iQOS- A Product Of Innovation Or Necessity For Philip Morris?

by Trefis Team
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Philip Morris International
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Philip Morris International (NYSE:PM) uses the term Reduced Risk Products (RRPs) to refer to products with the “potential to reduce individual risk and population harm, in comparison to smoking cigarettes.” The company has a number of products in various stages of development and commercialization, with numerous scientific studies being carried out to determine whether the claims for reduced risks can be substantiated. The firm’s aim is to garner 10%-15% of its sales from its RRPs portfolio within a decade. The company is betting on one such product, iQOS, a black pen-shaped device that heats sticks containing tobacco, and feels it will become more popular than e-cigarettes sold by other companies. Philip Morris has collaborated with Altria (NYSE:MO) for developing its RRP portfolio, which includes joint research, development, and a technology sharing agreement, wherein the e-vapor products developed would be commercialized in the US by Altria, and in markets outside the US by PMI. The company is also leveraging the popularity of the Marlboro brand by deploying Marlboro heatsticks in iQOS.

See Our Complete Analysis For Philip Morris International

Game-Changer For Philip Morris

iQOS is the result of more than a decade of research on a range of potentially reduced-risk products, which can prove to be an alternative to traditional cigarettes. The research, conducted by over 430 scientists in Philip Morris’ R&D facilities in Switzerland, involved an investment of $3 billion by the company. According to the company’s research, the device yields on average, less than 10% of the harmful constituents found in cigarette smoke. However, despite the growing awareness and publicity with regards to vaporizers and e-cigarettes, this segment still remains an insignificant part of tobacco firms’ income.

PMI expects its Reduced Risk Products (RRPs) to approach break-even OCI (Operating Companies Income) in 2017, and to start contributing positively by 2018. The company is targeting 30 to 50 billion units in incremental volume through RRPs, which would add an additional OCI of $0.7 billion to $1.2 billion by 2020, with an increasing confidence of reaching the upper end of the target range.

According to a Wells Fargo analysis of the future for the iQOS platform, the product has the potential for expanding the profit pool growth of combustible cigarettes and RRPs in the next decade by 400 basis points, to a 12.5% CAGR for Philip Morris. Further, it was also found that iQOS could displace up to 30% of the cigarette industry in developed markets by 2025, speeding up the premiumization of the market. This lends credence to the fact that iQOS could be a game-changer for Philip Morris in the years to come.

iQOS Market Share- Japan

Besides the product’s impressive showing in Japan, globally, as well, the product has performed favorably, serving as an indicator of the future potential of iQOS. Conversion rates of iQOS purchasers who have fully or predominantly converted to the product have grown over time, and stood at approximately 70% at the end of 2016. As of year-end 2016, the company estimates that approximately 1.4 million adult consumers have quit cigarettes and converted to iQOS. Moreover, during the fourth quarter, estimated off-take volume in all markets, with launches prior to mid-year, grew at a compound weekly rate of over 6%, comparable to Japan in the initial launch phase. This trend bodes well for the future national expansions, since in Japan, it resulted in an accelerated growth.

iQOS Conversion Rate

Till December-end, iQOS had been launched in key cities in 20 markets globally, with aims to expand nationally in many of these markets this year. The company is also targeting additional launches in 10 to 15 markets by year-end, subject to capacity. Currently the company has 15 billion units of installed annual HeatSticks capacity, and expects over 32 billion units in total capacity to be available for commercialization this year. The company anticipates an installed annual capacity of approximately 50 billion units by year-end.

Need For Cigarette Alternatives

According to WHO estimates, there will still be over a billion smokers by 2025. With such a huge demand for tobacco products in the future, the presence of less harmful alternatives to cigarettes is essential. For this, not only do alternatives need to be developed, but they also must be appealing to consumers. A significant health benefit can only be achieved when a large number of smokers switch from cigarettes to such products. The company’s innovation pipeline includes four product platforms that can meet the varying preferences of adult smokers, aiding them in the switch.

Smokers 2025

Given this situation, Philip Morris, on January 25, reaffirmed its commitment to designing a smoke-free future. The company’s momentum continues to grow behind a full-scale effort to market smoke-free products that can ultimately replace cigarettes, after a successful iQOS launch. According to Tony Snyder, Vice President of Communications, adult smokers are looking for products “that offer the satisfying taste, ritual, and pleasure they get from cigarettes, but with far lower amounts of the harmful compounds found in smoke.”

The company also aims to transition its resources from cigarettes to smoke-free alternatives in the future, and has proposed regulatory policies that encourage the replacement of cigarettes with such alternatives. The company has recognized the serious health risks posed by cigarettes and other tobacco products. Hence, accordingly, they feel an obligation to develop and market products responsibly. Success in the cigarette business has given them the resources to pursue this ambitious vision.

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Notes:

1) The purpose of these analyses is to help readers focus on a few important things. We hope such lean communication sparks thinking, and encourages readers to comment and ask questions on the comment section, or email content@trefis.com

2) Figures mentioned are approximate values to help our readers remember the key concepts more

intuitively. For precise figures, please refer to our complete analysis for Philip Morris International.
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