Tobacco Roundtable Report: Heated Issues

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What’s keeping you up at night? This question was posed to the 25 retailers attending CSP’s 11th annual Tobacco Category Review Meeting.

Not surprising for a category as volatile as tobacco, attendees had no shortage of answers. Federal, state and local regulations are certainly causing many a sleepless night—especially for retailers operating in “nanny states.”

“No doubt about it, legislation, mainly in cigars,” responded one attendee. “Last year, Massachusetts had 40 to 45 cities and towns banning single cigars; that number has tripled in 2014.”

The control manufacturers wield was also a hot topic, especially in the wake of the Reynolds-Lorillard merger.

“Soon 95% of our cigarette sales will be controlled by two companies,” fretted one retailer.

And it’s not just the “big” companies wreaking havoc: Other retailers decried the prepricing trend going on with OTP, saying “I don’t need manufacturers dictating pennies; you’re not helping.”

“How to keep profit in the whole category,” said another operator. “We’ve been able to grow volume, but at the expense of our margins. Yes, we’re seeing vapor sales, but not enough to offset everything else.”

Which brings us to the vaping craze. Barely a blip on the radar at 2013’s meeting, where it was easily dismissed as “not for c-stores,” it became the “it” product of the 2014 agenda, with multiple e-liquid companies in attendance and an entire mini-forum dedicated to the topic.

It’s exciting, yes—but also very confusing for retailers, many of whom said they were up at night wondering what to do with all the information, and misinformation, floating around.

“Look at the representation here: 27 vendors for 25 retailers,” mused one attendee. “There’s a million of you out there and somehow every company has ‘the only liquids made in the U.S.’ ”

Even retailers who feel they at least have a handle on vape worry about how to make room for the profit-friendly segment, asking, “Where does it all go? Three feet for e-cigs and vape is not enough.”

Two days may seem too brief a time frame to cover all these issues. But speakers such as NATO’s Tom Briant and Management Science Associates’ (MSA) Don Burke provided insights and advice that should have ensured at least some nights with better sleep.

CONTINUED: The FDA’s Deeming Dilemma

The FDA’s Deeming Dilemma

In a bit of a good timing, this year’s roundtable meeting took place just days before the deadline to submit public comments on the deeming proposal. It gave advocates such as NATO’s Briant the opportunity to make one more push on why it’s so important for our industry to speak out.

Although at first glance the proposed regulations on cigars, pipe tobacco, hookahs, electronic cigarettes and other nicotine alternatives seem rather retailer-friendly—lacking the bans on flavors or self-service many had anticipated—Briant, executive director of Minneapolis-based NATO, outlined many areas of concern during his legislative and regulatory general session.

Perhaps the most glaring concern Briant covered was the fact that, if the proposed deeming regulations are

enacted as is, manufacturers will have to submit a premarket tobacco application (PMTA) to the FDA for every cigar, pipe tobacco, electronic cigarette or vaping product that was not on the market as of Feb. 15, 2007.

“The PMTA process allows the FDA to authorize the introduction of products into the market where appropriate for the protection of the public health and prevent introduction of products that are detrimental to the public health,” Briant said. “However, a PMTA requires an application be submitted for each new tobacco product that did not exist prior to Feb. 15, 2007.”

In other words, it applies to every electronic cigarette or vaping product on the market, which could spell trouble for any electronic-cigarette company that’s not part of Big Tobacco.

The FDA estimates that an application will take roughly 5,000 man hours to complete and may require companies conduct studies, clinical trials and testing for harmful constituents. And that’s just for one application. In theory, manufacturers will need to submit applications not just for different products (for example, disposables vs. rechargeables) but also different flavors.

“[This] may result in newer products being removed from the market if a manufacturer is unable to afford the time and cost of compiling PMTAs,” Briant said.

Even more troubling is whether the FDA is actually prepared to review the applications that do make it through. When the agency released the proposed deeming regulations, it estimated just 27 PMTAs will be filed: one cigar, one pipe tobacco and 25 electronic-cigarette applications.

“I find these estimates very hard to believe,” said Briant. “There has been more than just one new cigar introduced in the marketplace after Feb. 15, 2007, more than one pipe-tobacco brand and certainly more than 25 brands of e-cigarettes.”

