Race to replace cigarettes is heating up

Today, vaping is the preferred alternative to smoking in the U.S. Reynolds American owner British American Tobacco expects it to stay that way, arguing on a recent earnings call that Americans won’t buy heated tobacco products in big numbers. BAT is applying to the U.S. Food and Drug Administration for permission to launch its Glo heated tobacco sticks, but executives say this is mainly to get leverage with overseas regulators rather than because they are bullish about local demand.

The maker of Lucky Strike cigarettes has reasons to talk up vaping. Its Vuse brand has overtaken Juul as America’s top e-cigarette, and heated tobacco is a much bigger business for BAT’s rival Philip Morris International, which sells Marlboro cigarettes outside the U.S. PMI will soon have a U.S. distribution network to roll out its pioneering IQOS heated tobacco devices, assuming it completes a proposed $16 billion acquisition of nicotine-pouch specialist Swedish Match.

Certain smoke-free products can dominate different markets depending on consumer tastes and local laws. IQOS has been a big success in Japan, where consumers have a record of openness to new innovations. It must have also helped PMI that e-cigarettes containing nicotine are banned. The situation is flipped in the U.S.: Vaping has a 7% share of the overall nicotine market, according to BAT, compared with 1% for modern oral nicotine pouches like Zyn and less than 1% for heated tobacco.

E-cigarettes have been available in the U.S. for around a decade, which may partly explain their lead. IQOS was only released in 2019, so the heated tobacco category is less familiar to American consumers. Covid-19 and an intellectual property dispute with BAT have also slowed the brand’s rollout.

But timing may not be everything. Nicotine levels in U.S. combustible cigarettes are high and it is technically easier to replicate the hit with nicotine salts in e-cigarettes than in heated tobacco—though levels in IQOS are close to those in traditional smokes.

Vaping also gets favorable tax treatment in the U.S. Federal excise levies on heated tobacco are the same as on cigarettes, whereas there are none on e-cigarettes. A smoker who usually pays around $8 for a pack of Marlboro cigarettes will pay the same to switch to IQOS heated tobacco sticks, but just $6 for BAT’s e-cigarette brand Vuse Alto, data from UBS shows.

However, this gap may not last if Washington decides to tweak nicotine taxes to offset the impact of falling cigarette sales on its revenues. And in another respect IQOS is advantaged: The PMI brand is one of the few noncombustible products that has permission from the FDA to tell smokers that using it lowers their exposure to harmful chemicals. So far, no vaping brand has been granted this modified-risk classification.

The U.S. e-cigarette market is in the middle of an overhaul. All vaping brands have had to submit applications to regulators to remain on sale. If flavored e-cigarettes, such as menthol, aren’t approved, it could be harder to encourage some smokers to switch, limiting the growth of the vaping category.

E-cigarettes are top of the U.S. heap today, but until regulations and taxes settle there is still a lot for big tobacco to play for.