I am very happy to speak today with Jacek Olczak, CEO of Philip Morris International. Typically shortened to PMI. PMI has more than 80,000 employees worldwide, is publicly listed and has a market capitalization of almost $250 billion. So it's big business. And of course, PMI is widely known as a cigarette company, which makes sense because it owns five of the world's 15 bestselling international brands, including the iconic number one, Marlboro. But, and as some of you may not know, PMI today is deriving about 40% of its revenues from smoke-free products. Not tobacco-free, but smoke-free products. And that 40% is up from 24% in 2020 and up from almost zero 10 years ago. The ambition is to grow this percentage of revenues coming from smoke-free products to about two-thirds by 2030. PMI today presents itself as a leading international consumer goods company. And as the first international consumer goods company making tobacco products to commit to, and I quote, a smoke-free future encouraging those adults who would otherwise continue to smoke to switch to better alternatives. Now we will discuss this transformation with Jacek including how they're going about it and what challenges the company faced and is still facing. Jacek himself grew up in communist Poland. He studied economics in lots before starting his career in an accountancy firm in London. Relatively soon thereafter and a bit more than 30 years ago, he joined PMI where he's had many roles over the years, including president of the EU region, then CFO, then COO, and finally, CEO in May 2021. Jacek, a warm welcome to you and thank you for coming to IMD today to have this dialogue with me.
Always pleasure to be with IMD.
Thank you. Jacek, let's start maybe with a brief history. So the company originated in London 1847, but PMI itself was established in 1987 as an operating company of Philip Morris Companies was the name of the organization. In 2003, Philip Morris Companies changed its name to Altria Group, and then in 2008 PMI was spun off from Altria and became a separately listed entity. At the same time, craft was also spun off. What was the reasoning at the time?
Yeah, conglomerate discount. I think in the... There was a moment when the stock market starts having a challenge in, you know, putting a proper value on the different parts of the business, and usually it results that the common denominator goes too low, and therefore, in order to release the shareholder value, for some companies, it's better to separate its parts. So this was very much when the tobacco was traded at that time at the significant discount. So craft couldn't realize its value. I mean, a good proof that the decisions made 2008 and a few years before where all the companies were being spun off is if you look at the valuation of these individual parts today versus the starting point. So we created or Philip Morris has created quite a lot of shareholders value by actually spinning off the assets, giving them the right to having its own strategy focus, et cetera.
Understood. Now 2016, your CEO at the time, Andre Calantzopoulos, announced a new purpose for the company. And here, I need to quote it directly, 'To deliver a smoke-free future by focusing its resources on developing scientifically substantiating and responsibly commercializing smoke-free products that are less harmful than smoking with the aim of completely replacing cigarettes as soon as possible.' So this is 2016. At the time, you were the company's CFO and hence very much a part of the executive committee's decision. How did you guys come up with this announcement, which it should be said was very much a first for the industry.
Yeah, so the announcement of the idea was in our minds for quite a few years before. These announcements, which you quoted very precisely, very accurately required quite a few months of weighing every word and the comma and the structure, it has the... And each of these parts has the meaning. Just to start with, whether we like it or not, smokers love smoking. So despite all the effort in a public health domain, and you're talking, you know, significant marketing restrictions, promotional restrictions, the whole awareness campaign about the risk of smoking, despite the high taxes, higher prices, despite the expanding essentially smokers from a civic society, smokers do continue to smoke.
And as a full disclosure, my wife is one of those. She's a responsible adult. She's raised three children, she votes, and she has made a very conscious decision to continue smoking and she alternates between two of your products.
