Behind Philip Morris International's Smokeless Bet -- WSJ

Most of its revenue still comes from traditional cigarettes. But CEO André Calantzopoulos says they aren't the future.

This article is being republished as part of our daily reproduction of WSJ.com articles that also appeared in the U.S. print edition of The Wall Street Journal (October 30, 2017).

Cigarette maker Philip Morris International Inc. is betting big on smokeless products with a device called IQOS that heats but doesn't burn tobacco.

The number of cigarettes big companies sell is declining and, with regulations continuing to tighten, the companies are focused on future-proofing their business, investing in e-cigarettes and "heat not burn" products that they say are less harmful than traditional cigarettes. Philip Morris has joined with Altria Group Inc. to apply for Food and Drug Administration approval to market IQOS in the U.S. as a less risky alternative to cigarettes.

Philip Morris, spun off from Altria in 2008, sells cigarettes only outside the U.S.; Altria sells cigarettes only in the U.S. If Philip Morris's IQOS wins FDA approval, it will be sold in the U.S. by Altria in a licensing agreement with Philip Morris, which will receive royalties from U.S. sales.

Making IQOS -- pronounced eye-koss -- a success has become an obsession for the company's chief executive, André Calantzopoulos.

A tobacco industry lifer and former smoker, Mr. Calantzopoulos is a walking advertisement for his new product, puffing away on the cigarette-shaped device through the day. He's counting on lower taxes and looser marketing restrictions than those levied on traditional cigarettes to push smokers to switch to these new, higher-margin products.

He's also betting many smokers will prefer IQOS, which heats tobacco, to existing e-cigarette options that heat a nicotine-laced liquid but contain no tobacco, making for an experience that's less like traditional smoking.

Philip Morris has poured money into clinical trials that have shown IQOS is safer than smoking. The company maintains that combustion, rather than the tobacco or nicotine in cigarettes, is what's harmful. Critics say more long-term studies and independent research are needed to evaluate IQOS's health effects.

The company in January relaunched its website, stripping away prominent mentions of big moneymakers like Marlboro and Benson & Hedges cigarettes and touting its decision to "develop, market, and sell smoke-free alternatives, and switch our adult smokers to these alternatives, as quickly as possible around the world." Last month, Philip Morris pledged $1 billion to create a foundation to encourage people to switch to smoke-free alternatives.

Critics note the company is still aggressively selling traditional cigarettes while challenging display bans and rules in some places that require plain packaging with graphic health warnings.

"I don't see any sign at all they're backing off the very aggressive effort to sell as many traditional Marlboros to as many people as they can," says Matthew Myers, head of the Campaign for Tobacco-Free Kids.

In an interview with The Wall Street Journal, Mr. Calantzopoulos discussed how Philip Morris sees the future of smoking and why he thinks IQOS is the key to the company's success. Edited excerpts follow.

Filling a gap

WSJ: With e-cigarettes already available in so many markets, why do we need IQOS?

MR. CALANTZOPOULOS: The problem we had with electronic cigarettes since the beginning of development was the satisfaction of the smoker. Because the taste is dramatically different and, at the initial stages, the nicotine pharmacokinetics were very slow. You could not get the satisfaction. It's not so easy to crack this code.

The taste satisfaction is very important. The closest you are to this, the more chances you have to switch people. It's very nice to have a zero-risk product, but if nobody uses it, you don't have any reduction in public health risk.

WSJ: Which markets are likely to be the biggest ones for these new, alternative products?

MR. CALANTZOPOULOS: When you look at the potential of these products you need to understand what is the readiness of smokers to switch. That relates to public-health concerns, social pressure, concern for people around you and many other more subtle things. You cannot say that Indonesia is at the same level of readiness as the U.K, Western Europe or the U.S.

The potential is in every market, because eventually I think people will switch to these products as they become available. There are two unmet needs in smokers: something that is much better for my health and something that bothers others much less or doesn't bother them. These are things cigarettes can't resolve. These new products are developed to address these needs.

WSJ: What's more profitable for you, IQOS or traditional cigarettes?

MR. CALANTZOPOULOS: Today it's IQOS because of the lower taxes.

WSJ: You say you don't want to encourage new cigarette smokers. If that's true, will you have a business in 40 years? What's the long-term plan?

MR. CALANTZOPOULOS: First, I don't think it's 40 years we're talking about here. It's much longer. Second, we only have, if you include China, a 15.4% share of the world [cigarette market outside the U.S.] With [alternatives to traditional cigarettes] we have seen we can grow our market share even if the market reduces. Plus we've started introducing accessories for the product.

WSJ: At over $100 for the starter kit, IQOS isn't cheap. Can you explain your pricing strategy?

MR. CALANTZOPOULOS: Innovation, in the minds of people, cannot be something extremely cheap. If you are an average person and you hear that something that is much better than cigarettes comes to the market at the cheapest possible price, you'll not trust it. This is the reason we didn't initially manufacture in China, because you need to create that credibility.

Over time you need to make the products available and affordable to different categories of people.

The big shift

WSJ: You redesigned your website recently to describe yourself as "committed to a smoke-free future" even though most of your business is still in traditional cigarettes. Why?

MR. CALANTZOPOULOS: We developed the website because we needed to make clear to our own stakeholders and employees here that this is the direction of the company.

This is not an easy thing, because we are entering into a territory that is very unknown. It's not your traditional competitors.

Our industry has been a fairly linear and predictable industry. You know what's going to happen every year. You know from time to time you are going to have a tax increase, you are going to have regulatory restriction, but, as it applies to everybody, I think we are doing very well.

But now you move to a model that from linear can become exponential for a period of time. It's much more technology-driven, much more digital-driven. Competitors other than our traditional competitors can come in, whether legitimate or fly-by-night ones, and you have to anticipate all those things. We are the first ones to be in the category, so we anticipated quite a lot. We are learning every day. The whole organization has to gear up to this new reality and these new competitive rules around it.

WSJ: There are still many regions of the world where you're actively trying to grow revenues in your traditional cigarette business. How do you reconcile those actions with your mission statement of switching adult smokers to alternatives as quickly as possible?

MR. CALANTZOPOULOS: Shifting the company to these products doesn't mean that I will give market share to my competitors free of charge. In the markets where we are not present with IQOS yet or the other reduced-risk products, you still need to defend your share of the market.

They still represent the bulk of our income, and so far they have financed the billions of dollars we have put behind these new products. But once we go national in a market, and absent capacity constraints, then you shift your resources and your focus to these new products.

WSJ: But isn't there an inherent contradiction here? Your new efforts are being funded by your traditional cigarette business, so it's important that you keep that going.

MR. CALANTZOPOULOS: Take a market like Indonesia as an example. If I just take my foot off the pedal completely, nothing is going to happen to the total market except that I lose share.

The logic says you don't do this until you go with IQOS.

We are focusing the organization much more on the new business. We will have very few new traditional product introductions, and as markets switch to IQOS we would remove resources [from the old business] completely.

Next year IQOS becomes profitable, so even the financing from these traditional businesses isn't necessary anymore, because it becomes fully self-sustaining.

Ms. Chaudhuri is a Wall Street Journal reporter in London. She can be reached at saabira.chaudhuri@wsj.com.

(END) Dow Jones Newswires

October 30, 2017 02:47 ET (06:47 GMT)