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Transitioning to Reduced-Risk Products: The Future of Tobacco

September 24, 2024

Note: We reveal investment insights through the quotes of top business leaders.

Key Takeaways

  • The tobacco industry is experiencing a significant shift towards reduced-risk products (RRPs), driven by consumer demand for smoke-free alternatives and declining acceptance of traditional cigarettes.
  • Regulatory challenges, including flavor bans and increased FDA enforcement, are hindering the growth and commercialization of innovative tobacco products.
  • Companies like Philip Morris and British American Tobacco are focusing on targeted marketing strategies to enhance consumer engagement and facilitate the transition to RRPs.
  • Despite challenges, the future outlook for RRPs remains positive, with projected growth in organic net revenue as demand for smoke-free products increases.
  • Collaboration with regulators and stakeholders is essential for promoting RRPs and ensuring a successful transition away from combustible tobacco products.

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Current market trends indicate a significant shift towards reduced-risk products, driven by increasing consumer demand for smoke-free alternatives and declining acceptance of combustible products. Companies face challenges in commercialization and market entry, while regulatory pressures and economic factors continue to shape consumer behavior in the tobacco industry.

"Is there a growing risk that ON loses its leading market share position? And as related to the combustible segment, with consumers under increasing economic pressures, what are the opportunities to leverage data analytics to better target resources or promotions to address the widened domestic cigarette price gap and adjust to changing consumer purchase patterns?" --- (MO, event transcript, 2024/05/16)

"Governmental actions, combined with the diminishing social acceptance of smoking and private actions to restrict smoking, have resulted in reduced industry volumes for our products in many of our markets, and we expect that such factors will continue to reduce consumption levels and will increase down-trading and the risk of counterfeiting, contraband, "illicit whites" and cross-border purchases." --- (PM, sec filing, 2024/Q1)

"And so I think that we are in a very strong position now to benefit from when the market starts to improve from the macroeconomic level and from the enforcement levels on the illicit products." --- (BTI, earning call, 2024/Q2)

"In addition, as consumer demand increases for innovative smoke-free products and decreases for combustible and MST products, the volume of tobacco leaf required for production of these products has decreased, resulting in reduced tobacco leaf demand." --- (MO, sec filing, 2024/Q1)

"PMI's future profitability may also be adversely affected should it be unsuccessful in its attempts to introduce, commercialize, and grow smoke-free products or if regulation or taxation do not differentiate between such products and cigarettes; if it is unable to successfully introduce new products, promote brand equity, enter new markets or improve its margins through increased prices and productivity gains; if it is unable to expand its brand portfolio internally or through acquisitions and the development of strategic business relationships; if it is unable to attract and retain the best global talent." --- (PM, press release, 2024/07/23)

Impact of regulations on reduced-risk product development

Regulations significantly impact the development of reduced-risk tobacco products. Companies like Philip Morris and British American Tobacco express concerns over FDA enforcement actions and flavor bans, which hinder growth and consumer uptake. The Reagan-Udall Report emphasizes the need for clearer regulatory pathways to support innovation in this sector.

"We oppose blanket bans and unreasonable restrictions of products that have the potential to present less risk of harm compared to continued cigarette smoking." --- (PM, sec filing, 2024/Q1)

"If you could just remind us on that? And by when do you assume that the increased enforcement efforts by the FDA could negatively impact the development of these disposable products." --- (BTI, earning call, 2024/Q2)

"The Reagan-Udall Report urged the FDA to clearly define product pathways, accelerate PMTA decision making, address the need for health risk communications to tobacco consumers and take enforcement actions against manufacturers and products that violate the law." --- (MO, sec filing, 2024/Q2)

"And therefore, the consumer offtake has been impacted quicker than what we were anticipating by the absence of a flavor product after the implementation of the flavor ban, and that has had some impact on the growth.And" --- (PM, earning call, 2024/Q2)

"During the first half, we saw an increase in enforcement action from the FDA with increasing fines, import refusals and seizures." --- (BTI, earning call, 2024/Q2)

Consumer behavior and financial implications of RRPs

Consumer behavior towards Reduced-Risk Products (RRPs) is influenced by targeted engagement strategies and regulatory support, as companies like Philip Morris and Altria navigate economic conditions and market dynamics. The potential for RRPs to benefit both consumers and public health is significant, despite challenges in the tobacco industry.

