Electronic Nicotine Delivery Systems (ENDS): an …

1 Electronic NicotineDelivery Systems ( ends ): an updateon a rapidly evolvingvapour marketJanuary 2017 report 2 This report has been prepared by Ernst & Young LLP in accordance with an engagement agreementfor professional services with Nicoventures Holdings Limited. Ernst & Young LLP s obligations toNicoventures Holdings Limited are governed by that engagement agreement. This disclaimer appliesto all other parties (including Nicoventures Holdings Limited s affiliates and advisors).Nicoventures Holdings Limited is wholly owned by British American Tobacco Plc. Ernst & Young LLP isa limited liability partnership registered in England and Wales with registered number report has been prepared for general informational purposes only and is not intended to be reliedupon as accounting, tax, or other professional advice. Refer to your advisors for specific & Young LLP accepts no responsibility to update this report in light of subsequent events or forany other report does not constitute a recommendation or endorsement by Ernst & Young LLP to invest in,sell, or otherwise use any of the markets or companies referred to in the fullest extent permitted by law, Ernst & Young LLP and its members, employees and agents donot accept or assume any responsibility or liability in respect of this report , or decisions based on it, toany reader of the report .

2 Should such readers choose to rely on this report , then they do so at theirown & Young LLP reserves all rights in this Nicotine Delivery Systems ; an emerging category1 DisclaimerElectronic Nicotine Delivery Systems ; an emerging category2 ContentsPage01 Introduction302 Key findings603 The market for ENDS704 Devices and purchase channels1005 User demographics1406 Patterns of use1707 Restricted-use markets21 Appendix A: Kantar survey methodology24 Appendix B: Restricted-use markets25 Background to the studyIn May 2016, EY published a report on trends in the market for e-cigarettes sometimes known as electroniccigarettes, vaping products, or Electronic Nicotine Delivery Systems ( ends ). The study explored developments in thesale and use of these products, and focused on seven countries in particular (that collectively account for 75% oftheir global consumer price turnover (CPTO) excluding US and China).1 This second report is an update of that study, and draws on the latest data, to assess how the market has developedin those seven countries over the past year.

3 In addition, this report includes a separate section on the developmentof the market in three additional countries; Australia, Canada, and Malaysia, where there are restrictions on thegeneral sale and use of Nicotine -containing 1: Countries analysed as part of this study* Electronic Nicotine Delivery Systems ; market update301 Introduction Core marketsThe seven core countries included in this report are Germany, France, Italy, Poland, Russia, South Korea and theUK. The analysis presented in this report on the core markets was drawn from a survey on consumer behaviour fromapproximately 2,000 adults in each selected country, for each of the years from 2013 to Restricted-use marketsThis report , as discussed above, also includes data for three markets where there are some restrictions on thegeneral sale and use of vaping products. These are referred to as restricted-use markets. They are Australia,Canada and Malaysia. The datasets provided by Kantar Group Ltd. include estimates for the restricted-use marketsfor the year 2016 methodology for this survey is explained in more detail in Appendix A.

4 EY has calculated cross-country averagesbased on UN population data, and the proportion of respondents to the survey who identified themselves as regularconsumers of vaping products. In addition to data from Kantar, market information has been obtained fromrecognised sources, such as the World Health Organisation, to provide further context and detail on the category.*Countries shaded in dark-grey are restricted-use Nicotine markets1 Nicoventures estimate2 Field work for the 2016 survey was conducted between the period 9 May and 22 June, therefore all references to 2016 datasourced from the Kantar study relate to this period. Six of the seven countries were included in the survey between 2013 and2016. South Korea was excluded from the 2013 survey, but included in 2014, 2015 and 20163 See Appendix B for further information on each restricted-use marketDefining the vapour marketThere are various terms used to describe these products, including e-cigarettes, vaping products andelectronic Nicotine Delivery Systems ( ends ).

5 This report often uses the terminology ends to remainconsistent with the terminology used by institutions such as the World Health Organisation and toreflect the fact that many of the devices themselves are not cigarette-like in are battery powered devices which heat a solution (typically, but not always, containingnicotine) to create a vapour. A heating element is activated electronically which vaporises the liquidformulation (often referred to as the e-liquid ) and the vapour condenses to form an aerosol. Nocombustion takes place; instead the user inhales the liquid s vapour rather than smoke. ends do notcontain tobacco, however, where Nicotine is used, it is derived from the purposes of this report , ends devices have been grouped under three broad categories: Disposable which can be used until the pre-filled cartridge of e-liquid is emptied Rechargeable where the user can replace pre-filled cartridges Modular can be refilled by the user, but also allows the user to regulate the power delivered fromthe system s batteries to the atomizerENDS form part of a group of products that have been collectively referred to (by some industryparticipants) as Next Generation Products (NGPs).

