South Korea's new tobacco market has been booming in recent years. According to data from Euromonitor, South Korea's new tobacco market—heat-not-burn (HNB) tobacco—exceeded 20 trillion won ($15.17 billion) in 2021, reaching 24.13 trillion won ($18.3 billion). It is expected to approach 25 trillion won ($18.96 billion) by 2025.

According to a survey by South Korea's Ministry of Strategy and Finance, the share of the e-cigarette market in the country's overall tobacco market increased from 2.2% in 2017 to 14.8% in the first half of 2022. HNB products have become a growth driver for the South Korean tobacco market in recent years.

South Korean domestic company KT&G's Lil accounts for about 48% of the market, Philip Morris International's (PMI) IQOS accounts for 42%, and British American Tobacco's (BAT) Glo accounts for 10%. Meanwhile, two other large international tobacco companies—Imperial Tobacco (IMB) and Japan Tobacco (JTI)—have virtually exited the South Korean market.

In particular, KT&G and PMI, as the two largest HNB product manufacturers in the South Korean market, are engaged in "competition" in the domestic market and "collaboration" in the global market, with a sense of "compromise" for their respective interests.

KT&G: South Korea's Market Leader 

KT&G is the largest domestic tobacco company in South Korea, with a 30% operating profit margin in 2022 and a market share of 48%, ranking first in the South Korean market.

KT&G's products have a dominant market share in South Korea, with Lil as its main product. Since its launch in 2017, it has been the leading competitor in the HNB category of the South Korean tobacco market.

After establishing its dominant position in the South Korean market, KT&G extended its reach to overseas markets. However, unlike its domestic advantages, KT&G's distribution system overseas is not strong, and its international business is still in its infancy.

Analysts were not surprised by KT&G's decision to expand overseas. As the world's fifth-largest cigarette manufacturer, 70% of its total sales come from South Korea. However, with the shrinking traditional cigarette market, South Korean smokers are switching to new tobacco products, reducing the proportion of cigarettes in its performance. To gain a larger market share, KT&G has increased the proportion of next-generation tobacco products (NGP) and shifted its focus to the global market.

KT&G's CEO Baek Bok-in said at the 2023 Investor Conference: "By 2027, we will raise our sales share in the global market to 50% and increase the sales share of NGP and health-functional foods to 60%."

However, KT&G's global market layout is lagging and slow. According to South Korean media Inews24, KT&G's large and fully staffed sales department in South Korea, along with a nationwide distribution network and intensive marketing activities, have been the "magic weapon" for winning the domestic market.

This distribution network is most evident in KT&G's 14 regional headquarters, 102 branches, and 11 subsidiaries under the sales headquarters in South Korea.

In contrast to the domestic distribution network advantage, KT&G's overseas distribution network is relatively small, with only 10 overseas subsidiaries and branches, including three in Indonesia, two in Russia, one each in Turkey, the United States, and Iran, and two in China.

This has become a disadvantage for KT&G in participating in overseas competition. How can they turn this disadvantage into an advantage and continue to expand in the overseas market? This is a difficult problem for KT&G to solve.

KT&G chose to cooperate with PMI, the world's largest tobacco company.

Previously, the two parties had signed a 3-year contract, and PMI would start selling KT&G's HNB products in the global market from 2020.

In February this year, the two parties signed a 15-year long-term contract.

According to the disclosed information from both parties, KT&G's HNB products will be sold in 70 countries or regions where PMI operates.

Why would PMI accept KT&G's products into its distribution network? PMI's comment on this is: "PMI is confident that even if KT&G grows in the global market, it will not reach a level that threatens it."

PMI's Market "Revival"

PMI's confidence comes from the popularity of its products worldwide. According to PMI's 2022 annual report[1], the total number of IQOS users is estimated to be around 25 million.

PMI did not miss out on the early competition of HNB products in South Korea.

In 2017, the same year that KT&G launched Lil, PMI's IQOS product was officially launched in South Korea, with annual sales reaching 800 billion KRW ($606.79 million) and a market share rising to the industry's first place.

That year, PMI's contract manufacturing plant in South Korea began operations. More than 300 billion KRW ($227.55 million) has been invested to produce heated tobacco products, ensuring the demand in South Korea is met.

However, by 2019, its sales had dropped to 500 billion KRW ($379.24 million), and its market share had also declined, remaining in second place, accounting for 42% of the market share.

In 2022, after experiencing four years of decline in performance, PMI Korea's IQOS product sales increased by 21.5% to 686.7 billion KRW ($520.85 million), and operating profit increased by 16.27% to 80.6 billion KRW ($61.13 million).

This month, PMI decided to change its senior management personnel in South Korea. Yoon Hee-kyung, the former CEO of the Australian company, will be assigned to the Korean subsidiary as CEO.

Analysts believe that the rebound in sales for PMI Korea in 2022 has given PMI a boost, and PMI will implement new strategic measures by changing senior management to achieve growth in market share.

In February of this year, PMI launched a new product, IQOS Illuma One, in South Korea to expand its product coverage.

Previously, KT&G also launched a new product, Lil Able, and the competition between the two companies in the South Korean market has intensified. In spite of that, they still chose to renew the 15-year contract in January[2].

Meanwhile, BAT, the third-largest participant in the South Korean market, is trying to capture the HNB market with new products.

BAT: Low-Price Strategy to Snap the Market 

In 2022, BAT had approximately 10% market share in South Korea's HNB products, the smallest among the major participants.

However, BAT has not lost confidence in the South Korean market and seems to want to use a low-price strategy to open up the market, recently launching "Glo Hyper X2" in South Korea.

The product is priced at 40,000 KRW ($30.34), while the recently launched IQOS ILUMMA ONE in South Korea is 69,000 KRW ($52.34), and KT&G's lil AIBLE is on promotion for 99,000 KRW ($75.09). BAT's low-price competition strategy in South Korea shows its strong intention to expand the market.

However, sales data shows that its performance is not satisfactory, and Glo's market share has not changed significantly.

Government Considers Taxing HNB Products 

On the one hand, the growth of the HNB product market in South Korea provides more choices for smokers; on the other hand, as cigarette sales have declined in recent years, the South Korean government has also seen the possibility of increasing tax revenue from HNB products.

From 2020 to 2022, cigarette sales fell from 3.2 billion packs to 3.09 billion packs, and a new historical milestone seems to herald HNB products as the new growth star of the South Korean tobacco industry.

Currently, the South Korean government levies a tax of 3,004 KRW ($2.28) on non-combustible cigarettes, which is 90.4% of the tax on ordinary cigarette products.

The South Korean government is seeking to change tax revenue.

At a South Korean National Assembly meeting in April 2023, the ruling party advocated levying a similar tax rate on HNB products as on cigarettes. However, this was immediately met with public criticism. The public believes that this is an attempt to boost declining tax revenues by collecting more taxes.

After facing opposition, the South Korean government abandoned the decision to increase taxes on HNB products.

Shortly after the decision was withdrawn, KT&G was about to announce its first-quarter results, but securities firms predicted that its first-quarter performance would fall short of market expectations.

Shinhan Investment Securities Research Institute believes that KT&G's sales and operating profits will be 1.39 trillion KRW ($1.05 billion) and 295.4 billion KRW ($224.11 million), respectively, a year-on-year decrease of 0.9% and 11.3%.

In the future, the landscape of the HNB market in South Korea may still have new possibilities.