I sat with a Juul Labs executive over coffee a while ago. Several days later it was announced all 1,500 Juul employees were going to share a $2 billion bonus following a $12.8 billion investment in Juul by Altria in exchange for a 35 percent stake. This valued the e-cigarette maker at $38 billion.
There is big money transitioning traditional smokers to these new and emerging market product categories.
A brand leader in industry today, with vaporizers and JUULpods, Juul, along with other electronic cigarette makers like NJOY and brand owners of tobacco heating products and vaporizors are looking in the mirror as FDA scrutiny and uncertainty in the (currently illicit)* e-cigarette market is causing Philip Morris, Altria, British American Tobacco, Japan International Tobacco, ITC Limited and other firms manufacturing electronic cigarettes, tobacco heating products (THP), and related next generation tobacco product segments to adjust or re-think manufacturing costs and their supply chain strategy.
Impact of manufacturing supply chain decisions
In 2015, leading electronic cigarette manufacturing at the time, VMR Products, proudly (and incorrectly) claimed it was taking a play from Apple’s playbook, and announced it was moving all manufacturing in house. The thinking centered around having manufacturing in house would allow VMR to have tighter manufacturing quality control.
Eventually, VMR would say an increasingly challenging environment, primarily due to regulation and tariffs, would make its business model unsustainable. Losses at VMR exceeded $25 million and operations closed November 2018.
VMR’s weakening cost structure and eventual loss of profitability was more directly tied to the Company’s decision of moving manufacturing in house, combined with poor marketing, than industry regulation and trade constraints. VMR’s brand rights were soon purchased by Juul.
VMR failed to recognize one primary benefit to outsourcing manufacturing, removing asset values for plants, property, and equipment (P,P&E) off their books. Removing P,P&E increases ROIC, where:
Today, the vaping device market for atomizers of e-liquids can estimate a CAGR of 20+ percent through 2022. To a large degree, success for makers of next generation tobacco products is theirs to lose. And decision-making concerning formulating and managing an effective and efficient manufacturing supply chain is center stage.
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Companies like Altria, British American Tobacco, and Imperial Brands (formerly Imperial Tobacco Group)…each still face challenges regarding regulations, but manufacturing supply chains are notorious for unnecessarily tying up excessive amounts of working capital.
And like VMR, each company above has branded e-cigs and related next generation tobacco products in the market competing with product brands owned by the others plus, competing against a plethora of other, large and small, ‘tobacco’ companies. And, they each have extended manufacturing supply chains through outsourcing with EMS manufacturers. (See links to EMS metrics and key performance indicators – KPI)
Add to this, US volumes declined for Altria, British American Tobacco and Imperial Brands at -7.6 percent, -7.2 percent and -8.2 percent, respectively, as of November 2019. However, this also coincided with a price increase in October, according to investment bank Barclays.
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The US is an important market for electronic cigarettes and other vaping products. And tobacco company boardroom minds are focused on ever-evolving FDA regulations still taking shape. Already, some vape flavors are being targeted for extinction to help stem the fast, and addictive growth, affecting youth in the US, and elsewhere.
US Cigarettes market, value share (last 52 weeks ending Oct. 2019)
As of October 2019, Nielsen data below measured on the US cigarettes market, primarily for British American Tobacco, Imperial Brands and Altria, retail channels only, not wholesale.
To emphasize the longer term importance of the US market, earlier this year, Philip Morris CFO said during a Q2 2019 conference call: “So we expect the U.S. to perform quite well. I mean we would expect it to be faster on average than the EU has developed. I mean I think you have to be realistic. I wouldn’t assume that it’s going to take off like Japan did or Korea initially, et cetera. But we expect U.S. to have very solid results.”
(Altria spun off Philip Morris in 2008. In August 2019 the two companies had begun talks to reunite. Merger discussion ended one month later but, with both companies jointly launching a heated (smoke-free) tobacco product called IQOS for the US market.)
British American Tobacco, Altria, Imperial Brands: US consensus volume expectations
The vaping wave everywhere has been easily sweeping up more people as the price for traditional tobacco cigarettes continues to rise. Accompanying this is the fact a vape ‘hit’ packs more punch than a hit from a traditional, legal** tobacco combustion cigarette according to CBSCIMB research, NanoSTIX Innovations, The Atlantic, OHI Media and channel checks.
US Electronics cigarettes (e-cig) market, value / volume / price growth
So, while companies serving these markets do have some important growth drivers, they’re not out of the woods. For example, Malaysia is an important vaping market for British American Tobacco and other companies. However, the Malaysian government’s proposed Tobacco Control and Smoking Act, originally called for a total ban on the sale of all types of tobacco products to individuals under 18 years old only.
