As hubs of innovation go, the area around Switzer- land’s Lake Geneva histor- ically trumps pretty much any region in the world, save the 30-mile radius around Dave Packard’s old garage. It’s where pharmacist Henri Nestlé perfected the concoction of milk, flour and sugar that spawned the world’s largest food conglomerate, the first quartz wristwatch was developed and Tim Berners-Lee invented the World Wide Web. Expand an hour or so further and you’ll find the birthplace of everything from the theory of relativity to LSD.
Which brings us today to the shore of Lake Neuchatel, where I watch hundreds of scientists and technicians, recruited from pharmaceutical giants like Novartis and Roche, scurry around a $150 million glass cube that could easily be mistaken for Google’s European headquarters. Researchers sit in the centre atrium, swapping ideas, while in the buildings on either side robotic machines churn out prototypes for a product that could have the biggest impact on human health since the introduction of antibiotics: A safer cigarette.
Cigarette smoking kills an estimated 5.4 million people a year worldwide, a figure that’s risen 30 percent over the past 20 years. You can plaster pictures of skull-and-crossbones or dying cancer victims on the wrappers and tax them until a pack costs more than dinner for two, but recent history has demonstrated that people, especially in Eastern Europe and Asia, still figure out a way to get their fix.
So what Philip Morris International (PMI) is doing from its Swiss headquarters is trying to help the world’s smokers get that fix in a way that a) doesn’t eventually kill half of them, and b) replicates the aspects of smoking that got a lot of them hooked in the first place.
It’s an ambitious plan that PMI has put $650 million into so far, with the current expenditure ramping up past $200 million a year. While many of the technical details of its products remain secret, PMI is sharing the results of its clinical research with the public and in academic journals—posters at the Lake Neuchatel lab testify to the regular tours offered visiting scientists—in an effort to reverse the well-deserved reputation for evasion and duplicity that the cigarette industry earned through most of its history. It opened its doors to Forbes and made its chief executive available for a rare interview in order to explain the strategy that may save the company in an industry that’s changing.
The first new model is an electronic device that looks like an old-fashioned cigarette holder, which heats tobacco to just below the burning point to release the nicotine and flavour of tobacco with fewer harmful combustion by-products like benzene and tar. It will hit the market in an undisclosed country sometime next year. Three more prototypes are in the works, including one that can be lit like a conventional cig.
Tobacco-based prototypes sit in direct contrast to the biggest disruptor in the cigarette business: Ecigarettes. Simple devices that combine a tiny lithium battery with a heating element to vapourise pure nicotine fluid, they deliver the drug that hooks cigarette smokers but without the taste. Competitor Lorillard is all-in on ecigarettes, having purchased Blu, now one of the largest US brands, for $135 million in 2012, and PMI’s former US parent, Altria, is test-marketing its MarkTen ecigs.
As with almost everything in the nicotine delivery business, there’s a moral quandary to all this innovation: If PMI proves successful, the new products will surely save the lives of tens of thousands of their customers. But they could also make smoking less scary to those who don’t smoke, creat- ing new nicotine addicts. PMI is shep- herding the new products through the Food & Drug Administration approval process on behalf of its former parent, which spun it out in 2008. Altria would then market the product here—assuming the FDA plays ball, which, given its reticence to green-light any product that could encourage cigarette use, is far from a sure thing.
Financially, the stakes are huge. Six trillion cigarettes are sold globally each year; if PMI’s tobacco heater attracts even a 5 percent share, that would boost profits, already a hefty $8.6 billion, by more than $1 billion a year—and still more if a kinder, gentler cigarette is taxed less aggressively. And that’s just the starting point: Bonnie Herzog, the tobacco analyst at Wells Fargo, believes that consumption of ecigs and other delivery devices deemed safer could eclipse conventional cigarettes by 2030. “We believe the market continues to underestimate the growth opportunities for the tobacco industry,” she says.
At PMI it’s André Calantzo-poulos, 56, who is spearheading the quest for new cigarettes. The urbane Calantzopoulos acknowledges the pressure he’s under. “We’re fully cognisant, because we started this journey,” says Calantzopoulos, the vapour from a black plastic prototype cigarette trailing out of his nostrils, as he sits in his office at PMI’s operational headquarters in Lausanne. “These products can bring the biggest single benefit in a short period of time, in terms of public health.”
A pack-a-day smoker since he was 25, Calantzopoulos has an engineer’s approach to the cigarette business. He studied electrical engineering at the Swiss Federal Institute of Technology in Lausanne, and after several years in the electronics industry working on robotics, he went back for a master’s in business administration from INSEAD in Paris.
