Wacky, volatile, unpredictable: These are just a few of the adjectives one could use to describe today’s state of tobacco.
With local communities threatening new sales bans, a bevy of states considering higher taxes and manufacturers giving rise to new segments, it doesn’t take much imagination to understand how retailers could look at their No. 1 category with a somewhat blurry eye.
So when more than 50 tobacco retailers, manufacturers and distributors gathered in Chicago in September to take part in CSP’s annual Tobacco Category Review Meeting, there was no shortage of conversation.
A pre-meeting survey of retail participants, one-on-one conversations and roundtable discussions revealed a multitude of concerns, such as contract limits and rising prices, and how these issues affect outside competition.
As far as pricing, the survey showed cost increases are still one of the biggest problems facing retailers, with every survey respondent listing cost increases as either “critically important” (58.3%) or “somewhat challenging” (41.7%).
And while results suggested the relationship between retailers and suppliers has improved (with 41.7% of respondents saying vendor relations are “not really a problem”), survey comments and roundtable discussions hinted at ongoing problems with contracts enforced by suppliers. When asked about the biggest challenge to the tobacco category, several survey participants referenced contracts, listing “navigating tobacco company contracts” and “major cigarette manufacturer contracts.”
At the roundtable discussion, retailers and e-cigarette manufacturers alike expressed concerns about major manufacturers imposing cigarette-like contracts on OTP and e-cigs as they get into the expanding categories.
“The influence contract agreements have on pricing and promotions,” said one retailer when asked what his company would change about tobacco category management. “It’s difficult to maintain pricing competitiveness and grow the overall category with agreements.”
Maintaining an edge against the competition for tobacco sales was another crucial worry expressed by retailers. There’s the new threat posed by dollar stores such as Family Dollar (which 50% of survey respondents listed as “somewhat challenging”), as well as the ongoing threat from Native American reservations—some of which are starting to manufacture cigars and smokeless products. And while Internet and mail-order tobacco may appear to be a thing of the past, one distributor warned that popular OTP products are “more widely available than you think” via such outlets.
However, the biggest competition facing tobacco retailers might not come from other sales outlets, but local government. While other brick-and-mortar and online retailers represent a threat to c-store sales, local ordinances determining when, where and how retailers can sell tobacco could be more detrimental if enacted.
Yes, the tobacco advertising ban in Worchester, Mass.; the tobacco display ban in Haverstraw, N.Y.; and the graphic warning ads in New York all were blocked or overturned—but with NATO fighting 15 bills through 2013, local government represents a significant threat to the tobacco retailer.
The Local Front
Welcome to Tom Briant’s world. Executive director of the National Association of Tobacco Outlets, Briant and his team spend their days trolling the news, municipal councils, health departments and other bodies capable of further restricting the sale of a legal category.
NATO’s work is recognized by the largest tobacco manufacturers, as well as scores of retailers and analysts, none of whom share NATO’s ability to seemingly spot the proverbial needle in the haystack. So when Briant shared at the tobacco meeting the story of Worcester, Mass., everyone took note.
In April 2011, Worcester passed one of the most restrictive tobacco advertising laws in the country, banning all outdoor advertising and all in-store advertising that could be viewed from the street. Objecting to what they asserted was a clear violation of the First Amendment, NATO and several tobacco manufacturers sued the city of Worcester—and were successful in their efforts to overturn the ban.
But why should retailers outside of Worcester care? “These local issues are very important for the entire retail industry across the country,” Briant said. “The Worcester, Mass., court ruling can be used as a precedent to prevent other cities from proposing and adopting a similar advertising ban law.”
It’s an important victory considering the money tobacco retailers are up against. Briant specifically referenced the 2009 American Recovery and Reinvestment Act, which earmarks about $1.5 billion through 2015 to the CDC for local government grants to be used for enacting tobacco-related restrictions. Those restrictions can include anything from advertising for promotions or cigar package sizes to banning the sale of flavored tobacco products or placing more limits on smoking in public.
“This year NATO established a special local ordinance project, and we are working with our field staff to go into these cities, engage retailers and get them to oppose these restrictive measures,” Briant said, citing a recent victory in which NATO and retailers successfully lobbied for the Haverhill, Mass., board of health to remove a provision that would have required cigars to be sold in packages of four, unless the price of an individual cigar was $2.50 or more per cigar.