But, now Malaysian government is looking to outright ban vapes and e-cigarettes, entirely. This would adversely impact companies wanting to enter the flourishing vape market, seeking to capitalize on the growing demand.
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And many believe regulations and other barriers in many geographic markets may only get worse.
Perhaps one saving grace amid the e-cig and vaping regulatory uncertainty is, larger supply chains serving larger companies typically have more opportunities for identifying and weeding out unnecessary manufacturing supply chain costs. Figures below are for leading tobacco companies worldwide (2018).
And, larger companies, unlike VMR mentioned earlier, have real scale on their side – supporting MCOGs leverage when formulating outsourcing manufacturing supply chain decisions.
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Its important to note that cause and effect(s) from poor manufacturing supply chain decision-making are amplified for companies who manufacture in house, while simultaneously facing competitors in the market place who decided to move the vast majority of their P,P&E off their books by choosing contract manufacturers as part of their manufacturing supply chain sourcing strategy. (Auto-download [PDF]: EMS Manufacturing contract service agreements development & negotiations)
Tighter manufacturing supply chains
Effective manufacturing forecast demand planning and adequate visibility needed to address dynamic production scheduling and shipping needs in advance to meet changing front-end materials and back-end fulfillment requirements can be problematic enough — even for savvy manufacturing supply chain executives.
Meanwhile, for producers of e-cigs, e-liquids, electronics nicotine delivery systems (ENDS) and electronic vaping devices (EVD)…heated and smokeless nicotine products and delivery systems are a big part of the near- and long-term future.
Decisions these companies make today regarding manufacturing supply chain strategy will help determine who is best suited to weather uncertainty in this ever-changing market. I suspect, if given the chance to do things all over again, investors and the team at VMR would be likely to set up their manufacturing strategy to embrace outsourcing.
In addition to JUULpods and IQOS, other brands, devices and, vape pens produced by some of the companies mentioned in this article include Eon, STEEM, VEEV, TEEPS, NuMark, Apex, MarkTen, Green Smoke, Elite, Vype, glo, ePen, iSwitch, ePod, eStick, eTank, to name a few.
This market is filled with brands competing for attention against a difficult and complex market backdrop filled with negative headlines. The future for companies mentioned in this article is no longer defined by tobacco. Instead, its dependent on the digitization of nicotine.
And, defining sound outsource contract manufacturing and EMS sourcing decisions will be important as companies move further into electronics devices. Large tobacco companies mentioned here have long histories sourcing and working with paper and tobacco leaves. Experience in the electronics sector is new to them, and very limited.
Another worry is, how much of their e-cigarette growth is coming at the expense of traditional cigarettes? Analysts think cannibalization rates can range from 25 percent to as much as 70 percent.
Supply chain uncertainty
Regardless of true cannibalization rates from e-cigs, hiring qualified contract electronics manufacturing vendor selection and supplier management teams (with EMS sourcing expertise) cannot be ignored in helping position new and emerging product categories so they have a fighting chance getting to market fast, against high quality and, profit margin objectives.
There is an inversely proportional relationship between the level of uncertainty in manufacturing supply chains and the need for formulating good quality supply chain decisions. This becomes more apparent amid fast growth. Take, for example, NJOY. With its LOOP, DAILY, and ACE devices NJOY commands a market penetration in the US of 14.5 percent, according to analysis by investment bank Cowan using Nielsen data, with a Company growth rate few e-cig makers can rival. NJOY has seen spectacular growth over the past year, with sales up more than 1,100 percent, year-on-year and, despite a global regulatory backlash.
New tobacco/nicotine products already carry a lot of uncertainty. From FDA and health ministry regulations still taking shape, to targeting some e-cigarette flavor bans and, raising minimum age in some areas from 18 to 21, to the possibility of disruptive tax hikes in some states and across various regions of the globe, and more.
The less certain you are about the supply chain behaving the way you want it to, your need becomes greater for the decisions you do make, to be formulated from a position of having as much information and experience as possible.
Will vaping eventually be banned entirely? The answer is probably no, despite India’s knee-jerk reaction.
Science has proven vaping of nicotine is safer than smoking tobacco, even though vaping does carry risks, because moving from tobacco to e-cigarettes as a means of (hopefully) quitting can save lives.
* **The FDA’s view of e-cigarettes is they are illegally on the market. The FDA is also walking a fine line with this stance in the face of high demand by youth in the market. This is putting pressure on Altria, Imperial Brands, British American Tobacco, and other makers of tobacco vapor, heating and, liquid products to further define their business models.
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