First the good news: In 2015, cigar volumes were up. Management Science Associates (MSA) retail shipment data shows large-cigar sales (which includes cigarillos) grew by 7% last year.
Now for the less welcome news: Volume growth came at the expense of profits, as consumers snapped up two, three, four or more sticks for just 99 cents. Yup, we’re talking about prepricing.
“An increase in prepriced promotion volume is fueling the increase in large-cigar sales,” says Don Burke, senior vice president of Pittsburgh-based MSA. “Such promotions continue to drive overall volume while all other promotions fall flat.”
Mention prepricing and many convenience-store retailers shake their heads. The uber-popular promotions have pulled needed margin out of the category. Volumes take off, but the increase in unit sales comes at a cost as profits drop and premium sales suffer.
Now, many retailers are looking to manufacturers to help turn around this race to the bottom with ideas to move customers to higher grades and prices and ultimately increase profit.
So has the time arrived to enter the “race from the bottom” and make those sticks pay off again? We asked retailers and industry analysts to share their observations and strategies.
Prepricing = Big Volume
Alex Davidovich, executive vice president of business development for Town Star Stores, Port St. Lucie, Fla., likes prepriced cigars. “Customers know how much the cigars cost when they come in so there’s no sticker shock,” he says. He makes as much room as possible on the shelf for the wide variety of cigar flavors he carries, especially Swisher Sweets. “I put the prepriced cigars out where they are visible,” Davidovich says.
And the Florida retailer is not worried about lost margins from prepriced cigars: “We make our margin with the larger market baskets of cigar customers.”
Davidovich’s primary supplier, Swisher International Inc., has been tops in volume in the cigar category for several years. The Darien, Conn.-based manufacturer continues to introduce new flavors for consumers in its prepriced packs, including the popular Sweets brand.
Prepricing provides consistency on the shelf, which consumers appreciate, says Jeff Rossi, senior director of trade marketing for Swisher. The company plans to continue its pricing programs, which it says makes the most sense for consumer demand and delivers steady profit to both retailers and distributors.
ITG Brands also preprices cigars, such as its Dutch by Dutch Masters in two-for-99-cents options. “Consumers are demanding value price products,” says a spokesperson for ITG Brands (who spoke on condition of anonymity).
While manufacturers are on board with the upsides of prepricing, there are many retailers who have long lamented the loss of control.
Ben Reinhart, vice president of merchandising for Seymour, Ind.-based Kocolene Development Corp., is not a big fan of prepriced products because it limits the company’s ability to manage margin. He has had offers to price cigars at even greater discounts, including offering three or four cigars for less than $1, but has turned them down … for now.
“Our competition is not offering those deals, and we don’t want to lower our margin by bringing them in if we don’t have to,” he says.
“Prepricing, as it’s evolved in cigars, requires that retailers sell many more units just to maintain current dollar sales levels,” says David Bishop, managing partner of sales for Balvor LLC, a Barrington, Ill.-based marketing firm. “Retailers can end up losing penny profits due to lower price points.”
One option to draw customers toward mid- and upper-priced cigars, Reinhart says, is limiting the number of lower-tier offerings. “You may lose some customers, but some will switch to the middle-of-the-road product out of convenience,” he says.
Choosing between profits and lost customers, however, is not a great proposition. “Retailers hate preprice but most don’t have a choice,” says Leonard Wortzel, vice president of marketing and product development for Scandinavian Tobacco Group Lane Ltd., Tucker, Ga. “It really puts them in a tough position.”
Puffing Upward?
Wortzel says his company is using its slightly larger Havana Honeys cigars to drive sales toward more mid- to premium product and build margin. Havana Honeys’ suggested retail price is $1.89.
“The premium-cigar smoker on a short break would find this stick satisfying,” he says. “We want to give consumers a reason to walk back up the price scale.”
