By PAUL WALDIE
Friday, May 25, 2018
AT FIRST GLANCE CARL VAS DOESN'T LOOK LIKE HE'S ON THE FRONT LINE OF A BATTLE THAT WILL DETERMINE THE FUTURE OF THE WORLD'S LARGEST TOBACCO COMPANY AND THE VERY EXISTENCE OF ITS CENTURIESOLD PRODUCT
Dressed in a white lab coat and decked out in special glasses, the 28-year-old Vas looks more like a mad scientist than a highly trained specialist with a background in pharmaceuticals. He's standing next to one of many long counters laden with bizarre-looking testing equipment, while other researchers slump in their chairs, analyzing reams of data. Vas works in one of a half-dozen or so labs at British American Tobacco PLC's sprawling research park here on the outskirts of Southampton, on England's south coast. In total, there are more than 400 researchers toiling away in Britain on projects that will shape the future of British American Tobacco (BAT), a smoking colossus that makes almost 700 billion cigarettes a year and sells them in almost every country on earth. There isn't a cigarette in sight in Vas's lab; the only reminder that this is a tobacco company comes from a handful of posters hanging nearby that promote BAT's main brands, Pall Mall, Kent and Lucky Strike. Vas's work involves something that has become far more critical to the company's future: e-cigarettes. And it's clear BAT means business. The Lon-vapdon-based giant has invested $2.5 billion (U.S.) in e-cigarette development over the past six years and converted what was once an old cigarette factory into a global research centre. Vas spends most of his days analyzing the effectiveness of BAT's new e-cigarette devices, taking the products apart and putting the pieces through a battery of tests. In many ways, he embodies the very challenge facing the company--he doesn't smoke but discovered e-cigarettes a few years ago. "I'm a passionate vaper," he says with a smile. "I love it." These are tumultuous times for BAT and the other tobacco behemoths: Philip Morris, Imperial Brands and Japan Tobacco. After decades of fending off almost every conceivable challenge and generating seemingly endless profits, cigarette makers are facing their biggest threat yet. E-cigarettes have taken the world by storm, offering smokers a satisfying alternative that's less harmful and a lot cheaper.
The phenomenon has caught Big Tobacco off guard, and the giants are scrambling to catch up, putting massive resources into product development, acquisitions and lobbying efforts. The goal is to marry tobacco with slick new electronic devices that they can market as a healthier alternative to cigarettes. This is a classic technology disruption story, and the fallout could change Big Tobacco forever. Even if the big four can fight off the slew of high-tech startups elbowing in on their trade, their business models will almost certainly be turned upside down. So much so that André Calantzopoulos, the chief executive of Philip Morris, is already preparing for something once considered unthinkable: a world without cigarettes. "We are crystal clear where we are going as a company," he told reporters last year. "We want to move out of cigarettes as soon as possible."
Like most revolutions, few saw this one coming and no one knows where it's headed. E-cigarettes were born about 15 years ago out of one man's desire to find a better way to quit smoking, and vaping has now become a $15-billion-a-year (U.S.) global industry, with some forecasters saying it could grow to nearly $50 billion (U.S.) in five years. The basics of e-cigarettes are simple: They are hand-held devices that create vapour by either boiling a nicotine-laced liquid or heating a small amount of tobacco. While both are generally referred to as e-cigarettes, the devices that use tobacco are usually called "heated tobacco products," or HTPs, and tend to be regulated more like cigarettes. Both are considered less harmful than cigarettes because there's no smoke, which is the real health danger from smoking. Canada is set to become a key battleground in this revolution. New legislation is expected to come into force this summer that will open the door to e-cigarette sales across the country. The move has been welcomed by tobacco companies, Health Canada and anti-smoking advocates, all of whom agree the vaping craze needs to be brought under some kind of supervision, since no one is entirely sure just how safe these products are. Canada will become one of the few countries with a fully regulated market, and it will be well ahead of the United States, which is still figuring out what to do. The lack of rules hasn't stopped the industry from taking root in Canada.
