10/11/2020

Ops Finance 2
- Driving Value in Operations

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ASU30
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Objectives

• Following this session you should:

Appreciate the big contribution Operations makes towards the delivery

of BAT’s financial objectives

Understand the key drivers of Cost of Sales (Inflation, Savings, Mix,

Innovation, Regulation, FX)

Contribute to better cost of sales management where they work

The need for Operations to

support cash delivery

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Why the pressure on cash…

The Business Pressure The City Expects

Operations can
‘Net Debt / EBITDA deliver through:
WE BORROWED $25bn TO FUND
REDUCE FROM 4.0x
RAI ACQUISITION, AND HAVE
COMMITTED TO SUBSTANTIAL
OVER NEXT 2-3 YEARS BY
0.4x p.a.’ Delivering Savings
NEW CATEGORY INVESTMENT

Reducing
Working Capital
1998 2002 2006 2010 2014 2018
& Managing Capex
£5bn
p.a.

Cost of Sales overview and

Drivers of the cost of sales
components

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Total annual costs

Primary Supply Chain – £5.3bn

Product and
Leaf WMS Make PSCC
GR&D

£0.1bn £2.1bn £1.8bn £0.9bn £0.2bn

Other Costs (inc. GSCSC Overheads) - £0.1bn

Bought in and non Cigarettes - £0.2bn

Cost of sales per mille increasing +5.3% vs SPLY

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What drives inflation in each

area?

2020 est.
CoS Components inflation Inflation drivers
Crop costs - Key components: Farmer labour costs,
Leaf +1.5% fertilizer costs (oil), supplier margins, harvest outputs,
global leaf demand

Material costs driven by: Supplier margins,

WMS +2.4% labour/utility costs, base input costs, global demand
Biggest spend: Board, Printing, Tow, Capsules
Labour costs (local inflation, labour market, unions)
Make +4.3% Utilities (local inflation, oil prices)
Impact of depreciation (innovation, growth, regulation)

Freight, warehousing, insurance etc

Logistics +2.2%
Drivers: Oil cost, Marine/road pricing
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Cost of sales per mille increasing +5.3% vs SPLY

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Which market is becoming a larger part

of BATs portfolio ?
High

Canada Geographic mix is

Cost of Sales

reducing BAT’s Cost of Sales

as volumes move to
lower cost markets

Pakistan
Low

Low Market Price High

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Which brands are becoming a larger part

of BATs portfolio ?
High

Portfolio mix is
GDB
increasing BAT’s Cost of Sales:
Cost of Sales

- local brands are migrated to GDB

- GDB have a similar price point
Smaller but are more expensive
brands due to more innovation
Low

Basic Portfolio Premium

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Cost of sales per mille increasing +5.3% vs SPLY

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Growing complexity: Lucky Strike Blue King Size Filter

Weakening of
3 mg gap Introduction of Launch of
LIP Introduction ADF launch (10/7/4/1) Firm Feel Filter LS Tube
2011 2012 2013 2014 2015

LS Blue
produced in
DE
5 mg Tube 1.4bn

6 mg Tube

7 mg Tube

8 mg Tube

Standard 6 mg FFF Standard 6 mg FFF

Standard 7 mg FFF Standard 7 mg FFF

Standard 8 mg FFF Standard 8 mg FFF

ADF 6 mg FFF ADF 6 mg FFF

ADF 7 mg FFF ADF 7 mg FFF

Standard 6 mg Standard 6 mg nonFFF Standard 6 mg nonFFF

Standard 7 mg Standard 7 mg nonFFF Standard 7 mg nonFFF

Standard 8 mg Standard 8 mg nonFFF Standard 8 mg nonFFF

LIP Standard Spec ADF 6 mg ADF 6 mg non FFF ADF 6 mg non FFF

LIP ADF ADF 7 mg ADF 7 mg ADF 7 mg

LIP Non LIP Standard Spec Non LIP Standard Spec Non LIP Standard Spec Non LIP Standard Spec

Lucky Strike Blue Non LIP Non LIP ADF Non LIP ADF Non LIP ADF Non LIP ADF

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Cost of sales per mille increasing +5.3% vs SPLY

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Tobacco Product Directive (TPD)

5000 SKU’s Up to 5000 SKU’s

changed within changed within
TPD adopted 8 months 12 months

2014 2015 2016 2017 2018 2019

65% pictorial top of pack 15bn stock build Annual set of Track & Trace on pack level Security feature
health warnings +450 Headcount health warnings (factory – first retailer)
To go last with rotation PHW to top of pack
New packers and tax stampers
new HW
across EU factories Relocation of tax stamp
Square Packs New tax stamp dimensions
Plain Packs
Pack formats:
› Min. 20 cigs/pack, min. pack width
› No lipstick/Ladylighter packs
› Plain packaging in certain markets
› Ban of flavour capsules
› Other pack format bans

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Cost of sales per mille increasing +5.3% vs SPLY

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Chat Question

$ What currencies are our main

materials normally purchased
in ?

