Why Is Korea Easier To Conquer For iQOS Than Europe?

Philip Morris International’s (NYSE:PM) heat-not-burn tobacco product iQOS has witnessed phenomenal growth in the markets it has been launched in. As of July 2017, the product had been introduced in key cities in 27 markets globally, following city launches in South Korea and the Czech Republic in the second quarter. The company has been particularly impressed by the performance in Korea, and announced increased distribution in Seoul, as well as further expansion into four additional cities. While the company has not disclosed the conversion rates or cannibalization rates for the country as of now, the management did say that the reaction in the region has actually been better than what was experienced when they entered Japan, the only country where the national expansion of iQOS has occurred. According to the latest data supplied by the company, the weekly offtake share in the region is already above 5%, a tremendous achievement considering the product was launched less than four months back. Given the strong showing of the product at the time of the launch, it will not come as a surprise if the results from the region surpass that of Japan in the future.

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How Is The Region Performing Better Than Europe?

iQOS has been introduced in a number of markets in Europe, where it is witnessing impressive conversion rates. However, it has a relatively low level of penetration, which has had a negative impact on the market share in the region. As can be seen in the chart below, the coverage areas in terms of percentage are quite small, and consequently, the offtake shares, while improving, are not at the same level as has been seen in Japan. In Korea, on the other hand, even though the coverage area is low, iQOS is performing well; in fact, it is doing even better than in Japan.

What has worked in PMI’s favor in Korea has been its proximity to Japan, as the region has benefited from this cross-border in terms of the flow of information. Korean customers can see the trends in Japan, and what the uptake and conversion rates have been in the latter country. As a result, before the product was even shipped to Korea, iQOS was already at 10% awareness levels. Such a level is not even present in many cities in Europe, despite the earlier launch and the huge levels of investment undertaken for marketing initiatives. Korea, like Japan, is a country that is also very open to innovation and trying new products. Such factors may be the reason that PMI is thinking of implementing a national roll-out for iQOS in Korea at some point this year.

What Are The Potential Pitfalls in The Region?

So far, Korea has classified e-cigarettes as different to traditional cigarettes for tax purposes. Hence, iQOS has been taxed at a lower rate than the 75% imposed on regular cigarettes. Under the current law, the taxes on a 4,300-won pack of 20 heated tobacco sticks is 126 won, compared to 594 won for a 4,500-won pack of 20 traditional cigarettes. However, this scenario may change in the near future. There is a proposed amendment for raising the taxes on the heat-not-burn products to the same level as cigarettes, which had at first reached an agreement but was later pushed back by the parliamentary finance committee. If such a tax rate is implemented, it would force Philip Morris to pass on the increased cost to the consumers by way of a price hike of its heated tobacco sticks. While the product is currently sold for 4,300 won, the company may have to increase the price to over 5,000 won per pack. Such a step would make these heated tobacco sticks costlier than traditional cigarettes, a factor that may discourage consumers from switching to this product. After a major tax hike on cigarettes was imposed in 2015, which almost doubled the cigarette pack prices, the Korean government has seen a surge in tax revenues from cigarettes. A loss of this, an outcome from the uptick in the sales of iQOS at the reduced tax rates, may result in the tax hike proposition passing through.

Another factor that may limit the growth potential of iQOS in the region is the quicker response of its competitors. In a country like Japan, iQOS had a substantial head-start to the competition. However, the competitors have been reacting quickly. Rivals British American Tobacco (BAT) and KT&G have also stated their intentions of entering the market. BAT’s heat-not-burn device Glo was launched in August in the country, and one of its selling points has been the cheaper price point. While the iQOS device sells for 120,000 won, Glo is priced at 90,000 won; the heated tobacco sticks for both are priced the same – 4,300 won. However, the one benefit that can arise by the entry of rivals is the increased consumer awareness that can be generated. Furthermore, in such a scenario, iQOS’ first mover advantage may benefit the company in the long run.

Have more questions on Philip Morris? See the links below:

• Philip Morris: Focusing On A Smoke-Free Future
• Strong Demand For Smokeless Tobacco In Japan
• iQOS- A Product Of Innovation Or Necessity For Philip Morris?

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