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.”
‘We fail early, fail fast, and fail cheaply’
Innovation in tobacco sounds a lot like innovation in the tech startup world.
“It’s a core part of our innovation strategy, that we fail early, fail fast, and fail cheaply,” Dr. O’Reilly says. The mantra of “fail fast” was first pioneered by software developers but has seeped into the wider business world as tech has become more and more pervasive.
“We’ll have incremental improvement of current platforms and then we’ll have disruptive technologies,” Dr. O’Reilly says. That’s right – platforms. Like Facebook, but for smoking.
He adds: “Then of course, when [a product] gets to the end of its relevance, we delist it fairly quickly. Like all companies you have incremental innovation and then game-changing, disruptive technology coming through.”
‘Where’s the next disruptive technology going to come from?’
Innovation in Big Tobacco is also bringing companies like BAT into contact with the startup world. BAT has made several acquisitions in the vaping and e-cigarette space since the turn of the decade.
“I’ve got a whole function here purely based on disruptive technology,” Dr. O’Reilly explains. “It’s about 30 in that group, dedicated to what we call new consumer technology platform.
“They’re just looking out there, where’s the next disruptive technology going to come from? And when they identify them, we can look to work with them, acquire them, develop the technology. We become the disruptors.”
‘It used to be very difficult to recruit into this sector. That’s changed 180 degrees now.’
The recent transformation in R&D has given BAT a big boost when it comes to hiring. Dr. O’Reilly says: “It used to be very difficult to recruit into this sector, particularly in the R&D world. I’d say that’s changed 180 degrees now.
“I’m getting high quality, senior R&D professionals from other FMCGs [fast-moving consumer goods] and beyond really wanting to work in this organisation, because what we’re doing is cutting edge, it’s fast moving, it’s changing the world.”
In recent years BAT has hired people away from companies like American food giant Kraft Heinz, Bacardi, and P&G, the consumer goods giant behind Head & Shoulders shampoo and Ariel detergent.
‘It’s very Apple-esque’
Becoming a next generation tobacco player means more than just mastering the technology, it also means figuring out how to make sexy tech.
“These are consumer electronic products. They have to look good as well as work really well,” says Dr. O’Reilly.
BAT works with design and branding agencies who are usually found working with funky Californian tech startups. Dr. O’Reilly says: “Consumers, when they move to vaping, no longer want to see themselves as a tobacco consumer. Actually, a tobacco brand is not helpful.”
He picks up glo, BAT’s tobacco heating product sold in Japan. It is a brushed steel box with lit up button that changes colour to tell people the tobacco stick that is holstered in it is hot enough to take a drag on. Dr. O’Reilly says: “People have likened this to – it’s very Apple-esque.”
A colourful Vype product known as the Pebble sits nearby, reminiscent of an early flip phone. Other vaping “pens” look like a stylus from a touch screen computer.
‘We should be allowed to innovate rapidly’
Of course, while BAT may like to think of itself in-line with Apple, regulators do not. Governments and scientists around the world see it as a tobacco company and treat it as such.
Marketing rules and taxation of vaping and tobacco heating products vary around the world but in many countries they are as strict as rules for cigarettes. Dr. O’Reilly wants regulators to give companies like BAT what he calls more “freedom” when it comes to new products.
“We should be allowed to innovate rapidly,” he says. “We should be allowed to communicate to consumers on these products in terms of advertising and marketing. There should be greater freedoms than you see for cigarettes.”
‘There are 1 billion lives at stake’
Why should regulators and governments give Big Tobacco a break after a history of bad behaviour in the sector? Dr. O’Reilly is keen to paint his R&D efforts as part of a public health battle, rather than a hunt for profit.
“In the 20th century, it’s estimated that 100 million people died prematurely from cigarette smoking,” he says. “In the 21st century, it’s predicted to be 1 billion. There are 1 billion lives at stake.”
It sounds rather pious coming from a company that built its business on the back of those 100 million people. Philip Morris International, BAT’s rival, has said it wants to reach a smoke-free future – essentially promising to eliminate its core product. Can BAT commit to that?
“Every right thinking person would want a smoke-free future, or more specifically, a future without smoking-related disease and death,” says Dr. O’Reilly. “Where we may differ [with Philip Morris] is on how long that may take. It’s a long journey, we have to manage expectations.
“We can’t tell consumers what to do. All we can do is give them great choices. And those choices should be life-saving choices. That’s our strategy, that’s how we intend to compete and win in these new categories.”
However, BAT shows no signs of slowing down its cigarette manufacturing to encourage a shift.
