As cigarette sales drag, OTP segments are filling the gap. For real momentum, however, e-cigs are breaking away from the pack.
By David Bennett, Senior Editor
Except for automobiles, processed food and banking perhaps, few U.S. industries have encountered the vast market influences that tobacco has. In the past century, the tobacco industry has been shaped by regulatory policy, product innovation and shifting public perception.
Increasing regulations, taxes and consumer health concerns have combined to drive cigarette sales down year after year. In 2013, 17.8% of Americans smoked, according to the Centers for Disease Control and Prevention. That percentage is far from half the proportion of Americans who smoked 50 years ago.
And though the U.S. cigarette market retains a resilient presence—enabled by strong consumer loyalty—regulatory initiatives continue to chip away at the industry’s dominance. For example, New York City, in October 2013, raised the smoking age to 21, the first major city to adopt such legislation. Now other municipalities and some states, including Colorado, Hawaii, North Jersey and Utah, are considering similar initiatives.
Lately, as more consumers look for smoking alternatives, other tobacco products (OTP) have moved to the forefront of consumer choice—from the current popularity in smokeless tobacco to the steadily performing cigar segment. As a result, in-store sales of OTP segments have been robust.
However, as stakeholders—including convenience stores—decipher the commercial tobacco leaves to determine what product segment to wager on, e-cigarettes currently have broken from the pack. Not only are brands jockeying for market share, but emerging technologies are staking claim to uncharted territory.
Flint Anne, senior category manager-tobacco for the Framingham, Mass.-based Cumberland Farms, said that e-cigarettes continue to be an important segment for the 550-store chain, which has seen the segment account for incremental sales growth year over year.
Flint, who has served as the tobacco category manager for Cumberland Farms for the last 16 years, has been stocking e-cigarettes at Cumberland from the outset and watched closely the various changes in the market, including the dip in sales that occurred late last year.
The growth in U.S. sales of e-cigarettes slowed to 5% in the fourth quarter of 2014 from 19% over the like period in 2013, according to Wells Fargo Securities.
Cumberland Farms is a regional chain operating primarily in New England and Florida.
“They may have dropped off, but we are still up,” said Flint referring to Cumberland Farm’s e-cigarette sales recorded last year. “Depending on the retailer focus, vape shop penetration and brand selection, different retailers will see different results. Either way, we see this as an important category going forward.”
BIG AND BOLD
According to Wells Fargo Securities, open system vaporizers now contribute more than $1.5 billion to the overall electronic vaporizer market in the U.S., with electronic cigarettes accounting for $1 billion. At an estimated $2.5 billion, the overall vapor category—open systems plus electronic cigarettes—experienced 23% annual growth in 2014, with open system devices generating increased revenue for the category.
Currently, vapors/tanks/mods (VTMs) have locked onto the lead market position. Not only are vapor items expected to surpass the $2 billion mark this year, but vapor sales could exceed e-cigarette sales by $500 million. Research by Wells Fargo Securities indicated vape sales now outpace other non-combustible smoking devices three to one.
In the last five years, there have been rollouts of three generations of products—from the cigalikes to mechanical MOD (which don’t contain any circuity or electronic components) and now, open-vaping systems.
Powered by Millennials and older smokers looking for safer smoking alternatives, e-cigarette and vapor technology is moving quickly to keep up with a shifting market. Of course, all of that activity was bound to draw bigger players and now the landscape of e-cigarettes is transforming again.
In July 2014, Reynolds American Inc., parent of R.J. Reynolds, announced it would buy Lorillard Inc. the third largest tobacco company in the U.S. for $27.4 billion. With the recent approval by the Federal Trade Commission, the companies will merge Reynold’s flagship brands, Camel, Pall Mall and American Spirit cigarettes, with Lorillard’s portfolio of Newport menthol-flavored cigarettes.
The deal has also introduced more opportunity for R.J. Reynolds to beef up its own e-cigarette offering—Vuse Digital Vapor Cigarettes—now available in more than 100,000 retail outlets and one of the top performers in the convenience store channel.
