Several Possible End States for Vaping Devices

Several possible end states for vaping devices are envisioned, ranging from strict to lenient regulations (note that these assumptions are continuous, not discrete):
 
Assumption 1

The strictest assumption is that if e-liquids (also known as e-juice or pods) are classified as controlled substances and fall under the jurisdiction of the Tobacco Monopoly Law, then all e-liquid products outside the China National Tobacco Corporation system would be illegal.

You would only be able to sell smoking devices, which would be similar to the “supporting” industry of cigarette accessories in Cixi City, and it wouldn’t be very interesting. As for e-liquids, producing and selling tobacco monopoly products in violation of the Tobacco Monopoly Law could lead to serious consequences, possibly being prosecuted for illegal business operations under criminal law. An illegal consumer market, regardless of its scale, would deter the current crazy capital from taking over.

Given the current flourishing market for e-cigarettes, I believe this assumption is unlikely. However, let’s not forget that the once-popular IQOS faced a similar fate.

Assumption 2

A more lenient approach would be to not classify e-liquids as controlled substances but to regulate and tax them like tobacco products.

Tobacco is not a highly profitable industry, and its net profit margins are very thin, often only in single digits, and it is still subject to taxation. I have previously discussed this in my article "The 'Most Profitable Company in China' is Not What You Think."

In short, the taxes are too high.

According to calculations done by my alma mater’s School of Finance and Taxation for Wuyou Tobacco, the comprehensive tax burden for Class I and II cigarettes (including income tax and other deductions) exceeds 80%. For over a decade, the tax rates on cigarettes in China have not decreased, and the collection process has tightened, so the current comprehensive tax burden is estimated to be no less than this figure.

Of course, strict regulation also brings higher management costs. This topic is quite broad, so I won’t elaborate here.

This situation has effectively forced the tobacco industry to improve production efficiency and supply chain management. It can be said that the net profit in tobacco production is actually squeezed out from the manufacturing and supply chain stages.

For private enterprises, especially grassroots ones, it is very difficult to make a profit under these circumstances.

In fact, current wild e-cigarette manufacturers have already given 60-70% discounts to channel partners to compete, and without external regulatory pressure, they are not doing as well as one might imagine.

Strong regulation will inevitably increase management costs and squeeze profits, leading to concerns about profitability. If there is no financing advantage, the situation becomes even more concerning. Financing can either be through credit or equity; which do you think has the advantage? Are they planning to issue a token instead?

Assumption 3

The most lenient scenario would be to open up competition.

I must mention that some e-cigarette manufacturers’ hopes of being classified as “electronic products” have completely shattered. The upcoming national standard for e-cigarettes is a mandatory standard, overseen by the State Tobacco Monopoly Administration (China National Tobacco Corporation), and the National Health Commission (which oversees smoking control) has also spoken out. Clearly, it is not “electronic products,” and there is no room for luck.

Even if competition is opened up, do you think grassroots private enterprises will win? Naive!

In terms of product quality, reports from 36Kr indicate that there is a serious oil leakage issue with e-liquids on the market, with some brands experiencing up to half of their products leaking. What kind of yield is that? This is a quality incident, and it’s simply unbelievable; there is no competitiveness whatsoever.

On the other hand, the established companies operate in a completely different world.

You rarely hear complaints about the quality of certain cigarettes, or that this batch tastes different from that batch, or that the cigarettes bought have gone stale after a few months. Consumers may take this for granted, but it is not easy to achieve. Not to mention pricing, which has hardly changed.

Those involved in manufacturing know how difficult it is to maintain stable quality and pricing. Even though I am personally very anti-smoking, I must say: behind every cigarette, there is no peaceful existence; someone is carrying the burden for you.

Every tobacco company has its own laboratory, and Zhengzhou has a dedicated national research institute and national-level laboratory, which need not be elaborated upon. As mentioned earlier, due to the long-term pressure on the tobacco industry to improve production efficiency and supply chain management, the current manufacturing level is not to be underestimated; it easily surpasses the aforementioned leaking products, with supplier qualification rates above 98%.

