A Look at Tobacco in 2012 ... So Far
From Marlboro's renaissance to the FDA's hoops for modified risk, analysts break down the biggest news in tobacco this year.
With more than half of the year gone as of this writing, 2012 has had plenty of important tobacco stories: President Obama effectively shut down the RYO movement with the Transportation Bill, powerhouse Altria got a new leader, e-cigs exploded onto the scene, and voters said close but no cigar to California’s divisive Prop 29 tobacco tax.
Perhaps one of the more controversial news stories for the category came from accusations made in a Centers for Disease Control and Prevention (CDC) report titled “Consumption of Cigarettes and Combustible Tobacco—United States, 2000-2011.” Released Aug. 3, this document alleged cigarette smokers were switching to less taxed cigars and RYO tobacco products, citing a slight 0.8% decrease in combustible-tobacco use from 2010 to 2011—a minuscule number considering a 32.8% decrease in pre-manufactured cigarette use from 2000 to 2011.
“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,” the report’s editors wrote.
Bonnie Herzog, senior analyst and managing director of tobacco, beverage and consumer research for New York’s Wells Fargo Securities LLC, has a different view of such numbers.
“It ultimately suggests that people enjoy tobacco, and they’re going to enjoy it in many different forms,” Herzog says of increasing shares cigars, smokeless and RYO have had in the category. “I think that’s the opportunity and the future.”
CSP recruited Herzog and other leading players in the tobacco category to help analyze the biggest surprises so far this year—and what opportunities such trends might open up in the future.
The Cowboy Rides Again
Marlboro has long sat at the top of the cigarette segment, so the brand’s success may not come as a huge surprise. However, with cigarette sales declining overall, CEO Michael Szymanczyk stepping down from parent company Altria, and many retailers disenfranchised with the maligned Marlboro Leadership Price (MLP) option, many analysts—including Herzog—questioned if the Richmond, Va.-based Philip Morris brand had peaked. Marlboro’s numbers in 2012 suggest otherwise.
“If you look at how the brand’s performed over the past six months, Marlboro increased its retail share by 0.3% in the second quarter of 2012; that’s a share of 42.9%,” says Altria spokesman Brian May. According to a Wells Fargo second-quarter earnings note, this 42.9% share surpasses Marlboro’s recent share peak of 42.8% in the second quarter of 2010.
“One of the key surprises of 2012 has been the reacceleration of Marlboro’s market share,” says Andrew Kieley, a tobacco analyst with New York-based Deutsche Bank. According to Kieley, this reacceleration came from “new promotions, retail programs and innovation, notably Marlboro Black.”
Launched in December 2011, Marlboro Black represents the newest of the “four flavor families” that make up the brand: Marlboro Red, Marlboro Gold, Marlboro Green and Marlboro Black, which Philip Morris describes as a “bold, modern spin on the traditional brand.” The company has recently made efforts to display Black and the other “families” on the retail level.
“If you look at the cigarette category and performance for the first half of this year, Marlboro grew its retail share through various brand-building initiatives supporting Marlboro’s new architecture and retail look,” May explains.
“It’s a tough thing,” says Herzog, who applauds such innovative efforts by the company. “Marlboro is a very strong brand, one of the most iconic brands in the world. It’s been extended, and time will tell if they can keep and retain some of these Marlboro consumers. They have been, but it’s something we’re watching closely.”
But Marlboro’s success isn’t merely about consumer satisfaction with its variety of products. It’s about satisfaction on the retail level as well, something Philip Morris has struggled with in the past.
“This is not any different than it is in the beverage category or the snacks category; I wouldn’t expect anything different,” Herzog says. “It speaks to the power and muscle of that company. You have to remember that, in tobacco, Philip Morris really has significant muscle compared to its closest competitor (as opposed to Coke and Pepsi). Pepsi is a closer No. 2 than what Reynolds is by virtue of share. That’s something that shouldn’t be underestimated.”
Still, Herzog says she does “think Altria is now entering a phase where I believe they’re going to work a little bit better with the retailers.”
While Marlboro has extended the less-popular MLP program, it also introduced a more retailer-friendly Flexible Option alternative in January 2012. According to Altria, this new option “allows retailers to have the flexibility to apply additional Marlboro promotional allowances in a variety of ways that best align with their strategy, while still focusing on Marlboro.”
The move is just one of many ways in which Altria has made changes to its business in response to retailer feedback.
“All of Altria’s tobacco companies value retailer feedback and actively seek it out,” says May, who lists Altria’s sales force, company-hosted retailer forums and involvement with various trade associations as ways the company gathers commentary from its retailers. “If you’re not asking for it, you might not get it.”
This kind of mutually beneficial communication with retailers could represent the answer to not only how Marlboro has grown its market share in 2012, but also how the industry giant could continue to grow its brand for years to come.
“I feel the changes they’ve made to their contracts seem to be a little more retailer-friendly,” Herzog says. “I think they’re willing to possibly compromise. If they can do this while retaining the share, that’s the goal.”
Big Tobacco Embraces Change
While Marlboro’s performance going from strong to stronger isn’t exactly earth-shattering, 2012 has offered its share of jaw droppers. Perhaps most notable would be an unexpected player venturing into untested waters.