Afterward, R.J. Reynolds spun off Lorillard’s popular blu eCig brand, selling it to Imperial Tobacco Group Plc. At the time, blu was the best-selling electronic cigarette brand in the country, accounting for 47% of the market.
Moving quickly, R.J. Reynold’s launch of REVO, which uses heat-not-burn technology, was introduced in Wisconsin. Not an e-cigarette by definition, REVO is a cigarette with a carbon tip that, when lighted, heats the tobacco rather than burning it, so that the cigarette releases a tobacco-flavored vapor and not traditional cigarette smoke.
Not to be outdone in the e-cigarette arena, Altria Inc., which owns Philip Morris—maker of Marlboro—in early 2014 launched MarkTen, which was around the time the tobacco maker acquired e-cigarette manufacturer Green Smoke.
With Vuse pushing into more stores, MarkTen furthering its national rollout, and blu eCig building upon its existing base, e-cigarette brands are experiencing great leaps in visibility, which means convenience stores stand to gain too.
However, many c-stores aren’t depending solely on e-cigarette offerings from big tobacco companies.
“We see the tobacco companies as playing a role; however, we determine brand selection based on sales, margins, ability to work flexibly with us and supportive of our chain specific initiatives,” Flint said. “In many cases, that criteria has us focused on brands not represented by the large tobacco companies.”
Not everyone is thrilled with big tobacco makers imposing their will and vast resources onto the e-tobacco market. Eventually, the e-cigarette business will begin to consolidate as too many smaller producers and their respective offerings are swallowed up, said Michael Siegel, a professor in the Department of Community Health Sciences at the Boston University School of Public Health.
“My concern is that if the market contracts and we see the industry fall into the hands of the big companies, I don’t think we’re going to see a continued expansion of the market as much as we have in the past,” Siegel said. “What’s really driven the market expansion has been the array of different products that are available, and if it contracts to a point that there are only a few companies out there, the opportunities for market expansion will decline.”
RESTRAINT OF TRADE
E-cigarettes still live outside of the tobacco industry’s stringent monitoring environment, but many experts predict that will change quickly as big tobacco companies stake more claims in the burgeoning segment and health and governing officials figure out the next regulatory steps.
Shane MacGuill, tobacco industry analyst for Euromonitor International, expects big tobacco-made brands to continue to dominate—at least in the short term. The primary concern of many retailers is what regulatory policies might be coming that will ultimately constrain the growth the OTP segment has enjoyed thus far.
For example, efforts to restrict e-cigarette use in states, such as California, are winding through local legislatures. Earlier this year, vaping industry representatives flooded California’s state capitol to oppose Senate Bill 140, which would prohibit e-cigarettes from workplaces, bars, restaurants and other public places.
The U.S. Food and Drug Administration (FDA) has just begun to move toward regulating e-cigarettes, working on rules that would force global producers to provide the regulators with ingredients and details about the manufacturing process, including e-cigarette tank systems and e-liquid usage.
In April 2014, the agency announced proposed regulations for e-cigarettes. They include a ban on sales to minors and an end to the distribution of free samples. Manufacturers would have to disclose the ingredients of e-cigarettes and place labels on their products warning about additive nicotine.
Other future considerations might include lengthy health warnings, restricted sales and scientific testing requirements, which would benefit consumers and e-tobacco companies alike by ensuring safety and quality standards.
“Obviously, regulation casts a shadow over any consideration of the future of the e-cigarette category in the U.S. and consumers increasingly appear to prefer open tank systems, which are themselves most vulnerable to regulation,” MacGuill said. “There isn’t a raft of hugely attractive brands remaining so on balance I would tend towards the period of consolidation rather than a flurry of further takeovers. Having said that, if consumer preference continues to move towards the open tank, later generation products companies like Reynolds and Altria may feel the need to acquire a tailor-made offering in this segment.”
TANK TECHNOLOGY
Among the components driving segment growth, technology is spurring e-cigarette and vape development. As a result more consumers are getting comfortable with smart technology offerings. For instance, Vuse e-cigs boast “SmartMemory” technology that remembers how many puffs you’ve taken on each cartridge, telling the user how much battery is left by illuminating different colors on the tip of the battery.