Briant outlined other local battles NATO is fighting on behalf of tobacco retailers:
- Philadelphia’s graphic health warnings sign: Last year, the Philadelphia Board of Health proposed that graphic warnings signs be placed next to every register at every store selling tobacco products (and received $10 million in stimulus money to lobby for it). A nearly identical ordinance passed by the New York City Board of Health was struck down by the Sixth Circuit Court of Appeals, prompting Philadelphia to put its proposal on hold until late summer, when members of the Philadelphia Board of Health circulated a memo, suggesting it was time to move forward with local graphic warnings sign efforts. “I sent the Philadelphia Board of Health the Sixth Circuit decision on July 20, but the Philadelphia staff members proceeded to issue the memo three weeks later,” Briant said. The Philadelphia Board of Health is expected to hold a hearing later this year.
- Massachusetts’ cigar pack restrictions: Haverhill is not the only city in Massachusetts looking to pass laws requiring cigars to be sold in larger packs or as higher-priced singles. “NATO has responded to 23 of these proposed regulations to date, and so far 17 boards of health have not adopted the restrictions,” said Briant, pointing out that additional Massachusetts cities have proposals on the table to ban tobacco product coupons and promotions.
- Providence and Miami-Dade’s flavored-tobacco bans: This past January, Providence, R.I. officially banned the sale of all flavored tobacco products, and Florida’s Miami-Dade County proposed a similar measure. NATO and several manufacturers sued Providence and, at the time of print, were still waiting to learn whether or not a federal judge would uphold the flavor ban. The Miami- Dade proposal has been postponed indefinitely. “If such a restrictive ordinance is allowed to stand,” said Briant, “other cities could adopt similar restrictions banning the sale of flavored tobacco products and limiting or prohibiting coupon redemption and tobacco product promotions.”
Evolving the Tobacco Set
From legislation to store operations, retailers are participating in a rapidly changing landscape. Even the largest of makers concede that the future tobacco set must be more balanced, equipped with an array of cigars, moist smokeless and emerging segments.
“The world’s most important mega-trend is evolution,” UBS Securities senior analyst Nik Modi said to begin his presentation. He offered a historical snapshot, beginning two centuries ago when cigarettes accounted for only 2% of a tobacco category dominated by smokeless. And with cigarette units on the decline, Modi believes it’s time for the tobacco industry to evolve again, focusing on the real reasons smokers consume tobacco products.
“The reasons for consumption stay consistent. It’s the way we consume the products that changes,” he said. “Tobacco is just the delivery system for nicotine.” The proof? While tobacco consumption (especially cigarette consumption) is falling, the amount of nicotine consumed in the United States has not changed in 40 years.
With products such as smokeless and e-cigs offering consumers more nicotine for their dollars and higher profit margins than cigarettes for retailers, Modi says the time has come for the category to rebrand.
“Reframing the ‘tobacco category’ into the ‘nicotine category’ is the biggest opportunity for everyone in this room,” he said.
Why the makeover? Image, for one. “Tobacco has long had a bad reputation and nicotine gets lumped in with it,” said Modi, pointing out that while tobacco can undoubtedly be linked to cancer, nicotine actually has some medical uses, similar to caffeine.
Such image elevation could offer even more upside if and when the government acknowledges the lower risks associated with low- to no-tobacco products. It’s already happened in Sweden: After the Swedish government recognized the reduced risk of snus, it grew to outsell cigarettes.
“I do believe in the next five years the FDA will endorse relative-risk products,” Modi predicted. “And that will be huge for everyone.”
And while the move from cigarettes to other tobacco products has not been rapid, it has brought in impressive revenue.
“OTP is just more profitable [to manufacturers] than cigarettes,” said Modi, citing that a mere one-point migration from cigarettes equals $1 billion in sales. “Even small changes make a big difference.”
It explains why Lorillard was keen to invest in e-cigarettes, why Altria is exploring low-tobacco and tobacco-free products such as Verve, and why RJ Reynolds has made the bold move to enter NRT.
“We need to redefine how we talk about the category,” Modi said. “ ‘Total tobacco category’ is yesterday’s phrase. It’s now the ‘total nicotine category.’ ”
A Retail Perspective
The fact that there’s a lot of buzz surrounding e-cigarettes is not exactly groundbreaking. Right now, e-cigs represent a miniscule part of the total tobacco pie, with an estimated 2.5 million e-cigarette smokers in the United States, compared to an estimated 45.3 million cigarette smokers.
However, the nascent segment portends outstanding growth potential: UBS reports e-cigarettes have experienced triple-digit sales growth since their inception, and Modi predicts sales to at least double in 2012.
