Recent announcements by the Food and Drug Administration to regulate e-cigarettes are significant for the future of the $1.2 billion industry, not just because of the material impact of future regulations, but also because of the impact of the public debate and media discourse on the topic. The FDA’s focus is on banning sales to teens and requiring content disclosure, but at this stage does not address advertising nor ingredients, such as flavor enhancements.
On Friday, May 2, 2014, Cornerstone Capital hosted a conference call on the topic with Dr. Derek Yach, SVP of the Vitality Group and Head of the Vitality Institute for Health Promotion and also Chairman of Cornerstone Capital Group, joined by Cornerstone Capital’s Research Analyst, Michael Shavel. The session shared new thinking in the debate over e-cigarettes and implications for policy, drawing upon Dr. Yach’s recent article “E-Cigarettes: A Positive Disruption to the Market and Health or a Distraction?” in The Cornerstone Journal of Sustainable Finance & Banking.
Please click the “play” arrow below to listen to the full conference call, with an introduction by Cornerstone CEO and Founder, Erika Karp.
Assessing the Landscape
From a market perspective, global tobacco market volume growth ex-China has been on a negative trend for some time, yet pricing remains strong, offsetting volume pressure and bolstering margins. A belief is now gaining hold among tobacco industry watchers, notes Shavel, that the rise of e-cigarettes is beginning to impact conventional cigarette volumes. Admittedly, e-cigs currently account for less than 0.5% of global volumes and just have a toehold in U.S. and European markets. But domestic e-cigarettes sales have come a long way in a relatively brief period of time — growing from less than $10M in 2007 to more than $1B last year. It would seem that tobacco industry heavyweights might have an advantage in the market given their large cash reserves that can support next-generation products and their considerable distribution networks. That said, less restrictive regulation could have the effect of keeping barriers to entry low, thus favoring new entrants to the market.
Yet as Dr. Yach notes, tobacco’s tolls are legion and the recent announcement by the FDA to regulate e-cigarettes is significant from both an economic and social perspective. Consider the numbers: Tobacco kills an estimated 480,000 Americans each year. There are 42 million smokers, costing U.S. taxpayers $290 billion a year with 40% of that allocated to direct health care costs. On the flip side, the U.S. federal government receives $16 billion in tax revenue from tobacco-related products annually. The Congressional Budget Office recently estimated that an additional $0.50 increase in the federal excise tax would generate $40 billion over the next decade or so and reduce Medicare and Medicaid costs by about $750 million.
The FDA seems intent to address some of the concerns particularly related to youth access, and states and cities have jumped into regulations, creating a confusing web of laws across the U.S. Some regulations treat e-cigs like tobacco and open the door to public place bans and taxes, while others protect e-cigs from these regulations. In March, the European Union issued regulations requiring e-cig manufacturers to comply with tobacco laws on advertising, youth access and warnings of addictiveness.
The Impact on Consumers
What has been the corporate and consumer response? At least one company, NJOY has developed a code of conduct that starts with their goal to make tobacco obsolete and includes voluntary actions to restrict sales to youth, restrict certain flavors and marketing approaches, introduce safety standards, invest in research aimed at refining the product in terms of nicotine uptake as well as safety. In addition, tobacco giants Lorrilard and Philip Morris have stepped up their R&D efforts, offering plans to evolve next generations e-cigs that address nicotine uptake, safety and battery life, emphasizing how rapidly technology is changing the products themselves. However, none have laid out a clear path to transition from their main tobacco products as they expand their reduced-harm products.
Regulations will evolve and take time. In the interim, the industry needs to it come together fast and develop the type of code of conduct that smaller players have already pursued. But a code that is not independently audited and used for action is not worth the effort. We have seen a real evolution in what companies are now required to report.
Cornerstone, its leaders and its Board hold the belief that integrated reporting of issues material to a companies’ long term performance must be incorporated into their financial reports. We have seen that happen with regard to environmental issues and more recently in discussions over obesity and the role of food and beverage companies. Now we need to define metrics for investors to use when deciding which e-cig company to invest in.
“Investors are changing how they assess companies and increasingly look at long term performance through a lens that includes sustainability from a broad perspective,” says Yach. “Investor decisions could help shape the nicotine company of the future that could be profitable and contribute to saving lives. ”