example, an R.J. Reynolds subsidiary and a sales executive were convicted of orchestrating a massive “round-tripping” scheme in which cigarettes produced by RJR’s Canadian unit were exported to the U.S. and then ferried back in small boats across the St. Lawrence River to evade Canada’s hefty cigarette tax.

According to government estimates, about one-fourth of exported cigarettes wind up being diverted from legal channels and spirited across national boundaries. Annual tax losses worldwide have been estimated as high as $30 billion. It makes little difference to revenue agents whether a smuggled pack is real or fake -- it’s a tax loss either way.

The distinction is crucial for cigarette makers. They get paid for each genuine pack sold, even if it’s smuggled. But counterfeits create double-barrel anxieties -- wiping out sales and threatening to drive once-loyal customers away. If a smoker buys a pack of knockoffs and finds “it tastes revolting ... we’ve lost them forever,” said one tobacco official who asked not to be identified.

The companies say they don’t know how much they are losing to bogus versions of their brands. Some estimate that as many as 200 billion counterfeit cigarettes are sold each year, enough to supply a pack a day to more than 27 million people.

And the flow of fakes is rising. “We’ve seen counterfeits come from nowhere in the last couple of years,” one European law enforcement officer said.

In recent months, Philip Morris has sued about 2,800 merchants, most of them in California, after undercover buys revealed they were peddling fake Marlboros from China. British American says imitations of its brands have been found in at least 70 countries. In Belgium, counterfeits make up more than 95% of smokes seized as contraband. In Colombia, once awash in real but smuggled Marlboros, a high percentage of black-market Marlboros are fakes.

While they continue to battle for market share, the industry’s Big Four have joined forces to attack the wave of counterfeits. They have recruited former law enforcement and intelligence operatives and patched together a global network of informants and private investigators who prowl ports and sniff out illicit production sites in counterfeit strongholds such as China, Paraguay and the Balkans.

“The counterfeit issue is so devastating to all of us that we’ve declared it a noncompetitive issue,” said Mark Mulvey, vice president of corporate security at Geneva-based JT International, a Japan Tobacco unit.

To be sure, counterfeiters have victimized other industries. There is a booming trade in bogus pharmaceuticals, cosmetics, toiletries and designer bags and apparel, along with pirated videos, music and software. According to the International Chamber of Commerce, counterfeiting and piracy were a $450-billion enterprise in 2000, accounting for 7% to 9% of global trade.

Only tobacco companies, however, are dogged by accusations that they have profited from illegal sales of their own products.

And the companies in recent years have begun to change their ways. Under legal pressure from governments -- and in a desire to burnish their image with law enforcement -- they have been severing ties with distributors they know or suspect of having links to contraband networks.

The companies may be victims of their good behavior. Some of their jilted distributors switched to counterfeits when they couldn’t get their hands on the genuine product, industry officials believe, and started selling fakes through long-established black-market networks.

The smugglers still have “the infrastructure, they’ve got the markets, they’ve got bent customs to move product through -- but they haven’t got the product,” said a British American official who wouldn’t speak if identified.

To critics who contend that the industry for decades rode smugglers’ coattails, it is poetic justice. “They’re getting hung on their own petard,” said Matthew L. Myers, president of the Campaign for Tobacco-Free Kids.

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Aided by Technology

Around the world, counterfeiters are exploiting high-tech advances. The anonymity of the Internet, for example, makes it easy to match producers and sellers: On the Web site Alibaba.com, which bills itself as an online marketplace of export and import, a recent ad touted the “good quality and cheap” price of “imitation famous” brand cigarettes from China.

Computer scanners and printers are increasingly sophisticated and cheap, making it easy to produce superior packaging. That’s crucial, because the pack has to be a dead ringer, even if the contents are not.

Manufacturers have tried to fight back by making almost imperceptible tweaks in packaging -- putting a tiny mark on the tear tape used to rip open the cellophane seal on a pack, for instance -- only to have counterfeiters quickly notice and incorporate the changes, Mulvey of Japan Tobacco said.

Meanwhile, the explosive growth in international shipping, spurred by globalization, has made it easier to slip contraband past overwhelmed customs agents.