These lowball estimates are more than a little concerning given the FDA’s current track record with the significantly less complex substantial equivalent (SE) applications. Of more than 4,000 SE applications filed with the FDA, the agency has approved 17 and denied 17, leaving 4,177 SE applications still pending. This is despite the fact that the Government Accountability Office (GAO) has twice issued reports instructing the FDA to speed up its SE review process.

One potential solution would be to push the Feb. 15, 2007, deadline to a later date.

“In the comments being filed by NATO and other industry members, we are urging the FDA to a more recent date than Feb. 15, 2007, so that such products as e-cigarettes would not need to have a PMTA submitted,” Briant said.

The FDA has ruled on 34 SE applications. Substantial equivalence is significantly less expensive and time-consuming for manufacturers, meaning some of the smaller, more profit-friendly players could hope to stay in business.

As to how long it will be before we get further clarity on PMTAs and the proposed deeming regulations as a whole, Briant estimated it would be at least 12 to 18 months before the regulations were finalized.

“The FDA staff must read each and every comment submitted by the public, and we are already at almost 63,000 comments,” Briant said. (The final tally when the comment period closed three days later was more than 75,000.)

“What all of this means is that the status quo will remain in place for retailers for at least 12 to 18 months,” Briant said. “However, the deeming regulations are just the first step in several more rounds of regulations that the FDA will propose on all tobacco products.”

In other words, stay tuned.

CONTINUED: Tobacco Trends to Watch

Tobacco Trends to Watch

As volatile as the tobacco category or, more accurately, the total nicotine category can be, it remains a crucial part of the convenience channel. And vice versa: According to MSA distributor data, the channel accounts for 72% of total nicotine delivery product volume. The next closest channel is tobacco outlets, with a mere 9%.

This symbiotic relationship between convenience and tobacco is part of the reason why MSA senior vice president Don Burke said it’s important for retailers to pay attention to how tobacco and nicotine products are performing across all retail channels.

“This doesn’t mean it will work for your stores,” Burke said during his presentation. “But it will give you an idea of what’s selling across the board.”

Some of Burke’s bigger takeaways included:

▶ The Cigarette Shuffle: Although cigarette volumes (not to mention margins) have continued to decline, MSA research suggests this decline is not inevitable. Burke cited a study on cigarette sales, which showed roughly 30% of retailers were able to grow their cigarette business. But how? Perhaps by smarter SKU rationalization.

MSA’s distributor shipment data on premium cigarettes paints a consistent picture: a 3.8% decline in volume across all channels (similar to that of previous years). C-stores also remained consistent in the average number of premium cigarette products stocked: 62 items in 2013 vs. 63 in 2014.

It’s the discount-cigarette segment where Burke observed a shake-up. Down 6.3% this year, discount-cigarette volumes showed a steeper decline across all retail channels than their premium counterparts.

What’s more, c-stores more significantly reduced the number of discount cigarette products carried this year, with just 52 items on average (as opposed to 56 last year).

“When you see a decline like this, it suggests you’re getting the right SKUs in the right places,” Burke said.

▶ Cross-Channel Competition: Though convenience has long reigned supreme in owning tobacco and nicotine sales, it’s no surprise that other retail channels are making a run at the elusive tobacco shopper. Burke has often spoken about the effect retailers such as Dollar General are having on c-store cigarette sales, but it’s no longer limited to cigarettes.

Take large cigars. Other retailers went from carrying an average variety of nine large cigars in 2013 to 17 in 2014. Burke said that jump was largely due to Family Dollar, which is upping its cigar game. That could prove quite problematic for c-store margins.

“This has been a category that’s really grown,” he said, citing the segment’s impressive cross-channel growth rate of 8.4% (with 80% of cigar volumes belonging to the c-store channel). “Many c-store retailers have said they’ve been able to protect their nicotine sales and tobacco business by adding SKUs in this category.”

But perhaps the most glaring example of other channels encroaching on  c-store tobacco sales is in the e-vapor category. In 2013, 70% of e-vapor volume came through c-stores; that percentage has fallen to 64%.  Tobacco outlets are also feeling the pain, going from a 20% share of all e-vapor volume to 14%.

“While convenience was one of the first channels to embrace e-vapor (after tobacco outlets), it’s now growing in the other outlets,” Burke said.

