Americans Quit Cigarettes But Take Up Cigars.” “Big Cigars Offer Way for Smokers to Save.” “Tobacco Companies Profit From Loophole.”
This is just a small sampling of headlines covering a U.S. Centers for Disease Control and Prevention (CDC) report titled “Consumption of Cigarettes and Combustible Tobacco—United States, 2000-2011.” Released Aug. 3, the report looks at overall combustible-tobacco consumption over the past decade using excise tax data from the U.S. Department of Treasury’s Alcohol and Tobacco Tax and Trade Bureau (TTB).
However, it wasn’t the data collected by the CDC that had the media abuzz. It was the sound-bite-friendly hypothesis the organization made based on that data. According to the report, cigarette consumption continued to fall while lower-taxed cigars and loose tobacco consumption increased, suggesting that cigarette smokers have been switching to cigars and loose tobacco.
And it’s a big problem.
The report warns, “The evidence that the increase in cigar and pipe tobacco use is the result of offering cigarette smokers a low-priced alternative product is a particular public health concern.”
And it’s not just the media that’s up in arms: The report has been cited by politicians and anti-tobacco advocates calling for stricter regulations and higher taxes on OTP. The CDC’s claim in part prompted Rep. Henry Waxman (D-Calif.) to write a letter urging the FDA to assert jurisdiction under cigars and pipe tobacco, proclaiming that “forceful and timely intervention by FDA can stop the tobacco companies from exploiting loopholes and endangering our youth.”
While the concept that Big Tobacco is using federal loopholes to lure cigarette smokers to lower-priced products may be appealing to the media and anti-tobacco advocates, many individuals who are actually in the business of cigars, RYO and OTP have questioned the legitimacy of such claims—particularly the lack of evidence the CDC presented to link the decrease in cigarettes to the increase in cigars and loose tobacco.
“When you take a look at the report, it’s basically regurgitating unit and dollar growth and trying to link that up with taxes,” says Paul Marquardt, vice president of marketing for Phoenix-based Prime Time International. While the company admits recent category gains might not be completely unrelated to cost, Marquardt says, “Ninety-nine percent of what we’re talking about here is unrelated to the tax and has a lot more to do with consumers in general.”
It’s a complicated issue, one that requires an examination of how the CDC came to such a conclusion, whether or not this conclusion matches up to both sales figures and consumer behavior—or whether other factors are at play. In an effort to clear the air, CSP recruited input from the CDC as well as tobacco analysts, manufacturers and distributors to break down what’s really going on with tobacco.
The Numbers Game
Numbers are at the heart of the “Consumption of Cigarettes and Combustible Tobacco” report’s findings. Specifically, the numbers depicting a drastic reduction in cigarette consumption, including a 2.6% decrease from 2010 to 2011, but a significantly less drastic reduction in overall combustible consumption: just 0.8% during the same time period.
The report says this negligible decline in overall consumption is “in part because of the effect of continued increases in the consumption of non-cigarette combustible tobacco products.” Per the CDC, consumption of non-cigarette products (such as cigars and RYO/pipe tobacco) increased 17.4% from 2010 to 2011.
Given the recent uproar over the tax discrepancies between cigarette and pipe tobacco used for RYO purposes, such findings are not surprising to many in the industry, including UBS senior market analyst Nik Modi.
“I agree with the findings of this report,” says Modi, who covers tobacco for the New York-based financial services company. “We have seen a pretty dramatic increase in consumers using pipe tobacco to make their own cigarettes.”
“We’ve seen that trend,” agrees Dennis Williams, national accounts manager for Harold Levinson Associates, Farmingdale, N.Y. “As a national distributor of cigar and tobacco products, we’ve seen the increase over the last 10 years in the RYO category, as well as cigars, little cigars, snus, snuff—across the whole gamut of OTP products.”
Still, others object to the notion that cigars are benefiting from a breadth of cigarette smokers switching over to a lesser-taxed alternative.
“I don’t know if I would paint it quite that rosy,” says John Mayer, product director of cigarettes and OTP for Temple, Texas-based McLane Co. “Cigars took a hit on the last federal excise tax increase, just as cigarettes did.”
The numbers from the 2012 CSP Category Management Handbook support Mayer’s claims: According to SymphonyIRI Group data, c-store cigar dollar sales dropped 1.7% from 2010 to 2011. And while cigar units did rise 4.1% during that time period, the segment experienced double-digit unit growth the previous year.
