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    Technological Innovation Needed for Vapor Category Growth

    New products raise concerns of SKU proliferation.

    NEW YORK — Growth of vapor products in the convenience channel is holding steady, but innovation is seen as the key to the segment's future.

    According to Wells Fargo Securities LLC's latest Tobacco Talk survey, total vapor category sales growth in c-stores remained solid at 8 percent in the first quarter, but decelerated relative to the 17.4-percent increase in the fourth quarter of 2014.

    The growth, however, is likely driven by continued heavy promotions on both R.J. Reynolds Vapor Co.'s Vuse and Nu Mark LLC's MarkTen vapor brands, which is driving unit momentum but not dollar sales, explained Bonnie Herzog, managing director of beverage, tobacco and convenience store research at Wells Fargo Securities.

    "Vuse continues to be on a roll, though discounting remains heavy, while MarkTen remains lackluster," she said. "However, we've heard that MarkTen XL's technology is light years ahead and sounds promising given it's doing very well in test markets."

    The firm conducted the Tobacco Talk survey among its tobacco retailer and wholesaler contacts representing approximately 12,500 U.S. convenience stores.

    As growth slows, retailers are excited about regulation and innovation, but concerned about SKU proliferation and oversaturation of vapor products, according to the Tobacco Talk results. 

    "Consistent with feedback from our vapor surveys since the category's inception, retailers remain excited about innovation, particularly in second- and third-generation products that are starting to hit the market," Herzog said. 

    Many retailers also conveyed their "excitement" for ultimate regulation of the category, as regulatory clarity should help stabilize the overall vapor market, set product standards and clarify the "long-term stance" on flavors, she said. 

    Importantly, regulation should also help to improve public perception of the vapor category, which has been deteriorating, according to almost 30 percent of Wells Fargo Securities' contacts (up from approximately 26 percent in the fourth quarter). 

    Still, retailers are "somewhat underwhelmed on advanced devices from Logic and blu," Herzog explained. According to the latest survey, retailers that carry blu+ noted high cannibalization rates and one retailer noted, “Why would anyone want two-year-old technology if a new version of the brand you trust is available?" 

    Other retailers are encouraged by improved technology being a "catalyst for growth." With regards to Revo — R.J. Reynolds Tobacco Co.'s heat-not-burn product —  retailers believe the heat-not-burn concept "has lots of potential," noting it's a "bridge from combustible to vaping," but acknowledged it will take a lot of consumer education for the concept to take off. 

    Overall, Tobacco Talk found that vapor is displacing roughly 3 percent of combustible cigarette volume, down from approximately 4 percent in the last two quarters of 2014 but flat to last year. 

    In addition, repeat vapor purchases continued to accelerate to more than 65 percent in the first quarter, marking a steady sequential increase from 40.5 percent in the second quarter of 2014. Electronic cigarette subcategory growth sequentially accelerated to approximately 8-percent growth in the first quarter, up from roughly 5 percent last quarter but down year over year from 15 percent in the opening quarter of 2014.

    "Overall, we remain cautious near term given slowing category growth and regulatory uncertainty, but bullish long term continuing to believe consumption of vapor and other non-combustibles (i.e., heat-not-burn) could surpass consumption of combustible cigarettes in the next decade (by 2025)," Herzog said. "However, technology must continue to improve."

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