“To me, the biggest surprise was the acquisition of blu eCigs by Lorillard,” says Michael Siegel, a tobacco researcher and professor at Boston University’s School of Public Health, referring to the $135 million April acquisition. “That truly changes the playing field, and it is a solid indication that electronic cigarettes are here to stay and may be able to make a significant impact in the market.”
But why all the fuss? Currently, electronic cigarettes represent less than 1% of tobacco-related sales, with an estimated 2.5 million e-cig smokers in the United States. But as power players such as Jacksonville, Fla.’s Swisher join Greensboro, N.C.’s Lorillard in the segment, electronic cigarettes are proving they’re more than just a fad. (See p. 163 for more on Swisher’s e-cig move.)
“It was expected that, as this category starts to go into a high growth stage, it was going to attract the attention of traditional tobacco players,” says Roy Anise, executive vice president of e-cig leader NJOY, Scottsdale, Ariz. “Reports put out by some of the analysts have been very favorable. That’s going to generate additional interest.”
Herzog is one of many analysts to issue favorable reports on the potential of electronic cigarettes, going so far as to predict that e-cigs could one day surpass traditional cigarettes in terms of both market and dollar share. As such, she wasn’t caught off guard when one of the big three tobacco companies got involved in growing the segment.
“I assumed one of these three or all of them would be in this category,” Herzog says, admitting she was surprised by which company was the first to do so. “Reynolds seems to have been typically more of a leader and willing to take on some risk in entering new segments or categories. But Lorillard made the first move.”
With Reynolds testing e-cigs in limited markets and experts speculating Altria will announce its own e-cig venture in the very near future, big tobacco appears to have endorsed the nascent category. Perhaps more important than the validation is the power such established companies can lend to the ongoing FDA discussions on how to regulate e-cigs—something that could make or break products many believe to represent the future of the tobacco industry.
“I don’t know if it will occur in the next year, but the FDA will most definitely be announcing regulations for electronic cigarettes and cigars,” says Siegel. “The nature of these regulations will be of great importance to the industry and could impact steps the companies take in terms of developing or not developing harm-reduction products. I do think that electronic cigarettes will continue to take off, so the decision of the FDA about how to regulate electronic cigarettes is going to be critical.”
Regulations Good and Bad
An important step toward the regulation of harm-reduction products such as electronic cigarettes came in March, when the FDA publicly introduced the guidelines for products to be marketed as reduced or modified risk. Referencing the Tobacco Control Act, which states tobacco products can’t be marketed as reduced risk without scientific support, the draft guidance outlines what tobacco manufacturers must do to certify a product as modified or reduced risk. According to Lawrence Deyton, director of the FDA’s Center for Tobacco Products, the guidance “sets very high scientific standards for demonstrating that products sold to reduce harm or risk actually do so.”
Some see this action as a step in the right direction. Kieley says he’s impressed with the “FDA’s willingness to keep an open mind toward modified-risk products.”
Others see the modified-risk tobacco products (MRTP) guidance as a huge obstacle to companies trying to get into the reduced-risk market. Siegel believes the guidelines clearly indicate that the FDA “is going to make it virtually impossible for tobacco companies to market reduced-risk or reduced-exposure products. While not stopping the companies from going down this route, it sure puts a damper on things and makes it much more challenging for the companies to be successful in the harm-reduction market.”
While it’s too early to tell whether the FDA’s MRTP guidelines will inspire companies into or deter them from pursuing harm-reduction products, the majority of legislative and regulatory news has been positive for the tobacco industry, especially on the state level. Of the 27 states that proposed cigarette and/or tobacco tax increases in 2012, only three passed such measures.
“This positive outcome in 2012 mirrors the state legislative results in 2011 when only two states, Connecticut and Vermont, raised cigarette and tobacco tax rates, while New Hampshire actually reduced the taxes on cigarettes by 10 cents per pack,” says Thomas Briant, executive director of the Minneapolis-based National Association of Tobacco Outlets (NATO). “The outcome of the 2012 state legislative session is positive for retailers because the vast majority of stores will not experience higher cigarette and tobacco tax rates.”
Other 2012 legislative victories for tobacco retailers include the voluntary repeal of Lake Haverstraw, N.Y.’s tobacco display ban; the decision to overturn the Worcester, Mass., ban on indoor and outdoor tobacco advertising; and the continued opposition from both state and federal courts to mandatory graphic warning signs and labels.
With NATO joining R.J. Reynolds Tobacco Co., Philip Morris USA and Lorillard Tobacco Co. in the successful lawsuit against the City of Worcester, Briant says this victory “sets a precedent that will deter other cities from attempting to ban tobacco advertising and result in protecting the rights of retailers to advertise legal tobacco products.”
So what does all of this mean? A tobacco leader re-establishing its dominance, big companies testing new tobacco innovations, the FDA attempting to assert its control over new markets, manufacturers fighting unconstitutional legislation—are any of these stories all that new or unexpected? Perhaps not, but such events have all helped the tobacco category continue to grow and thrive in the face of stricter regulations, higher taxes and advanced scrutiny.
As Herzog says, “people enjoy tobacco”; as long as players in the category are willing to embrace innovation and stand up for their right to manufacture and sell legal products, tobacco will continue to grow and thrive through 2012 and beyond.