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Bennett LeBow, CEO of tobacco company Vector Group (VGR
), has been shunned by his peers ever since he turned over internal company documents about the dangers of smoking to government investigators in the mid-1990s. His betrayal, an admission that cigarettes can cause cancer, wasn't entirely altruistic. As CEO of a small player in the cigarette business, LeBow was looking out for his own hide.
In return for his testimony about the dangers of cigarette smoking, Vector pays substantially less than other tobacco companies to the Master Settlement Agreement (MSA), a 1998 settlement under which the industry's biggest players have to pay 46 states more than $200 billion over a 25-year period to compensate for previous tobacco-related disease costs. Payments are based on quantity of cigarettes sold.
LeBow's latest, less-than-altruistic stratagem is to market a new brand of low-nicotine cigarettes called Quest as an aid to smokers who want to quit. They're still cigarettes, and they still cause cancer and other diseases associated with smoking. But LeBow contends that they can help those who are trying to kick the habit. He bills Quest as an alternative to the nicotine gum or patch.
Officially, LeBow can't yet promote Quest as a smoking-cessation aid, but he hopes to eventually win Food & Drug Administration approval to do so. "We can really make a safer cigarette," he says. "Public-health people want smokers to quit completely, but it's not practical."
FIRST TIME A BOMB. LeBow believes that the low-nicotine cigarettes are the key to Vector's survival, as cigarette sales decline. U.S. smoking consumption has been falling since 1981, according to the American Lung Assn., a trend LeBow expects to continue.
Vector is still buttering its bread with tobacco revenues. It generated revenues of $502 million in 2002 by selling a slew of little-known discount brands, including Liggett Select and Grand Prix. It lost $31.8 million last year, largely because of heavy spending to fund Quest.
Yet LeBow frankly admits that his first attempt to market a less harmful cigarette "bombed." That product, a cigarette called Omni, which Vector claimed had fewer cancer-causing agents, was launched in 2001 but still shows no signs of lighting up with the nation's 50 million smokers.
On Apr. 3, LeBow discussed the future of the cigarette business and his hopes for Quest with BusinessWeek Online reporter Amy Tsao. Edited excerpts of their conversation follow:
Q: Between price increases, lawsuits, and rising antismoking legislation, what's your long-term prognosis for the cigarette business?
A: Sales of discount cigarette are increasing. But with all the hoopla and rising prices, we believe that the true decline in cigarette consumption was just 2% in 2002. I would expect consumption to continue a 2% to 3% annual decline in the foreseeable future.
Q: To what degree are markets in the developing world going to help tobacco makers stem declining numbers of smokers in the U.S.?
A: Right now, about half the big companies' profits come from international sales. We have no sales abroad right now. The other half of their profits come from the U.S., which accounts for only 8% of sales volume. The big money is still here, but there are a lot more people overseas. The numbers are shifting as the U.S. market gets tougher and tougher.
Q: How serious is the effect of more and more smokers trading down to discount brands because of the weak economy -- and how is that affecting Vector?
A: In the cigarette-pricing structure, you have four tiers. There are the premium brands like Camel and Marlboro. In the second tier are Doral and Basic. The third tier is where Vector's Liggett Select is. Liggett costs $1.75 per pack, around $1.50 a pack less than premium brands. That's a lot of money. Until the economy starts booming, that will be a significant advantage for us.
The fourth tier is made up of renegades. These are fly-by-night makers, not paying into the MSA. States are going to start enforcing that everyone makes payments, so these renegade operations will probably go away in the next couple years.
Q: When it comes to repositioning your company for a future in which there'll be far fewer smokers, what's your strategy?
A: To help people eventually quit. Quest is not a safer cigarette at all. It's low nicotine, made with a special tobacco that is genetically modified. What we've done is found a way to stop a gene that causes development of nicotine in the tobacco plant. There's no change in the plant except for the lack of nicotine.
What we have now is Quest 1-2-3. We've blended regular and genetically modified tobacco to control the nicotine at each level. It's a step-down approach to nicotine-free cigarettes.
There are some data that nicotine is very bad for the cardiovascular system, but we're not making any health claims for Quest. The potential health claim for Quest that we would like to make is that it aids in smoking cessation. That's a couple years away.
We're doing a Phase One FDA trial of 90 people. So far, that's going well. Then we'll go to the FDA and design a larger study and work with them on trying to get the approval.
Q: Who are your competitors?
A: I don't think anyone. Philip Morris [now known as Altria, (MO
)] is making some noise. But they're not as advanced or dedicated as we are.
Q: When do you plan to launch Quest nationally?
A: We don't know yet. The seven states we've launched in this January have been very good on a trial basis. People are buying them. We want to get some longer-range data before a national launch so we can see what repeat business is like.
Q: Vector posted a per-share loss of 91 cents in 2002, and it looks like it'll lose money in 2003, too. When will it return to profitability?
A: We have a special deal with the states with the MSA. Vector is exempt from paying into the settlement for the first 7 billion cigarettes it sells annually. We aren't having operating losses. Our losses are all due to Quest and Omni ramp-up costs. As soon as Quest starts to work, we return to profitability. And Quest is going very well. We have it in 32,000 stores in the seven states we've launched in.
Edited by Thane Peterson
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