E-cigarettes fell into a regulatory grey zone after they entered the Canadian market around 2007. Health Canada effectively banned the sale of most of them in 2009, but the department rarely enforced its edict. As a result, the e-cigarette business operated on an ad hoc basis, with roughly 1,000 independently owned vape shops popping up across the country, selling whatever they thought was legal. Big Tobacco stayed away, keeping its new devices off the shelves for fear of sparking a public backlash if it jumped into an unregulated market. Instead, the giants began a fierce lobbying campaign and became active in helping to shape the new regulations. Now, with the law set to take effect soon, Big Tobacco is preparing to rush in with e-cigarette products, massive marketing campaigns and perhaps its own retail outlets. Some say e-cigarette sales in Canada could double almost overnight to $1 billion. That troubles many public health advocates, who worry the impending regulations have given tobacco companies too much leeway, especially since it's still unclear whether e-cigarettes help or hinder anti-smoking efforts.
"It's going to fundamentally change the products that are on the market," says David Hammond, a professor in the School of Public Health at the University of Waterloo. "I don't see any evidence that e-cigarettes have increased smoking use today. But I think you'd have to be an utter fool to not have that be an ongoing concern." Eric Gagnon, who heads corporate and regulatory affairs at Imperial Tobacco Canada, a division of BAT, says the company backs the new law but would like to see greater flexibility so that companies can explain the advantages of vaping. "The government needs to get this right initially and then move forward and embrace harm reduction as a tool for consumers to switch to less harmful products," he says. The new regime puts plenty of restrictions on e-cigarettes, but also opens fresh opportunities for tobacco companies.
E-cigarette makers will be able to advertise most of their vapdon-ing products and sell them through special shops so that customers can find the best product for them. That's unheard of in the cigarette market, where advertising has been banned for decades, and packs of smokes carry dire warnings and are hidden from view in convenience stores. There are some limits, such as rules forbidding "lifestyle advertising" and prohibitions on vaping flavours that might entice children, such as "bubble gum" or "candy floss."
And heated tobacco devices, the ones that use small amounts of tobacco instead of nicotine liquid, will be regulated like cigarettes and banned from advertising. That's still enough to give Big Tobacco an edge when the market opens up. These companies already dominate the traditional cigarette market, which gives them a crucial advantage when it comes to selling e-cigarettes, since most people who vape are either current or former smokers. BAT, Philip Morris and Japan Tobacco account for 99% of all cigarette sales in Canada, with BAT's Imperial Tobacco selling nearly half. Brands like du Maurier, Player's, Number 7 and Export A are household names among Canadian smokers, and it's likely e-cigarette products will carry many of the same brand names (there's already a Marlboro e-cigarette), making them more appealing to smokers. Outside Canada, the tobacco giants have been moving fast to capitalize on their position and resources. In the past six years there's been a flurry of activity, with the cigarette makers gobbling up e-cigarette ventures and spending billions on their own creations. The first significant move came in April 2012, when U.S. tobacco company Lorillard paid $135 million (U.S.) for Blu, an upstart e-cigarette designer with a hot product that had captured 40% of the menthol vaping market at the time. About two years later, Blu was purchased by Imperial Brands, which has made it a key part of its e-cigarette strategy and plans to bring the product to a dozen more countries. That set off a wave of deals that culminated in last year's £41.8-billion tieup of BAT and U.S.-based Reynolds American Inc., instantly making BAT the largest tobacco company on the planet and giving it a roster of high-profile e-cigarette devices, such as Vuse and Vype.
Last year the combined entity's e-cigarette brands generated £500 million in revenue, and BAT expects that to double this year and rise to more than £5 billion by 2022. By 2050, BAT executives predict half of the company's revenue will come from e-cigarettes and heated tobacco. hose are big numbers, and while the e-cigarette market is now worth billions of dollars, the device itself had a humble beginning. The origin can be traced back to a faraway corner of northeastern China and a pharmacist named Hon Lik who just couldn't quit smoking. Hon had been trying for years to kick his three-pack-a-day habit, fearing he'd end up like his father, a heavy smoker who died from lung cancer. In 2001 he started dabbling with a machine that vaporized a nicotine solution, much like a home humidifier. After months of refining his invention, Hon produced a simple hand-held device that used a small heating coil to create vapour from a nicotinelaced liquid. He patented his technology in 2003 and partnered with a Chinese company called Ruyan to bring the first e-cigarettes to market in China a year later. Soon Ruyan was exporting the products overseas, and by 2007 e-cigarettes had swept across Europe, the U.S. and Canada. Hon sold his patents to Fontem Ventures in 2013 for around $75 million (U.S.), and now 66, he works for the business, which is a subsidiary of Imperial Brands. Today the biggest proponents of e-cigarettes tend to be people like Boris Giller, a Toronto businessman who, like Hon, found salvation in vaping.
