Case Study » How Philip Morris International is transforming away from cigarettes
How Philip Morris International is transforming away from cigarettes
An in-depth look at how Philip Morris International is leveraging financial tools and strategies to drive its sustainability agenda. This case study explores the role of CFOs in shaping a more sustainable future within one of the tougher industries
In a controversial industry often criticised for its health and environmental impacts, Philip Morris International (PMI) is defying the odds by putting sustainability at the forefront of its business strategy.
In a candid conversation with Nicole Austin, PMI’s head of Sustainability Stakeholder Engagement, it became evident this tobacco giant is not paying lip service to sustainability.
“When you think about our sustainability strategy at PMI, it’s not that we have a business strategy and then a sustainability strategy. They are one and the same integrated strategy,” Austin clarified.
The core of PMI’s strategy is to address the health impact of their products and create a ‘smoke-free future’ – hard to imagine for a business whose revenue has historically been contingent on selling cigarettes.
But in 2016 the company announced a transformation of its business away from cigarettes and set itself an objective to replace cigarettes with better, smoke-free products for the benefit of adults who smoke, its shareholders and society more generally.
The company’s smoke-free products primarily consist of heated tobacco products, e-vapour products, and nicotine pouches.
To put in context the pace of PMI’s transformation, at the time they announced this ambition less than 1% of their net revenue was coming from the smoke-free product portfolio.
In 2022, PMI shipped 621 billion cigarettes, according to its full-year results report. However, 32.1% of their net revenues were derived from smoke-free products, and the volume of combustible tobacco products decreased by 27%.To reach a smoke-free future, PMI is seeking to take a three-pronged approach: maximising the benefits of smoke-free products, purposefully phasing out cigarettes, and seeking a net positive impact in new business operations of wellness and healthcare. The company recognises they cannot succeed alone, however.
According to their 2022 Integrated Report, they are “seeking to work with policymakers to ensure that scientifically substantiated smoke-free products replace cigarettes as quickly as possible for those adults who continue to use nicotine products. ”
Steering the ship
So how does PMI approach its sustainability efforts?
According to Nicole, sustainability starts from a deep understanding of the context in which the business operates which is informed by a sound double materiality assessment. Also, clear governance structures and the proper organizational set-up play a pivotal role in enabling progress.
The company’s board of directors is actively involved in overseeing these efforts. Risk oversight is conducted by the full Board of Directors, as well as by Board committees in their respective areas of responsibility. Throughout the year, Company Management regularly updates the Board and its committees on the evolution of key risk areas.
Austin goes on to explain the importance of embedding sustainability into the business.
“At PMI, we strongly believe that to drive progress you need to incorporate sustainability into business decisions which requires sustainability teams to be embedded in the different business functions from human resources, operations, to product development,” she says.
This model ensures that sustainability is not an afterthought but a key component of the company’s decision-making strategy.
The decision was also taken for the Chief Sustainability Officer to report directly to the CFO.
Austin described this structure as critical given the evolution of non-financial reporting which is becoming more akin to financial reporting; from a risk-management perspective topics such as climate, water, social inequalities, and human rights issues may represent a form of risk to the business, and therefore be captured in the company’s enterprise risk management processes.
Scorecard of change
Accountability is the cornerstone of PMI’s sustainability journey, and the company has developed a robust framework of Key Performance Indicators (KPIs) to ensure it stays on course.
The financial teams contribute to this framework by overseeing the company’s business transformation metrics which measure how internal resources such as R&D spend, supply chain spend, employee headcount, and factory production are being allocated to the conventional cigarette business in comparison to the smoke-free portfolio, and how that is changing over time.
The finance teams also measure the impact these investments are having in terms of volumes, revenues, and number of users of smoke-free products.
The Company has also developed a bespoke Sustainability Index comprising 19 KPIs directly linked to its eight strategies, including tackling climate change, preserving nature, reducing post-consumer waste, fostering an inclusive and empowered workforce, and improving the lives of people in their supply chain.
Each Sustainability Index KPI is assessed and scored annually, using predefined target ranges. This rigorous approach allows PMI to measure progress quantitatively against its aspirations and offers stakeholders visibility into the progress the Company is making towards its sustainability aspirations.
PMI also links the long-term equity compensation of its executives to the performance of the sustainability index, constituting 30% of the total award.
Green dollars and sense
PMI employs innovative financial tools like an internal – carbon levy and a shadow price for carbon to incentivise and drive reductions in GHG emissions. These tools have a direct impact on financial planning and investment decisions.
PMI integrates its shadow carbon price into the financial evaluation of business proposals to boost investment decisions favouring projects accelerating emission reduction. This supports the approval of carbon emission reduction projects, including projects under their Zero Carbon Technology (ZCT) program.
Both the shadow price and the carbon levy, according to PMI’s latest TCFD report, are revised annually to reflect changes in risks and emission profiles. Most recently, the shadow price was adjusted from $65 to $105 per ton of CO2e, and the carbon levy increased from $8 to $11 per ton of CO2e.
“What is important when evaluating sustainability initiatives is to take a holistic approach by considering not only conventional drivers of financial performance but how different stakeholder groups concerned about sustainability may impact business profitability and growth over the longer term,” Austin says.
The open book strategy
Transparency is a cornerstone of PMI’s sustainability strategy.
“Transparency is key. We have a responsibility to our stakeholders to be transparent about our sustainability efforts, and that includes both our successes and our challenges,” Austin says.
The Company aims to pursue the same degree of rigour in internal risk, control, and measurement systems for nonfinancial metrics as they do for financial information. As part of this, PMI is working to expand the scope of external assurance of their ESG data, whilst seeking further alignment with mandatory and voluntary non-financial reporting standards.
Playing the long game
PMI’s approach to sustainability is a lesson in how financial strategies can drive sustainable change.
“When you think about the word sustainable and what we mean when we say a business is sustainable, we are inherently thinking longer term. Sustainability is about asking yourself the question, what is the unique value proposition that I as a business have?” Austin says.
“Given that value proposition, how can I manage the impact of the business on environment and society to mitigate negative impacts and ideally drive positive value creation over all three capitals, financial, environmental, and social so that I’m sustainable over the longer term?”
This article was written by the CFO network who retained editorial control. Whilst Philip Morris International (“PMI”) made representatives available for interview, the views expressed are those of the author and do not necessarily reflect the views of PMI except as otherwise attributed to PMI spokespeople.