As E-Cigarette Growth Booms, 3 Major Challenges Loom

The war on tobacco has been one of the largest conflicts that has ensued within the U.S. over the past 50 years.

Led by public campaigns packed with knowledge, as well as a recent print, media, and online ad campaign from the Centers for Disease Control and Prevention – the first of its kind for the CDC -- the U.S. adult smoking rate in the U.S. has dropped from 42% in 1965 to just 18% as of 2011. This is what you would call a successful reeducation campaign.

Source: Centers for Disease Control and Prevention.

Unfortunately, this still means that somewhere in the neighborhood of 40 million Americans are classified as smokers. With the negative health effects of smoking well known, the CDC, Food and Drug Administration, and U.S.regulators would like to persuade as many people as possible to put down their cigarettes and quit for good.

Electronic cigarette growth is booming
However, nicotine is a highly addictive substance and most smokers won't be able to simply quit "cold turkey." This is where electronic cigarettes come in, and why a number of smokers have turned to these devices as a way to wean themselves off cigarettes.

Source: Lindsay Fox, Flickr.

Electronic cigarettes, or e-cigs for short, heat a flavored liquid solution containing nicotine inside a metal tube, turning the liquid into an inhalable vapor. The allure of these devices is that they contain the nicotine that smokers are addicted to without a number of the harmful chemicals typically found in cigarette smoke. In other words, the perception would be that e-cigs are a safer alternative source for nicotine.

Growth in e-cigs is absolutely soaring, at least according to a study published this week by my alma mater, the University of California, San Diego. Researchers at UCSD's School of Medicine noted that "10 new e-cigarette brands have entered the Internet marketplace every month, on average, from 2012 to 2014, and that there are currently 466 e-cigarette brands online, offering more than 7,700 flavors."

UCSD's study also demonstrated a distinctive shift between established e-cigarette brands and newer brands. As lead author Shu-Hong Zhu noted, older e-cig brands tended to focus their marketing message around the cost-effectiveness and comparable health benefits of e-cigarettes compared to traditional cigarettes. Newer brands try and avoid any comparisons to cigarettes whatsoever, emphasizing flavor and choice instead. 

Three major challenges loom for e-cigarette industry
Growth might be off the charts for the e-cig industry, but that doesn't mean it won't face a number of challenges over the near-term. Specifically, I see three hurdles it will need to overcome in the coming years in order to be successful.

Source: Alex Proimos, Wikimedia Commons.

One we dove into just last month: the Food and Drug Administration's initial proposal to classify e-cigarettes as tobacco products. The truth of the matter is that we don't know a lot about the long-term effects of e-cig vapor as of yet, and until more is known the FDA would much rather take a conservative approach to classification. More so, the FDA wants to ensure that minors aren't allowed access to e-cigarettes as this could actually cause tobacco addiction rates to rise.

While these seem like fair concerns, the FDA's decision could have an adverse impact on the bottom-line of e-cig manufacturers like Lorillard (NYSE: LO.DL  ) , the company behind the dominant Blu E-Cigs brand, while potentially boosting insurers' profits. If insurers choose to classify e-cigs as tobacco products they could jack up the premium rates of those using the inhalable devices and would likely reap significant financial benefits as the long-term health effects of inhaled vapor versus traditional cigarette smoke is portrayed as night and day by the e-cigarette industry. If insurance costs rise because of e-cigarette use it's possible that companies like Lorillard could see their sales growth stall. For the moment we're still waiting to see where most insurers will stand on their classification of these devices.

Secondly, while pundits have focused to no end on the possible health benefits and risks of e-cigarettes, they've ignored the potential for market oversaturation that UCSD's study exposed. Competition is good for the consumer, but it can be bad for businesses as it has the potential to reduce pricing power and pressure margins. More e-cigarette manufacturers means higher advertising budgets just to stand out from the crowd.

Furthermore, the rapid growth of e-cigarette brands creates a Catch-22-like dilemma for consumers and investors.

E-liquid vapor shop, Source: Lindsay Fox, Flickr.

On one hand, I'd be concerned about the quality of product given the rapid influx of new brands. As UCSD's study points out, newer e-cig brands appear to be more focused on flavor, which lends concern that they could be enticing the wrong audience (i.e., minors) or sending the wrong signal. The FDA has been pretty clear that e-cigs are to be used as smoking cessation tool and nothing more.

On the other hand, if the FDA does choose to regulate each new brand that comes to market we could be looking at a veritable mountain of paperwork that could slow new e-cig brand emergence to a crawl and divert FDA attention away from where it should be – regulating pharmaceutical drug development.

Finally, investors have been gung-ho about the potential for the e-cig industry -- and with good reason given initial consumer demand -- but the question no one seems to be asking is whether or not this is a viable business model over the long-term.

In 2013, for example, e-cigarette sales crossed the $1 billion mark. By comparison, total tobacco revenue for the largest six tobacco companies in the world – China National Tobacco, Philip Morris International, British American Tobacco, Japan Tobacco International, Imperial Tobacco, and Altria – tallied $346 billion with $35 billion in profits in 2010. Put simply, the impact of e-cigarettes is but a blip on tobacco producers' radars at the moment.

