The Ivey Business Review is a student publication conceived, designed and managed by Honors Business Administration students at the Ivey Business School.

Big Tobacco, once one of the most lucrative and stable industries, appears to be burning out in many of the world’s developed countries. Government intervention through advertising bans and increased taxation is exacerbating the fact that consumers are increasingly informed about the well-known health issues associated with smoking cigarettes. The tobacco industry’s decline is especially apparent in Australia, where the prevalence of smoking and per smoker consumption are steadily declining. Estimates have Australian tobacco sales on a compound annual decline rate of 3.4%, but expectations are that market degeneration will accelerate to upwards of 4% through 2017.

For British American Tobacco (BAT) – the producer of Winfield (an Australian favourite), Benson & Hedges, and Holiday cigarettes, a weak forecast outlook “down under” is especially threatening, as 30% of its global revenue is derived from the country-continent. The historical market leader has been able to maintain consumer traction because 95% of consumers demonstrate brand loyalty. However, the Australian government has stripped tobacco companies of branding privileges, forcing cigarettes to be sold in drab olive green packs, with graphic health warnings covering 70% of packaging and only uniform font brand names listed on the bottom, thus removing a core strength used by BAT.

The Opportunity (Tobacco’s Technological Breakthrough)

Unfavourable market and non-market conditions in Australia reveal opportunity, however, for both BAT and the e-cigarette – a nascent technology that is a “safer” alternative to traditional, combustion cigarettes. The e-cigarette industry is in its infancy with sales just short of $2 billion, but Goldman Sachs estimates that e-cigarette sales could reach $10 billion by 2020. This would account for more than 10% of total tobacco industry volume and 15% of total profits. BAT, which recently launched its own version of the e-cigarette in the UK, is well-poised to protect its tobacco market leadership in Australia, albeit by broadening its product portfolio. BAT should pivot from being a traditional, tobacco-centric company to prioritizing e-cigarettes in Australia. This represents a bold strategy which can grow the firm’s share of the market, allowing it to both capitalize on growth in a new category and hedge from relying upon the status quo: being the leader in a declining market.

“Does Not Contain Tobacco”

The e-cigarette industry has been built on the idea of “vaping” rather than smoking. The new name for the act of lighting up derives from the fact that e-cigarettes operate by heating a nicotine-infused liquid solution, producing vapour which resembles smoke. Importantly, e-cigarette producers are marketing this new activity as a healthy alternative to smoking, which reduces the stigmatization associated with traditional cigarettes. This is exemplified by the promotion of “vape bars” – swanky lounges that emphasize using e-cigarettes as a cool and social activity. The sentiment of messaging associated with e-cigarettes is not new to the tobacco industry; it is analogous to past marketing tactics used to sell traditional smokes – the Marlboro Man campaign being a famous example. This time though, companies want the experience and product to be distinctly separate in the minds of consumers, regulators, and the general public. On its website, one producer of e-cigarettes prominently notes that “although nicotine is derived from tobacco (as all nicotine is), e-cigarettes do not contain tobacco.”

To some extent, those behind e-cigarettes have good reason to want to separate them from the negative health effects and consequent stigma attached to traditional tobacco. E-cigarettes have not yet been medically proven to be safer than regular cigarettes, but most of the carcinogens and toxins have been stripped from the new version of an old product, leading many to believe they are certainly a better replacement.

Many of the world’s leading e-cigarette producers are Big Tobacco firms, but they have maintained separate brands specific to e-cigarettes, highlighting a strategy aimed at separating the new devices from its core product lines. Lorillard entered the e-cigarette market by acquiring Blu e-cigarette in April 2012 for $135 million. The distinct Blu unit now accounts for 4% of Lorillard’s sales. Reynolds followed suit, launching its own Vuse line of e-cigarettes in the summer of 2013. BAT has likewise sought to capitalize on the e-cigarette space and has launched its own e-cigarette known as the Vype, albeit only in the UK. A variety of other, smaller firms fill out the rest of the global competitive space. Bigger players have largely contained their foray into e-cigarettes to the United States and Europe, however, signalling uncertainty about what drives adoption and about how regulation will play out in various jurisdictions. Australia, for example, has not yet seen a major entrant into the e-cigarette market, allowing BAT to be the first.