Giller quit smoking several years ago and then zealously tried to get his parents to give up the habit too. He attempted everything from making threats to hiding their cigarettes. When nothing seemed to work, he went online in 2011 and bought an e-cigarette device for his father. His dad took to it instantly. "He was somebody who says no to hypnosis, acupuncture, anything like that. And yet when it was a substitute, it's a carrot and not just a stick, and when he didn't lose the perceived benefit, he liked it." His father never entirely gave up cigarettes, and he later died from heart disease caused by years of smoking. The tragedy prompted Giller into action, and he gave up an online dating service he'd launched and took up the e-cigarette call, pledging to sell the devices to as many Canadians as possible.
It wasn't long before he met Gopal Bhatnagar, a Toronto cardiovascular surgeon who'd become fed up with watching patients die from smoking. Bhatnagar was skeptical about e-cigarettes at first, but after a difficult day in the operating room, he signed on to Giller's idea. "The reason was that he did a third operation on somebody who was refusing to quit smoking," Giller recalled. "He said, 'Okay I'm in.'" In 2014 they opened a vape shop in Toronto, and today their chain, called 180 Smoke, has 16 locations in Ontario, Sas-katchewan and New York. Giller sees e-cigarettes as something akin to health products, and his shops spend more time instructing smokers on how to use them rather than pushing a particular brand. "It's a harm reduction, and that's how it should be treated," he says.
He and many others in the e-cigarette industry are hostile toward Big Tobacco, blaming cigarette makers for their habit and eager to show customers that the alternative is tobaccofree. That's led to the creation of e-cigarette companies like San Francisco-based Juul Labs Inc., founded by a pair of exsmokers who openly boast that their mission is to eliminate cigarettes altogether. Juul has become the top-selling e-cigarette in the U.S., capturing more than half of the market in just two years, according to the most recent Nielsen figures.
Its sleek look, which is similar to a USB drive, and high nicotine level have made Juul a particular favourite among high school students. Juul devices are also cheaper than many regular e-cigarettes, and they contain disposable cartridges, or "pods," that cost about $4 (U.S.) each and carry 0.7 millilitres of nicotine juice, the equivalent of a pack of cigarettes or 200 puffs. The concentration of nicotine in each pod is 50 milligrams per millilitre, roughly twice as high as most e-cigarettes. But Juul may be the exception rather than the rule--it's not clear whether the company's device is a fad. NJOY Inc. also once had a seemingly unassailable e-cigarette product back in 2012, when the Scottsdale, Arizona, company dominated the U.S. market with a 48% share. It too shunned Big Tobacco and took pride in its anti-cigarette stance.
But the company soon struggled in the face of increasing competition, patent challenges and a failed product launch. It filed for bankruptcy in 2016, and although it has re-emerged, the episode was a stark lesson in how tough the e-cigarette market has become with the arrival of Big Tobacco. Jan Verleur, co-founder and CEO of VMR Products, which owns V2 e-cigarettes, has warned that Big Tobacco will ruin the e-cigarette industry by chasing out innovative smaller companies. "Big Tobacco is trying to hop on the vaping wave, and it could be a big problem for vape manufacturers, and trickle extra cost down to the consumer," reads a blog post on his company's site. He might be right. When e-cigarettes first came on to the market a decade or so ago, liquid-based vaping devices were far more popular than heated tobacco products, and the business was dominated by upstarts and entrepreneurs.
