For tobacco, change is in the air
E-cigarette companies continue to innovate the category, all the while waiting for the FDA to regulate them. The electronic cigarette industry is still young, which brings good news and bad news. The good news is adult smokers present opportunities for sales growth in the e-cigarette category, which industry observers say is currently worth nearly $2 billion. The bad news is that manufacturers might soon face new regulations, as the U.S. Food and Drug Administration (FDA) continues its long deliberation of how, and whether, to regulate e-cigarettes. The FDA has not indicated when it will announce any proposed rules on e-cigarettes, so for the time being, observers are looking on the bright side. “We are increasingly optimistic on e-cigs,” Bonnie Herzog, managing director of beverage, tobacco and convenience store research for Wells Fargo Securities, wrote in a report. In November, Wells Fargo Securities hosted its inaugural e-cig forum, “A Vaping State of Mind – E-Cig Fireside Chats.” After the event Herzog wrote that e-cig industry leaders, public health and regulatory experts and investors remain enthusiastic about the category. “We came away with an even greater conviction that e-cigs will be a game changer and will eventually be margin enhancing to the tobacco industry,” she wrote. One reason for the positive outlook is that the category is moving towards a “rechargeable razor/blade” model. Consumers are encouraged to buy a higher end product and then continue to buy flavor cartridges and refills, or cartomizers. That model has higher margins than disposables. “E-cig manufacturer margins can rival or exceed those of combustible cigarettes,” Herzog wrote. “Based on our interactive model, we anticipate e-cig margins will surpass traditional cig margins in 2017.” Todd Millard, chief operating officer of Charlotte, N.C.-based Ballantyne Brands, which makes Mistic e-cigarettes, says this model is central to the continued growth of the category among adult smokers. “There appears to be a shift away from disposables and to rechargeables and cartridge refills,” he says. “The rechargeable program is our core business model, so we are continuing to emphasize it while gaining new retail distribution and store count.” Retailers are embracing e-cigarettes and they are trying to figure out how best to merchandise the category. Some successful retailers have adapted a wine shop approach, in which they educate shoppers about the products. That approach is typically not available in the grocery channel, but there are ways to help adult smokers. Most companies position e-cigarettes as an alternative to smoking, not as a smoking cessation product. That is not just a marketing message but also a way to help retailers merchandise the items. “Consumers believe that e-cigarettes are better for them and safer, because of their own experience or the talk on the Internet,” says Roy Anise, executive vice president of NJOY, based in Scottsdale, Ariz. “We get letters all the time from people who say these kinds of things.” Anise says most smokers claim they would like to stop smoking, which makes them unusually reluctant consumers. “We don’t see that trend changing,” says Anise. “That’s the overwhelming macro trend that creates this opportunity.” The opportunity for supermarkets is to display e-cigarettes separately from traditional cigarettes, says Anise. Years ago, 50% of smokers bought cigarettes in supermarkets; that number has dropped to about 10% as grocery stores have deemphasized tobacco in the stores’ healthful, better-for-you marketing messages. Grocery stores have made tobacco shopping inconvenient for consumers, and they should be careful not to do that with e-cigarettes, he adds. Retailers should not merchandise e-cigarettes with combustible cigarettes in locked glass cases, because that would be “guilt by association,” say observers. Instead, retailers should recognize e-cigarettes as a new category with a large demographic. “There is a huge opportunity for the grocery market, and the merchandising of the product is key to its success,” says Elliot Maisel, chairman and CEO for Atlanta-based Fin Branding Group. “It has to be shoppable; it has to be visible; and the pricing has to be visible.” E-cigarettes have a price advantage over combustible cigarettes; since the electronic version is not federally regulated, it is not taxed. Currently, only Minnesota taxes e-cigarettes. Growing smoke Much of the growth comes from repeat purchases. Maisel says that many smokers have tried e-cigarettes, so they are a destination product for smokers as they return to the grocery retailer. Other adults are entering the space for experimentation and trial. Both customers want to make as few shopping trips as they can, and retailers should respond to these consumers. “They are in the grocery