Blazing Into Australia with Vype

In order to protect itself from another Big Tobacco player transplanting its e-cigarette offering into Australia and gaining first mover advantage, BAT should first use its already-built Vype brand to solidify its prominence in the Australian tobacco market. Core reasons for BAT to patriate Vype into Australia include its size advantage over the existing e-cigarette boutiques, and the firm’s experience rolling out Vype in the UK. The firm should blitz the Australian market through social media promotion to develop a strong presence online, allowing it to build the Vype brand quickly; speed is important with such high rates of customer loyalty to nicotine products. Going online enables BAT to market its product without using traditional advertising, which is tightly regulated for cigarette producers in the country. Online promotions must emphasize brand rather than product, though this can be done efficiently and fits into the marketing strategy of selling lifestyle rather than e-cigarettes themselves.

Unfortunately for BAT, it will not be able to sell the Vype through retail channels: government regulation currently restricts e-cigarettes from being sold in the traditional outlets for cigarettes in Australia, like grocery stores. As a result, BAT must resort to online sales. In attempt to bridge the convenience gap between traditional retail and online selling in Australia, BAT should launch a Vype mobile app. The app can offer a periodic ordering feature that extracts usage patterns to alert users when a refill is needed, allowing Vype users to enjoy a personalized purchasing experience, and providing for additional customer engagement avenues to build further awareness. This would match the positioning BAT currently employs with Vype – hip and relevant. Similarly, BAT should replicate the brick-and-mortar Vype Social Bars it has used to build awareness for its product in England. The Social Bars, though unable to sell the product directly due to retail sales restrictions, can complement the “does not contain tobacco” marketing approach that has been taken with Vype by hosting an atmosphere where vaping is encouraged.

There are obvious risks associated with expanding in order to enter the tightly regulated Australian market, but there remains definite upside. Implanting the Vype brand will allow BAT to capture a new audience of consumers who are intrigued by the idea of vaping. Moreover, realizing growth from the expanding e-cigarette market will serve to hedge against declining traditional tobacco sales. The financial upside derives largely from the fact that margins on the new, vapour-based products are 35% compared to 20% on regular cigarettes. Finally, BAT has real incentive to diversify its presence in Australia by transplanting its e-cigarette capabilities because the Australian government is considering the idea of banning traditional cigarettes altogether should the e-version be proven safe. Though the government remains reticent to the likelihood of such a progressive policy measure, the Australian government is known for being a leader in implementing environmental and health and safety legislation.

If the ban were to go through, BAT would see a serious drag on its $1.6 billion of Australian cigarette sales. Surely, in that case, the demand for e-cigarettes would pique, and competitors would look to take advantage of the forced shift of consumers away from regular cigarettes; it would displace consumers who are used to a particular brand for their nicotine fix. To differentiate, BAT would have to be willing to take a unique approach not yet used by incumbent Big Tobacco players in the e-cigarette market.

Accelerating Adoption

BAT should also expand with a second e-cigarette offering that features its traditional Winfield brand in order to spark familiarity amongst its traditional tobacco smokers and drive e-cigarette adoption. Traditional smokers are not as susceptible to the new category of vaping, because they are used to the traditional product and partial to their favourite brand. One Big Tobacco executive notes that there remains difficulty in adjusting smokers to a different product due to emotional and cognitive dissonance; marketing an e-cigarette in a manner that caters to their loyalty remains ideal. Preferably, a Winfield brand will even help Australian smokers of non-BAT cigarettes transition, allowing the firm to capture competitors’ market share. BAT should not be overly concerned about whether the Winfield e-cigarette cannibalizes its traditional tobacco sales, either, as there is higher margin in the e-version. This strategy is well suited to combat a potential government ban of cigarettes and also provides a proactive approach to hedge against a declining industry while positioning BAT for a differentiated competitive position.

Clearing the Air

To thrive with this dual-offering, the clear distinction between Vype and traditionally branded e-cigarettes must be highlighted to avoid confusing consumers. Currently, in the UK, the Vype brand is disassociated with BAT’s other products, and avoiding reference to this relationship in Australia must be done so as maintain the validity of its message alongside the Winfield e-cigarette. Clear establishment of product offerings with distinct benefits, differentiated perceptions, and separated user bases will avoid a loss of BAT’s message in translation.

BAT must be prepared to diversify its product offerings in Australia to take advantage of growth in the higher-margin e-cigarette category and to protect against decline in the traditional cigarette space. Its Vype product, currently marketed as a vaping product and not a smoker’s product, can be transplanted from the UK in order to build a new consumer base, while a Winfield-branded e-cigarette can enable it to transition smokers to the product of the future.

E-Cigarettes Up to BAT

Baby Steps

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