Intellectual property is at the heart of the tobacco industry's second life

In this first article I want to illustrate how intellectual property truly defines the existing and future game lines of many industries, and further how IP strategy is now one of the key drivers behind corporate success or failure. The tobacco industry has been on the brink of extinction for a number of years, yet one major IP transaction has been the key to the industry’s profitable pivot.

With a product with proven negative health effects, the tobacco industry has been increasingly pushed into a tricky corner. Further development of the cigarette market in both developed and developing nations led to a slew of class action suits, marking a crisis point for the industry: either commit to traditional tobacco cigarettes and to the inevitable death of the industry; or pivot into something more acceptable in social and public policy terms, and therefore sustainable.

The invention of a viable electronic cigarette by Hok Lin in the early 2000s facilitated a massive shift in the industry by small and larger players alike. The genius of Lin’s product is that it appears to pose none of the health issues associated with conventional cigarettes, yet still contains the highly addictive component of tobacco, nicotine. This concept, which was quickly protected by a number of broad patents around the world, has facilitated a rapid reinvention of the centuries-old tobacco industry with earnings going from zero in 2005 to a predicted $10 billion annually by 2017, with a massive 90% margin.

At the core of this reinvention is intellectual property, enabling an effective switch from a dying product (the traditional tobacco cigarette) to a more sustainable e-cigarette product, while retaining the nicotine required for high addiction rates and therefore perpetuating high sales. This pivot was about intellectual property in three ways:

  • the occurrence of a major IP transaction;
  • which has in turn transformed the business model applied in the industry; and
  • which will be leaving a series of IP cast-offs in the increasingly redundant ancillary businesses associated with the traditional tobacco industry.

While a number of industry players already have their own e-cigarette offering, including Altria’s MarkTen and British American Tobacco’s Vype, what has repeatedly been deemed the original design of this product is now owned by Imperial Tobacco. Upon acquisition of Dragonite International (Lin’s Hong Kong-based firm which owned all the patents to his e-cigarette technology) for $75 million in November 2013, Imperial became the proud new owner of the original e-cigarette IP package – an IP transaction with major implications for the industry moving forward.

In the past, the large tobacco players were effectively marketing and branding firms. They took a product with proven negative health effects and made it glamorous – and they were very good at what they did. The business model we are likely to see in the industry going forward will be different. The industry is migrating from a level playing field, where success was directly related to marketing and branding prowess for all players, to one where there is currently a dominant ‘technology enabler’ in Imperial, which holds title to core technology-based intellectual property. In a fashion not dissimilar to Qualcomm, Imperial is positioned to reap revenue in the form of royalties. The remaining players are now free to use their decades-old marketing expertise to build new brand-based intellectual property free of the fetters of traditional tobacco advertising restrictions. Of course, this assumes that the broad nature of the Lin patents holds and enables Imperial to protect its technology rights. With so much at stake, there will be pressure to create or source alternative e-cigarette intellectual property.

Given this transformation, what happens to the redundant ancillary businesses – the tobacco farmers and paper makers – now? The big players are moving on, yet the survival of their cast-offs remains to be seen. These smaller players have their own intellectual property and it is clear that with strategic management of their IP assets, smaller players may also come back from the brink.

So why do we care about Imperial’s acquisition of Dragonite and the associated e-cigarette IP package? Dragonite was already in the process of litigating a number of international firms for breach of IP rights, but it was relatively small and under-resourced. The Imperial acquisition has changed things, as Imperial has the muscle to enforce the intellectual property more broadly and effectively. In effect, the transaction has meant the perpetuation, or perhaps recovery, of big player domination of the cigarette industry and has initiated a rapid series of acquisitions of smaller players in the e-cigarette market. The big players, with well-characterised brands and distribution pathways, are now set to rebuild the tobacco (or rather, nicotine) industry’s second life.

This article has shown that even in a dying industry, intellectual property is integral. The lesson which we all understand is this: intellectual property is relevant in all industries, all the time.

This is an Insight article, written by a selected partner as part of IAM's co-published content. Read more on Insight

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