Lorillard, which controls 45% of U.S. e-cigarette market share based on its first-quarter results, actually saw sales slip year-over-year to $51 million from its Blu E-Cigs brand from $57 million in the year-ago quarter. Additionally, a near-doubling in selling, general and administrative costs pushed its e-cigarette segment to an $11 million net loss. If the biggest e-cigarette maker in the U.S. is having trouble turning a steady profit with 45% market share, then what exactly does it take for this industry to be economically viable? 

For now I'd suggest that there are far too many questions and few answers. While the industry does offer rapid revenue growth opportunities, the potential for industry regulation and slower growth through tougher competition remain distinct possibilities. Until we see healthy profits from e-cigarette manufacturers, it's probably best not to fall for their smoke and mirror growth promises.

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  • Report this Comment On June 21, 2014, at 4:46 PM, oldoldold wrote:

    Vaping liquids are so misunderstood. The big question is why is the FDA trying to jump in to regulate them. Almost every item in them is already regulated by the FDA. I think first we must get people to understand Nicotine is harmful in large doses. This is why smokers who also use the patch have trouble. They get way to much nicotine at one time. Yet the FDA allows patches to be sold. The Gum is the same as the patches smoke and double up the nicotine and Heart attack possible. Again the FDA says ok to those. Then the pills many companies sell. They are FDA regulated yet have effects like, liver damage, Kidney damage, and heart attacks. The Drug companies even warn the user yet the FDA allows them to be sold.

    We do know that tobacco contain harmful tars and other added chemicals. Many of us also know for facts that the Obama Administration and key members of Congress pushed a 1,000% increase in the tax on roll your own products but exempting pipe tobacco. This is a real fact and the Tobacco companies paid a lot in PAC money to get it. It was to kill sales of roll your own Additive free products. These can not be disputed because they are TRUE.

    Now comes a product called by many E-Cigarettes. They use a liquid to make vapor not smoke. In fact if you blow the vapor through a white handkerchief you see no residue. With smoke you get a brown/black residue. It is called vaping and for many it was the answer to quitting the 30, 40, and 50 year habit of smoking. Even those who still smoked would never get double the nicotine like the patch and gum delivers with a cigarette. I can tell you also that the Vaping juice can be bought with 36mg,24,mg,16mg,11mg,6mg and 0mg amount of nicotine. I can also say from experience these do aid in quitting smoking because you reduce the nicotine amounts. I use ZERO nicotine now for over 4 years. I have been smoke free for over 5 years and I was a 40 plus year 2 pack a day smoker. It took me under 8 months to go from 36mg nicotine to ZERO nicotine. I also have many friends who quit by vaping. Others have cut to low nicotine levels. But the real key is NO TAR.

    Let's talk Vaping Liquid. Many use FDA approved flavors with Vegetable Glycerine (also known as Glycerol). They add nicotine levels and flavoring. Again the FDA already has approved these ingredients. Some also use Propylene Glycol with flavoring and or vegetable Glycerine. I mix my own since I use zero nicotine. I use a kosher food grade Vegetable Glycerine with Watkins brand flavoring (Anise or Peppermint). Again these are already FDA approved. Now many say vaping is BAD since you inhale. Then why do doctors tell people to use a vaporizer and add Vicks etc. and inhale that? The misinformation is unbelievable. Often many of us think it is the Drug companies hating the fact Vaping does work in many case to help people quit smoking. Even the Tobacco compaies are jumping on the Vaping band wagon but they hate the people who make the products like the E-GoT system. They hate the independent sellers and makers who sell products cheap. My liquid when I buy premixed cost me $5.99 plys inder $5 to ship for a 30ml botle. That bottle will last me a month.

    Where else is Vegetable Glycerine (Glycerol) used? It is in Medical, Pharmaceutical and Personeal care items. Look at tooth paste. a few expectorants, cough medicines, mouthwashes, shaving creams, soaps, personal lubricants. Then look at cakes and even breads we eat. Again all FDA approved.

    Where else is Propylene Glycol used? Also in many foods and as a non stick cooking spray. So we also inhale it as we cook our eggs in the morning. Again also FDA approved. Look at many health foods and also see it as a preservative and to keep moisture in foods. If you use an inhaler from a prescription there is a good chance Propylene Glycol is in that inhaler.

    I think Congress should quit trying to bow to the Big Drug Companies and the Tobacco industry and leave e-cigarettes alone. The fact is all the companies I use do not sell to minors (those under 18). Again this is a fact. I wish congress would start cutting its waste of time and get a balanced budget. They also must cut the welfare fraud and put a stop to abuse in disability claims. We also must secure our border or we the people will vote out all who refuse to act. This is a fact with over 50 of my friends in 100% agreement. The word is out..

  • Report this Comment On November 05, 2014, at 3:24 AM, MsMeg wrote:

    First of all I would like to say that I agree completely with the commentary written above. Secondly I would like to say just how sad it is that an article like this can even begin to be considered real journalism, which it is not as it is clearly written with an incredibly strong and incorrect bias, so much so that it makes me wonder if the writer is not employed by the cigarette industry or someone recieving some sort of monetary gain by the cigarette lobby. You can call me a "fool" all day long, doesn't bother me a bit because I know the truth, and the truth is that you are not interested in the truth, but rather furthering your own agenda. THAT is the truth.

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Sean Williams

A Fool since 2010, and a graduate from UC San Diego with a B.A. in Economics, Sean specializes in the healthcare sector and in investment planning topics. You'll usually find him writing about Obamacare, marijuana, developing drugs, diagnostics, and medical devices, Social Security, taxes, or any number of other macroeconomic issues.

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