Upon graduation he returned to Lausanne to work at Philip Morris’s European headquarters and rapidly advanced to high-level jobs, including helping to oversee the company’s $800 million campaign to buy former state tobacco monopolies in countries like Czechoslovakia and Poland. He was chief operating officer of PMI when it was spun out of Altria in 2008 and became chief executive in 2013.
While tobacco companies have worked on safer alternatives for years—and have been accused of duplicity and worse by marketing “light” smokes that proved just as deadly as their “heavy” counterparts—Calantzopoulos says the current effort began in 2002, when Philip Morris gave up on developing a safer version of the combustible cigarette. Filters, he says, simply can’t remove the dangerous by-products of burning tobacco that cause lung cancer, emphysema and heart disease.
PMI took a close look at ecigarettes developed in the early 2000s and even considered buying the technology. The battery-powered cigarette substitutes have rapidly grown to more than $2 billion in global sales.
The price was too high when PMI frst looked at the technology, and Calantzopoulos says subsequent history has shown PMI was right to pass (although an Altria-developed ecigs among the alternatives it is testing now). Studies in various countries show that ecigs have close to 100 percent consumer recognition among smokers and 20-50 percent have tried them at least once—but less than 10 percent use them regularly. While they satisfy the oral cravings (industry executives prefer the term “ritual”) and nicotine addiction of smokers, ecigs vapourise flavoured nicotine instead of tobacco and lack the rich taste and thick smoke of traditional cigarettes. “In any marketing definition, you’d say, ‘I have a product problem,’” Calantzopoulos says of ecigs.
PMI is betting that smokers prefer the taste of real tobacco. The product that consumers will try later this year is a thin black device that holds a paper tube containing tobacco and a white filter. The smoker draws on the paper tube, while a software-controlled, rechargeable heating element raises the temperature to almost 400 degrees, creating a vapour from the tobacco to release nicotine and flavours. The smoker exhales vapour that quickly dissipates in the air.
Calantzopoulos says he switched entirely to the new device after two weeks and won’t go back to traditional cigarettes. “Now I have great difficulty smoking combustible products,” he says, which he still must do when approving new blends. So consider him hooked on his product. But not so much that the cancer-stick stigma has faded. Despite running the company, Calantzopoulos refused to have his picture taken while smoking the prototype he so gleefully espouses.
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The argument for safer cigarettes seems as simple as the argument for installing air bags in cars. And some public health experts, including Boston University’s Dr Michael Siegel and Charles Connor, past president of the American Lung Association, support ecigarettes as a way to wean smokers of their favourite smokes.
But others oppose anything that might perpetuate nicotine addiction, even if it theoretically saves lives. Anti-tobacco activist Stanton Glantz of the University of California, San Francisco thinks the FDA should block new tobacco products until cigarette manufacturers remove traditional cigs from the market: “If it were any other product, and if it were any other business that doesn’t have the complete lack of ethics combined with maximum chutzpah of the cigarette industry, they would stop selling the more dangerous product.”
“They’ve been trying to say they only want to attract existing smokers, but the evidence does not bear that out,” adds Erika Sward of the American Lung Association. “The most heavily marketed brands by the major tobacco companies are the most heavily used ones by kids.”
And PMI is heading down a well-worn path with its new heat-driven devices. Reynolds American introduced Premier, a heated-tobacco device, in 1988 but withdrew it months later after the American Medical Association and other groups urged the FDA to ban it or at least regulate it as a drug. Reynolds, which makes Winston and Camel cigarettes, tried again with Eclipse, another heated-tobacco device. Its reward was being sued by the attorney general of Vermont for violating consumer protection laws by describing the new device as safer than smoking. A judge ordered Reynolds to pay $8.3 million in 2010 after determining the company’s extensive scientific research was inadequate because it didn’t include long-term human studies.
PMI could be heading into a similar morass, although not for lack of spending money. Inside the glass cube on Lake Neuchatel researchers working under former Novartis executive Manuel Peitsch are conducting tests in petri dishes and on human cells using the cutting-edge technique known as systems biology to try to assess how the new devices affect known pathways to cancer and other smoking-related diseases. It’s a shortcut compared with running years-long human trials, but PMI hopes it can persuade the FDA and health authorities in the EU by the results. PMI is also testing a device developed by Duke University researchers including Jed Rose, co-inventor of the nicotine patch, which uses a chemical reaction to deliver nicotine. All of the PMI devices are designed to prevent users from inhaling dangerous fumes from the heating element, a knock against the Reynolds products.