Yeah, so she should create or she should switch. I mean, that's my short version of the best advice I can give now. But so one of the problems which we have identified is that despite all of these efforts, smoking will continue. Okay, so we also know that humans most likely are not the best in assessing the risks, so despite the fact that you are fully aware about the risk of smoking, people still continue to smoke. Despite the fact that, you know, the risk can be very severe and they do materialize. Then the question somebody put on the table was, 'Okay, if smokers will continue to smoke, nobody would like to live with the consequences of smoking. Is this the way that we can develop the product, which on the one hand gives the similar satisfaction, whatever is the definition of satisfaction as cigarettes, but that significantly reduces risk?' That's the first part of a statement. Second, a scientifically substantiated. This was not supposed to be something which, you know, improves the trajectory of the harm reduction compared to cigarette smoking, you know, on the fringes of urges. But something which materially has the chances of reducing the health impact. If you talk to many toxicologists, they will tell you that reductions in exposure to any harmful substance of more than 50%, so by half, has very high chances of reducing the final outcomes, which is the disease. We have put for ourselves the standard at that time that we will not go to the market unless it reduces the exposure to the harmful toxicants, which you can find in cigarette smoke by less than 75%. So we increased the bar, put the bar higher.
So in other words, it's not marginal. It's a major breakthrough.
Not marginal. No, it's actually a major breakthrough. The final products, which we have today in the markets, have anywhere in the 95% plus reduction of all the harmful toxicants, which you can find in smoke, including carcinogens and many others. Obviously, the best for a smoker is to quit smoking. What we know, as I said at the beginning, smokers love smoking and therefore, despite the fact that they know everything about the risk associated with smoking, they don't. Some do, many don't. So this is how we built the research and development center in Neuchatel, the famous Cube. Hiring the first scientists was extremely difficult because it essentially meant for them that they were being expelled from the scientific community.
Exactly because you collaborate with tobacco companies, et cetera. Okay, fast forward many years later, today it's not an issue. So this was why we put emphasis in the statements that these products will go to the market as long as there is very objective, strong science to demonstrate that this product is a significantly better alternative than smoking.
And today, this has been approved by the FDA.
This has been authorized by FDA. The whole scientific evidence behind this product has been reviewed by many other, similar to FDA authorities in other countries. So the science is subject to verification, scrutiny, et cetera. And I think the conclusions are all coming, pointing in the same direction: for those who won't quit or can't quit or don't quit, the best solution is to switch. And you're reducing significantly the exposure to all the bad stuff, which you find in tobacco smoke. And the third part of that statement was, we're trying to bring this at that time. We're trying to bring this product to the market in addition to cigarettes.
Or as the replacement to cigarettes. And I think a very deliberate decision at that time was, the only way we should do it is to replace cigarettes. Because essentially confronted with... Once you have scientific substantiation, you are confronted with one fact. You know that you have one product which is significantly better than the other product. So what's the purpose of continuing to invest and promote the other product, which I think is good for smokers, for consumers, for the public at large, for the company to move into this product. Later on, that statement was the guiding principle for how we allocate resources, how we drastically disinvest in cigarettes, combustible cigarettes, and pull all available resources behind the R&D, science, product development, and commercialization of the new products.
How controversial was this decision internally? Was there enormous alignment through the company or were some people more comfortable than others?
I mean, obviously, you have the people who are more skeptical about this whole thing, who had doubts, but this is always that moment when the company is as strong as its leadership. And I think we've been very gifted that the leadership board, CEOs, and a few other execs at that time had a common belief that we can change the world and we can actually address the problem of smoking. And the rest is change management, right? So you communicate, you talk. We have communicated a lot. I mean, as somebody at that time told me that there is essentially zero risk of overcommunication. I thought that was blah blah, this statement. But I learned the hard way that there is a significant risk of undercommunication, but there's actually no risk of overcommunication. So we spent a lot of time getting our 80,000 plus employees on board, despite the fact that some of them were still very much in the combustible business, cigarettes business, and those which are moving into the new business. I mean, from today's perspective, when we have allowed these products into a hundred markets, everyone sees that we are not leaving any of our companies behind or any of the markets behind. For the last 10 years, we haven't built any combustible factories, but we opened 16 manufacturing centers for the smoke-free products. Many of these manufacturing centers are being opened on the back of the combustible centers. There is a lot of re-skilling, retraining of our engineers, technicians, and so on. There's a lot of similarities between the two products when it comes to processes from a manufacturing operations perspective. I mean, today it's much easier. Today you will not find anybody doubting that it was the right direction.