Also opposing prepricing is Kretek International, Moorpark, Calif. The company touts Djarum, a premium line that yields a market basket in the $10 to $20 range, says Albert Jose, Kretek’s senior brand manager.
It’s not always an either/or situation. Though they offer some prepriced cigars, ITG’s portfolio skews heavier in nonprepriced products. The company believes consumers are willing to pay a little more for premium offers, including ITG’s leading brands, Dutch Masters and Backwoods.
“We’ve seen the explosion in the last few years of deep discount products (three for 99 cents and four for 99 cents),” says ITG’s spokesperson. “But this has slowed drastically. Today, smokers prefer paying a bit more for quality.”
With Swisher’s purchase of premium-cigar manufacturer Drew Estate Tobacco Co., it looks like there will be more upgrades on the horizon. In summer 2015, Swisher launched Acid premium cigarillos, a natural-leaf cigarillo developed in collaboration with Drew Estate, in both nonprepriced and prepriced 99-cents options.
Not surprisingly, retailers are embracing this race from the bottom. Preprice fan Davidovich is introducing Swisher’s Drew Estate line in his stores (albeit the prepriced options). They are selling well, he says, adding that cigar sales are different in Florida, where there is no tax on large cigars and small cigars have a lower tax rate than cigarettes.
Kocolene’s tobacco outlets take it a step further, carrying premium products in packaging that ensures freshness and fitting seven stores with humidors for the premium consumer. It’s a small but profitable niche for the Seymour, Ind.-based retailer. (Kocolene recently sold its c-stores to Circle K but continues to operate tobacco outlets and service stations).
“We don’t have a lot of turns on premium cigars, but the margin is great for the sales we do have,” says Reinhart.
Manufacturers are making moves that may help balance the category, giving retailers more options toward earning profit. Scandinavian recently launched two cigarillos that Wortzel says give retailers more margin choice while driving volume. Havana Honeys and Cubero can be sold as two for 99 cents, but they are not prepriced.
Likewise, Swisher’s go-forward strategy focuses on products that strike a balance between prepriced and premium, Rossi says, citing plans to expand distribution of the Acid G-Fresh line in mid-2016.
“Swisher will look to drive greater margin growth for its retail partners with expanded premium offerings during 2016 and beyond,” Rossi says.
Striking a Balance
Just as many manufacturers are striking a balance between consumer demand for value-driven preprice options and more mid- to premium cigars, retailers are also seeking to enjoy the benefits of both.
Reinhart seeks to “control prepricing as much as possible,” but sees some value in offering the two-for-99 cents deals currently popular in Kocolene’s Indiana base.
“Even though customers are pretty price sensitive in our market, the two-for-99 (cents) deal gives the customer a trial,” Reinhart explains. “If they really like the cigar, they may be willing to buy a five- or 10-pack, which results in higher margin.”
Although Brion Gillett, a cigar and tobacco industry veteran of 50 years, agrees prepricing can be a good temporary tool to promote new products, he points to the risk of endless prepricing.
“Constant prepricing destroys the integrity of natural wrapped cigars,” he says. “If more retailers take a stand and say they do not want prepriced product except in a special set that is in and out, margin and mid- to premium sales would build. A limited-time promotion of prepriced product is valued more by the consumer.”
Like many analysts and retailers, Wortzel believes the category needs product and price diversity—and ideally some signage to promote the unique aspects of higher-priced options.
“Explain why the premium cigar is worth what is charged,” he says. “Retailers need to carry both promotional products and at the same time ensure visible space for more quality, nonprepriced brands,” agrees the ITG spokesperson, adding that the price difference between prepriced and nonprepriced should remain reasonable.
Convenience stores will evaluate what makes sense for their businesses, factoring in monies from retail, trade contracts, competitive situations, and how the consumer will respond, says Balvor’s Bishop.
Value or premium, the retailer should be in control of the category with the main goal of doing what is right for customers, Gillett says.
“The sign outside the store has the retailer’s name, not the manufacturer’s,” he says.
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