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Electronic Cigarettes: The New Frontier for Altria Groups Inc?

December 22, 2013 | About:
Muhammad Bazil

Muhammad Bazil

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Electronic cigarettes have been on the market for about five years now, primarily coming from smaller, independent companies. The primary selling points for the new product are that it is a safer, more affordable, and more socially acceptable alternative to the traditional combustible cigarettes. With independent companies controlling about 60% of the market, electronic cigarettes are also seen as an alternative to “big bad tobacco” companies.

But as profits from the product continue to grow—sales in 2013 were three times higher than in 2012—while sales of traditional tobacco products are stagnating or even falling for some, the big names in tobacco are starting to take a keen interest in the electronic cigarette market.

Fast growing market:

In less than a decade, electronic cigarettes have become a $2 billion dollar industry—still small in comparison to the $80 billion tobacco industry, but its fast growth is making it a viable threat. Regular cigarettes are already feeling the effects of this growing market as Altria Group Inc’s tobacco sales fell by 5.2% in the first quarter of this year.

The end of the year debut of MarkTen:

Earlier this Fall, Altria Group Inc (MO) launched its first electronic cigarette, MarkTen, in a key test market of 3,000 stores in Indiana. After seeing good results in that test market, the company decided to expand to about 2,000 stores in Arizona. While Altria will not yet release the exact numbers, the fact that it is expanding the product indicates a plan to continue into the market.

A little late to the game:

Altria Group Inc’s entrance onto the electronic cigarette scene is a little delayed as its two major competitors have already made forays in to the market in 2012 and early 2013. Reynolds American (RAI) developed and began selling its own product line, Vuse, earlier this year and Lorillard (LO) acquired the successful independent electronic cigarette company, Blu, for $135 million last year.

A relatively unregulated market:

Up until now, electronic cigarettes have benefited enormously from existing in a sort of classificatory grey area as lobbyists have successfully prevented them from being categorized as “drug-delivery devices” or “tobacco products.” This not only helps the image of the product in the eyes of health-conscious consumers, it adds a lot of economic benefits as well.

Not subject to the same laws and regulations as traditional tobacco products, electronic cigarettes can sell for much cheaper as the only tax levied on the product is, in most cases, the sales tax. Traditional tobacco products, on the other hand, are subject to often increasing taxes driving their prices higher and higher.

In addition to lower taxes, companies are also free of the many restrictions on advertisements that tobacco companies must deal with. Electronic cigarettes can and are marketed on television, promoted by celebrities, and—although typically only marketed toward adults and current smokers—do not currently have any age limitations.

And while they are marketed as the safer alternative to regular cigarettes, the lack of FDA oversight means that little testing has been done to find out what potential health risks might be, meaning that electronic cigarettes do not suffer from the same negative image that traditional tobacco products have. In fact, no surgeon general’s warning is even required on electronic cigarette packaging.

The looming threat of government oversight:

Last month, the FDA made its intentions clear that it plans to take more control over this emerging market. In order to do so, it plans to reclassify the electronic cigarette as a tobacco product and subject to the same regulations and restrictions as traditional tobacco products.

This means increased taxes, limitations on marketing, and stricter control over the product. It would also mean the many different flavors currently available—a big selling point for many users—would be taken off the market as menthol is the only legal alternative flavor allowed in tobacco products.

Additionally, years of trials and testing by the FDA to determine the safety and effects of the product could effectively take electronic cigarettes off the market. And if that happens, it is hard to say if it will be able to achieve the same momentum it is currently experiencing later on down the road after its extended absence.

What this means for Altria Group Inc and other companies:

For many of the smaller companies currently controlling the market, stricter government oversight will spend the end of their business. But the larger companies, with more capital to bear the brunt of the increased costs associated with the new regulations, will likely be able to continue to expand into the market.

The final decision of the FDA is still to come as the administration first will open up the discussion to interested parties—namely lobbyists for electronic cigarettes and representatives from the public health sector. But, should the new ruling pass, one of two things could happen.

Smaller companies, unable to withstand the additional costs, will go out of business or pull out of the market, making room for Altria’s new MarkTen as well as Reynold American’s Vuse and Lorillard’s newly acquired Blu. In this case, it will be a battle for market control among these dominant competitors.

On the other hand, the new FDA regulation could prove too damaging to the sales and stunt the record-breaking growth the electronic cigarette market is currently seeing. It is still a new product and with new restrictions on advertising and increasing retail prices due to taxes, potential consumers might be effectively deterred and stick with the traditional tobacco products they are already familiar with.

Conclusions:

With the anticipated decision of the FDA, electronic cigarettes have currently reached a watershed from which the market will either continue to grow exponentially, pulling more consumers away from traditional tobacco or it will be stopped in its tracks, potentially even declining substantially.

This lack of certainty is perhaps why Altria Group Inc is hesitant to dive right into this emerging market and instead chooses to play it safe by testing its new MarkTen in limited, strategically chosen areas around the country. Its competitors might have done well to follow Altria Group Inc’s cautious example rather than making large, potentially premature investments in the new product.

About the author:

Muhammad Bazil
Muhammad Bazil is a financial journalist and editor for a variety of websites, public policy organizations, and book publishers. He has written hundreds of published articles and blog posts on topics including budgeting, credit management, real estate and investing. His articles have been featured on the homepage of Yahoo!, MSN and numerous local news websites.

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