Competition in the e cig market is heating up. Both Altria (NYSE MO ) and Reynolds American (NYSE RAI ) are set to join the electronic cigarette, or e cig, market later this year or early next year. Lorillard (NYSE LO ) already has its own brand of e cig called blu, and the company has used its first mover advantage to snap up a 49% share of the retail electronic cigarettes market.
What’s more, the domestic e cig market as a whole is expected to be worth a total of $1.7 billion this year. This is double what it was worth in 2012. Indeed, if growth like this is set to continue then there might be room for all companies to have their own share.
However, the Food and Drug Administration will decide this month if it will lump e cigs in with conventional cigarettes when it comes to regulation and taxes. Obviously, this would slow growth within the market, but there would still be plenty of room for expansion .
The rapidly growing e cig market is already showing some signs of maturing. According to this Forbes article, while there are over 300 e cig companies, the top three have 85% of the market. This is set to change as the big fish like Altria, Reynolds and UK based British American Tobacco enter the fray, which is set to happen during the next few months.
Still, Lorillard’s early movement into the market has helped the company surge forward. As I have already mentioned, the company’s blu e cig brand has captured a large share of the domestic market and produced income of $9 million, or $0.02 per share, for the company during the first nine months of the year. However, it would appear that after this performance growth from Lorillard’s e cig division is going to slow down over the next few years.
Running into trouble
In particular, Lorillard’s venture into the e cig market is already showing some strain. For example, looking through the respective earnings reports, we can see that Lorillard’s e cig gross margin has declined from 37%, reported during the first quarter of this year, to 32 % during the second quarter, and finally 24% during the third quarter.
What’s more, Lorillard’s operating income and margin from its e cig segment have declined from $7 million and 12%, respectively, in the first quarter of this year to 0 during the third quarter. That’s right, Lorillard made no profit from its e cig sales in the third quarter.
The reason for this? Well, the company rolled out a new, cheaper e cig product and expanded its offering into an additional 127,000 stores, which damaged the gross margin. In addition, the company’s marketing spend increased as it tried to beat competitors.
Far from being a short term effect, it seems as if higher marketing spending is going to become the norm as more competitors enter the e cig market.
Here comes the cavalry
That said, Lorillard is only trying to compete with smaller peers. The impending entry of tobacco industry behemoth Altria into the e cig market could change all of that. Indeed, this comment from Wells Fargo Securities researcher Bonnie Herzog sums up Altria’s entry into the market. “Altria has the ability to leverage its war chest of cash, its sizable infrastructure, its deep understanding of the tobacco consumer, and its entrenched position at retail.”
Elsewhere, Reynolds is also claiming that its new electronic cigarette, Vuse, will be a “game changer.”
There has also been some concern among smaller e cig companies that the entrance of big tobacco could spur big tobacco to use aggressive marketing tactics. This could include telling suppliers that they cannot stock the respective brand’s cigarettes unless they carry its e cigs. .
Over the next few quarters a number of new e cig products are going to come to the market. With more products hitting the market, price wars are likely to take hold. This will hit margins and force companies to spend more on promotion.
Unfortunately, in this situation a big tobacco company such as Altria is likely to come out on top as it uses its deep pockets and experience in the sector to grab customers’ attention.
Public backs plans to remove branding from cigarette packets
Almost two thirds of people support moves to sell cigarettes in plain packaging, suggesting tobacco companies will soon lose the battle to protect their brands’ identities.
The government will publish a consultation on Monday examining plans to strip all branding from cigarette packs sold in England. The move has been welcomed by health groups.
“Pack designs are used to promote brand imagery, and also distract attention from health warnings,” said Professor John Britton, director of the UK Centre for Tobacco Control Studies. “Putting tobacco into plain packs creates no problem for existing users who want to continue to buy the product, but protects children and young people from becoming familiar with and perhaps identifying with specific brands.”
Branded cigarette packs are considered vital to the profits of the tobacco firms, which are mounting a ferocious lobbying campaign to defend their right to differentiate their products.
But an independent YouGov survey of 10,000 adults, conducted for Action on Smoking and Health, suggests 62% of people support plain packaging while only 11% oppose it. The survey found that only 6% believe the tobacco industry can be trusted to “tell the truth”.
Ash also claims around eight out of 10 people support smoke free legislation, with the majority of the public in favour of further restrictions on smoking in public and on tobacco promotion.
Deborah Arnott, chief executive of Ash, said the poll showed the cigarette companies were fighting a losing battle. “Big Tobacco has the money for a fight, but money can’t buy legitimacy,” Arnott said. “Now that even a business friendly government like ours can say they want the tobacco industry to have no business in the UK there’s nowhere left to turn. This is the endgame for Big Tobacco.”
A spokesman for the British Medical Association said plain packaging was key to the strategy for reducing levels of smoking in the UK. “As doctors we see first hand the devastating effects of tobacco addiction, and therefore we support moves to reduce the number of people taking up this deadly habit,” the spokesman said.
But a backlash against the proposals is already mobilising.
“It would appear that Andrew Lansley the health secretary has made up his mind before the consultation has even been launched on Monday,” said Simon Clark, director of the smokers’ group Forest. “We do think that the total process is a total farce.”
The Association of Convenience Stores, which represents corner shops, has vowed to fight the proposal. “We do not believe that government should impose such a measure at a time when the recently enacted tobacco display ban is still to be implemented in England, Wales and Northern Ireland,” said James Lowman, its chief executive. “The confusion that this would create would create further regulatory burdens on thousands of businesses.”
Tobacco firms argue that they have a right to defend their intellectual property rights.
“Our trademarks are protected by law and we have a fundamental right to differentiate our brands from those of our competitors,” said a spokesman for Imperial Tobacco, which manufactures the Lambert & Butler and Embassy brands.
The spokesman warned that generic packaging would increase “the already high level of counterfeit product available in the UK”.
Australia is the only country so far to pledge to introduce plain packaging.