But the market is turning, and sales of heated tobacco devices are soaring. And while Big Tobacco has been rushing out liquidnicotine devices, heated tobacco offers a far more lucrative opportunity for the giants because it's so much closer to actual smoking and provides a bigger jolt of nicotine. A June 2017 study by Euromonitor International found that heated tobacco devices are expected to represent 45% of the e-cigarette market by 2021. The sale of these devices has been growing so fast it could offset the steady decline of traditional cigarette sales, which have been falling by about 3% annually. "Simply put, rather than declining, combined cigarettes and heated tobacco value sales are forecast to grow 1% in constant terms," the report found. "All of which is to say that heated tobacco--on these indicators--is truly a coming force in global tobacco." None of this has been lost on Big Tobacco, which is now focused on developing heated tobacco devices as quickly as possible. The big winner so far has been Philip Morris, which has invested $4.5 billion (U.S.) since 2008 on e-cigarette products, targeting heated tobacco in particular with its IQOS brand. Launched in 2016, the IQOS system includes a pen-shaped holder that heats a tobacco stick, known as a Heatstick. A holder and a battery charger cost around $125, and the sticks sell for about $10 for a pack of 20, making it a reasonable alternative to smoking (the holder can last for more than a year). IQOS has proven to be a huge hit in Japan, which has strict rules governing nicotine liquid e-cigarettes, and the device has been rolled out to more than 40 other global markets, including the U.S., where it's under review by the Food and Drug Administration. Along with piggybacking on its popular Marlboro brand, Philip Morris is hoping to capture more sales by selling IQOS accessories, such as stick holders, carrying cases and cleaning devices. Initially the company could barely keep up with demand. Heated tobacco volumes jumped from 400 million units in 2015 to more than 36 billion last year, and Philip Morris is hoping to boost its IQOS production capacity to 100 billion units this year. The company has said that by 2025, all of its e-cigarette brands could generate 40% of total net revenue, up from 13% last year. BAT has taken note and launched its own heated tobacco product, called Glo. By 2022, BAT expects to generate more than twice as much revenue from its heated tobacco line of devices as it does from its nicotine liquid products. Japan Tobacco is fighting back too, with a hybrid device called Ploom Tech, which mixes flavoured liquids and tobacco leaves. Whether e-cigarettes actually are healthier than smoking is still an ongoing debate, but tobacco companies have been keen to embrace the harm reduction message. Philip Morris has gone so far as to revamp its website to carry the message "Designing a Smoke-Free Future," and all of the big cigarette makers have been rushing out studies to show e-cigarettes are far less harmful than cigarettes. "We want to transform the industry," says David O'Reilly, BAT's scientific and research director. "We want to transform the lives of smokers." For now, most governments and health agencies remain uncertain. Several countries, including Australia and Brazil, have banned e-cigarettes over concerns about safety and their potential to encourage smoking. Other countries, like the U.K., have welcomed the products and made them a part of national anti-smoking strategies. Health Canada has been more circumspect, unwilling to go as far as the U.K., at least for now. "Despite emitting fewer harmful substances than cigarettes, vaping products are harmful," the department noted last year when drafting proposed regulations. "The long-term health effects are unknown, and there is limited research on the effects on bystanders." Health Canada acknowledged the challenges posed by e-cigarettes, adding they could be useful in offering smokers a less harmful alternative. Studies vary on the safety of e-cigarettes and their effectiveness as a smoking replacement. Public Health England has concluded that e-cigarettes are 95% safer than cigarettes, and it found no evidence that the vapour is harmful to bystanders or that these products encourage smoking. But the Washington- based National Academies of Sciences, Engineering, and Medicine has concluded that while e-cigarettes are far less harmful than cigarettes, the long-term health effects aren't clear, and there is evidence these devices increase the risk of young people taking up smoking. And for people like Neil Collishaw, research director at Physicians for a Smoke-Free Canada, the situation is even more troubling. He says studies show e-cigarette users continue to smoke as well as vape, meaning that while they might cut down on smoking, they stick with the habit longer. "When you look at the whole public health impact, it looks like it's bad news," he says. E-cigarettes "depress quitting and they are really only helpful for a small minority of people."
