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Is Philip Morris International Facing an Industry Civil War?

By Dan Caplinger - Oct 5, 2015 at 3:50PM

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The company took criticism from an unexpected source over its tobacco alternative.

Image source: Philip Morris investor relations.

For decades, tobacco companies have relied almost entirely on cigarette sales for their massive revenues, and even though it hasn't existed as an independent company for nearly that long, Philip Morris International (PM 1.80%) has milked the international markets for profit throughout its history.

However, as health concerns about tobacco have increased around the world, Philip Morris and its competitors have all looked toward alternatives to conventional cigarettes as a potential next step in the evolution of smoking. The result has been the development of electronic cigarettes and further research into other forms of reduced-risk products such as Philip Morris' iQOS heat-not-burn technology.

Regulators haven't been entirely comfortable with the rise of these cigarette alternatives, but some even more surprising criticism of iQOS and Philip Morris came from an unusual source: rival Imperial Tobacco. The comments show the high stakes in the tobacco-alternative market and could lead to further disagreements among major companies in the industry in the future.

What Imperial Tobacco said
The harsh commentary on iQOS came from Imperial Tobacco's head of scientific regulatory affairs, who characterized the product by saying, "it smells like an ashtray." In particular, the company's representative noted that "there's a lot of black crud" left over in the heating device after the tobacco-containing heat-sticks are consumed, and in general, Imperial appeared to be seeking evidence that claims of heat-not-burn technology leading to reduced risk might not be everything proponents claim.

At first glance, the attack from a rival might not seem all that unusual. For decades, though, tobacco makers have generally had one thing in common: They all had to support a product that was under attack from outside bodies like regulators and consumer advocates. One company's claims about another's cigarettes could usually equally apply to its own products, so most companies stayed out of the critical arena.

With iQOS, though, Imperial Tobacco has drawn battle lines between electronic cigarettes and heat-not-burn products like iQOS. Unlike Philip Morris, Imperial has thus far stuck with e-cigarettes, which have found a following among an increasing number of customers worldwide. Yet Philip Morris has justified its iQOS efforts by noting that even though both types of products could have reduced-risk benefits, the heat-stick product feels and tastes more similar to the smoking experience traditional tobacco users are used to having.

Could reduced-risk shatter the tobacco industry?
As the tobacco industry seeks to go beyond its traditional cigarette focus, a big question looms: Will manufacturers hold to the party line and seek to distinguish their products from their competitors' solely on the basis of subjective factors like taste and brand awareness, or will they start attacking each other's claims with respect to safety and health impact?

So far, the industry has done a good job of winning the prisoner's dilemma against regulatory agencies, with various companies choosing not to take shots at their rivals for fear of torpedoing their own long-term prospects. Yet if some tobacco companies are already willing to make big bets on certain reduced-risk products beating out others, then they may not be afraid to use tactics they've never used before in an effort to get a competitive edge.

The alternative-product realm could well be the battlefield for tobacco manufacturers for years to come. While cigarettes have existed for centuries, companies are still pioneering new reduced-risk processes, so they'll have plenty of incentive to tout the benefits of their own proprietary products versus those of their competitors. With companies taking different positions on the likely outcome of research studies and other sources of vital data to come in the future, there will inevitably be winners and losers -- and those that miss out will have greater incentives to try to attack the victors.

Philip Morris shouldn't be all that surprised at Imperial Tobacco's comments, but they do represent a shift from past policy. Smart investors will keep a close eye on the industry both in the U.S. and abroad to see whether similar criticisms start to multiply among its biggest companies.

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