Managing a Changing Tobacco Category

Experts say look to OTP to drive profit margins, cigarettes to drive store traffic

Melissa Vonder Haar, Freelance Writer

David Bishop

LAS VEGAS -- It's no surprise that OTP has become a crucial part of any successful tobacco operation. "It's the little train that could," said David Bishop, managing partner of Barrington, Ill.-based sales and marketing firm Balvor LLC, and moderator of the "Tobacco: Managing the Changes" educational session at the 2012 NACS Show in Las Vegas. "And it's getting bigger every day."

Just how big have "other tobacco products" (OTP) gotten? Bishop revealed OTP has seen a 3.3 point share gain in tobacco sales dollars in past 10 years; however, the true impact has been on the bottom line of gross margin dollars, where OTP has nearly tripled its contribution with a 10.6 point gain.

"The shift is dramatic," Bishop said. "The business isn't just about cigarettes anymore."

"You need to look at tobacco as an entire category," said Mary Szarmach, senior vice president of trade market and government relations for Boulder, Co.-based retailer Smoker Friendly. "Cigarettes are not going to bring in the money you need to survive."

By contrast, OTP boasts better margins and less restrictive contracts, presenting retailers with significantly more flexibility in the category.

"Get rid of those low-turning SKUs," advised Nik Modi, a senior analyst at New York City-based banking and financial services group UBS. "[With OTP], customers may be more loyal to your store than a particular brand."

Innovations to smokeless pouches, retailers figuring out the Snus phenomenon and the increasing potential of e-cigarettes are just a few of the changes to OTP the panel credited with the category's growth.

"The growth is coming in a variety of ways, coming from different parts of the business," Bishop said.

The value of OTP only increases as retailers look at the shrinking value of cigarettes--which Modi predicts will continue to decline at around 3% to 4% per year. But that doesn't mean cigarettes aren't still a crucial sales driver for retailers.

"From a traffic-driving perspective, there's almost no other category that compares," said Bishop, noting that a whopping 90% to 95% of cigarette sales are planned purchases. And those purchases don't stop with cigarettes: Bishop reported that one in five cigarette purchasers also pick up a high profit margin fountain soda.

"You have to look at the value of that transaction as a whole," Bishop concluded.

"The industry is traditionally slow to embrace change," said Modi of the importance of cigarettes. "It's still a large category--it's not going away."

Managing a tobacco category in which OTP represents the greatest potential for growth, but cigarettes are still the most crucial sales driver may seem impossible for retailers dealing with limited space or restrictive cigarette contracts. The truth is, tobacco is a changing category--and successful retailers need to constantly adjust to the shifting trends.

"Good retailers are looking at the category every day," Szarmach said. "They're slicing and dicing their business for the best possible fit."