Mentors often advice wannabe entrepreneurs to find scalable solutions to widespread problems. But what if such solutions end up being worse than the problem it was intended to solve? That’s the piquant situation that companies in the e-cigarette/vaping business now find themselves in.

Tightening regulations constrained conventional tobacco-based cigarettes

Over the past two decades, mounting evidence that tobacco-based cigarettes were bad for not just the smoker’s health but also to the health of others (passive smoking) triggered a series of tough regulatory responses worldwide. Numerous restrictions were placed on tobacco-based cigarettes, cigars, cigarillos and other similar products. These laws covered where such products could be sold, who they could be sold to and how they could be marketed. Health warnings had to be mandatorily printed on packs. Smoking in public places was banned. Tobacco products were taxed at higher rates. Companies adopted no smoking policies at workplaces, as did commercial establishments such as restaurants, malls etc.

All this forced cigarette companies to work on developing less harmful alternatives that would also be perceived by smokers as being better than vaping products, which, over the past decade, had steadily positioned themselves as safer alternatives to conventional cigarettes.

The e-cigarette/vaping business emerged as a response

The advent of “e-cigarettes” (also called “vape pens” and “electronic nicotine delivery systems”) allowed consumers to inhale nicotine with reduced tar (the ingredient in tobacco that is largely responsible for lung damage). These battery-powered devices essentially heat a liquid (“e-juice”) and convert it into vapour that users inhale. The liquid is a combination of nicotine, water and various popular flavors such as menthol, mint etc. E-cigarettes come in different shapes and sizes; some look like regular cigarettes or cigars, while others are designed to look like pens or USB flash drives.

Juul Labs (Juul) dominates this space; its market share is still a jaw-dropping 66%, down from 76% at the end of 2018.[1] Juul sells both vaping pens and “juice”. The company’s marketplace dominance in this category is such that “Juuling” has become an acceptable generic verb form for “vaping”.

E-cigarettes and vaping pens did not come under the regulatory net of conventional cigarettes. This attracted many other players to this lucrative, high-growth market. In fact, this new segment was seen to be such a large opportunity that US cigarette major Altria acquired 35% equity stake in Juul Labs for a whopping US$12.8 Billion in December 2018. [2]But how things have changed in just nine months!

But dark clouds are looming on the vaping horizon

Recent reports indicate that in the US alone, there have been 34 deaths and 1604 reported cases of people developing lung illnesses tied to the use of e-cigarettes.[3] Vaping is rampant among US teenagers and growing at an alarming rate. This teenage vaping epidemic is being attributed to the following reasons:

• E-cigarette/vaping products are largely unregulated.
• Vaping liquids are easily available in a range of popular flavours including bubble gum and menthol.
• Young users mistakenly believe that the “juice” contains only water and flavouring or that nicotine levels are too low to be addictive or harmful. It is reported that each Juul pod contains as much nicotine as in 20 cigarettes.[4]
• Younger users appreciate that e-cigarettes significantly reduce the risk of giveaway tobacco odours (there is virtually no residual smell in the breath or clothes other than the smell of the flavouring agents in the vaping liquid).

Many teenagers have admitted to using vaping pens to inhale THC (the ingredient in marijuana that causes the high). There is thus a real fear that vaping products are causing both nicotine and THC addiction.

The now-apparent risks of vaping have brought the industry into sharp focus, with business implications for companies operating in this space. A major overhang is the threat of regulation. Some states in the USA have already started taking steps to control vaping. For example, while Massachusetts has announced a four-month ban on the sale of all vaping products, Rhode Island has announced a ban on flavours. The larger ecosystem too is responding. Walmart has decided to stop selling all e-cigarettes, while some TV networks have stopped broadcasting Juul’s ads.[5]

The FDA has stated that by May 2020, e-cigarette companies making tobacco-flavoured products would be given the chance to file for approval. Manufacturers of flavoured-product manufacturers would also be given the opportunity to file for approval, but until they are approved, their products would be off the market.

The above threats could impact the very existence of players in the e-cigarettes industry. In addition, there are also specific legal threats against market leader Juul Labs. The company’s marketing practices are under the Federal Trade Commission’s scanner, while a criminal investigation into the company has been initiated by the US attorney for Northern California.

