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All eyes on iQOS

After a promising test-marketing phase, Philip Morris International’s iQOS is moving into additional markets.

By Stefanie Rossel

In the not too distant future, the Marlboro Man had better bring his power bank to the campfire—at least that’s what Andre Calantzopoulos, CEO of Philip Morris International (PMI), recently seemed to suggest. At the Consumer Analyst Conference Group of New York, in February, he said that it was his company’s stated ambition to convince all adult smokers who intend to continue smoking to switch to reduced-risk products (RRPs) “as soon as possible.”

He went on elaborate on iQOS, the company’s most prominent alternative to combustible cigarettes. Introduced in 2014, iQOS is a heat-not-burn (HnB) product consisting of a rechargeable, pen-like device into which a short, cigarette-like tobacco product, called a HeatStick, is inserted and heated to create a tobacco-flavored nicotine aerosol. No combustion takes place, and the product is heated to a temperature of less than 350 degrees Celsius (662 degrees Fahrenheit).

“For the first time in history, we have products with the real potential to both accelerate harm reduction and grow our business,” Calantzopoulos commented. He said he was confident that PMI’s range of RRPs could achieve a market share, net of cannibalization, of between 3 to 5 percent of the global cigarette market by 2020, with the incremental volume of 30 to 50 billion units generating a potential additional margin of between $720 million and $1.2 billion per year. One of the prerequisites, he added, was that regulators and anti-tobacco groups embraced the principle of harm reduction and implemented appropriate frameworks and unambiguous communication that would “drastically accelerate” current smoker adoption of RRPs and further foster innovation in this area.

Analysts share Calantzopoulos’ optimism, as the device not only mimics the smoking ritual but also provides real tobacco taste—something that has thus far proved difficult to achieve with e-liquid. James Bushnell, an analyst at Exane BNP Paribas, said iQOS was “the closest yet that the industry has got to the holy grail of a commercially successful ‘safe’ cigarette.” Wells Fargo Securities analyst Bonnie Herzog forecasts the device to achieve a volume of 5.3 billion sticks this year, which represents 0.6 percent of PMI’s total cigarette and HeatStick volume. By 2025, she estimated, iQOS will account for 366.9 billion sticks, excluding the U.S., or 35.9 percent of the company’s combined combustible and HeatSticks volume. Including the U.S., she predicted that as many as 420.1 billion HeatSticks could be sold per year by 2025. PMI’s new HnB technology, she said, could displace up to 30 percent of the combustible cigarette industry in developed markets by 2025 and had “the potential to change the trajectory of smoking.”

Fresh approach

Whether the analysts have looked into the correct crystal ball remains to be seen. The introduction of iQOS followed a series of hapless launches of other HnB products, among them R.J. Reynolds’ Premier (1988), Eclipse (1994) and, most recently, Revo (2014), for which marketing support was discontinued after five months of test-marketing in Wisconsin, USA, last year. Philip Morris had its Accord (1998) and Heatbar (2007). Most of these products failed because of poor consumer reception. During the recent TMA conference in Williamsburg, Virginia, USA, one speaker derided his company’s first HnB product as “smelling like a fart and tasting like shit.”

IQOS is different from its predecessors in many aspects. For starters, it is backed by significant investment. In 2014 PMI built a €500 million (then $680 million) new factory near Bologna, Italy, to produce the tobacco components of its HnB products. Altogether, the company has invested $2 billion in its RRP product portfolio over the past decade. Furthermore, iQOS features a slimmer, lighter design and new technology. Importantly, it offers an improved taste and sensorial and ritual experience over former HnB devices, according to PMI. At the same time, iQOS appears to deliver on its promise to reduce output of harmful and potentially harmful constituents (HPHCs). According to comprehensive studies carried out by a 300-strong scientific team dedicated to PMI’s novel product portfolio, the aerosol generated by iQOS contains on average 90 percent less of all classes of HPHCs compared with the smoke of the standard reference cigarette. Further studies showed that the product does not negatively affect indoor air quality. Toward the end of 2016, PMI intends to submit a modified-risk tobacco product application to the U.S. Food and Drug Administration.

Into the world

First launched in Japan and Italy, iQOS is currently being test-marketed in selected cities in seven countries, among them Switzerland, Russia, Romania, Portugal and Ukraine. PMI plans to introduce the device to another 13 markets globally by the end of the year.

At the Goldman Sachs Global Staples Forum in May, PMI Chief Financial Officer Jacek Olczak said that in its main test market Japan, iQOS had by now achieved a full conversion rate of 60 percent from combustible cigarettes. Sales figures look promising, too: According to PMI’s 2015 annual report, the device generated an “off-take” share of 2.4 percent in Tokyo and 1.6 percent in the expansion areas outside Tokyo; the weekly off-take share was reported to be growing. PMI said it had to postpone the national rollout date for iQOS in Japan to mid-April, citing potential supply shortages due to the popularity of the device.

While iQOS is not the only product currently competing in this segment—in November 2015, British American Tobacco started to test-market Glo iFuse in Romania, and in January 2016, Japan Tobacco launched Ploom Tech in its home market—PMI’s timing may have been just right: The device enters the market as the initially phenomenal growth rate of vapor has ebbed, and some smokers who had switched to e-cigarettes have returned to combustibles. According to Euromonitor International, vapor sales have decelerated considerably; the research company has cut the category’s forecast five-year compounded annual growth rate of 114 percent to 57 percent.

In addition to being a “first mover” with regard to commercialization and clinical trials, PMI also benefits from its ability to leverage the ubiquitous Marlboro brand globally. Except for Russia, where HeatSticks are sold under the Parliament brand, iQOS is offered with Marlboro HeatSticks.

To ensure communication with potential users of their new device also in highly restricted marketing environments, PMI has created specialized points of sale—dedicated flagship stores the company calls “iQOS embassies,” which are reminiscent of Nespresso shops. It also uses grass-roots marketing and an e-commerce platform for distribution.

IQOS is one of four RRP platforms PMI is currently developing and the first of two HnB platforms; the other one—for the time known as Platform 2—uses a pressed carbon heat source that, once ignited, heats the tobacco to generate a nicotine-containing aerosol. Platform 2 has been designed to resemble a cigarette as closely as possible, the company says, and is scheduled for an initial city test still this year. At the end of 2015, the device passed a four-week whole-offer test in Romania, where it led to 60 percent of smokers using the device predominantly.

Platform 3 is an inhaler more similar to the current e-cigarettes. Using acquired technology, it creates an aerosol of nicotine salt formed by the chemical reaction of nicotine with a weak organic acid. Product development was also progressing for Platform 3, PMI said. The company expects to conduct a city test for the device in early 2017.

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