Consider it a case of mass merchandise striking again. However, it’s not only dollar stores after the profitable  e-vapor segment, but more traditional mass merchandise operators such as Walmart as well, Burke said.

“This is something to watch,” Burke said. “You don’t want to lose your edge in this possibly strong category.”

One potential opportunity Burke sees is in the blossoming e-liquid and vaporizer business. While mass  merchandise is all in on electronic cigarettes and cartridges, MSA data as of June 28, 2014, showed less than 1% of mass merchandisers were carrying e-liquid or vaporizer hardware units.

▶ Volatile Vapor Data: When retailers were asked what they most hoped to get out of this year’s meeting, understanding vapor was one of the most prominent answers. It’s a concern Burke shares, considering even research firms (including MSA) don’t quite understand what’s going on with the segment thanks to the lack of concrete data.

MSA’s data focuses on wholesale shipments to retail. This is highly problematic when looking at vapor, which is distributed in many different and nontraditional ways. Burke estimates 60% of the segment is distributed through traditional wholesalers, 20% online and 20% through direct-to-store shipments. Because online sales and direct-to-store shipments are not tracked by MSA, Burke readily acknowledged that he wasn’t presenting a complete picture.

“The data I’m showing you covers just 60% of the market,” he said. “It may give you indications, but may not necessarily be accurate. In fact, today no one really knows what is accurate in the e-vapor category. It varies so much and is very tough to measure.”

While wholesale data is better than no data (while Nielsen and IRI track electronic-cigarette sales, neither company measures vaporizer or e-liquid sales), it can be very easily skewed, as we’re currently seeing with big pushes of Vuse and MarkTen. Relying only on wholesaler data, it would appear that Reynolds’ and Altria’s e-cigarettes are completely crushing the vapor category. But Burke pointed out that this doesn’t necessarily mean that customers are buying the products, just that a ton of stores are carrying them.

“It’s too early to get reorder info,” said Burke about both Vuse and MarkTen. “Right now, they’re getting a huge distribution deal that’s going to throw off this category.”

In the meantime, MSA is working to provide a more complete picture of the segment by partnering with a firm that tracks Internet sales, as well as reaching out to the currently untracked vape-shop market.

But that will take time—which means retailers will need to take any so-called facts on the segment with a grain of salt.

CONTINUED: RIP Cig-alikes?

▶ RIP Cig-alikes?: With all the attention on vaping, it’s easy to understand why many retailers have  questioned whether it’s worth staying in the “traditional” electronic-cigarette, or cig-alike, business.

“Everyone says cig-alikes are dying,” Burke said. “But we’re not seeing sales going down.” Quite the opposite:

MSA shows cig-alike volumes are up 8%. Granted, e-liquids are growing by roughly three times that rate, but Burke believes it’s an issue of technology, not a preference for larger devices.

“What we are finding is that many consumers who try the product aren’t getting quite the level of satisfaction in a cig-alike as they may be getting from liquids and vaporizers,” he said. “But as technology improves in cig-alikes, I wouldn’t rule them out. As that satisfaction level increases, I think sales may go back up. They’re still more convenient.”

Hot Topic: Are Vape Shops a Real Threat?

Yes: “I’m concerned about all the vape shops opening on every block. Our consumers can go around the corner and spend an hour in a vape shop, getting the full vapor experience. We simply can’t do that in a c-store.”

Probably Not: “I don’t know if you’ve been to a lot of vape shops, but they’re typically inconvenient, usually in an area where there’s a younger audience (near universities, crowded areas). Many people getting into vaping go there because they can try many things, experiment, there’s a lot of knowledge … but I’m gonna tell you, once they become committed, they go elsewhere.”

They Could Actually Help: “I think consumers will go to vape shops to learn about the segment and experiment. They may sell the hardware, but they’re not going to be able to beat [c-stores] on price and convenience on e-liquids. Let the vape shops ‘own’ the hardware; we’ll take the repeat business and margins on liquids after they’ve ushered new consumers into the segment.”

Hot Topics: Vuse and MarkTen: Good For Business?

Yes: “Vuse’s displays and material have really helped grow the entire vapor category.”

No: “Everyone thinks they’re great for the category: I think they’re going to compress my margins.”

Participants in CSP’s 2014 Tobacco Category Review Meeting,
held Aug. 7-8 in Chicago:

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