channel as frequently as any other trade,” says Maisel. “The stores that embrace that, and concentrate on merchandising in their stores, will have opportunities for increased profitability and customer service satisfaction.” If not, the retailers might lose these customers not just to other grocery and mass retailers, but also to tobacco storefronts, which have jumped on the e-cigarette opportunity. For their part, e-cigarette companies are launching marketing efforts to educate smokers about the products. “Branding and product performance are critical,” says Jim Raporte, president of blu eCigs, part of the Lorillard Tobacco Co. “We back up our brand image with continuous consumer conversation and product development based on direct consumer interaction and input.” Raporte says the brand’s marketing efforts have relied on TV commercial testimonials. “We know that authenticity matters to our customers, so our marketing campaigns needed to reflect that,” he says. “It is not so much the product, but the story or overall experience that customers relate to, and this approach has really further expanded our brand recognition and loyalty.” Charlotte, N.C.-based blu eCigs signed celebrity endorsers such as Jenny McCarthy, whose photo appears on the company’s website with the tagline, “Freedom to have a cigarette without the guilt.” Other ads have the tagline, “Take back your freedom.” Like other e-cigarette manufacturers, blu focuses on users’ ability to use the product indoors, in workplaces and at restaurants. Smokers also want an authentic experience, says Rafael Llopis, vice president of sales at Miami-based VMR Products, which makes V2 Cigs. “Most e-cig customers are, or were traditional smokers, so making sure that we deliver as realistic a smoking experience as possible, without the smoke, smell and ash of regular cigarettes, is critical,” he says. In addition to a realistic smoking experience, Llopis says consumers want new flavors, longer lasting batteries and much vapor, at an affordable price point. “An electronic cigarette is more than just a consumable,” says Llopis. “It’s inherently a technology product.” That means e-cigarettes must keep up with consumer demand for innovations and upgrades, similar to how smartphones do. The concept of e-cigarettes as technology, not as something related to tobacco cigarettes, points to another desire by the industry. According to the website of the Smoke-Free Alternatives Trade Association, based in Hallandale, Fla., “Vaporizers such as ecigs are technology products for adults, not tobacco, and, according to the ever growing and significant body of existing research, do not present the same risks as tobacco.” That means, according to the lobbying group, “we do not believe that the FDA has the authority to regulate these products.” The FDA disagrees. The agency says on its website that it currently regulates cigarettes, cigarette tobacco, roll-your-own tobacco and smokeless tobacco, and has been able to since 2009, when The Family Smoking Prevention and Tobacco Control Act (TCA) took effect. The agency announced its intent to issue a proposed rule deeming products meeting the definition of a “tobacco product” to be subject to FDA regulation, which could include ingredient listing, good manufacturing practice requirements, user fees and other controls. As of December 2013 there were no announcements yet on new proposed regulations. Many manufacturers say they welcome regulations. “Potential regulation might ultimately affect the rate and pace of the e-cig revolution,” says Llopis. “We are, however, working with regulators to ensure any proposed regulations are reasonable, grounded in science and addressing issues that we all find appropriate and proportionate for this growing category.” Millard says the uncertainty from the FDA has been a challenge for Ballantyne Brands and for the industry. Another challenge, he says, is the industry’s inability to reasonably make the case for the harm reduction that e-cigs represent, versus combustible cigarettes. The FDA might have slowed some sales, says NJOY’s Anise. Some retailers are waiting to see what the agency comes up with and are hesitating to display e-cigs differently from tobacco cigarettes. Anise says that uncertainty is creating slower uptake by retailers. The potential regulations will raise several questions for manufacturers and retailers, says Ed Denk, director of marketing for Swisher International, based in Jacksonville, Fla. “How will that shape the landscape of the category and which brands will be in a position to succeed in a regulated environment? With over 200 brands on the market and almost all being manufactured in China, how many brands will be left and how will retailers choose which brands they will carry that they know will be around in 12 months?” he says. Some think only the more