"Consumer interactions in a very targeted and focused way for us to gain learnings on the product, gain learnings on our commercial engine and then once IQOSILLUMA is authorized by the FDA, that is the moment to which the bigger investment will come because we really want to provide U. S. Smokers with the best available technology that is IQOS in Luma and this is the main technology we have by now across the world in 64 countries." --- (PM, conference, 2024/05/07)

"For a discussion regarding discount category dynamics in 2024 and the economic conditions, including a high inflationary environment, that impact adult tobacco consumer purchasing behavior, see Operating Results by Business Segment - Business Environment - Summary above." --- (MO, sec filing, 2024/Q2)

"So it's a great product. Of course, the red line is underrate consumption. And that's a place where I think we are having an impeccable approach in terms of market influencer in the U. S. We need to be helped by the regulator, we need to be helped by the trade, But we believe that the category has a fantastic potential for the benefit of the consumer and for the benefit of Public Health." --- (PM, conference, 2024/06/04)

"We've amassed the portfolio of products. We engage with those consumers and we're steadily looking to proactively get them on the journey as they make the choice and help them make the choice to move the smoke free products." --- (MO, event transcript, 2024/05/16)

"Business Environment Taxes, Legislation, Regulation and Other Matters Regarding the Manufacture, Marketing, Sale and Use of Tobacco and Non-Tobacco Products The tobacco industry and our company face a number of challenges that may adversely affect our business, product sales volume, results of operations, cash flows and financial position." --- (PM, sec filing, 2024/Q2)

Innovations in reduced-risk tobacco products

Innovations in reduced-risk tobacco products are gaining momentum, with companies like Philip Morris and British American Tobacco focusing on reducing health impacts and phasing out traditional cigarettes. Regulatory developments, such as potential FDA standards for flavors, may further shape this evolving landscape.

"This tobacco product harms your health and is addictive. The best choice is to quit tobacco and nicotine use altogether. With this authorization, Greece is the second country officially recognizing the reduction in level of toxicants in the IQOS aerosol compared to cigarette smoke." --- (PM, sec filing, 2024/Q2)

"The FDA could propose an additional product standard for flavors in innovative tobacco products, including e-vapor products and oral nicotine products." --- (MO, sec filing, 2024/Q1)

"Here, you have the opportunity to see firsthand how our teams are focused on reducing the health impact of our business and enabling BAT to deliver long-term sustainable value for all our stakeholders. Thank you very much." --- (BTI, earning call, 2024/Q2)

"Led by science and innovation, we are disrupting the industry to completely end the sale of cigarettes." --- (PM, twitter, 2024/05/14)

"In addition, new scientific data continues to be developed relating to innovative tobacco products, which could impact the FDA’s determination as to whether a product is, or continues to be, appropriate for the protection of public health and could, therefore, result in the removal of one or more products from the market." --- (MO, sec filing, 2024/Q1)

Competitive landscape in the reduced-risk product market

The competitive landscape in the reduced-risk product market is marked by consumer switching behaviors and varying objectives among competitors. Companies like Philip Morris and Altria are adapting their strategies to address these dynamics, with a focus on long-term success and navigating regulatory challenges.

