Today, RBC Capital Markets analyst Nik Modi defended the thesis that the e-cig business will be dominated by Big Tobacco, due to its resources and distribution network. Big Tobacco is commonly known as the oligopoly comprising Lorillard (NYSE:LO), Reynolds American (NYSE:RAI), Altria Group (NYSE:MO), Philip Morris International (NYSE:PM) and British American Tobacco (NYSEMKT:BTI).
I don't believe this thesis will play out as Nik Modi expects. The e-cig market is intrinsically different from the cigarette market.
The traditional cigarette market intrinsically consists of a disposable product -- it burns; you burn 20 of them or 40 of them in a single day, and the next day you'll burn 20 or 40 more.
The e-cig market, on the other hand, works differently. While there are also disposables, these are entry-level devices. The entry-level devices can provide an acceptable experience, but they don't provide the best experience. Vapers will thus enter the market mostly through disposables, but they then "graduate" to refillables.
And therein lies the problem for Big Tobacco. Refillables are a massive cottage industry already, an industry that's almost infinitely customizable. It starts with the $20 kit, and then goes up to custom mods in the thousands of dollars. Plus, since they're refillable, they also expose the customer to another infinitely variable market for e-liquids.
It will thus be very hard for Big Tobacco to corner this market. Even winning at the entry level, where economies of scale can make for cheaper disposables, does not assure Big Tobacco wins the larger game. It cannot hope to offer large customization (other than different colors and superficial changes) on an economical scale.
E-cigs will thus probably be more akin to watches than to cigarettes. There will be cheap ones, and a plethora of suppliers of increasingly expensive models coming in all makes and sizes (Pictured is a Portuguese e-cig mod, Caravela. Source: e-cigarette-forum.com).
The trend is accelerating
As I said in a previous article, the trend towards e-cigs is now accelerating. Retail e-cig shops are opening left and right, and the product is becoming mainstream quickly.
Since the e-cig has so many advantages over traditional cigarettes, this trend is probably unstoppable. As a reminder, e-cigarettes are:
- Less harmful;
- More diverse in terms of flavor;
- Sometimes allowed where smoking is forbidden;
- Don't leave a stink in your clothes or home/car;
- Lead to better breathing in the short term;
- Allow for the return of the sense of taste;
- And are even the basis for a new collectible industry, given their diversity.
It's likely that e-cigarettes will start having a real-world, accelerating impact on Big Tobacco economics, even if Big Tobacco enters the e-cig market in a big way.
E-cigs are unlike traditional cigarettes. Disposable e-cigs are but entry models. Whereas Big Tobacco might be able to control the disposable e-cig market, it will have no way to staunch the bleeding caused by graduation to more advanced, better, refillable e-cigs. Likewise, Big Tobacco will have no way to control the gigantically diverse e-liquid market.
It is thus likely that Big Tobacco economics will start suffering mightily from e-cigs going mainstream.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.