established brands will succeed, even thrive, with FDA regulations. “Once regulation is imposed manufacturers will require more manpower, money and professional expertise to meet the guidelines recommended,” says Joe Gorelick, chief operating officer of Green Smoke, based in Miami. “We believe the larger players will withstand even onerous regulation while smaller players might not fare so well. Green Smoke understands the need to control manufacturing, responsible marketing and sales to offer quality products in this evolving category.” Raporte, from blu eCigs, agrees. The company was acquired by Lorillard in 2012, a transaction that the Wall Street Journal called, “the first foray by Big Tobacco” into e-cigarettes. The corporate backing will help blu, Raporte says. “Many brands entering the market are unlikely to have the infrastructure or manufacturing controls in place to be able to comply with new, tighter regulations. Therefore, rather than taking the quick and easy approach to entering the market, these brands will have to step back and evaluate if they are conducting business responsibly.” The impending regulations have not discouraged other manufacturers from looking at the business. Cheyenne International, based in Grover, N.C., has noticed the impact e-cigs have had on the category. “Cheyenne acknowledges that the e-cigarette and vapor categories are the fastest growing segments in the tobacco category,” says Jessica Fratarcangelo, marketing director. “We are developing our own product that will be introduced in the near future.” The Altria Group, based in Richmond, Va., and the parent company of Philip Morris USA, is also testing an electronic cigarette under the brand name MarkTen. R.J. Reynolds Vapor Co., based in Winston-Salem, N.C., brought its new VUSE digital vapor cigarette into Colorado in July 2013. “We have seen that awareness and trial of electronic cigarettes by adult smokers to date has been high, but adoption has been low,” says spokesperson Richard J. Smith. He adds that consumers are looking for factors such as quality and consistency of experience, and R.J. Reynolds Vapor Co. responded with technology that controls puff count, puff duration, battery performance and V-Liquid cartridge management. The emergence of e-cigs is part of a larger trend, says Smith. “Meeting the evolving expectations of adult tobacco consumers will always be the biggest challenge, or rather, opportunity for this industry. We see the growing interest in vapor, moist snuff and SNUS as part of a transformation in tobacco.” Others say they have been in the alternative business for years. “We were within this trend of adult tobacco alternatives before it was a trend,” says David Savoca, president of Smokey Mountain, based in Sandy Hook, Conn. “We will continue to develop and evaluate tobacco alternative products and brand extensions that appeal to adult tobacco consumers.” He adds that while e-cigarettes are gaining traction, sales of moist smokeless tobacco have also increased significantly over the last decade. GHQ This looks familiar To see the evolution of electronic cigarettes, just look to the packaging. E-cigarette boxes are getting smaller—and with good reason. Four or five years ago packaging consisted of large kits that looked like gift boxes. Then it moved to more of a blister pack. “They were clear, plastic cases,” says Kevin Frija, CEO of Vapor Corp., based in Ft. Lauderdale, Fla. “People didn’t know what they were getting inside the box they were buying, so a lot of companies were showing the e-cigarettes through the package.” Today consumers are more familiar than ever with e-cigarettes, so less explanation is needed on the packaging. Now e-cigarette packaging is much smaller, designed to fit in traditional cigarette display cases. The boxes look more like combustible cigarette boxes, so that consumers can fit the product in their pockets or bags. Frija says it helps that the size of the e-cigarette is also decreasing, so that it looks more like a traditional cigarette and can fit into the smaller box. “We still have a small window but typically the package is the size of a cigarette box,” says Frija. Vapor Corp. learned everything anyone wanted to know about packaging when the company went through a rebranding exercise recently for its Krave brand. In July they began surveying consumers about e-cigarettes, packaging and other details. Vapor Corp. then tested several iterations of the new packaging, including one version at the NACS Show in Atlanta in October 2013. “We designed and rebranded our product, cleaned it up a lot, made it more appealing, more attractive,” says Frija. “We went back and got a big thumbs up from consumers and retailers.” The company also makes Smoke 51, Green Puffer and VaporX, and will debut the new Krave packaging at the Tobacco Plus Expo in Las Vegas in January.