In fact, Wells Fargo analyst Bonnie Herzog has said she believes e-cigarettes sales could surpass tobacco cigarette sales in as little as 10 years. Such enthusiasm has prompted Kristi Prior, CSP’s director of EduNetworking, to dub e-cigarettes as “the new frontier of OTP.”
But this fervor of tomorrow means little today for retailers in the trenches actually selling e-cigarettes. Instead of wondering about utopian growth, operators are vexed with fundamental questions such as which e-cig brands to carry, how many facings, how to effectively merchandise offerings, and where to find real, concrete sales data for a new and often inaccurately tracked segment.
The three retail participants of the Tobacco Category Review Meeting’s culminating e-cig panel have all faced these questions—and all have different solutions.
“I wouldn’t characterize it necessarily as a line extension,” said Trey Powell, director of national procurement and national accounts for Alimentation Couche-Tard, Laval, Quebec. As one of the largest company-owned c-store operators, with more than 6,000 Circle K and Mac’s sites across North America, Couche-Tard is focused more on the total tobacco category than on isolating e-cigs, Powell said.
“We’re committed to succeeding [in tobacco], whether it be through e-cigs or another subcategory,” he said. “In terms of viable nicotine products, we’re bullish on anything the customer wants to buy and is both legal and ethically sound.”
Chris Colon offered a different perspective. “We definitely consider e-cigs to be its own category,” said Colon, category development manager for Cary, N.C.- based The Pantry’s more than 1,600 stores.
Tracee Danchak serves as the marketing director for Fremont, Calif.-based Vintners Distributing, which operates 200 locations in California. Danchak offered a sentiment shared by many operators in the convenience channel: “We didn’t have a really good response to the first e-cigs we brought in,” she said, admitting that at least part of the problem was how Vintners handled the new products. “Now that we’ve brought in two to three more brands, it’s picking up.”
Determining the right number of e-cig brands to carry is still a mixed bag for most retailers: Of the operators in attendance, 50% carried one to two brands, 33% carried three to five, and 17% offered more than five e-cigarettes.
For larger operators such as Couche- Tard, the number of e-cigs could vary from region to region, based on demand. “We have three national suppliers [of e-cigarettes] throughout the chain,” said Powell. “However, each division has the autonomy to select additional brands.”
Perhaps more important than how many is which brands to carry. With the number of e-cig companies expanding, all claiming to have the best product on the market, it’s not easy—especially considering traditional data is hard to come by.
“Data is worthless right now. It reports all over the place,” said Colon of The Pantry, pointing out that many smaller stores don’t report to Nielsen, which also doesn’t track Internet sales. “Having the largest market share doesn’t really matter right now either, as there are smaller brands that perform better against those that have been around for a few years.”
So how does Colon choose which e-brands to stock? “I personally try them all,” he said. “If it tastes gross to you, it will taste gross to your customers.”
That works as long as the buyer appreciates subtle (and sometimes not-so-subtle) differences in quality, a differential that’s increasingly difficult with so many products on the market. Although one of Danchak’s co-workers tries out the various options, “with everything coming from China, there’s not a real difference in products,” she said. Instead of the products themselves, Danchak focuses on “the brand equity and looking at what’s behind it.”
“Ultimately, we are resellers of brands,” agreed Powell. “In most cases, a successful brand already exists and as the retailer we are simply positioned to resell it. However, I don’t think any e-cigs have really distinguished themselves in terms of brand.”
This focus on brand doesn’t necessarily mean retailers should automatically jump on board when big companies invest in e-cigs, as Lorillard has done with blu. “It doesn’t [make a difference] for me,” Colon said of such moves, referencing Red Bull’s success in the energy category compared to Pepsi’s and Coke’s offerings.
Powell sees the lack of brand reputation in e-cigarettes as a unique opportunity for c-store operators. “The c-store channel consists primarily of loyalists,” he said. “If the consumer smokes Marlboros, there’s often little opportunity to convert them to another brand. But it’s not to that point with e-cigarettes yet.”
And though Colon acknowledged that there is certainly an opportunity to sway consumers (and, therefore, the category), he prefers to let consumers take the lead: “What the customer likes is what’s important to me.”
While there are no easy or universal answers when it comes to e-cigs, one area the three panelists agreed upon was the importance of a strong brand presence supporting e-cig programs, especially with costly FDA and state regulations looming.
“Long term, everything we do is very brand-centered,” Powell said. “I’d bet on companies that are focused on building their own brand.”
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