More and more open systems are gaining share. Part of that might reflect changing consumer tastes, including the emergence of tank system technology, which presents an alternative to e-cigarettes. Vape tanks are usually part of open systems, giving consumers the maximum amount of choices and personalization.
Users now have another vaping option in the form of disposable e-cig tanks. Two recent examples are blu Plus and LOGIC Pro. Both products combine the benefit of the higher performing battery with the convenience of the no fuss disposable cartridge or tank.
“Consumers increasingly appear to prefer open tank systems, which are themselves most vulnerable to regulation,” MacGuill said. “It seems that major manufacturers would prefer more restrictive regulation of the market. I envisage them attempting to meet the consumer in the middle with the increased rollout of products like closed tank systems such as LOGIC’s forthcoming LOGIC Pro.”
Japan Tobacco Inc.’s (JTI) announced in April 2015 plans to acquire LOGIC Technology Development LLC. JTI has long been on the sidelines of the U.S. tobacco market, representing less than 1% of cigarette volume sales.
By acquiring LOGIC e-cigarettes, MacGuill said JTI better positions itself in the midst of other competitors jockeying for market share in the world’s largest vapor device market and the fastest growing segment of tobacco in the U.S.
“LOGIC is a good brand with a closed tank product at launch stage which I think displays a good reading of the market trends,” MacGuill said. “JTI has the resources to back the brand in the U.S. market so I think this acquisition can only help them domestically but it may be a purchase as much with an eye on the international market as with generating revenue from the U.S.”
Still, open systems may soon come under the government’s watch list.
“We have to factor in potential regulations both at the federal and state level to understand the long-term role that open systems will have,” Flint said. “We also agree with some of the manufacturers that as rechargeables advance in technology for adult smoker’s satisfaction, open systems will be less attractive.”
MADE IN THE USA
Recently, the Electronic Cigarettes International Group Ltd., distributor of electronic cigarette and vapor products whose brands include FIN, Vapestick, Victory, VIP and others, announced financial results for its first quarter ending March 31, 2015.
The meetings resulted in an agreement on an annual cost-saving target of approximately $12 million. This project includes an overall reduction of 75 SKUs, an aggressive implementation of acquisition synergies between Must-Have and Vapestick, consolidation from 10 product suppliers to seven, as well as transferring liquid refill production to the U.S. and the United Kingdom, from China.
Still, there are increasing government and consumer demands for domestic production with pharmaceutical level of quality control, especially when it comes to the e-liquid used in vaping systems. More and more there is a call to produce high quality e-liquids that have a U.S. stamp.
Enter Universal Corp., a leading leaf tobacco merchant that supplies tobacco to various tobacco companies including Philip Morris. Two years ago, a subsidiary of Universal Corp., Virginia Tobacco Co., joined botanical extraction company, Avoca Inc., to form a joint venture to produce high quality, United States Pharmacopeia-(USP) grade liquid nicotine for the e-cigarette industry.
If successful, the joint venture, Merry Hill, N.C.-based AmeriNic Inc., might go far in allaying some industry concerns over the quality and origin of nicotine and e-liquids entering the U.S. market.
Stanley Dudley, AmeriNic’s vice president, said after two years of planning and preparation, production is set to begin this month. While, it will take some time to penetrate the highly fragmented markets, expectations of AmeriNic’s success are conservatively optimistic.
“When we began doing our market research, we found out pretty quickly there was no producer of nicotine in the U.S.,” Dudley said. “Avoca is a very high quality, well-respected company in the extraction business. Universal is a very high quality company, and well-respected on the leaf tobacco side. We can produce full traceability for our customers. I think that’s what’s lacking in the nicotine world of the other manufacturers that are manufacturing in India, China and other places. ”
GOING FORWARD
While 2015 has already brought more wrinkles to the e-cigarette and vape segments, striking changes for e-cigarettes, vape offerings and the c-stores that carry them might not be that far down the road. Flint of Cumberland Farm’s said both manufacturers and regulators will have a decisive hand in the direction that the market goes.
“It all depends on product innovation and the regulatory / taxation pathway for these products,” Flint said. “We would like the category to grow since it is margin enhancing, versus traditional combustion-based cigarettes.”