Fakes typically arrive by container ship, concealed behind cover loads of toys or other goods. A 40-foot container can hold about 8.5 million cigarettes, or 425,000 packs. A British American official said that quantity could be imported from China for about $120,000, which would cover the cost of the cigarettes, any necessary bribes in China and the shipping charge.

Assuming a street price of $3 to $6 a pack, depending on where it’s sold, one load generates roughly $1.25 million to $2.5 million in sales for a profit of about $1 million to $2 million.

“The potential profits from this game are huge and the risks involved are nowhere near as much as ... say, drug smuggling,” said Peter Clark, who until recently was a senior technical officer with the World Customs Organization in Brussels.

For all their muscle and money, tobacco companies lack the power to make arrests or seize counterfeit shipments. So the companies have sought to put their gumshoes and expertise at the disposal of law enforcement agencies and have supplied tips that led to arrests and seizures. This year in Dubai, for example, police raided a factory churning out sham versions of Japan Tobacco’s Monte Carlo brand. The companies have briefed government authorities on how to spot counterfeits and signed cooperation agreements with several countries, including China, Britain and Colombia.

Still, there is a distinct chill. Governments continue to investigate the industry’s alleged collusion with contraband rings. After the European Union filed a lawsuit in November 2000 accusing Philip Morris and R.J. Reynolds of abetting smugglers, EU officials advised customs agencies in member countries to limit contact with company executives, one law enforcement official said.

Many in law enforcement still are simmering over what they regard as the industry’s failure to cooperate in past smuggling investigations. Cigarette makers treated customs departments like dirt, “and then all of a sudden they’ve got a problem and ... they desperately need us,” said a European investigator who asked not to be named.

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Countermeasures

In China -- the epicenter of cigarette counterfeiting -- the industry and the State Tobacco Monopoly Administration are working together to crack down on underground factories that turn out an estimated 85% of the world’s supply of knockoff smokes. The government is motivated, tobacco executives say, because counterfeiters are ripping off domestic smokes as well as international brands.

The companies have agents on the ground, ranging from professional investigators to the “guy on a bicycle who’s just sniffing the air” for processed tobacco, as one industry official put it.

The tobacco monopoly administration says it has taken a “very firm” stand, last year seizing nearly 5 billion counterfeit cigarettes and 1,375 pieces of production equipment and making about 4,075 arrests.

“We have had very successful cooperation with famous international tobacco companies,” an agency spokesman said via e-mail. “We have special phone and fax lines to keep contact with them.”

But nimble counterfeiters are good at the cat-and-mouse game. They typically operate in rural backwaters and are decentralized, with cigarettes produced in one place, packaging in another and smokes hand-packed in a third. Outlaw factories sometimes are set up in underground chambers or on hillsides, with machinery hauled in by workers or donkeys and reassembled in caves.

“It’s an amazing feat, what they have done,” said Mulvey of Japan Tobacco.

With unemployment high and most villagers desperately poor, local officials tend to look the other way. After raiding parties shut them down, the operations sprout again like mushrooms in the woods.

A major gateway for bogus Marlboros from China are the ports of Los Angeles and Long Beach. U.S. customs agents there have seized tens of millions of counterfeits in the last 18 months and have captured a few traffickers.

Arrests don’t always stop them. Consider Giashian “Mike” Lin. After he was caught in April 2002 with nearly 1.97 million fake California cigarette tax stamps, which couriers had carried in their luggage through Los Angeles International Airport, agents searched his Monterey Park home. There, they said, they uncovered shipping documents linking him to about 16 million counterfeit Marlboros in shipping containers supposedly carrying furniture and china.

Despite surrendering his Taiwanese passport and pledging not to apply for a new one, Lin failed to show up for his smuggling trial in September 2002. Authorities discovered he had obtained a substitute passport and, the day before the trial, purchased a one-way ticket to Shanghai.

Lin had retreated but not retired. Two months after he skipped out, customs agents tracked millions of counterfeit Marlboros to a self-storage unit in El Monte, where they arrested two men who were loading the cigarettes into delivery cars and vans. One of the men told authorities he was working for a man who had been forced to leave for China -- Mike Lin.