Altria Group Inc.'s Biggest Failure in 2016 So Far

Image source: Philip Morris International.

Over the long run, Altria Group (NYSE: MO) has done an impressive job of navigating changing trends in the tobacco industry and dealing with downward pressure on cigarette sales. In addition to promoting its key Marlboro brand, Altria has increasingly looked at alternatives to traditional cigarettes as a potential avenue for future growth. In particular, one product that has emerged from Altria's partnership with former subsidiary Philip Morris International (NYSE: PM) is iQOS, a system that heats tobacco rather than burning it to produce vapors that consumers then inhale. Yet even though Philip Morris International has had great early success with iQOS, Altria has followed a different strategy with its alternative products lineup that might not be as successful. Let's take a closer look at why this might prove to be a mistake for Altria in the long run.

What iQOS is and how it's found success

The iQOS system that Philip Morris has marketed is different from the way that most e-cigarette products work. In general, e-cigarettes use liquids that contain nicotine and other ingredients that are designed to replicate the effects of smoking tobacco. That leaves e-cigarette makers free to look at a wide variety of innovations in formulating their liquids, giving customers a broad array of potential experiences but in a way that distances e-cigarettes from traditional tobacco. By contrast, iQOS uses specially formulated HeatSticks, which are made of tobacco and mimic the content of actual cigarettes. Yet rather than burning the tobacco, iQOS heats it up, producing a vapor that users can inhale in the same way they would a regular cigarette.

Philip Morris has started rolling out iQOS in several major markets across the globe, and early results have been promising. In Japan, iQOS already has a market share of more than 2%, and Philip Morris has reported considerable proportions of cigarette smokers who have decided to make a permanent switch to the iQOS product. Initial rollouts in areas such as Switzerland and Italy have also shown strong interest, and Philip Morris recently opened a new manufacturing facility dedicated exclusively to heated tobacco products in order to meet current and future growing demand for iQOS and HeatSticks.

Why Altria has had to move more slowly

Despite the success that Philip Morris has seen with iQOS, Altria hasn't had the opportunity to move forward very far with plans for the product. The reason is simple, as CFO Billy Gifford explained at a consumer conference earlier this month: "We have to go through the FDA process with iQOS."

Specifically, Altria is working with Philip Morris to submit an application to the U.S. Food and Drug Administration seeking to get regulatory approval for iQOS. The companies seek a designation for iQOS and HeatSticks as modified risk tobacco products, and CEO Marty Barrington said in July that Altria is "making excellent progress on commercialization strategies for the U.S. market" for iQOS.

However, Altria clearly hasn't committed to iQOS to the same extent that Philip Morris has. In describing the opportunity, Gifford characterized iQOS as merely being a piece of Altria's overall cigarette-alternative strategy, saying that the company's strategy should be "providing our consumer who wants something as an alternative with a portfolio of products to let them decide where they want to land." Meanwhile, in nearly every discussion of its reduced-risk prospects, Altria leads out with its MarkTen lineup from Nu Mark, which is much closer to the typical e-cigarette product that most rivals have focused on.

It makes sense that Altria wouldn't want to overcommit to iQOS before finding out how the FDA will respond to it. Yet given the success that Philip Morris has seen and the way that iQOS differentiates itself from the rest of the reduced-risk products market globally, Altria should arguably try to advocate for the potential benefits of iQOS more aggressively in order to take full advantage of the proprietary technology.

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