Case1: Pakistan Tobacco Company

Case1: Pakistan Tobacco Company
PTC has successfully established itself as one of the largest tobacco

manufacturers of Pakistan and accounts for a significant proportion of the
tobacco market. Despite its success, there is one problem that PTC faces that
has not been resolved for the past many years. This problem is that of illegal
tobacco being sold in the market. Illegal tobacco manufacturers produce
counterfeit cigarettes which have nearly the exact same packaging as original
cigarettes and therefore, successfully manages to trick customers into buying
it. PTC, being one of the giants of the Pakistani tobacco industry, has also been a
victim of these illegal manufacturers. Over the years, the illegal production of
tobacco has increased which has resulted in PTC losing out on many potential
sales. According to estimates by Mr. Syed Javed Iqbal, who is currently serving
as the Managing Director and CEO of PTC, illegal tobacco manufacturers
produce almost 40-50% of the tobacco in the market. As PTC is one of the major
power players in the tobacco industry in Pakistan, Mr. Iqbal feels that if
somehow this illegal tobacco could be eliminated, it would greatly boost the
sales of PTC and would allow it to grow even more.
To solve this problem, PTC has been in discussion with the Federal Board of
Revenue (FBR) who have suggested that PTC install a certain chip, designed by
the FBR, into the packaging of their cigarette packs. Once installed, this chip
would allow FBR to trace each cigarette pack to its manufacturer. Therefore,
PTC would be able to distinguish its products from the illegal manufacturers
who sell counterfeit cigarettes. Although this would mean that FBR would gain
access to the exact number of products PTC manufactures and therefore, result
in an increased tax expenditure for PTC, Mr. Iqbal believes that the benefit
produced would surely outweigh this increased expenditure. On one hand, it
would allow FBR to crack down on the illegal manufacturers, whereas on the
other, PTC can discern its products from their counterfeits. With a good
advertising campaign to inform their customers about these chips, PTC may
well be able to successfully deal with the problem of illegal manufacturers
which would thereby lead to an increase in revenue for the company.
Mr. Iqbal, however, knows that there is a great externality involved in this
decision problem. He feels that the market reaction to this decision would play a
huge role in determining the success or failure of this project. He categorizes
the three market reactions as favorable, flat and unfavorable. The market
reaction is said to be favorable in case the project outcome turns out to be as
planned and there is a reduction in illegal tobacco sold in the market which
would invariably mean increased revenue for PTC. For this to happen, PTC
would need the full support of FBR on cracking down on illegal manufacturers
and would need to ensure that they communicate with their customers
effectively and inform them about their project. The market reaction is said to
be flat if there is no significant change in the amount of illegal tobacco in the
market, which would mean that there is no significant change in PTC’s
revenues either. Lastly, the market reaction is said to be unfavorable if the
project has an effect contrary to the expectations. He says that this would be the
case if illegal tobacco increases in the market as a result of the project. This
could happen if illegal manufacturers cut down their prices in comparison to
PTC, if PTC is not able to effectively communicate their project to their
customers so that they fail to distinguish between original and counterfeit
products like before or if FBR is not able to effectively crack down on the
manufacturers and they continue operating as they have been for the past many
years.
Mr. Iqbal estimates that there is a 40% chance that market reaction is favorable,
40% chance that it is flat and a 20% chance that it is unfavorable. Furthermore,
he reckons that a favorable market reaction would lead to an additional revenue
of 20 billion PKR, a flat market reaction would have no impact on revenue,
whereas an unfavorable reaction would lead to a loss of 20 billion PKR.
Given the high costs and uncertain result of the project, Mr. Iqbal has been
advised to conduct a preliminary test. This test would be conducted on one of
the many brands of cigarettes produced by PTC. This would enable the
company to obtain better estimates for the market reaction and therefore, allow
them to make a more informed decision. Some costs would have to be incurred
for the test as well. These include the test cost, chip installation cost, training
cost, advertisement cost and increase in tax expenditure. Mr. Iqbal posits that
the test can have 3 results; “highly profitable”, “little or no impact” or “results in
losses”. He estimates that the probability of each happening would be 40%, 30%
and 30% respectively. If the test result is “highly profitable”, PTC can expect an
increase in revenue of 20 million PKR. If it turns out to be “little or no impact”,
PTC can expect no change in revenue and lastly, if it turns out to be “results in
losses”, PTC can expect a loss of 20 million PKR.
Your Task
a. Draw the influence diagram and decision tree of the problem
incorporating all the possible factor constituting it. Explain your choice of
nodes for each factor as well.
b. Should PTC conduct a preliminary test or not and whether it conducts it
or not, should it opt for installing the chips manufactured by FBR. Given
the uncertainties and payoffs attached to each option, justify your answer.

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Case1: Pakistan Tobacco Company

PTC has successfully established itself as one of the largest tobacco

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