But it’s not just outside numbers that are problematic for the “Consumption of Cigarettes and Combustible Tobacco” report’s data: Critics question how exactly the CDC tracked consumption.
The report states the CDC was able to make comparisons between loose tobacco and cigarettes by converting “tax data from pounds of tobacco to a per-cigarette equivalent, based on the conversion formula contained in the Master Settlement Agreement.” The math is clearly outlined: 0.0325 ounces (or 0.9 grams) of loose tobacco equates to one cigarette, making a side-by-side comparison feasible.
But what about cigars, which were lumped in with loose tobacco as “non-cigarette combustible tobacco” in the report’s findings? “We did not convert cigars because they are already manufactured as individual units,” a CDC spokesperson told CSP on condition of anonymity.
Additionally, the CDC’s own data seems to contradict its claim that extreme escalations in non-cigarette combustible consumption were the result of 2009 tax increases, which further widened the price gap between cigarettes and OTP. Yes, the “Consumption of Cigarettes and Combustible Tobacco” numbers show total consumption of non-cigarette tobacco increases 18% from 2009 to 2010 and 17.4% from 2010 to 2011. However, the most drastic increase in non-cigarette consumption happened from 2004 to 2005—when the report shows total consumption rose 19.8%. According to the CDC, it could not explain why such drastic growth would occur in the pre-SCHIP era.
Ultimately, though, it’s not the smaller details of the report that tobacco manufacturers object to, but the wider accusations: specifically, the claim that “recent changes in consumption patterns, particularly increases in large-cigar and pipe-tobacco use, have resulted in a slowing of the decline in consumption of all combustible tobacco, and indicate that certain cigarette smokers have switched to using lower-taxed non-cigarette combustible products.”
As Marquardt previously admitted, the claim may not be entirely untrue— just greatly exaggerated. “It’s all about scale here,” he says. “The way they’ve written this, someone who can’t read between the lines will think everyone will be smoking cigars in a couple of years.”
Because cigarettes make up such a vast majority of tobacco sales, radical increases in cigars, loose tobacco or any kind of OTP cannot combat even a minor drop in cigarette sales. For example, CSP’s exclusive Midyear Category Data Report (CSP—Sept. ’12, p. 68) shows a 1% rise in cigarette dollar sales for the year ending June 10, 2012—a figure that equates to $24.4 billion in c-store sales. While OTP dollar sales increased significantly more—by 8%—that figure equates to a mere $2.2 billion in sales.
Those who sell tobacco products agree that the rising demand for cigars, OTP and loose tobacco still falls far short of covering the loss of revenue from decreasing cigarette sales.
“We’ve had to find other profit centers,” says Williams of Harold Levinson Associates. “The whole OTP category has covered some of it, but for the most part larger distributors and your average c-store have had to find alternate sources of income, like foodservice or coffee.”
While the CDC acknowledges the scale of cigarette to non-cigarette consumption, it was only to showcase how greatly the percentage of non-cigarette consumption has increased over the past decade, going from 3.4% of total consumption to 10.4%. While it’s an impressive shift, the report fails to acknowledge that cigarette consumption still accounts for nearly 90% of total tobacco consumption in the United States.
“You’re comparing one grain of sand vs. the entire beach,” Marquardt says.
Pack-of-Stogies-a-Day Habit
With so many different numbers coming from the CDC, manufacturers and industry analysts say, it may be impossible to decipher whether or not the data presented in “Consumption of Cigarettes and Combustible Tobacco” truly validates the theories offered by the report. But it’s not just the numbers tobacco manufacturers and retailers are protesting; they’ve also questioned the idea that cigarette smokers could or would replace their habit with cigars or RYO tobacco.
First and foremost, there’s the question of whether or not “switching” to cigars or RYO would actually save cigarette smokers money (which is less of an issue with RYO now that RYO operators are taxed as tobacco manufacturers). While most cigars and loose tobacco are undoubtedly taxed at lower rates on the federal level, are they actually a less expensive habit?
“I’m not going to argue that cigars are taxed at the same rate as cigarettes, but the reality is, if you’re looking to buy one cigar, in a lot of states, you’re looking at $1,” says Marquardt. “If you try to equate that one-to-one to the cost of cigarette consumption, it would be $20 for a pack.”
Of course, Marquardt is referring to individually sold large cigars, citing that little cigars (which come in packs comparable to cigarettes) are in fact taxed at the same rate as cigarettes. The style of cigars the CDC specifically targeted was not large cigars or official little cigars, but similarly sized small cigars that avoided the 2009 SCHIP tax increase.
