Since 2008, Reynolds American has enjoyed a stronghold on the small but burgeoning capsule market: The Winston-Salem, N.C., company’s Camel Crush and Camel Crush Bold have been the only capsule products available, allowing smokers to switch from traditional tobacco to menthol flavor with a simple crush of the filter.
Although SymphonyIRI Group reports capsules make up a mere 1.8% of the total cigarette market, the segment has grown an impressive 34% this year. And because Camel Crush is the only game in town, that 34% growth belongs entirely to Reynolds. Naturally, Reynolds recognizes the importance of such an exclusive product.
“The use of R.J. Reynolds’ innovative capsule technology with these styles offers relevant product differentiation and strong appeal for consumers,” CEO Dan Delen said in the company’s third-quarter earnings report.
Analysts have also acknowledged Crush’s value to Reynolds’ portfolio. Deutsche Bank research analyst Andrew Kieley covered the phenomenon in a Sept. 10 report titled “Capsule Clash,” saying “although we don’t believe capsules are pulling new users into cigarettes, they are attractive as offering smokers a new experience, are briskly growing sales, and [there is] only one competitor.”
That is, there was only one competitor.
In late September, industry juggernaut Philip Morris, Richmond, Va., began offering a capsule of its own in the form of Marlboro NXT. Although higher-ups at parent company Altria are quick to point out NXT is available only in test markets for now, the message is clear: The cowboy is coming for some of that capsule volume.
“For me, it makes sense,” says Bonnie Herzog, a senior analyst with Wells Fargo. “I think Altria has entered a period of accelerated innovation, which is one of the reasons we upgraded the stock many months ago.”
With so many innovations out there, it’s important to consider what drove Altria to get into the relatively small capsule market. Equally important to consider is that if the company has indeed entered this “period of accelerated innovation,” what does it mean for Reynolds and the tobacco category as a whole?
Crushing It
To understand the appeal of capsules, look to Camel’s sales data: Camel Crush accounts for a whopping 17% of the brand’s single-pack cigarette sales. Only Camel and Camel Blue sell more packs— an impressive feat given the fact that Crush has been on the market only since 2008, and Crush Bold since 2011.
“Camel Crush and Camel Crush Bold include a capsule in the filter that releases a small amount of menthol when crushed,” says Reynolds spokesman Richard Smith. “Camel Crush’s tobacco blend is the same as Camel Blue cigarettes. Camel Crush Bold’s tobacco blend is the same as Camel Filter cigarettes.”
And as menthol competition has heated up, Camel Crush provides the only option for smokers who prefer both menthol and regular flavors.
“Adult smokers have told us they liked the fact that they were able to decide when, or if, they wanted to add a fresh menthol taste to their cigarettes,” Smith says.
Such appeal to adult smokers has helped Camel Crush become an integral sales driver for Reynolds, especially as other products are seeing a volume decline.
“When you look at Reynolds’ portfolio, they’ve got their growth brands of Camel and Pall Mall,” says Herzog. “We’ve just seen in the last quarter that Camel volume was down pretty substantially at 8%. [Camel Crush] is very important to the Camel brand franchise.”
Still, Reynolds’ management is aware that exclusivity has been a big part of Crush’s appeal.
“Generally speaking, Camel Crush and Camel Crush Bold would be of interest to both menthol and non-menthol adult smokers,” says Smith, “since the unique capsule technology offers the opportunity to experience menthol flavor on demand.”
NXT in Line
Starting Sept. 26, Reynolds could no longer make the claim of being the only capsule on the market. During Altria’s third-quarter earnings call, the company’s chairman and CEO described the potential of Marlboro NXT.
“Philip Morris USA continued to support Marlboro’s new brand architecture within the Marlboro Black family by expanding Marlboro NXT into 27 states at the end of September 2012,” Marty Barrington told media and analysts on the call. “Marlboro NXT contains capsule technology that allows adult smokers to switch from non-menthol to menthol taste.”
Of the announcement, Herzog says, “To me, it makes sense they would do this because they are the leaders in the tobacco industry. This has been a niche area of growth, so it makes sense that they would enter with their new Marlboro brand architecture.”
Yet with capsule technology having been available since at least Camel Crush’s 2008 release, one has to wonder why Altria chose to launch NXT now.
“We designed [NXT] in response to changing adult smoker preferences,” says Altria spokesman Brian May. “The non-menthol option has a smooth tobacco flavor; one pinch of the filter changes the cigarette to have a unique, bold menthol taste. We understand that some consumers prefer both menthol and non-menthol cigarettes; this product is intended for those consumers.”
