Bloomberg

(Bloomberg) -- Competition to sate Japanese nicotine addicts is heating up.

Philip Morris International Inc. and Japan Tobacco Inc. have rolled out products that are heated -- not burned -- in battery-charged devices, seeking to appeal to smokers who want their nicotine fix without the usual smell and smoke. The move, part of the rapidly growing global vaping trend, has created a bright spot on Japan’s otherwise bleak tobacco market.

The approach is winning devotees because it avoids the part of smoking that involves setting tobacco on fire and inhaling the smoky fumes. In fact, demand for the cigarette alternatives -- while still tiny compared with the paper-rolled type -- has grown faster than manufacturers had anticipated, leaving Japan Tobacco grappling with a supply bottleneck and ceding ground to Philip Morris, the world’s largest tobacco company. 

“Our goal for Japan is to switch every consumer we have to this,” said Paul Riley, who joined Philip Morris in Sydney in 1988 and became its Japan unit’s president last September. “For me, it’s like a no-brainer. The biggest thing is we know that smoking kills. If we’ve got an alternative to that, that’s a pretty good reason to switch.”

$50 Billion Market

Sales of electronic nicotine delivery systems are booming. Within a decade, the industry has grown from a single manufacturer in China in 2005 to 466 brands on the market, according to the World Health Organization. More than $50 billion may be spent annually on the devices worldwide by 2030, the WHO says, noting “concern about the role of the tobacco industry in this market” and the potential for the products to serve as a “gateway to nicotine addiction.”

Most of the products haven’t been tested widely enough by independent scientists to gauge any harm-reduction benefits and to determine whether they can help smokers quit. Still, the reduced exposure to toxicants of well-regulated devices by adult smokers as a complete substitution for cigarettes is likely to be less toxic for the smoker than conventional cigarettes or other combusted tobacco products, the Geneva-based WHO said in a September 2014 report.

Companies have seized on that in Japan, where the smoking rate among adults has been falling for decades, dropping below 20 percent in 2014 -- the lowest since annual surveys began in 1965. Cigarette sales declined 0.7 percent to $32.1 billion in Japan last year, while vapor-producing products increased fivefold to $4.6 million, according to Euromonitor International.

“Tobacco companies are seeking the chance for new opportunities in the tobacco market in Japan,” said Akari Utsunomiya, a research analyst with Euromonitor in Tokyo. So-called electronic cigarettes have shown “strong potential,” she said in an e-mail. “The product is seen as extremely hygienic in a country that values both cleanliness, as well as well as being seen as ‘more healthy’ due to the lack of smoke compared to cigarettes.”

Philip Morris began selling its heat-not-burn vaporizer, called iQOS, nationwide in Japan in April after testing it in selected sites from 2014. Monthly sales in the 10 countries in which it’s sold now top 250,000, with Japan accounting for more than 95 percent.

The 9,980-yen ($99) device, which works by a inserting a tobacco-containing “HeatStick” into a cigar-shaped heating device, has more than 6 percent of the broader cigarette market in Tokyo, according to Phillip Morris’s Riley, who expects that share to double in the next year. A pack of 20 Marlboro-brand HeatSticks sells for 460 yen -- the same as a traditional pack of 20 Marlboro cigarettes.

‘Game Changer’

Tetsuo Yamamoto, a 40-year-old Tokyo designer, said he took up using iQOS to help him quit his 20-year-long smoking habit. Now, he says he can’t stand the bitterness and smell of paper cigarettes. “I’m relieved as my wife doesn’t complain any more if I take a puff in front of her,” Yamamoto said.

“It’s a game changer,” said Masashi Mori, an equities analyst at Credit Suisse Group AG in Tokyo, who sees vapor-producing products eventually gaining a 10 percent foothold in Japan’s tobacco market. “There is no doubt that iQOS is taking the lead, and it looks like Japan Tobacco is still testing the water from both the production and marketing perspective.”

Japan Tobacco began selling its Ploom Tech system in March in about 900 convenience stores and retail outlets in Fukuoka Prefecture as well as via an online store. The pen-shaped, battery-powered device uses vapor from heated liquid to deliver the taste and other properties of granulated tobacco leaves in a capsule.

A week after its release, Ploom Tech shipments were suspended as demand exceeded supply. When deliveries resumed, about 100,000 online orders were received in around 15 days, Executive Deputy President Hideki Miyazaki told reporters in Tokyo in August.

Supply Crunch

“The market response was tremendous -- beyond our expectations -- and we are still having to limit our product supply,” said Naohiro Minami, Japan Tobacco’s chief financial officer, on an Aug. 2 conference call with analysts and investors, according to a transcript.

The device costs 4,000 yen and is used in combination with one of three types of tobacco capsule from the company’s bestselling “Mevius” brand. A pack of five capsules sells for 460 yen, 20 yen more than a 20-stick pack of the brand’s traditional cigarettes.

Nicotine-laced liquid -- commonly used in e-cigarettes popular in the U.S. -- is categorized as a pharmaceutical ingredient in Japan, where it’s strictly controlled. In contrast, vapor-producing products that use tobacco leaves, such as iQOS and Ploom Tech, are viewed as pipe tobacco, while non-nicotine e-cigarettes aren’t regulated in Japan and are available even to minors.

Vaping Ape

Keiichi Ando sought to catch the emerging vaping wave in Tokyo two years ago, opening a Vaping Ape store in Shibuya, the shopping and entertainment district popular with teenagers. While none of the more than 150 varieties he stocks contain nicotine, sales have been increasing gradually, Ando said. On a visit to the fog-cloaked shop last week, one customer said switching to vaping helped him quit using tobacco.

Japan Tobacco is already feeling the heat. On Aug. 1, it cut its domestic sales target for paper cigarettes by 1 billion units to 107 billion for the year ending December 2016 to reflect competition from the vaped alternatives after suffering a 7.9 percent slide in the volume of stick sales in July.

With plans to invest “several tens of billions of yen” in tobacco-vaping over the next four years, Japan Tobacco aims to become the market leader, Miyazaki told reporters. He didn’t say when Ploom Tech would be released nationwide or overseas.

“A lot of our customers are still waiting for Ploom Tech, so we will boost production as soon as possible,” said Masanao Takahashi, director of the company’s emerging products marketing division, in an interview. “They just continue to sell out at shops in Fukuoka.”

--With assistance from Kiyotaka Matsuda To contact the reporter on this story: Monami Yui in Tokyo at myui1@bloomberg.net. To contact the editors responsible for this story: Daryl Loo at dloo7@bloomberg.net, K. Oanh Ha at oha3@bloomberg.net, Brian Bremner at bbremner@bloomberg.net, Jason Gale

©2016 Bloomberg L.P.

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