There was also, if I remember well, a certain amount of pain, right? You had some reduction of staffing in some areas. I guess, also in order to make room for other folks.
Yeah, there is pain. I mean, always, I guess when you are doing something new and sizable, important, something big, there is a degree of pain. There is actually one of our long-lasting investors, his name is Tom Ronsky, very successful. He's an investment officer for many years. He coined, and I think he borrowed this from Warren Buffett, one of them has inspired the job, and he coined the term of a capacity to suffer. And if companies to do the pivotal change in strategies, et cetera, if you don't have this capacity to suffer, which is with all the pressure of the short-term versus long-term, take the risk, big risk, going into new versus continuing with the old, which still can yield good returns, good results. This is what differentiates a great company from a good company. So I think Philip Morris has demonstrated that we did have, we do have, and we will have a capacity to suffer.
Looking at PMI today, almost 10 years after this new purpose came up, as I said earlier, about 40% of your revenues come from smoke-free products. That's a bit more than 40 million adults all over the world using these smoke-free products. And in more than 20 markets actually smoke-free products generate more than 50% of your revenues. Now, as I was preparing for this, it seems to me that you're running three different businesses. A burning tobacco cigarette business, a smoke-free business that has three major components, and we'll get to this. And then there's a completely different set of activities that sometimes are referred to as Beyond Nicotine and sometimes are referred to under the umbrella health and wellness. Is that fair, these three different buckets?
Yeah, it's absolutely fair. The combustible business, essentially, I think these decisions, which I described earlier, we didn't want to do it in addition to, but as a replacement of. There was obviously supported by the massive resource allocations, which was to accelerate the smoke-free transition. It was up to management to take the R&D money, commercial money and move it behind the smoke-free. 99% of our R&D spent today is behind the smoke-free product. About two-thirds of the commercial is behind the smoke-free. Okay, so it is a massive allocation of resources which accelerates the transition, which we wouldn't be able to do if treating these businesses as separate businesses. And the Beyond Nicotine businesses rely on the capabilities which we have developed internally, which definitely have been excelling in building the brands. Hence, as you notice in your opening remarks, we are the house of the most iconic brands, including Marlboro. So we know how to do that from a marketing perspective, brand building. We have added during the smoke-free transformation all the capabilities about the product development including electronics, product assessment. So, you know, there are a lot of life science capabilities, which we didn't have before. And essentially we are looking at all these capabilities saying, 'Do we have enough to start playing in another territory?' So there is a corridor of what we think Philip Morris can do in addition to just solving the problem of smoking, which is under this umbrella of Beyond Nicotine. This is more into the wellness therapeutics, but very much focused around certain skills or enhancements of the skills or capabilities, if you like, of the human. So the whole transformation of a smoke-free is very well accepted, especially by the investors. I mean, the consumers obviously, but very much by investors. You'll see this in the delta difference in valuation of Philip Morris versus other tobacco companies. I mean, some people ask questions, 'Am I still, are we still a tobacco company?' Maybe we are a CPG type of a company with defined territories. But this is very exciting.
So let's get back to the Beyond Nicotine, briefly cigarette business, still 60% of your revenues, but did I get this right, lower profitability than smoke-free products?
Yes, I mean, the product has better unit, better revenue per unit, and better gross margin per unit than cigarettes. Partially because the difference in taxation as many governments are recognizing the lower negative impact, gonna have positive impact in our harm reduction. So therefore these products enjoy lower taxation quite rightly because indirect taxation has this ability to stimulate demand in the right direction. Second is obviously now we operate at scale. Remember this is 10 or 11 years since we commercialized this product. And as the first mover, we obviously take the lion's share of the economy of scale benefits, right? I mean, IQOS today, the proposition is in a unit volume of 150 plus billion. You could build almost a very sizable cigarette company based on these volumes, right? On a global basis. So the product is attractive from the margin perspective and obviously, it's also attractive from the geographical mix. Okay, in a sense that we started in the most challenging environments, which are developed countries. We started in Japan, Italy, Western Europe, European Union, et cetera. We're going to developing countries which obviously also have a geographical mix margin impact on these products. But the transformation is very profitable. And again, this is very much recognized in today's valuation of the company if you compare Philip Morris International to all other tobacco companies. But there is one thing which I would like to mention, could we do better or more that already 10 years into this transformation our smoke-free revenues are higher, like 50% or 60%?