€¥
$ LC

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Russian Ruble vs the US Dollar

Imports almost double in cost…
and Russian business profits half in value for the group..

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Savings: History of Delivery

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Cost of sales per mille increasing +5.3% vs SPLY

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How we calculate savings?

“A benefit initiative is an activity whose purpose is a sustainable (greater than 2 years) cost reduction compared against
the previous year, and is not a result of the standard business cycle. It is a "Hard" cost saving that takes the form of a
tangible year-on-year bottom-line cost reduction, net of any ongoing costs incurred.”

Where do we Make
Direct
Leaf Footprint Logistics Indirects
generate savings? Materials
Sourcing

Basic Methodology (New Cost - Prior Year Cost) x Volume in 1 st Year of Savings

Exclusions Savings occurring due to normal business conditions, savings vs budgeted

cost, differences between higher and lower quoted costs

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How we calculate savings - example

Basic Methodology (New Cost - Prior Year Cost) x Volume in 1 st Year of Savings

Example Previous filter cost (External) – 2020 £3.00/mille

Sourcing Direct New filter cost (Internal) – 2021 £2.00/mille
Materials External to
Internal (e.g Filters) Volume – 2021 0.2bn

How much is the reported saving ?

£200k

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£1.1bn COS Savings delivered by Operations 2015-

2019
COS Savings Indirects and SSC NC Savings
264 258 221 75
201 73
216 222
206 10 7
163 158 164
177
128 42 30
4
5
65
10
36
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2015 2016 2017 2018 2019 2020 2015 2016 2017 2018 2019 2020 2018 2019 2020
THP Vapour Hybrid Oral

Total Productivity Savings - £2.1bn delivered 2015 to 2019

534
481 459
422
369
305

2015 2016 2017 2018 2019 2020

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Which area delivered the largest savings?

BLEND MANUFACTURING

› Source changes › Factory Footprint

£58m › Blend changes £61m › Sourcing
› Complexity reduction › IWS
WMS LOGISTICS
› Pricing
£77m › Print & Tow Tender £35m › Tenders
› Filter In-Housing › Network Review
› Spec & Complexity
INDIRECTS NGP

› Contract negotiation › Pricing

£206m
› Primarily IT & Marketing
£42m › Automation

services › In Housing consumables

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Savings: The future challenge

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The future challenge is more difficult

Filters in- Factory

housed Footprint
Fibex blend WMS Contracts
inclusion Locked In
FG / WMS /
Core Chassis
Leaf Sourcing

NO MORE BIG ONE-OFFS EXPECTED

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Areas where Savings can come from - The Stick

2
1
Reduce Tobacco Input Standardise Slims
3
Weight ++ Circumference + Migrate all King Size to Demi Slims
+++

4
Move all Tipping to Simple
9
Cork Design ++
Reduce Rod Length by 1mm
++
5
8 Standardise Tipping
Migrate all Multi-Capsule SKUs Designs+ +
Designs
to Single Capsule +
7
Remove Capsules
+ =>£1m ++=>£10m +++ =>£30m +++ 6
Change potentially Consumer relevant (visual or smoking profile change)
Remove Tube Filters
Change deemed non Consumer relevant +++

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Areas where Savings can come from - The Pack

3
2 Move to Plain White
Printed Film Removal Inner Frame ++ 4
Standardise Inner
+
Bundling designs by
brand variant +
1
Move all non GDBs to 5
Remove Reloc
soft cup packs +++
+++
6
Replace all Inner Bundling
9 with cheapest alternative
Use only category D +++
materials ++ 7
Simplify Pack Designs
+ =>£1m ++=>£10m +++ =>£30m 8 +++
Change potentially Consumer relevant (visual or smoking profile change) Remove Transmet Board
Change deemed non Consumer relevant ++

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IWS PROGRESSION
DRIVING OPERATIONAL EFFICIENCY
FACTORIES PHASE
PROGRESSION 6

Minutes

1 Minutes
18
1
13
9 Minutes
0 7
3
0 10
2016 2017 2018 2019 2020 2021 2022 MTBF
PHASE 1 PHASE 2
Potential additional benefits
FOUNDATION INHOUSE CAPABILITY ACCELERATION from acceleration
BUILDING STAGE
> £55m + £50m
IWS E2E scope Productivity savings Coming from:
delivered 2017 - 2020
Pillars Activation Global Pillars • Performance increase
synchronization And…
POV Global Standards • Leaf & WMS waste reduction
• Crew optimization
RTT Basics • Energy consumption improvement
• £27m Capex Avoided
• 50% CoCo Reduction
• Improved Responsiveness

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How can we deliver Productivity going forward?