95% safer than smoking
From a public health standpoint, vaping appears to be healthier than smoking – especially for people who are using vaping to quit. Still, for young people who have never smoked, research from the US Centres for Disease Control and Prevention and the University of Hawaii Cancer Centre suggests it could pose a substantial risk, as teens who try e-cigs are three times more likely to take up smoking.
That said, BAT’s business is not built solely on vaping. The company also has i-glo, its tobacco heating product that it sells in Japan and recently launched in Canada. BAT’s own internal tests suggest that, like vaping, tobacco heating products are less harmful than cigarettes.
However, there are fewer external studies verifying these findings and internal testing by companies is largely seen as unreliable in the science community unless verified by a third party such as the US Food and Drug Administration.
In its release announcing the launch of i-glo in Canada, BAT says it delivers “delivers a cleaner experience,” but admits in a footnote: “These qualities do not necessarily mean that this product produces less adverse health effects than other tobacco products.”
‘It’s unfortunate because there are a lot of great universities in the UK that we’d like to work with’
Much of BAT’s efforts at the Southampton site go into demonstrating that its new products are safe and healthier than cigarettes.
“We are world leaders in in vitro testing,” says Dr. O’Reilly. “It’s like lung on a plate, if you like. Then we can expose these systems to the cigarettes and various devices.”
Universities in Britain have boycotted working with tobacco companies since the early 2000s after pressure from charities such as Cancer Research UK.
Dr. O’Reilly says: “It’s unfortunate because there are a lot of great universities in the UK that we’d like to work with. Obviously, as a multinational company, there are lots of other universities we can work with, whether in Europe or the United States. It’s a shame. We can do the work, just not here in the UK.”
‘A smoke-free future is not going to happen in my professional lifetime’
Dr. O’Reilly doesn’t see the boycott changing anytime soon, in part because BAT expects cigarettes to be around for a long while yet.
“We project 10 years into the future on average, give or take, and that’s a rolling projection. In 10 years time, we still think a sizeable percentage of tobacco consumption will still be in the cigarette. It just will be. We can’t change that.”
“Certainly a smoke-free future is not going to happen in my professional lifetime or the CEO’s professional lifetime. The generation that follows? Let’s see. It’ll take many years we think. And that’s just being realistic we think, it’s not lack of ambition. We’re doing everything we can.”
‘This is not a developed vs. developing market thing for us’
A cynic might say that BAT and its rivals are investing next generation nicotine products to help combat declining smoking rates in the developed world, where the dangers of smoking have been drilled into people’s mind for years. New products mean new revenues to combat the decline.
If BAT is really out to save 1 billion lives, why not focus on marketing Vype products in Indonesia, where over two-thirds of adult men smoke?
“Market selection is a complicated subject,” Dr. O’Reilly says. “There’s got to be sequencing. You can’t roll out everything, everywhere, at the same time, not in this industry. These are quite complex products. Each product has to be modified for each market, changed for regulation.”
Dr. O’Reilly’s insists that next generation products are not a “developed vs. developing market thing” BAT. But recent studies have found that Big Tobacco companies take a different approach to emerging markets, with studies suggesting some such as BAT’s rival Reynolds appearing to still market products to the young.
Dr. O’Reilly hits back: “If you look at the footprint of BAT, we are very big in the developing world. Why would we not take next generation products there? It’s not that this is for the rich.”
‘If you want to get rid of cigarette smoking, you have to give people somewhere to go’
The UK is the biggest market in the world for next-generation nicotine products, with 4.2% of the population vaping in one way or another according to EY. Its popularity is partly down to the regulation here, which is some of the “most progressive” in the world, Dr. O’Reilly says.
Elsewhere in the world vaping and tobacco heating products are banned, something Dr. O’Reilly sees as counterintuitive. “If you want to get rid of cigarette smoking, you have to give people somewhere to go,” he says.
‘I feel incredibly fortunate to be in this job’
Dr. O’Reilly has been with BAT for 25 years now and has been group scientific and R&D director since 2012. But he feels that his current role is perhaps his most exciting.
“I feel incredibly fortunate to be in this job, in this moment of our history, compared to my predecessors of many years ago who were in a much more static and undynamic environment,” he says.
As well as the vaping revolution, BAT is in the midst of a huge $49 billion merger with US rival Reynolds, which will create the world’s largest listed tobacco company. BAT already has an innovation agreement with RAI Innovations, a subsidiary of Reynolds created last year to focus on next generation nicotine products. Once the deal completes Dr. O’Reilly will doubtless have even more resources at his disposal to drive innovation.
BAT’s “next gen” products are currently sold in 13 markets and the company hopes to double that in 2017, then double it again in 2018.
He says: “It’s a really exciting time, particularly to be the R&D director.”