About halfway through an online forum last December, Mitch Zeller did something he said he wouldn’t do: He got specific in talking about tobacco products potentially targeted for federal regulation.
“There’s one thing that I do want to add about cigars, especially the so-called ‘premium cigar’ category,” said Zeller, director of the U.S. Food and Drug Administration’s Center for Tobacco Products.
“We have gotten the message that there may be differences when it comes to premium cigars vs. other cigars,” he said. “And the message is that the FDA needs to take that into account in figuring out how they should be regulated.”
The suggestion that the FDA might consider some leeway for premium in any potential regulation of cigars raises a question: If the government cracks down on cheaper cigars considered more appealing to underage smokers, is there fresh opportunity for the sluggish premium-cigar segment in convenience stores?
Yes, says Dionne Lucas, brand manager of cigars for Scandinavian Tobacco Group Lane Ltd., based in Tucker, Ga. But there are obstacles.
“I think the romance of that big cigar is going into that cigar shop and having a conversation with someone who actually knows and not be rushed,” she says. “It’s part of the luxury of it.”
For the same reason, Swedish Match’s Joe Teller is skeptical about whether premium cigars can occupy more than a very small niche in c-stores.
“Consumers who enjoy high-quality premium cigars already buy them from dedicated cigar stores that have the freshest products, a huge variety of products to choose from and highly educated store personnel to help with product choices,” says Teller, director of category management for the Richmond, Va.-based manufacturer. “I’m not sure many will choose to buy from c-stores.”
Andrew Kerstein owns six such specialty tobacco shops in New Jersey and couldn’t disagree more. A former c-store operator himself, Kerstein contends that convenience stores don’t need to wait for government action to take a hard look at the profit potential in premium.
“That is an area where convenience stores really have opportunities to significantly increase their sales,” he says.
CSP magazine’s 2013 Outlook Survey found that retailers are ambivalent concerning cigars. While most spoke effusively about electronic cigarettes and moist smokeless, they were mixed when addressing cigars.
Specifically, nearly 19% of respondents said they plan to expand both single cigars and flavored cigars. But when asked what areas of the tobacco segment they planned to shrink, nearly one-quarter said flavored cigars and roughly 18% said single cigars. Few talked about premium cigars as a growth opportunity.
Where There’s Smoke
With many new mass-market cigar brands, line extensions and new flavors being introduced, Teller says retailers are under pressure to create the best possible mix, “which means the highest-turning products— which are not premium cigars.”
The introduction of foil pouches made it possible for convenience stores to offer cigars that don’t require humidors to maintain their freshness. Pre-priced foil pouches and three-for-two options have helped drive cigar volumes. At the same time, retailers have seen dollar sales decline.
“Slowly but surely, industry unit sales have been responding positively, but gross profit percentage per SKU has been whittled down,” says Paul Marquardt, vice president of marketing and operations for Prime Time International, Phoenix. “You just can’t make as much penny profit when you’re selling pre-priced cigarillos for 69 or 79 cents that you could possibly sell for 99 cents or $1.09 or $1.19.”
The “perfect storm” of a sluggish economy, value-driven consumers and the rise of pre-priced foil packs has left some retailers reluctantly accepting these lower-margin cigars, Marquardt says.
However, RBC Capital Markets tobacco analyst Nik Modi believes the premium-cigar market is poised to grow this year and beyond. He cites several reasons.
First, consumers are increasingly driven by “aspiration,” the pursuit of finer things that has led to increased demand for craft beer, premium spirits and even prestige beauty products. “We likely also see this trend falling over into the cigar category,” Modi says, “particularly as millenials, a very aspirational generation, age and become more interested in the category.”
Second, a growing number of small premium-cigar makers are entering the market and making waves. Even celebrities are getting in on cigar innovation, he says, pointing to rapper Jay-Z’s recent launch of his own high-end cigar.
Third, Modi says, there’s the FDA’s pending proposal on OTP regulation and the expectation it will be “less onerous on premium cigars than affordable cigars, given affordable cigars’ popularity among youth.” Indeed, in speaking about premium cigars, Zeller cited their higher prices.
Expansion of premium-cigar offerings “would be accretive to c-store margins,” Modi says, “though we note premium-cigar consumers prefer to go to smoke shops where they can often smoke cigars and speak with knowledgeable store associates.”
Premium’s Place
Kerstein, who operated 250 convenience stores at one point before deciding to focus solely on tobacco with his Smoker’s Haven stores, sees a role for both tobacco shops and c-stores in the lives of premium-cigar smokers.
The convenience store, he says, won’t be the retailer that introduces smokers to new cigars or where they’ll go to talk about cigars. “The role I think for the convenience store to play in the marketplace is just that: It’s going to be a convenient location for the customer to pick up their one or two cigars on the run because c-store hours are typically much longer than tobacco stores are open,” he says.
Retailers may see more affordable cigars as a greater hook for c-store customers, but premium cigars offer higher margins and potentially a broader market basket, Kerstein says: “If somebody is a premium-cigar smoker and they do go into a convenience store to purchase that cigar, odds are they are not just going to walk out with that cigar. They’re going to make other purchases, whether it’s a beverage, candy or mint purchase or some other snack product.”
At a store level, a core group of repeat customers is all it takes to profit from higher-margin cigars, says Prime Time’s Marquardt. Because c-store customers are creatures of habit, “you really only need to get a certain number of those people to purchase that product to really drive success.”
