E-Cigarettes Heat Up: Capital Floods In and a Price War Begins

Take a look at how truly wealthy companies distribute year-end bonuses. In December 2018, American e-cigarette company Juul Labs planned to distribute $2 billion in special dividends to all 1,500 employees, averaging about $1.3 million (approximately 8.95 million RMB) per person. This powerful company is the most popular e-cigarette in the U.S., boasting a gross profit margin of 75%. After American tobacco giant Altria Group invested $12.8 billion for a 35% stake, Juul Labs' valuation soared to $38 billion.
 
For Chinese e-cigarette entrepreneurs, this is not an unattainable myth but a goal to surpass—after all, China has the largest number of smokers in the world, approximately 350 million people, making it the largest tobacco consumer and producer, accounting for 44% of global cigarette consumption.

However, this delicious cake is attracting more competitors.

A Battle Among Giants

The Chinese tobacco industry is a trillion-dollar market. According to public data, in 2018, the tobacco industry achieved a total tax profit of 1,155.62 billion RMB, contributing 1,000.08 billion RMB to the national treasury, with an industrial added value of 787.7 billion RMB.

For many, the concept of a trillion-dollar market may be abstract. To put it into perspective, the tobacco industry accounts for about 1/16 of China's tax revenue, with its contributions to the national treasury consistently stable at 6% to 10%. Moreover, the tax profits from the tobacco industry have been growing annually, surpassing 500 billion RMB for the first time in 2009 and successfully breaking the 1 trillion RMB mark in 2014.

The 1,155.62 billion RMB tax profit in 2018 was a historical high. This figure is equivalent to the combined profits of PetroChina, Sinopec, the four major Chinese banks, Alibaba, Tencent, and Baidu.

Data from the China Industry Research Institute shows that 30% of traditional smokers in the UK have switched to e-cigarettes, while the e-cigarette penetration rate in the U.S. has reached 13%, whereas China's e-cigarette penetration rate is only 1%. According to the China Electronic Chamber of Commerce, the global e-cigarette market value in 2018 was 110 billion RMB, while the domestic market size was only 4 billion RMB.

Assuming that only 5%-10% of traditional cigarette consumers in China convert to e-cigarette consumers, the market size would be enough to drive industry players crazy. Moreover, a report released by Goldman Sachs in 2013 indicated that by 2020, e-cigarettes could account for 10% of overall tobacco industry sales and 15% of profits. Even if this expectation is overly optimistic, it still represents a "longer slope, thicker snow."

For smokers, tobacco is a necessity. In such a vast market, e-cigarettes aim to carve out a share.

China is the world's largest e-cigarette producer, with over 90% of e-cigarette devices manufactured in Shenzhen. According to e-cigarette industry insiders, e-cigarettes only require imported chips; everything else can be sourced domestically, with production costs not exceeding 50 RMB, yielding a gross profit of 80%.

The e-cigarette industry chain includes upstream raw material suppliers, e-cigarette design manufacturers, and downstream sales companies. Upstream raw materials are divided into battery raw material suppliers (batteries, battery cells, control circuits), atomizer raw material suppliers (plastics, glass, hardware, heating resistors), and e-liquid raw material suppliers. The midstream design and manufacturing include both professional e-cigarette manufacturers and the manufacturing departments of international tobacco giants: domestic brands hold a small market share, with companies primarily focusing on OEM/ODM for well-known foreign brands. World-renowned tobacco groups such as Philip Morris International, Imperial Brands, British American Tobacco, and Japan Tobacco have become the main force in e-cigarette branding due to their strong R&D, production, and distribution capabilities. The growing demand in Europe and the U.S., combined with China's developed manufacturing industry, has created a global industrial chain pattern where manufacturing centers are in China and demand centers are in Europe and the U.S.

The entry barrier to the e-cigarette industry is actually not high; it is a relatively light business model. Since the industry chain is already quite complete, it can be entirely outsourced for production, requiring only various combinations of parts provided by suppliers. An investment of a few million RMB and six months is enough to create a new brand.

China has a mature and complete industrial chain, which is a ready advantage for entrepreneurs. Although the production of atomizers and batteries is not very difficult, the production of cartridges, which is crucial, has a very high barrier. However, this does not prevent entrepreneurs from becoming profitable, as the main profit point is the atomizer, with costs typically between 30-50 RMB, but selling prices often reach ten times that, resulting in substantial profits. #p#分页标题#e#

A large influx of capital into the e-cigarette industry raises the question: why not follow the smartphone industry, group buying, or sharing economy by directly capturing the market through price reductions?