And obviously, based on today's knowledge, there are a few things internally which you could do faster, differently, et cetera. I mean, that's obvious, but I think the one thing which we haven't taken into consideration in the very beginning is opposition from regulators in certain places. So we ended up in a situation today that Philip Morris operates in 160 markets. Smoke-free products only in a hundred markets. The question is why I'm not in the remaining 60 markets, and we are not in these remaining 60 markets for one fundamental reason. Cigarettes are being allowed by the legislation while the smoke-free products are being banned and this is when I think... One thing which didn't cross our mind at the very beginning of the transformation is that despite the fact that we invest only into scientifically substantiated products, we were very much on the rational part of the problem solving. We completely underestimated the irrational part of the problem solving. Having said so, every year, we're making progress. So, you know, we recently opened Taiwan, like a tiny country, but also was stuck a little bit in the past that cigarettes were allowed, not the smoke-free products. I think it's gonna come. It's a regrettable belief that it takes us so much time to accept that this actually solves the problem.
In the meantime, there's 1.3 billion smokers of cigarettes globally and some parts of the world are still growing, Middle East and Africa, Southeast Asia and in terms of countries, places like Indonesia, Egypt, Thailand and Turkey. And in those markets, PMI is fighting for market share, right? With other cigarette manufacturers. How do you reconcile this? We want to get out of it, but in some parts of the world, we're still fighting for market share.
Actually, we are not fighting for market share, we are fighting for maintaining the value. So it obviously... I mean, otherwise, if we wouldn't be fighting for the market share, we wouldn't allocate that much or reallocate that much of commercial resources.
So obviously the objective is not to give the market share for free to competition, but also don't fight for the growth of the category or growth of our share in that category. But maintaining what we call the fair share of the category, which is a component of maintaining the value creation there and the resources, because let's remember all of the resources which we generate from the combustible business are continuously feeding the smoke-free business,
As we continue with the development and science behind the new products and we have all the programs for the Beyond Nicotine, which is discussed. Obviously, this is being financed by the cash flow coming from the combustible business.
I wanna build on this because this is not unheard of in many other companies where you have one historical line of business which ends up being basically a bit of a cash cow. And here, the growth comes from smoke-free products. Clearly the purpose highlights, we wanna move in that direction. As you said earlier, almost all of the R&D investment is in that direction. Almost 75% of the commercial budget goes in that direction. How do you ensure that this unit does not completely lose its energy and its drive, right? Because they are the unloved child in many ways.
No, but they are truly recognized as the equal member of the Philip Morris family. So when all starts with employees, I think. I mean, we are 80 plus thousand headcount company. If you go to those parts which are only focusing today, as I mentioned, because of regulations very much on the combustible business, they will not say that they are not involved, that they are not taken care of, that they are left behind or anything of this nature. They know that their time will come and they also will directly be able to support the smoke-free transformation. So this is not an issue. I think, you know, this is one of the assets which we have created, this internal alignment behind the purpose, despite the fact that obviously you still have a combustible business, but with a different purpose than the smoke-free business.
So the value proposition is we're under investing in your business, but you should feel good about the fact that you're funding the development of these new activities.