In terms of marketing, due to the Advertising Law, the tobacco industry cannot advertise, and the marketing environment has been considered “harsh” for decades. Surviving in this hellish mode for decades, once entering a normal mode, imagine how strong the competitiveness would be.

In contrast, the current e-cigarette industry is simply throwing money at channels, with varying levels of quality among channels and agents. I even know e-cigarette agents who do not realize that the e-cigarettes they sell contain nicotine and are addictive, blindly recruiting sub-agents, with low quality that is shocking.

As for channels... let’s not even go there; it’s like bullying. Just to give you a comparison, SF Express and YTO have been around for years and seem ubiquitous, but in terms of channel networks, they are still far inferior to China Post.

I want to emphasize again that the above three assumptions are continuous, not discrete; they are not the only three possibilities. I personally believe that the optimistic scenario will actually fall between the second and third assumptions.

Opportunities

I believe that an independent grassroots e-cigarette brand has a predetermined outcome. However, this does not mean that there are no opportunities in this industry.

If you can’t win, you can still share the pie.

The opportunity for the e-cigarette industry lies in the supply chain.

The first step is to become a supplier to various tobacco companies (or affiliated companies).

A strong supplier can be very profitable.

In fact, cigarette production heavily relies on suppliers. Over the decades, core suppliers have made steady profits and have significant bargaining power, forming deep alliances that begin from the product development and research stages.

I am not joking when I say that core suppliers often understand the thoughts and trends of the State Administration better than some tobacco companies.

Even taking a step back, in the “Assumption 1” scenario, Cixi, which produces smoking devices, although this possibility is slim and sounds unappealing, has indeed made a lot of money from traditional smoking devices. Each tobacco company’s procurement amount starts at eight digits; you can imagine that.

To become a supplier for the “established companies,” grassroots enterprises face competition from these core suppliers.

For example, the well-known JinJia in the e-cigarette industry is almost the top supplier in the printing and packaging sector; Huabao and Barton are important and stable flavor suppliers, and e-cigarettes require e-liquids, which gives them a natural advantage that is self-evident.

These large manufacturers produce stable products, have reliable supply chains, and strong product capabilities, and are at the forefront of innovation and research. Pure grassroots enterprises still have no chance.

Even more astonishing is that these suppliers have already taken the second step: they have directly collaborated with various tobacco companies to launch e-cigarette brands or even established joint ventures.

Due to space limitations (mainly because I am too lazy to look up data), I won’t provide examples here, but you can refer to the articles I posted in the Dots organization community and a series of reports from Tianfeng Securities’ small-cap group.

In summary, pure “grassroots” enterprises still have no chance. You must understand that there are thousands of e-cigarette companies, and those that are too grassroots or have a weak foundation are unlikely to be acquired.

Putting it all together, we can arrive at the initial conclusion: “grassroots e-cigarettes” have no future.

Of course, I believe that many e-cigarette companies and investors do not necessarily fail to understand this. They are just chasing the trend, waiting for someone to take over, and as long as they can make money, that’s enough.

The problem is, after all this, among the thousands of e-cigarette companies, only a few can be considered to have a “good ending,” and at least we can paint a picture of them. As for the remaining thousands, who do you think will ultimately take over?

No one.

Capital is not foolish; they are also unwilling to take over businesses that no one wants to take over. Thus, some e-cigarette companies can only jump around, trying to maintain their presence; the more they jump, the more anxious they become, and the more anxious they are, the more they feel the need to jump.

Thus, the low quality and various chaos in the e-cigarette industry are not difficult to understand.

But is there really only this one solution for e-cigarettes?

Of course not.

If we treat “e-cigarettes” as a tool or a method of consumption, when “e-cigarettes” become “atomizers,” there are many solutions, and there may even be an optimal solution.

This will be discussed in the next article.