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E-Cigarettes Are Smoking the Competition: Part 2

Check out the first part of this two-part series at TheStreet: "E-Cigarettes Are Smoking the Competition: Part 1."

NEW YORK (TheStreet) -- Part 2 of 2

Yesterday I wrote about electronic cigarettes, commonly called e-cigarettes, which have grown in sales from virtually zero five years ago $1.5 billion in 2013. This growth will likely continue, overtaking traditional cigarettes sales within the next decade.

Today, let's consider how investors can profit from this new market sector.

Competitive Landscape

There are more than 200 e-cigarette producers. The number of competitors is decreasing, but competitive pressures are increasing as the large tobacco companies are entering the fray.

In 2012, Lorillard (LO), the third-largest tobacco company and maker of Newport cigarettes, entered the e-cigarette market with its purchase of Blu. Reynolds American (RAI - Get Report), the second-largest U.S. tobacco company and maker of Camel, entered the market in 2013 with their own e-cigarette offering, Vuse. In 2014, Altria (MO - Get Report), the largest U.S. tobacco company and maker of Marlboro, acquired Green Smoke to enter the e-cigarette market.

The increased competition from larger players should lead to a consolidation in the market, with five to 10 players at the end of the industry shakeout. Economies of scale should be present in the market.

The large fixed costs associated with marketing and potential regulatory costs will likely eliminate smaller players. Marketing is particularly important at the early stages of an industry life cycle, when no brand has established itself as the clear leader and all companies are trying to increase brand awareness.

Limited shelf space at retailers creates another important market inefficiency, as the FDA may ban online sales of e-cigarettes. The access to retail outlets will be one of the key determinants of survival.

The large tobacco companies will gain access, given their relationships via traditional tobacco. But for smaller companies, this will be important to monitor.

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