Capital Influx for China’s E-Cigarette Market

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The year 2018 saw a growing number of Chinese consumers using e-cigarettes, especially young people in their 20s and 30s, who accounted for more than 30% of the total consumption, and this number is still rising.

By TobaccoChina Online

One reason for this growing popularity is the perception of e-cigarettes as sensory stimuli, gorgeous visual effects of vaping, various flavors, and a sense of technology, which all appealed to the consumption psychology of these consumers.

However, the draw for this market segment is only part of the reason why e-cigarettes have become so popular in China. The main driving element comes from the strong flow of capital investment that became available. In 2018, more than a dozen e-cigarette companies in China obtained financing, with a total financing amount of several hundred million yuan, involving a number of top investment institutions such as Zhen Fund, The Arena Capital, Source Code Capital, and IDG Capital. It has become clear that these institutions have long been eyeing e-cigarettes, making it one of the market segments with great potential in the Chinese market in 2019.

Capital ignites China’s e-cigarette market

In May 2018, Shenzhen IJOY Technology Co. Ltd won round A financing of RMB300 million. In June, RELX announced the completion of RMB38 million angel round financing, which was led by Source Code Capital. This was followed by IDG Capital in December, when e-cigarette developer Zhisheng Energize completed the RMB30 million Pre-A round of financing and MOTI Magic Flute Electronic Cigarette received the Pre-A round of US$10 million investment from Zhen Fund.

On December 31, 2018, the Hong Kong Stock Exchange announced that China Tobacco International Inc., a subsidiary of China National Tobacco Corporation, was going to list in Hong Kong, aiming to actively explore new tobacco markets while continuing to strengthen its cigarette export business.

In January 2019, Luo Yonghao, a famous Chinese mobile phone entrepreneur, introduced Flow, an e-cigarette product,  at a press conference. At the end of the same month, the pre-sale of Flow was launched on the Chinese e-commerce platform Taobao, priced at RMB299. Also in January, Cai Yuedong, former co-founder of Tongdaodashu (a company going viral on the internet through comics and other forms with his sharp perspective and style) posted a banner announcing that the e-cigarette brand he founded, YOOZ, was launched for sale. According to data provided by YOOZ, the turnover of the e-cigarette on the first day of spot sales reached RMB5 million through the promotion in circles of friends, KOL, and the accounts of online celebrities. In addition, another five new media founders jointly launched their own e-cigarette brand, LINX.

A senior investment consultant in China said that, compared with the traditional tobacco market, the future sales of e-cigarettes would double. According to the report of China National Gold Securities, the overall scale of e-cigarettes will exceed RMB300 billion within the next four years.

Why does capital favor the e-cigarette market?

Capital investors judge whether an industry or project has investment value. High-frequency, rigid demand and large market scale are the three basic criteria, which China’s large e-cigarette market absolutely meets.

E-cigarettes also boast the attributes of electronic products and consumables. In particular, many entrepreneurial projects focus on those with replaceable cartridges, thus meeting the condition of high-frequency continuous purchase.

Whether it is for fun, fashion, or out of the need for cigarettes, whether or not it contains nicotine salt, e-cigarettes meet the rigid demand of those looking for an alternative to traditional cigarettes.

Although the exact revenue scale of the Chinese e-cigarette market is unclear, it is definitely a trillion-scale market estimated simply on the single-box structure and total sales volume. As per the current switch rate of about 10% of e-cigarettes in the European and American markets, it can be expected that the Chinese e-cigarette market is at least at the RMB100 billion level.

In addition, e-cigarettes are still a high-margin product. Both the equipment and the cartridge (liquid) are consumables, and the profit of the e-liquid is very remarkable. According to some e-liquid companies interviewed for this article, the profit from e-liquid sales is up to 10 times the costs, and the gross profit of e-cigarette with replaceable cartridges is basically more than 100%. High profits are a direct incentive to stimulate capital flow into the market.

As an emerging new category, China’s e-cigarette market is almost an untouched market with great opportunities for those who attempt to tap into its potential.

Although many e-cigarette manufacturers that have been mainly producing for export have launched their domestic brand strategy, there is still no leading brand for Chinese consumers. Moreover, most Chinese manufacturing companies focus more on the profit of the production chain, unwilling to participate in the downstream competition because that means additional cost investment. Therefore, for such an initial market, these entrepreneurs with an advantage downstream will have ample opportunity to seize users, channels, and terminals.

Uncertainty of policies with inflow of capital

Despite making such an impact in the consumer market, e-cigarettes are also faced with certain controversy. The industry is still in a regulatory vacuum since it falls neither into the food or drug categories, which also complicates how to regulate them. However, manufacturers are very aware that regulators are about to intervene.

The State Administration of Markets and the State Tobacco Monopoly Administration issued the Notice on Prohibiting the Sale of E-Cigarettes to Minors in August 2018 and investigated and cracked down on illegal activities such as the production and sale of e-cigarettes with no product standards, no quality supervision, no safety evaluation.

The Regulations on Smoking Control in Public Places in Hangzhou, which was officially implemented in the city since January 1, 2019, clearly stipulates that a ban on smoking in venues not only prohibits the igniting of tobacco products and smoking traditional cigarettes but also prohibiting e-cigarettes.

Shenzhen followed on Hangzhou’s heels. Recently, the Regulations on Smoking Control in Shenzhen Special Economic Zone (Revised Draft for Public Comment) was published on the website of the Standing Committee of the Municipal People’s Congress. The Draft further upgraded the “Tobacco Control Order” to include e-cigarettes.

In February, Hong Kong was in the final stages of passing a complete ban on not just e-cigarettes but also other next-generation products like HNB devices and herbal cigarettes. Once the ban is in force, anyone importing, making, selling, distributing, or promoting these products will be looking at a maximum penalty of six months’ imprisonment and a fine of HK$50,000 (US$6,370) if convicted.

The “negative” sides of e-cigarettes were presented by China Central Television in its annual “3.15” investigation program, which was on World Consumer Rights Day, including claims such as “identification is not standardized”, “containing harmful gases such as formaldehyde”, “its harm is not less than cigarettes”, “lack of supervision”, etc.

In a sense, e-cigarettes have stolen market share from traditional tobacco. Regulatory bodies will not sit idly by to let it develop unrestrainedly. Once they get involved, e-cigarettes may face multiple challenges in terms of policies, tax increases, and licenses.

As tobacco companies are gearing up, entrepreneurs are rushing in and the funds are betting heavily, whether e-cigarettes will really open the investment floodgates in the Chinese market. The current situation is that e-cigarettes, though still difficult to compete with traditional cigarettes, are accelerating to seize the market share. Even Big Tobacco has entered this segment. However, if e-cigarettes are to open up the market further, they will face more issues. Corresponding laws, policies, and standards are still not established, which means hidden dangers for e-cigarettes. Perhaps the exposure by the CCTV 3.15 party would accelerate the introduction of regulatory policies and promote e-cigarettes to a benign development path.