For Big Tobacco, the financial stakes are high, and even if it wins the battle over e-cigarettes, the cost could be punishing. The margins on vaping devices are nowhere near as healthy as they are on traditional tobacco cigarettes, which cost just pennies to make and sell for a lot more per puff. So it's hard to see a scenario where the transition to the new technology doesn't seriously hurt the tobacco companies' bottom line. For consumers, vaping is simply a lot cheaper than smoking. Devices that burn nicotine liquid start at about $30, and liquids go for about $20 for a 30-millilitre bottle, which lasts two or three weeks. Compare that to around $13 for a pack of cigarettes, which lasts a day or two. The Canadian Vaping Association estimates that a pack-a-day smoker spends about $4,800 annually on cigarettes, whereas vaping costs only about $400 annually, excluding the initial cost of the device. All of that spells looming problems for Big Tobacco. With margins squeezed on e-cigarette devices, overall sales of tobacco cigarettes in free fall and consumers spending less to satisfy their habit, the financial outlook isn't great. And developing new devices isn't easy. BAT spent years designing an e-cigarette called e-Voke that was so popular with U.K. health officials, the country's Medicines and Healthcare Products Regulatory Agency licensed it as a smoking cessation aid in 2016, meaning in some cases, it could actually be prescribed by doctors. That's a stunning endorsement for a tobacco company hounded for years over claims its products killed people. And yet BAT recently dropped plans to take e-Voke to market, saying only that "a lot has changed in the category and the U.K." since the company got the licence approved. Philip Gorham, an analyst who covers the tobacco industry at Morningstar, says heated tobacco devices will help the cigarette giants weather the e-cigarette storm. But Gorham is less sold on the overall impact of e-cigarettes, believing it will be many years before vaping or heated tobacco poses a real threat to traditional smokes. Most new consumer products tend to follow similar patterns, he says, with sales soaring initially as early adopters rush to buy the new gizmos. But then growth slows, and even tapers off in some cases, until a wider consumer base can be satisfied that this product genuinely offers something that adds value. That's beginning to play out in Japan, where sales of IQOS have started to soften faster than Philip Morris expected, forcing the company to adjust some of its plans for the product. "I think e-cigarettes have an opportunity to grow, but I think many people may be exaggerating the growth potential," Gorham says. The key issue is whether tobacco companies will succeed in getting regulators to approve these products as less harmful than cigarettes. "To me, that's the critical point that tips the growth one way or another. If they can market this as a safer product that gives less exposure to carcinogens, I think that's the game changer," he says. Entrepreneurs like Daniel David can't afford to wait. With Canada's e-cigarette market about to be legalized, there are real questions about how he and others will fight off the tobacco giants. He's been at the forefront of the Canadian e-cigarette industry for years, and he's concerned about Big Tobacco taking over. He believes BAT, Philip Morris and the others will change the culture of the industry, which has been nurtured by small businesses dedicated to helping people quit smoking. David, too, was a heavy smoker who twice tried to quit when his wife was pregnant. He took his first puff on an e-cigarette in 2008 and he never went back. The effect was so strong he quit his job in banking and opened a vape store in 2010 in his hometown of Wasaga Beach, Ontario. He spent years battling customs officials over imports of e-cigarettes and convincing government bureaucrats that these products were beneficial. He now has eight Evape locations across the province and he's become a tireless advocate for e-cigarettes, something he hopes to continue even as Big Tobacco moves in with its high-tech devices and massive marketing budgets. "I got into this because I firmly believe in it," he says from his office in Wasaga Beach. "I know from personal experience, from myself and from the customers who have come back to me, that this works and that it saves people's lives." When asked if he could envision a future where cigarettes no longer existed, David doesn't hesitate. "Honestly, that's the goal."
A "SMOKING MACHINE" IN THE BRITISH AMERICAN TOBACCO RESEARCH FACILITY TESTS THE DRAW AND SMOKE OF TRADITIONAL CIGARETTES
ERIC GAGNON, HEAD OF CORPORATE AND REGULATORY AFFAIRS AT IMPERIAL TOBACCO CANADA
ERIC GAGNON, HEAD OF CORPORATE AND REGULATORY AFFAIRS AT IMPERIAL TOBACCO CANADA