SUPPORT - RELIES ON OPS TEAMS AT EVERY LEVEL FOLLOWING

GLOBAL FORUMS THE PROCESS – CONTROL & TRACKING

DRIVE SAVINGS - EVERY LITTLE HELPS - IT ALL ADDS UP

LOCALLY - GENERATE & SHARE IDEAS

BE COMMERCIALLY - CHALLENGE NPI BRIEFS FOR UNNECESSARY SPEC

AWARE - PROMOTE STANDARDISATION WHERE SENSIBLE

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The New Categories challenge

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Spend across THP and Vapour

90% of spend is with external suppliers

Overall spend has grown as the NGP Business expands THP Devices are 77% of total THP spend
Vapour spend shows the biggest growth in 2020
602 Vapour consumables are 80% of the total Vapour spend

£170mn
THP & Vapour Spend Evolution (£mn)
Vapour THP
£571mn
£52mn
£454mn
222
5.8Mn Devices 9.9Bn Sticks

£327mn Devices Consumables

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£221mn 159
£280mn
125 349
225
£33mn 168
96
33 £69mn
2016 2017 2018 2019 2020
15Mn Devices 311Mn Pods
NTO £0.13bn £0.48bn £0.97bn £1.26bn £1.44bn Devices Consumables

Note: Spend based on SOP-5. including RAI, excluding TWISP, VIP and Chic

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NGP supply chain is complex & reliant on external parties

Complexity
High component complexity & maturing supplier relationships
• 9,031 finished goods SKU • 2,239 finished goods SKU
FMC NGP • 15 components • 277 Tier 2 components
Farm to factory: Multi Nodal: • 248 suppliers • 167 suppliers to Tier-4
BAT manage & control from BAT manage tier-1 & 2 suppliers
the farm to factory only - limited visibility beyond
• Stable preferred supply base • Foundations established:
preferred supply base

Network
China centric multi-tiered network designed for responsiveness
• Linear supply chain • Multi-tiered supply
• Supply network across the • 90% in China
world • 96% air freight (Demand
• 2% air freight responsiveness)

Operations
Device production outsourced and manual with a China centric MCSP
• Predomin. insourced production • In & Outsourced production
• Highly Automated • Evolving Automation
FMC Network NGP Network • Mature MCSP • China-based MCSP

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Supply Chain “Complexity” & Tiering

Supply Chain tiering amplifies complexity & dependence on a very large component network
“The Supply Chain is as strong as its weakest link”

Example: Tier-6 ‘Epoxy glue’ remained key risk on Hyper SC for last 6 weeks

THP Hyper PCBA Distributor IC Wafer Epoxy

Nolato BYD WPI Onsemi Onsemi Onsemi
China China Taiwan Philippines USA China
£29.16 £7.08 £0.0034 £0.115 £0.001 £0.000045

Tier-1 Tier-2 Tier-3 Tier-4 Tier-5 Tier-6

5 Suppliers 40 Suppliers 122 Suppliers Limited visibility at this stage;

2,239 SKUs 277 components ~661 sub-components Stronger relationships established with
(£571mn) (£368mn) (~£279mn) COVID-19

167 Suppliers up to T-4

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Supply Chain “Operations”

THP consumables fully automated in BAT factories;
Device & Vapour Consumables being automated as suppliers mature & scale operations
3 Fully Automated Factories – Same setup as FMC
• HC: c. 150
• KSSS Capacity: 13 bn pa
• DS Capacity: 11 bn pa

2 Factories, 1 Supplier – Mostly Manual Operations

• HC: c. 1,600
• Hyper Capacity: 8 mn pa
Industrialisation of the Vapour Industry
• Pro Capacity: 4 mn pa
• Transforming manual production to
3 Factories, 1 Supplier – Mostly Manual Operations automated lines for pod assembly
• HC: c. 1,200 • Includes – Heater assembly, Filling &
• Device Capacity: 6 mn pa Packaging
• Pod Capacity: 90 mn pa 6,700 -82%
5 Factories, 1 Supplier – Mostly Manual Operations
• HC: c. 5,500 1,200
• Device Capacity: 28mn pa
• Pod Capacity: 350mn pa (Sep: 420mn pa) Before After (FP incl. US)

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NGP Savings

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Key Take-outs – NGP Supply Chain

Industry
Best Practice

• Complex – Multi-tiered Procurement & Multiple • Platforming & Simplification

categories (Evolving control & visibility) • Planning HUB for improved SC visibility across Tiers

• Centered in China – Scale, IP & Ease of • Reliance on China & South East Asia with dual source
doing business • IP ownership to enable flexibility

• ODM/EMS partnerships and preferred tier-2 suppliers

• Outsourced – with primarily manual operations
• Automation - minimize labour reliance & improve Quality
(Automation plans underway)
• Strong DFM/DFA

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Thank you!

• HEWM facilitators - contact details

Julian Honey Joe Metcalfe Jim Wells

[email protected] [email protected] [email protected]

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