The E-Cigarette Industry, Waiting to Exhale

MGEC 612 Group Project

“The E-Cigarette Industry, Waiting to Exhale”

The New York Times, October 26, 2013

Team JASCOT (F5)

Claire Fauquier

Ossama Ghazal

Sherry Lee

Theodore Orsher

Allison Silverstein

Jackie Wong

Introduction

 “The E-Cigarette Industry, Waiting to Exhale,” published in The New York Times on October 26, 2013, focuses on the electronic cigarette (‘E-cigarette’) market, which has grown over the past few years to $1.7 billion in U.S. sales. The article touches on several managerial economics concepts, including consumer demand functions, production and supply curves, and government interventions.

Non-combustible and odorless e-cigarettes deliver nicotine through a liquid-vapor-based formula, which demonstrates lower toxicity than traditional cigarettes and does not emit secondhand smoke. Many e-cigarettes look and feel like conventional cigarettes, mimicking the habitual smoking experience associated with paper-enveloped-tobacco. Many traditional smokers have gravitated toward the emerging technology, which costs significantly less than tobacco-based cigarettes and demonstrates a superior health profile.

Consumer demand

In assessing the aggregate demand function for e-cigarettes, there are several diverse market segments that firms must consider. E-cigarettes serve unique purposes for different customers: an introduction to nicotine, a tobacco alternative, or a smoking cessation tool. For some customers, e-cigarettes may serve as an introduction to smoking and a path to dependency. Some who have converted from traditional cigarettes consume e-cigarettes at levels consistent with their habitual nicotine-usage patterns and express no ambitions to quit. Others have transitioned methodologically from traditional cigarettes or nicotine substitutes to e-cigarettes in order to eventually quit altogether, developing tailored programs to gradually reduce nicotine intake levels, sometimes to nothing.

The demand function (i.e., in terms of reservation prices, elasticity, and quantity demanded) for e-cigarettes will likely vary, given several factors. Diverse consumer segments have varying reservation prices for e-cigarettes, depending on product characteristics, the utility they derive, and whether they perceive the products as substitutes or complements to traditional cigarettes and smoking cessation products.

The average price of traditional cigarettes (as measured on the basis of nicotine content equivalence per cigarettes) is significantly higher than that of their electronic counterparts. Given that the product profile of e-cigarettes is similar to that of traditional cigarettes (albeit with a superior health profile), they often serve as substitute goods. Sometimes, e-cigarettes complement a traditional smoking routine. The price of a traditional cigarette pack has increased over the past several years and, today, ranges from $5 to $15 (according to varying state taxation regulations). On the other hand, the NJOY King, a disposable e-cigarette, sells for $7.99 and delivers the nicotine equivalent of a 20-cigarette pack. Reusable, rechargeable e-cigarettes, on the other hand, incur a fixed cost of $50 to $90 per device, and nicotine fluid refills have a variable cost of $3 to $4 each; the products are often sold in a bundle format. Once a consumer purchases an e-cigarette device, it is a sunk cost, and the consumer is aware of prospective costs for future nicotine inputs. If consumers set their reservation price on the basis of nicotine content, they will derive greater consumer surplus from the purchase of e-cigarettes than that of traditional cigarettes. The price elasticity of demand among smokers for traditional cigarettes is notably high; given the addictive qualities of nicotine, their purchase decision and quantity do not vary significantly with changes in price. This will likely be the case for e-cigarettes, though price elasticity may increase, as users utilize e-cigarettes to gradually reduce their nicotine dependence and will eventually lower consumption. In considering the positive cross-price elasticity of e-cigarettes as a substitute for traditional cigarettes, e-cigarette product sales volumes will likely increase as long as the traditional cigarette pack pricing continues to grow.

Production and supply curves

As big tobacco firms assess where to direct their marketing efforts and spend to optimize returns, given this emerging trend, many firms are weighing the short- and the long-term productivity functions. Although traditional cigarettes are currently more profitable than e-cigarettes, e-cigarette profit margins are forecasted to grow, as manufacturers benefit from economies of scale. Once the marginal productivity derived from investment in e-cigarettes exceeds that of traditional cigarettes, suppliers will likely shift their focus to the novel technology.