E-Cig Lessons From the Cigarette Margin Squeeze

With Big Three solidly in vapor game, analysts weigh in on what it might mean for category

Melissa Vonder Haar, Freelance Writer

E-Cig Products

NEW YORK --Where have all the promos gone? When it comes to premium cigarettes, those once-flush promo dollars and buybacks have been reinvested in covering Master Settlement Agreement (MSA) payments and steeper excise taxes, often to the detriment of retailers (see CSP magazine's NATO Show Supplement).

It has caused quite a dilemma for convenience store operators, who are still very reliant on cigarette sales to drive business but suffering due to the segments’ plummeting bottom line.

“From a cash-flow perspective, [heavy promotional spending] was much more beneficial for retailers,” Bonnie Herzog, a senior analyst covering tobacco and the c-store channel for New York’s Wells Fargo, told Tobacco E-News. “The lower amounts that are now coming in have been challenging, to say the least--and have continued to squeeze margins.”

It is part of why the boom of electronic cigarette sales has been so beneficial to the channel, offering retailers both attractive margins and rapidly increasing sales.

“Now there’s e-cigs and the vapor category, it’s going to continue to evolve,” Herzog said. “As retailers allocate more shelf space and carry more SKU’s, I think it will benefit them.”

“What retailers would be smart to do is to really see how they could leverage the latent opportunity that exists in that business today to drive stronger growth to help offset a little more of incremental profit declines from cigarettes,” added David Bishop, managing partner of Barrington, Ill.-based sales and marketing firm Balvor LLC. “That’s easier said than done because of issues like space and regulations. [But] in the near-term, take advantage of every opportunity that’s legally available.”

Taking advantage of the e-cig opportunity now could be critically important with Big Tobacco jumping into the e-cig business and regulations (and likely taxations) looming on both the federal and local level--the same issues that caused the promo squeeze in cigarettes. Because the segment is so new, however, Herzog believes that if retailers take a strong stand, they can help protect themselves from the margin struggles they have faced with premium cigarettes.

“This is an opportunity for the retailers to regain some of their power and maybe have more of a say in terms of how the new, evolving category should be merchandised,” she said.

This is especially true because--unlike premium cigarettes--there are a lot of independent players who are succeeding in the electronic cigarette segment.

“It’s a more fragmented industry, when you’re talking about e-cigs,” said Herzog. “That will continue to consolidate over time, but I think for the next five-to-10 years you’ve got less power in the hands of a few players.”

Clearly, that will change as power players like Altria and Reynolds take their MarkTen and Vuse e-cigs national, but Herzog said there’s still room for private players, especially if companies merge to grow their presence.

Meanwhile Judy Hong, a tobacco analyst for New York-based Goldman Sachs, argued that because of the differences in the segments, electronic cigarettes might not ever face the kind of squeezed margins and lack of promotional spending prominent with premium cigarettes.

“The two categories face very different dynamics,” she said. “The electronic cigarette category is a growing category and retailers make very attractive margins on e-cigarettes at the moment. Moreover cigarette manufacturers’ cigarette margins are already high and have been expanding. While they are likely to continue to raise prices, they also need to be mindful that cigarette prices are becoming very expensive, particularly to those consumers who are in the lower income bracket.”

Predicting the future of such a nascent segment is difficult, even for the most seasoned tobacco analyst. For the time being, retailers hold the upper hand when it comes to electronic cigarettes.

“You’ve got more power in the hands of the retailers right now,” said Herzog. “They should take advantage of that in these early years, as that category really is still so brand new. This is their time.”