"Which, to Faham's earlier question, we see sequential declines in growth now quarter-to-date. So what gives you the confidence that the consumers are switching to on consumers that are switching to rogue, some of the consumer reviews of some of these competitive products are sometimes better than this. So what gives you the confidence that now that consumer awareness for these other brands has grown as a result of your supply chain issues that you're going to immediately win those consumers back when the supply comes online again?" --- (PM, earning call, 2024/Q2)

"And we do think that the vision sets us up for success in the future, long term success in transitioning and changing the landscape of nicotine in both the United States and then with the progress we're making in international markets." --- (MO, event transcript, 2024/05/16)

"Some competitors have different profit, volume and regulatory objectives, some international competitors may be less susceptible than PMI to changes in currency exchange rates, and some competitors may sell products in circumvention of applicable regulations that compete directly with our products." --- (PM, sec filing, 2024/Q1)

Future outlook for reduced-risk tobacco products

The future outlook for reduced-risk tobacco products appears promising, with Philip Morris projecting a 7% to 8.5% growth in organic net revenue driven by increased demand for smoke-free products. However, regulatory risks from the FDA and potential government restrictions could impact market dynamics and consumer choices.

"Factoring the increased ZYN shipment forecast and a strong pricing outlook on both combustibles and smoke-free products, we are increasing our organic net revenue growth forecast to plus 7% to plus 8.5%." --- (PM, earning call, 2024/Q1)

"It is possible that tobacco manufacturing and other facilities and the facilities of our suppliers, our suppliers’ suppliers and our trade partners could be subject to additional government-mandated temporary closures and restrictions." --- (MO, sec filing, 2024/Q2)

"Cigarette smoke and smoke-free product vapour are distinctly different. Recognising this is a step toward a future without cigarettes ➡️ https://t.co/6fDvEDLb6D #SmokeFree #Science https://t.co/ak6n2BtcAJ" --- (PM, Twitter, 2024/05/06)

"For example, actions by the FDA could: • impact the consumer acceptability of tobacco products; • discontinue, delay or prevent the sale or distribution of existing, new or modified tobacco products; • limit adult tobacco consumer choices; • impose restrictions on communications with adult tobacco consumers; • create a competitive advantage or disadvantage for certain tobacco companies;" --- (MO, sec filing, 2024/Q1)

"In case you missed it, you can still learn from leading experts about the future of smoke-free products." --- (PM, Twitter post, 2024/06/21)

Role of marketing in consumer acceptance of RRPs

Marketing plays a crucial role in consumer acceptance of reduced-risk products (RRPs). Effective branding and communication strategies, as seen with IQOS, enhance consumer sentiment and engagement. Additionally, collaboration with regulators and stakeholders is essential for promoting these products and facilitating a shift away from traditional smoking.

"Any significant change in such factors could negatively impact our ability to continue manufacturing and marketing existing products, increase our costs or negatively impact adult tobacco consumer product acceptability and have a material adverse effect on our business and profitability." --- (MO, sec filing, 2024/Q2)

"There was the launch in a few other countries that is planned for H2. And it's always difficult to say what this new product is triggering, but we've been seeing clearly a new acquisition of IQOS user. We've been seeing consumer sentiment going up with some very good reaction to this product." --- (PM, earning call, 2024/Q2)

"Just shy of 18 million consumers now engaged with a step up of both those that are fully converted and those that are still using cigarettes in e-vapor." --- (MO, earning call, 2024/Q1)

"I think it will be, as always, very important to create the image, the brand territory, but also talk about closely with the smokers, okay, this is a journey to move away from smoking and to go to a better product to IQOS. We will have the same commercial, I would say, a machine that has been successful in so many markets with developing our own retail sales point." --- (PM, earning call, 2024/Q2)

"Surprisingly, I am not receiving many responses. So if we want to unsmoke the world and help 1 point more than 1,000,000,000 smokers in the world, it is not just the Philip Morrissey industry, but it's also an orchestrated effort by the regulators, policymakers and many other stakeholders, including like organizations like yours.I hope I comprehensively answered your question. Thank you." --- (PM, event transcript, 2024/05/08)

See also