Absolutely, and, you know, there is also value in this whole thing again going back to or referring back to our initial decisions. Don't do it as a separate business but do it as one business with different lines of product is that in all the markets when we are selling cigarettes, we have a faster route to the consumer. We have a faster route to the trade and there's actually the capabilities which serve us very well the moment when we start offering the smoke-free products in a given geography to accelerate the growth. It's much easier for us to put our QR code on a pack of Marlboro or referring still smokers, go visit website of our smoke-free products. Whether there's a Zyn, the pouches, or the IQOS, or the electronic cigarettes. I mean, it helps, it shortens the path to the consumer in the markets where I don't have a cigarette, which we don't have a cigarette business. I mean, how can I find the consumers? Here, at least we know, and we have no mercy in targeting our own combustible smokers with the information and the support in the transition to smoke-free product.
Now let's talk about the smoke-free business. Three major pillars. Two of them are non-tobacco related and one of them, you've mentioned it IQOS, which is heat but not burn. So tell us about IQOS, but tell us also about the other two.
Yeah, so they are all three meeting the criteria, which I mentioned before, they significantly... But I mean, very, very significant to reduce the exposure to all the bad stuff which you find in cigarette smoke. They're not risk-free, but definitely they generate significantly less harm. Now each of these products offers a different degree for a smoker of ability if you like to convert or to switch into these products. IQOS heat not burn was developed with the principle of resembling as much as possible the ritual of smoking while obviously reducing the exposure. Hence, you have an electronic way of controlling the temperature profile, so we don't trigger combustion so we don't go into the danger zone, et cetera. It has the tobacco taste, some degree of the tobacco taste because it contains tobacco. The actual results from the marketplace confirmed that IQOS has still today, by far, the highest abilities to switch permanently smokers to the alternative. And that's very important because we didn't want to go into some sort of complicated situation that I reduce my average smoking of cigarettes by three or four cigarettes and replace them with IQOS. We knew that the real benefit will, to its maximum, be accrued to you if you fully switch to this product. And IQOS delivers on this one and you have a range of adoptions somewhere in the 70%, okay? E-cigarettes at the time were offering lower rates of adoptions, not even at the 30%.
So e-cigarette means not tobacco, but nicotine.
Nicotine liquid and some flavors. Then you have oral category like a US addition to our portfolio, nicotine pouches, which is a completely different ritual. You don't have the hand mouth movement. It's less visible, more discreet. It's a different way of absorbing nicotine. It's not via inhalation and it's coming through your gums. These products have a very high potential, but we also know that the smoker's ability to adopt straight this product from a smoking ritual might take time. So at the end of the day, you need all three because they have a different... Giving consumers a different difficulty level, convenience level in switching. And we also now learning that some consumers will try to mix any of those three depending on the moments of consumption they have during a day. And I don't think one of the categories will take it all or product categories will take it all. I think at the end of the day, you will have a mix of these three categories. It might be different by country, by history, by geography, by culture, et cetera, all three categories will serve the consumers very well.
IQOS heat not burn. I think I read several numbers, but basically between 10 and $15 billion of investment over the years with some initial relatively resounding failures in the sense that you develop a product and consumers don't really want it. This must have been difficult, right?
Then we learned all these things the hard way. Okay, one of my reflections on where we are today, and this is undisputable success. I mean, IQOS is big and it keeps on growing. You have a-
We should say, IQOS today is bigger than Marlboro.
It is, and it was already last two years, I think in 2023, we crossed the revenue line of Marlboro with IQOS. A spectacular success and it keeps on growing double digits per annum. So it's all great. Now here's the story. If we would have today's knowledge in 2014 when we pressed the button for the first commercialization, we wouldn't launch the product. But we wouldn't know today what we know if we didn't press the button in 2014. So this is a classical catch 22 what you do, and I think ultimately we did the right decision. It's a lot of learning, which I think also sets us apart from many other participants in this market. There is not just the capability which is the function of resources and the time to build this capability, but you put this capability at work, which means you have experience, which means you have knowledge and to every new product development of every new idea is this behind the heat not burn or the pouches I think is better developed, better prepared because we have a ton of knowledge which you have accumulated over this 10 years. Now, as always, you know, the past performance is not a guarantee of the future for future success. It's nobody's believing that the product which we have today in the market, that's it. Now, for 50 years, we'll be doing nothing than just selling the same product. So this is the continuous challenge. Can we do better? We put the consumer in the center. I mean, we have taken a massive effort in converting this business or transforming this business from a classical B2B to B2B2C when we own the majority of the relations with the consumers, not necessarily transactions, but the relations, this allows to continuously feed the development machine, both in intangibles, the service which we provide to the consumers, but very much tangibles, which is the closed loop to the product development. So that machine goes.