And although no one from Altria referenced Camel Crush, retailers are well aware of NXT’s desired competition.
“It’s really no secret which consumer the NXT brand is intended to satisfy,” says Trey Powell, director of marketing, Midwest business unit, for Alimentation Couche-Tard/Circle K Stores Inc. “But it’s probably too early to tell whether or not the launch will be accretive or simply erode another brand’s share.”
Which begs the question: What effect will NXT have on Camel Crush’s growth?
“We expect NXT will mean some slowing of Crush,” says Kieley of Deutsche Bank. “Crush has first-mover advantage and should keep growing, but NXT is a direct overlap and attractively priced. NXT should add to [Altria’s] market share momentum, via [the] small but growing capsule segment.”
According to a September UBS-CSP Daily News survey, retailers are divided on whether Camel Crush will lose consumers to NXT or if NXT will cannibalize other Marlboro brands.
“I don’t think that it will have that much impact,” said one respondent. “It will only pull from another Marlboro [product].” Others agreed with the sentiment, predicting Marlboro Red and Marlboro Menthol would lose sales to NXT.
Still, more than 50% of responding retailers believed Camel Crush would be most affected by NXT’s release, pointing out that “it has a limited audience.”
Ultimately, the truth likely lies somewhere in between these two options.
“There will probably be some cannibalization of Marlboro,” Herzog says. “But I would believe it’s going to be incremental. The bulk of the pain, in my view, will be felt by Camel Crush—assuming [NXT] is successful.”
Powell says, “There are several factors at play here, but we do know that the Camel Crush buyer has proven to be relatively loyal and resilient.”
As Powell pointed out, it’s too soon to tell what NXT’s true effect on Camel Crush or other brands will be, especially considering Altria had not officially decided to take the product national at the time of publication. However, Reynolds is optimistic that Crush can stand up to NXT or any future capsules on the market.
“While I can’t speak for the competition, what I can tell you is that Camel has a long history of innovation,” says Smith. “Innovative products like Camel Crush set Camel apart from the competition and get the attention of adult smokers. Camel was first in the U.S. to offer the innovation of the capsule experience to adult tobacco consumers.”
Broader Implications
It’s not just Reynolds’ employees who tout the company’s strength in innovation. Herzog has long applauded Reynolds’ efforts.
“I give a lot of credit to Reynolds for being the first mover and a leader with innovation,” she says. “Over the years, it’s always impressed me with this company: They’re typically willing to take more risk than the others.”
“[Reynolds] will continue to lead change in our industry by driving innovation throughout our businesses,” Smith says. “It’s our vision that we will achieve market leadership by transforming the tobacco industry.”
However, just as Reynolds is no longer the only major player in the capsule market, it may no longer be the sole player in the innovation game.
“I’ve been sensing and seeing this stepped-up period of accelerated innovation [from Altria],” says Herzog. “I think Altria has just started to enter that period this year, and our tobacco industry contacts have consistently told us it is helping drive incremental share gains for Marlboro. Going forward, I believe we’re probably going to hear other things like this—other types of products, packaging, etc.”
As Altria’s spokesman, May agrees with this sentiment, telling CSP, “We see innovation as an important driver for growth in all the tobacco categories, particularly as adult tobacco preferences continue to evolve. You’re going to see this as products come out designed to meet the consumer where they are.”
While Altria’s innovations certainly won’t end with NXT, the product does have consumers talking—which in turn has retailers enthused about Altria’s new direction.
“At least anecdotally, customers are telling us that they are very much anticipating the NXT launch,” Powell says. “From that standpoint, if a new item can create excitement for a mature category, we view it as a positive development.”
Creating such awareness and excitement is key to tobacco’s success and ultimately a good thing for the industry. Even if it’s Marlboro’s product driving consumers to try capsules, Camel Crush could benefit as more people become aware of the different capsule options out there. And more important, as more players embrace innovations in tobacco, the more consumers become aware that the category is evolving, creating that “excitement for a mature category” retailers crave.
“The perception is that there’s no innovation (in tobacco) because you can’t advertise, you can’t market,” Herzog says. “That is so false, in my view. What gets forgotten is that the fight for market share is at retail. It’s all about these different features (such as the capsules in Camel Crush and Marlboro NXT). To create trial, awareness and excitement is critical.”
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