One reason is that the e-cigarette industry is a business with healthy cash flow. Compared to the hundreds of millions of dollars in financing amounts for shared bicycles, artificial intelligence, and autonomous driving, e-cigarettes only require initial funding from investors. The hardware structure is simple, and the e-liquid composition is not complex, while the supply chain and supporting facilities are all in place.

Secondly, the e-cigarette industry has a short return cycle. Investors are most concerned with rapid cash returns from e-cigarette investments, as its high gross profit can ensure quick capital recovery, which alone guarantees the lower limit of investment.

Thirdly, the retail model of influencer-driven sales is prevalent. Some believe that the e-cigarette business is similar to influencer marketing. Influencers focus on their audience, producing what their fans like, and then sell it through their influence. The low entry barrier and severe homogenization mean that the most important aspects of the e-cigarette industry are brand-building and marketing capabilities. Thus, figures like Luo Yonghao and Zhu Xiaomu, who have struggled in the smartphone sector, as well as influencers like Zhang Jinyuan and Cai Yuedong, are now venturing into the e-cigarette industry to get a piece of the pie.

Various e-cigarette brands, large and small, previously avoided bidding wars, but now entering the e-cigarette industry, many aim to take advantage of regulatory gaps and make a quick profit. They are all thinking, though not openly expressing it—making quick money.

Signals of a Price War

The e-cigarette sector appears somewhat hazy, with some pressing the fast-forward button, adding a bit of uncertainty.

"Breaking the high-price industry rules."

Lingxi LINX e-cigarettes fired the first shot in the e-cigarette industry's price war, launching a new product on May 25, with a regular kit priced at only 99 RMB, while similar products on the market range from 239 RMB to 599 RMB. This could signal the start of a price war in the e-cigarette industry.

While various brands have traditionally made profits through low-cost, high-margin e-cigarettes, why did Lingxi choose to lower prices first? Currently, the leading e-cigarette brand RELX has monthly sales exceeding 100 million RMB, yet its overall market share is only about 10%. In mature markets like the U.S., e-cigarette brand Juul already holds over 70% market share. The Chinese e-cigarette industry needs a leader, and the top-tier e-cigarette brands are competing for users and market share, all hoping to seize this window of opportunity.

So far, other brands have not followed Lingxi's price cut, opting instead to observe. The significant price drop has not stirred up waves, but this does not mean the e-cigarette industry is resistant to price wars. All high-margin industries essentially provide a ticket for onlookers.

Lei Jun once promised that Xiaomi's profit margin on all products would never exceed 5%, with most profits coming from internet services. The core of retail lies in having a good product and high efficiency; only then can one achieve the same benefits in traditional retail as in e-commerce.

Is this logic applicable in the e-cigarette industry? After the launch event, the e-cigarette brand Xike, founded by Xiaomi employee Zhong Yufei, saw articles claiming "Xike has gone crazy, with replaceable e-cigarettes priced at only 1 RMB!" Is the e-cigarette really only 1 RMB? In fact, this is just a marketing strategy of the brand, requiring the purchase of a box of four cartridges for a total of 141 RMB to buy the device, with the cartridge capacity being only 1ML, half of the market capacity.

Lingxi employed a similar marketing tactic, recently launching a low-priced replaceable product at only 99 RMB, with a cartridge capacity of only 0.7ML. They broke the market average price to attract attention and hype, but the cost-effectiveness is not high. This is also one reason why other brands are hesitant to follow suit.

Will capital continue to invest in e-cigarettes? Sustainability: E-cigarettes are mildly addictive consumer goods, which are favored by capital; Fashionability: E-cigarettes are trendy items in influencer social media, easily imitated by young people who want to showcase their individuality, presenting huge market potential; High profitability: If e-cigarettes are divided into devices and cartridges, the former has a gross profit margin of up to 80%, while the latter also has a gross profit margin of 20-30%, averaging over 50%. Even if competition intensifies and margins drop to 20%, profits from volume sales would still be considerable.

E-cigarettes meet the conditions for a "Xiaomi-style super cost-performance strategy"; they are just waiting for someone to pull the trigger. As capital flows in, the industry is beginning to enter deeper waters. With low entry barriers, low costs, and high margins, and severe product homogenization, the vast market potential makes a bloody price war just a matter of time.