At the same time the company is using scores of outside researchers to study how consumers use the products and whether they will attract new smokers. This is critical, because the public health impact of reduced-risk products is a numbers game: If they are 80 percent safer and used by the 20 percent of US adults who smoke, that’s a public health win.
If they create a bunch of new nicotine addicts, not so much. PMI, in other words, is trying to prove to regulators that its great new product won’t actually attract new customers. Such is life in the perverse cigarette business.
“Any product we commercialize with any claim must be based on the most robust scientifc evidence, given the sensitivities,” says Calantzopoulos. “Because anything we do, it will be scrutinized ten times more than anybody else.”
Safer cigarettes promise a path out of the dismal long-term outlook for traditional smokes, where even PMI, with its dominant Marlboro brand, saw unit sales fall by 5 percent last year. But they also introduce uncertainty to a business that for most of Calantzopoulos’ 29-year career has been as predictable as the deaths it generated.
Disruptive innovations like ecigarettes are going to arrive more frequently, the chief executive says, and PMI has yet to work things out with the most important partner in its business: The taxman. Cigarettes deliver tax revenue as efficiently as nicotine. Of PMI’s $80 billion in revenue last year, $48.8 billion went to the taxing authorities. It’s as if 12 out of the 20 cigarettes in every pack are sold by some form of government.
In PMI’s ideal world there’d be little or no tax on the new products, assuming they prove to have reduced risk. That would encourage current smokers to switch. But Calantzopoulos is a realist: He assumes full, cigarette-level taxation in his financial models, knowing that governments will loathe losing revenue, especially since the new products continue to deliver nicotine.
The worst tax, from PMI’s perspective, is a simple sales tax based on the wholesale price. That encourages manufacturers to engage in price wars, since most of the cost is borne by tax authorities, hurting premium brands.
If there is to be a tax—and so far only Italy has announced a policy on these new products—Calantzopoulos prefers a per-cigarette excise tax. Since they contain tobacco, if they make it to the US they’ll also be subject to the massive 1998 settlement with state attorneys general in the US, which still generates billions of dollars in revenue (and hundreds of millions of dollars in legal fees each year for the private lawyers who helped negotiate it).
Tobacco also remains an incredibly effective profit-delivery device. PMI has been doubling earnings every 10 years since Calantzopoulos joined the firm in 1985, and investors have earned 122 percent since the spinoff in 2008, compared with 67 percent for the S&P 500 index. That includes a 4.4 percent dividend yield, compared with less than 2 percent for the S&P. The company operates in 180 markets outside the US and holds a 16 percent share of the international cigarette market—28 percent outside of China, where a government monopoly controls the business (and might be interested in the new products from PMI if they could trim that country’s rising death toll from cigarettes).
Calantzopoulos is diplomatically obtuse when asked if PMI is trying to reverse its shrinking unit volumes with these new products. Isn’t it strange, he is asked, to forswear growth in a consumer business, as hinted by the consumer research he’s commissioned to assuage regulators?
“When I joined Philip Morris 30 years ago my friends asked me exactly the same question,” he says. “‘What are you going to do in an industry that has no future?’” The answer, until now, has been raising prices and stealing market share from competitors, and Calantzopoulos maintains the new products present mainly a “market share opportunity”.
While he’s spending $680 million on a factory in northern Italy that can produce tens of billions tobacco cartridges a year for the first generation of these safer cigarettes, Calantzopoulos says he has no way of knowing which product will succeed. The equipment in the plant will cost about double the equivalent for producing conventional cigarettes, and earnings will suffer unless PMI can keep some of the revenue it now pays out in taxes for itself.
He’s similarly evasive about whether PMI will exploit the Marlboro brand, one of the best-known brand names on earth. While that would make it much easier to convince existing customers to switch, it also could be seen as an end to runaround marketing restrictions on conventional cigs. “We’ll do a parallel development based on both” brand-name strategies, he says. “And that’s all I can say today.”
“You have to try rather than test,” he adds, stubbing out the third butt of his next-generation cigarettes in an elegant ceramic ashtray. “The best research on earth will never tell you what success is.”
That’s especially true in the cigarette trade, where success comes with all sorts of dubious and unexpected by-products. Even the story of Prometheus ended poorly. His reward for restoring fire to the earth was a box delivered by the alluring Pandora. It unleashed plague and misfortune that would torment mankind for generations to come.
(This story appears in the 27 June, 2014 issue of Forbes India. You can buy our tablet version from Magzter.com. To visit our Archives, click here.)