The buzzword du jour in boardrooms globally is “innovation,” with industries from banking to pharmaceuticals forced to contend with tech-driven disruption.
Perhaps the most unlikely industry to face this grand wave of disruption is Big Tobacco — a field where the menthol once passed as innovative.
“We are becoming a tech company,” British American Tobacco (BAT)’s Dr. David O’Reilly told Business Insider during a recent tour of the company’s research and development (R&D) headquarters in Southampton, England.
Dr. O’Reilly is the group scientific and R&D director of BAT, the global cigarette giant known for brands like Lucky Strike, Pall Mall, Benson & Hedges, Dunhill, and Rothmans. The company sold over £14 billion-worth of tobacco products around the world last year.
But the industry is changing. A Chinese pharmacist called Hon Lik invented the modern day e-cigarette in 2003 and in the 14 years since vaping has come from nothing to become a small but significant — and fast-growing — corner of the market.
Now, “innovation in next-generation tobacco products is a main priority” for BAT, Dr. O’Reilly says. Like any other big business, BAT doesn’t want to become this decade’s Blockbuster — a once great business made redundant by the march of technology.
What’s more, these new products could even provide a lifeline. Smoking rates in the developed world have been in decline for decades. New and novel products could help alleviate the impact of this.
“These are consumer electronic products,” Dr. O’Reilly said gesturing at a table of BAT’s vaping products. “They have to look good as well as work really well.”
Business Insider went see how BAT is trying to build its future. Here’s what we found:
‘There’s been a transformation in R&D over the last 5 years’
BAT, founded in 1902, has had an R&D facility in Southampton since 1955 and for decades scientists here worked to try and create what they call a “safer cigarette” — a smoke that contained smaller quantities of the harmful chemicals associated with causing diseases, including carbon monoxide and lead. This was largely a slow and monotonous slog that yielded little real improvement.
Then the e-cigarette came along and turned everything on its head.
The core innovation was to divorce the nicotine hit that smokers crave from the burning of tobacco. “Vaping” — inhaling nicotine in vapour form — can be done in all sorts of ways. Finding out what works and what doesn’t is now a key part of the job for BAT’s R&D staff.
“There’s been a transformation in R&D in this company over the last 5 years, moving away from what was a kind of fairly stable agricultural product to a consumer tech world,” says Dr. O’Reilly.
A £6 billion market — and growing fast
Rather than searching for the safer cigarette, the main thrust of Dr. O’Reilly’s job now is to discover the products that smokers will be using five or ten years from now, he says.
This involves testing and developing BAT’s own vape and e-cigarette products, looking at everything from safety standards to the quality of nicotine hit, as well as scouring the market to look for “next generation” products that could become popular.
BAT focuses on two main types of systems today: vapes, where nicotine is mixed with a flavour and an agent that can turn it into a vapour that can be inhaled; and what are called tobacco heating products, which heat tobacco to create an aerosol rather than burning it. BAT says this process produces smaller quantities of toxicants like carbon monoxide and formaldehyde when compared to cigarette smoke.
The market for these products is small. EY estimated in a report earlier this year that “electronic nicotine delivery systems,” as it calls them, were worth £6.1 billion last year. That compares to a global cigarette market worth almost $700 billion. But the market is growing fast. EY expects next-gen nicotine will be worth £12 billion by 2020.
‘The question is who will gain in that period of disruption and who won’t’
BAT has spent around $1 billion on R&D over the last 5 years and also has centres in Brazil, Malaysia, Indonesia, Russia, and Turkey. The Southampton site is the largest hub, with 1,200 people employed there.
Dr. O’Reilly, who sits on BAT’s board, says: “R&D is of particular interest [to the board] at the moment. Probably three times a year we have our strategy away meetings. R&D takes up a sizeable proportion of that time.
“It’s very much the heart of the business now, particularly in these categories. Unless we have the best performing consumer-line products, we’re not going to be successful commercially.”
The company is in a development arms race. Philip Morris International, a Big Tobacco rival known for Marlboros, has spent over $3 billion on next-generation tobacco products, according to Bloomberg.
Dr. O’Reilly plays down the difference, saying: “I get what I need to drive the R&D programme. It’s not a restriction on progress, put it that way.
“The question is who will gain in that period of disruption and who won’t,” he adds. “I’m very confident we will gain here, because we’ve invested a lot for a long time in the science, the technology, the products that will transform the marketplace. We’re very confident we’re going to be on the right side of the line on this.”