“Manufacturers were able to increase the per-unit weight of certain small cigars to take advantage of a tax benefit when classified as large cigars,” the report reads. “As a result of relatively minor increases in per-unit weight, the new ‘large cigar’ can appear almost identical to a ‘small cigar,’ which resembles a typical cigarette and can cost as little as 7 cents per cigar.”
While the CDC called out these “small cigars,” the report did not provide any data to show that this style of cigar was gaining more than traditional large cigars. “The data used in this report did not differentiate between different types of cigars,” the CDC spokesperson admitted.
Perhaps if the CDC had tracked the consumption patterns of different cigar types, it would have discovered what wholesalers such as McLane Co. have long known: It’s not cigarette-like cigar packs that are accounting for segment growth.
“Smaller cigars have been getting most of the increase, meaning the cigarillo size, not the ‘little’ size,” Mayer says. “Manufacturers have made changes in terms of the pack size available on cigarillos. Instead of the consumer having to buy five cigars at a time, manufacturers have expanded the number of packs available, which allow the consumer to purchase one, two and three cigars at a time. This in turn makes the cost a little bit more palatable to the consumer.”
Marquardt agrees: “I think the whole point is this really is a baseless comment. [The CDC] is saying little cigars may also be appealing to teens; the reality is, when youth start smoking, the vast preponderance of the evidence shows they start smoking cigarettes. The reason is: Cigarettes are designed and made in a way to be palatable to have a certain sweetness, to be easy to smoke.”
While the easy smoking experience of a manufactured cigarette might appeal to new smokers, it could also explain why certain tobacco smokers prefer the experience of a cigar or even an RYO cigarette.
“Manufactured cigarettes are sold as a pre-blended product with a predetermined taste and flavor,” says Steve Sandman, vice president of RYO tobacco manufacturer Republic Tobacco, Glenview, Ill. “Consumers that choose to make their own cigarettes will often experiment with different tobaccos and will ultimately find the blend that suits their tastes, and even alter their blends depending on what type of flavor and taste they are in the mood for at the time.”
As for cigars, manufacturers such as Moorpark, Calif.-based Kretek International Inc. have made it a priority to understand what draws consumers to its products. The company’s 2012 National Awareness Attitudes and Usage Study (conducted by ECH Solutions) found cost had little to do with the decision.
“The single largest reason for [consumers to] switch to cigars is that they ‘find it relaxing,’ ” says John Geoghegan, Kretek’s director of strategic planning and brand development. “ ‘Aroma’ and ‘taste’ were the second and third reasons given. For smokers of the top 10 brands of mass-market cigars, price was way down the list.”
The simple truth is cigars and cigarettes are very different products. Even smaller cigars take longer to smoke than cigarettes. Because of the way they’re made, the two products smoke differently. While some cigars are filtered, cigars tend to be significantly stronger than cigarettes.
“Cigars aren’t meant to be frequently used, habitual products; they’re designed for occasional, social or supplementary use,” says Marquardt. “I’m not going to claim there aren’t people who break that mold, but the vast majority of people are using cigars in that way. All of that really flies in the face of what the CDC is trying to do in this report.”
All About Taxes?
While cigar and RYO manufacturers offer many valid reasons consumers enjoy their products, these reasons existed long before 2000. So why have cigar and RYO sales skyrocketed in the past decade?
According to the CDC, it’s the tax discrepancy between OTP and cigarettes, which is also the reason cigarette sales have declined over the same time period. But are taxes solely responsible for these changing tobacco trends?
If there’s one theory both the CDC and tobacco manufacturers are on board with, it’s that huge tax incentives are responsible for the recent boom in loose tobacco used for RYO cigarettes. UBS’ research indicates that RYO tobacco (including pipe tobacco) volumes at retail have increased 55% since 2006. Pipe tobacco used for RYO purposes has accounted for the surge in loose tobacco; pipe tobacco is taxed at $2.8311 per pound vs. $24.78 per pound for tobacco sold as RYO.
“Assuming a smoker uses the same tube, paper, etc., when making their own cigarette, a consumer would pay nearly 87 cents less in federal excise taxes per stick equivalent by using pipe tobacco,” says David Bishop, managing partner of sales and marketing consulting firm Balvor LLC, Barrington, Ill. “This in turn would equate to a pack savings of over $17, highlighting the economic value to an everyday adult smoker.”
It was this vast discrepancy that prompted NACS, NATO and other retail organizations to call for RYO reform. Now that such reform has passed, Modi predicts the future of RYO is hazy at best.
