Politicians, activists, and regulators may be trying to undermine Philip Morris International's (PM 0.80%) ability to earn a reduced-risk designation for its heated tobacco iQOS device in the U.S., but in Japan, where the electronic cigarette has been selling longest, the tobacco giant may already own the market.
First-mover advantage
Philip Morris first began selling the heat-not-burn device in Japan (and Italy) in 2014 in limited test markets. Soon after, however, the response was so great that it rolled it out into more markets and subsequently started selling the iQOS throughout Japan in 2016. The results have been so good that it's given Philip Morris hope it can achieve similar returns elsewhere.
Image source: Philip Morris International.
In its fourth-quarter earnings report issued earlier this month, Philip Morris shipped a total of 20.8 million traditional cigarettes and heated tobacco units for the period. Of that amount, 13.1 million were heated tobacco units, or 63% of the total, and its Marlboro HeatSticks branded devices earned more than 13% share of the market.
That's an even bigger share than its Marlboro combustible cigarettes, which stood at 8.1% in the quarter, and represented a major change from last year when HeatSticks had less than 5% of the market and Marlboro owned over 10%.
This is key because the total cigarette market -- traditional and reduced risk combined -- continues to shrink. At the end of 2017, the Japanese market stood at 43.4 billion units, down 4% from last year, but Philip Morris was shipping 47% more units into it. That's due wholly to the iQOS device, which saw shipments surge nearly fourfold year over year while combustibles declined by almost 28%.
There are cultural differences that likely explain Japan's overwhelming acceptance of the iQOS and similar devices, and they have regulations that favor heat-not-burn technology over traditional electronic cigarettes, which are strictly regulated. For example, the e-liquids used in electronic cigarettes are regulated under the country's pharmaceutical laws.
Such differences have helped Philip Morris stake out a commanding lead in Japan, whereas even though the iQOS was introduced in Italy at the same time (there the device is marketed as Heets), it only has a 1.2% share of the market.
Competition to heat up
Philip Morris' rivals may want to take on the leader, but their competing devices have only limited availability. For example, British American Tobacco's iFuse glo heated tobacco device is available in just a handful of cities, including Tokyo, Osaka, and Sendai. While it reports it has a near 11% share in Sendai, the glo's share in the other cities is in the low single digits.
Similarly, Japan Tobacco was late to the game and only introduced its Ploom Tech battery device last year. Now it is so worried about Philip Morris' lead that it has committed to spending upwards of 1 billion yen, or around $917 million, to develop a new heat-not-burn product this year.
According to analysts, that Philip Morris dominance adds up to a 76% share of the heated tobacco market, with the balance evenly split between the other two.
Change may come, but not likely
It's possible that if and when new products are introduced or when more markets are exposed to these competing products, Philip Morris' rivals will peel off more share from the leader. But having run so far ahead of the competition, it is Philip Morris International's game to lose.
It is going to be a high hurdle for its rivals to overcome. From the broadly available device to the benefit of being able to market it under the well-known Marlboro brand (in Japan at least), Philip Morris International will undoubtedly continue to own the cigarette alternative market.