6 However, the NGP category also includesproducts that do contain tobacco ( tobacco heating products). For the avoidance of doubt thedata in this report only relates to Nicotine Delivery Systems ; market update4 Electronic Nicotine Delivery Systems ; an emerging category5 Key findings from our survey of seven core markets:1. The market has more than doubled in size since 2013 The number of consumers using ends grew from an estimated in 2013 to in 2016, an increase of120%.4 Total usage is highest in the UK and France, where it is estimated at and of the adultpopulation Regular usage of ends is risingOver 40% of consumers consider their use as regular rather than proportion has remainedroughly constant since 2013 despite a rapidly growing market. South Korea (63%), the UK (52%) and France(49%) are the markets with the most regular Sole-use of ends rises as smokers switchThe proportion of consumers using both traditional tobacco products and ends (so-called, dual-users ) fell from64% in 2013, to 43% in 2016.

7 The ex-smoker represents a growing proportion of consumers, nearly half (44%),which is a sharp increase from 29% in ends most popular with the over-30sThe largest proportion of consumers (38%) are in the 30 44 age range, with another 37% between 45 64. Theproportion of consumers who are between 18 29 varies between 19% in Italy and 33% in The appeal of ends is evenly spread across men and womenThe appeal of the new sector is broadly balanced between men and women. Their usage is similar, with 53% ofconsumers being men and 47% women. The prevalence of smoking, as opposed to vaping, among males is oftengreater than Modular devices preferred choice for over two-thirds of consumersIn many markets modular devices, which allow for greater customisation, have overtaken rechargeable modelsas the most commonly used type of device. Modulars are chosen by two-thirds (68%) of all consumers, up from55% in 2013. The research findings also highlights that many consumers currently use more than one type Consumers opting for non-tobacco flavoured e-liquidsEvolving consumer taste is driving diversity in e-liquid flavours.

8 Tobacco, botanical and fruit flavours are themost popular. Three quarters of consumers opt for non-tobacco flavoured e-liquids such as fruits (23%) andbotanicals (21%).8. Specialist vape stores are the preferred channel for purchaseIn 2016, 75% of consumers purchased their modular devices at a retail store, with the most common beingspecialist vape stores. Retail stores were also the main purchase channel for rechargeable and disposableproducts. Online purchasing is slightly more common for users of modular devices9. The biggest driver: ends are perceived to be safer The primary motivation for the consumer is a perception that ends offer a safer alternative to cigarettes . It isclosely followed by a similar motivation, namely that ends enable smokers to reduce their consumption oftobacco . This is alongside the fact that ends have no unpleasant smell compared to The biggest barrier: ends are perceived to be harmful One of the most commonly cited barriers to take-up is a view that ends might be harmful to the health of theuser.

9 This was cited by 32% of people (smokers and non-smokers) who had not tried or did not intend to usethese Nicotine Delivery Systems ; market update602 Key findings4 Nicoventures estimate5 ends users were asked to self-define their usage as either regular or occasional The market continues to grow rapidly, supported by relatively low barriers to entry which have allowed manybusinesses to bring a diverse set of products to consumers through a variety of channels. This section of the reportoffers an overview of some of the emerging trends within this market, providing an evidence-based comparisonacross countries and over in the market slowing, but remains robustBy year end 2016, sales of ends are expected to reach globally from just in 2010, an increase ofaround 800%. By 2020, sales are projected to rise to just under 12bn, increasing at a compound average growthrate (CAGR) of 17% per 2: Global sales of ends ( bn) and annual growthElectronic Nicotine Delivery Systems ; market update703 The market for ENDSThe market is most developed in the UK, followed by FranceIn 2016, the total number of regular consumers across these seven countries is estimated to be around , upfrom in 2013, an increase of 120%.

10 As illustrated in Figure 3 below, in 2016, total usage across the corecountries surveyed was highest in the UK ( ) and France ( ) and lowest in South Korea ( ) and Germany( ).In both Italy and Russia, usage has steadily increased in recent years. By contrast, in other markets the market sizeappears relatively more volatile, which may reflect the relatively nascent nature of the market, and hence thechallenges in collating accurate usage shaded in dark-grey are restricted-use Nicotine markets024681012201020112012201320142015 20162017201820192020 Global sales ( bn)Source: EuromonitorFigure 3: Consumers (both regular and occasional) as a percentage of adults, 2013-2016* Electronic Nicotine Delivery Systems ; market update8 The most commonly cited driver of usage is that ends are perceived to be potentially asafer alternative to cigarettes ..This was followed by no smell or smoke compared to tobacco .Notably, the top five drivers, as reported by regular users, predominantly relate to the perceived potential healthbenefits of ends vs.