The road ahead is bumpy

Vaping companies are waiting for the inevitable regulatory actions in the coming months to make course corrections to their business architecture (products, sales and distribution networks, marketing etc.). But their market is being shaped by other forces as well: cigarette majors have been working to provide smokers with supposedly less harmful options to conventional cigarettes.

Philip Morris International (PMI), the US$130 Billion cigarette major, has already made a strategic commitment to “unsmoke” the world by developing products that deliver the flavour of cigarettes, but without tar and ash. Work on such products began much before Philip Morris split its business into two entities in 2008. [The erstwhile Philip Morris company’s business in the US was sold to Altria, which also owns stakes in beermaker Anheuser Busch and Canadian marijuana company Cronos. Its business in the rest of the world was transferred to PMI (which is headquartered in Switzerland)].[6]

In 2014, PMI launched a range of smokeless products under the name “IQOS” (I Quit Ordinary Smoking) in Nagoya (Japan) and Milan (Italy). A rolled stick of tobacco placed inside a pen-like electronic device (that resembles a cigarette case) is heated to release nicotine vapour that can be inhaled. Unlike a traditional cigarette, the IQOS device does not burn the tobacco. In the absence of combustion, there is no smoke; it is also claimed that IQOS releases fewer noxious chemicals than conventional cigarettes. Also, unlike vaping products, IQOS uses real tobacco- which, PMI claims, makes this product more attractive than vaping pens to smokers of conventional cigarettes. The push towards smokeless products prompted Altria and PMI to explore merger possibilities. But just over a month ago, the companies called off their merger talks. Leaders from both companies reiterated their strategic intent to focus on heated tobacco products, which they see as the future.

PMI already sells IQOS in nearly 50 countries around the world, including the US, France, Germany, and the Netherlands. In the US, IQOS is approved for sale by the FDA, but it does not have the permission to be marketed as a reduced risk product. Menthol flavoured “heatsticks” (tobacco sticks) for IQOS have received FDA approval for marketing in the USA, although with strict guidelines to ensure that children do not get access to IQOS. Altria will market IQOS in the USA under a licensing agreement with PMI. IQOS was officially launched in the US a few weeks ago in Atlanta. IQOS devices will only be sold through Altria’s stores and kiosks; the heatsticks can be purchased in about 500 stores across Atlanta. Customers can order the products online, but must visit stores to collect them (after due id verification).[7]

While IQOS products have done well in markets like Japan and Russia, sales have been slow in the UK and Canada (admittedly, they were launched much later here). It is too early to say how IQOS will do in the US. But is safe to say that the future of the market for alternatives to conventional cigarettes will depend on multiple factors such as the degree and type of regulations imposed on Vaping products, the extent to which millions of cigarette smokers perceive IQOS as doing a good enough (or even better) job than what they have been used to, and of course, the price differentials. PMI’s growth will also depend on how countries with large populations of smokers (e.g. China and India) decide to treat these products (a couple of weeks ago, India banned vaping products).

Sources:

[1] https://www.cnbc.com/2019/10/01/e-cigarette-sales-slowing-led-by-juul-amid-negative-headlines.html and https://www.journalnow.com/business/juul-ends-with-percent-market-share/article_6f50f427-19ec-50be-8b0c-d3df18d08759.html

[2] https://www.cnbc.com/2018/12/20/altria-takes-stake-in-juul-a-pivotal-moment-for-the-e-cigarette-maker.html

[3] https://www.cnbc.com/2019/10/24/vaping-illness-deaths-rise-to-34-as-health-officials-hunt-for-cause-of-outbreak.html

[4] https://www.cdc.gov/tobacco/basic_information/e-cigarettes/Quick-Facts-on-the-Risks-of-E-cigarettes-for-Kids-Teens-and-Young-Adults.html

[5] https://www.nytimes.com/2019/09/25/health/juul-vaping.html

[6] https://www.pmi.com/our-transformation

[7] https://www.pmi.com/smoke-free-products/iqos-our-tobacco-heating-system