Beyond Nicotine, you are now operating these activities in a subsidiary called Aspeya, and we can come back on this. I looked at the website and mentioned three different types of activities, consumer health, and they said especially purposeful energy, cannabinoids, so I guess cannabis-based product, and inhale therapeutics. How have you chosen these other areas? Clearly you have deep pockets, which is nice, but beyond the deep pockets how did you identify, here we have a right to win and here not.
Yeah, so there are some common denominators which are much higher than just the focus. You describe it. We have deep pockets, right? 'Cause deep pockets shouldn't allow you or create-
Well, it helps, but it's not sufficient.
Well, it's nice to have the resources right?
You need to have a purpose. And the purpose is not to build something which is completely unrelated or not related to the other parts of PMI. So we always try to either repurpose the capabilities, you go, you play into your strength rather than play into your weakness. We're not, for example, trying to add a business which could be characterized as classical pharma. This is not our aspiration. I don't think we have enough of the reasons or the arguments if you like to play there. But I think we can add a lot in the broad world of the wellness therapeutics, et cetera. Yes, we're looking at the cannabinoids, but only on the medical side. We're not interested in anything which would impair your ability, for example, to judge. Because one of the things... And this is presumably a topic for separate conversations, one of the common denominators of smoke-free products is that they contain nicotine. And as opinions are divided, again, rational versus irrational world, what's the role of nicotine? The reality is nicotine is not causing the... Or is not the prime cause of harm created by smoking. It's all the other compounds that you find in tobacco smoke, et cetera. Nicotine itself is actually more on the access of satisfaction, right? And maybe enhancer of some certain cognitive skills, attention, et cetera, et cetera. But nicotine doesn't impair your ability to judge. You see, I can have a cigarette, which I shouldn't. I can have IQOS, I can have a vape, I could use them, and I can drive the car. But there are many other substances which you should. Take alcohol, take certain of the hallucinogenic substances, et cetera. So this is not the territories which we want to go. I want to stay away from this. Now, Aspeya, with the newest name or label which we awarded to this unit, you give it to this unit is the... As I said earlier, I mean, that's the longer play. I mean, are we fully aware that it's gonna take a while until that thing's gonna be substantial, especially in the group of PMI, which has over 40 billion revenues. It's gonna take time. But this common denominator of trying to see what do we know in terms of product platforms. I mean, our expertise is now in oral and inhalations. How we can-
Okay. Oral and inhalations. How we can, based on our knowledge, further the development of certain solutions to the existing needs of the consumers, which are now not defined as the smokers only, but the broader range of the consumers? We're adding also another thing. Should we ever end up in substances or products which should have a higher scrutiny when it comes to the marketing execution. We learned it from cigarettes and it serves us extremely well in the smoke-free transformation is the ability to manage the accessibility of our product to certain audiences. So obviously, we're all in agreement that kids, underage people shouldn't smoke, kids, underage people shouldn't have access to smoke-free product. This is being translated into a certain set of rules, procedures, processes in the company. The execution is very high. The level of execution is very good. So should we ever end up in a product that we need to control one audience or restrict one audience versus others? I think it's another ability, which many other companies don't have.
Don't have. Okay, so oral inhalation, we understand. Regulated marketing and regulated supply chains, we understand. Now some of this is also to what extent does society let you play in that field, right? A few years ago, you bought a company which was a UK asthma inhaler maker, Vectura Group, and you paid a very significant amount of money for it and ultimately you had to divest it. Tell us about it.