Although common ground was found on RYO, the CDC and tobacco manufacturers have vastly different opinions on why cigarette consumption is declining as cigar consumption is on the rise. Everyone can admit that taxes play a role, but those in the business of tobacco believe there are many other factors involved in both the decline of cigarettes and rise of cigars.
“The reason cigarettes are declining is pretty obvious: Public awareness is increasing,” Marquardt says. “[Cigarettes] are going to continue to see consumption decline.”
Geoghegan agrees, blaming lower cigarette sales on “smokers quitting for health reasons, social pressure and high taxes.”
What, however, is drawing new consumers to cigars if it’s not mainly former cigarette smokers picking up stogies?
“Innovation,” says Williams, citing manufacturers and operators. “Retailers have done a really good job in merchandising the category better in their stores. Consumers not only have a choice, but they have a section they can actually shop at.”
“Over the last five to 10 years you’ve seen a lot of innovation in terms of packaging variance, flavor and variety of options,” Marquardt says. “Buyers are demanding different types of products overall.”
And while stricter regulations on when, where and how people can smoke may have hurt cigarette sales, some are of the opinion that such measures have helped cigars.
“I believe that restriction and regulation have made the smoking occasion a more precious piece of time,” says Geoghegan. “People are smoking better because they are smoking less often. Consumers have told us they can get more enjoyment out of the time they take for a cigar.”
Who’s Right?
At the end of the day, tobacco is an incredibly complex category. As such, there’s very little black and white—and lots of smoky gray. Is the claim that cigarette smokers have been enticed by lower-taxed options correct? Probably, but not to the extent that the “Consumption of Cigarettes and Combustible Tobacco” report claims. And it’s certainly not the simple bait-and-switch many news stories have focused on.
“It’s not so much a ‘switch’ as it is a part of smoker experimentation with different forms of tobacco,” Geoghegan says. “For example, a significant number of Djarum cigar smokers also smoke other cigars, e-cigarettes and, surprisingly, snus. The variety of delivery forms like smokeless and e-cigarettes allows tobacco users to fit different products into different environments.”
Geoghegan credits such smoker experimentation with negative cigarette press activity, local restrictions and the higher cost of cigarettes due in part to taxes.
“Consumers are migrating to other forms of tobacco and smokers are smoking less per day,” Modi says of the past decade’s tobacco consumption, also citing the “migration of cigarette smokers to other tobacco products like smokeless.”
And what of the CDC’s claim that non-cigarette consumption has made up for falling cigarette consumption? Again, the answer is not as simple as the report makes it out to be, especially because the report only covers combustible tobacco—ignoring increases to alternatives such as smokeless and electronic cigarettes (even though these nascent segments represent a meager slice of the total market).
“The number of tobacco users probably hasn’t changed that much over the last 10 years,” Williams admits. “However, the shift is definitely moving from traditional cigarettes to utilizing another form of tobacco. We’ll continue to see the category evolve.”
Perhaps the biggest threat the “Consumption of Cigarettes and Combustible Tobacco” report poses is the legislative action it seemingly calls for—which may have been the ultimate intent of the CDC to begin with.
“Whether you agree or disagree with the report, the implication is clear,” says Bishop. “[It] provides the evidence that politicians and various groups will use to argue for higher taxes at both the federal and state level.”
With Rep. Waxman already arguing for higher taxes and stricter regulations based on the CDC report, at least one manufacturer is fighting back: On Sept. 21, Prime Time International sent its own letter to the head of the FDA, urging the organization to look at more concrete data.
“We’re simply asking [the FDA] to consider the broad-based studies of more validity rather than the smaller CDC study,” says James Deer, secretary and general counsel for Prime Time, citing the Substance Abuse and Mental Health Services Administration (SAMHSA) report as one of many government studies refuting the CDC’s data. “The industry needs to be a little more forthright about correcting a lot of the things that become matters of so-called public knowledge.”
And while tobacco manufacturers rarely celebrate tax increases or stricter guidelines, it’s the simplification of an incredibly complicated issue that most offends them.
“The fault is not so much with the report as it is with the reporting,” Geoghegan says. “Tobacco use is a complex social issue. It is legal, it involves nicotine, it’s a big industry, and it has a very vocal and influential opposition. It’s easy for the press to summarize the in-depth CDC report in a few sound bites.”
Only time will tell if those few sound bites prompt drastic changes in the way cigars and loose tobacco are taxed.
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