To have any hope of success selling premium cigars, merchandising is critical, Kerstein says. At a bare minimum, retailers need to offer 25 to 30 premium-cigar SKUs. Upwards of 100 is even better, though space at the backbar can be an issue. “If you’re going to sell candy, you’re not going to offer just five kinds of candy bars,” he points out.
Jane Green, vice president of marketing for Jacksonville, Fla.-based Swisher International, says new packaging, like that of Swisher’s Gold Strike, solves a lot of the problems c-stores once faced in merchandising handmade premium cigars. The resealable pouch keeps three premium cigars in perfect condition, she says, “and retailers will enjoy the strong margins.”
“Most premium cigars require humidification, which is why the Gold Strike pouches offer a unique opportunity to stock premiums without the costly humidor,” Green says.
Without speculating on the impact of any pending regulations on the category, Altadis USA vice president of marketing Janelle Rosenfeld says there is opportunity for retailers “as premium cigars have a strong adult-smoker following, especially for those adult consumers looking for quality and name brands.” Altadis’ portfolio, she says, “offers both at fair consumer prices and great margins to the retailers.”
If the FDA shows premium cigars leeway, Lucas of Scandinavian Tobacco Group Lane sees greater opportunity for Macanudo and Punch freshness packs in convenience stores. She also believes c-stores would have success with smaller cigars, such as the Havana Honeys that the company plans to launch later in the year.
“I refer to it as almost hand-rolled because it has all of the other elements possible, from the good blend to the natural binder and the natural leaf,” she says. “But it is a machine-made cigar, so we can sell it at a reasonable price.”
Absent any effects of new federal regulations, Kerstein believes c-stores already have an opportunity to get existing lower-end- cigar customers to trade up to premium. Depending on the tax impact of various states, the difference between some popular-priced cigars and premium may not be significant. A smoker of Antonio y Cleopatra Grenadiers, for example, could be urged to try a Pasade Garcia from Altadis, he says, “then move them up to the next step.”
“There are a number of what we would call premium cigars that are very competitively priced with what the industry would call popular cigars,” Kerstein says. “Properly merchandised, you will get customers to trade up. You have to have a section for cigars and you have to integrate the premium cigars within that section.”
Cuban Rounds from Kretek International is a premium product that targets the c-store shopper, says John Geoghegan, director of strategic planning for the Moorpark, Calif.-based company.
“We’ve focused our new Cuban Rounds on the everyday cigar smoker. It’s a true imported hand-rolled premium in a value-priced resealable pouch of three cigars. For the c-store shopper, it’s affordable,” he says. “For the c-store operator, it displays well on the shelf. No humidor or display space.”
But he believes it would take “a tectonic shift” in both merchandising and cigar smoker shopping habits for premium handmade cigars to have a significant effect on the c-store cigar set dominated by lower-end options.
“The premium-cigar smoker and the mass-market smoker are two completely different animals,” he says. “And it has to do with the strength of the cigar, the style of the cigar, the size of the cigar, how long it takes to smoke.” A hand-rolled Robusto or Churchill-size cigar can take an hour to smoke, an unlikely amount of time for a c-store shopper on a smoke break, he says.
“Over the years, we’ve done countertop humidors for convenience stores. We’ve put our products in aluminum tubes for convenience stores. These things in terms of the volume metrics don’t do nearly as well as mass-market machine-made cigars,” Geoghegan says. “We’ll see how it goes after we all get a chance to read the proposed new FDA rules.”
Certain Uncertainty
So what will 2014 bring for the cigar category? Much is unknown, pending the FDA’s publishing of its proposal. Marquardt, however, expects the coming months to bring a flood of new products.
“You’ll probably see a lot of companies release products this year just to get them out ahead of any FDA control over cigars, so that they don’t run into as many issues with substantial equivalence like the cigarette companies have had on their products,” he says.
While no one knows when or if the FDA will take action, some believe the agency might seek to ban some flavors or single cigars. Swedish Match’s Teller suggests retailers prepare by stocking unflavored cigars, the sales of which are growing.
As far as single cigars, consumers already have made it clear that they will embrace foil pouches containing two or three cigars. Retailers should merchandise these multi-stick foil pouch cigars together in one large section, Teller says.
“They should be placed in the highest position possible, as it is a huge segment with explosive growth and lots of variety. Blocking them all together at eye level allows the shopper to see the full variety of foil-pouch products the store offers,” he says. “Second, single-stick cigars should be placed right underneath foil pouches, again all brands and products blocked together.”
The cigar set is one place where retailers cannot afford to let their competition beat them to market with new items, he says. Cigar shoppers are interested in variety and trying the latest offering.
“The low-price competition and revolving door of new items means retailers have to do high-quality assortment analysis and reset their stores twice per year, or they risk losing out to retailers with a more updated mix of products,” Teller says.
Brian May, spokesman for Richmond, Va.-based Altria and its cigar subsidiary John Middleton, declined to speculate on potential FDA action and its effect on premium cigars. After the proposal is published, the company will share its perspectives during the public comment process, he says, and retailers can do the same.
“It really depends on what adult consumers are looking for when they’re coming into the store and how retailers differentiate their products within the cigar space,” May says. “That’s true whether you are selling machine-made cigars or hand-rolled cigars.”
Marquardt says retailers have to pay attention to what changes might be coming with any action by the FDA. But they shouldn’t make pre-emptive changes in their cigar set based on speculation about what regulators might do.
“I don’t believe it would be in the retailers’ best interest to start making guesses as to how the regulation is going to go,” he says. “It could make you very uncompetitive in your market for either a short time or a long time. On top of that, you could lose a good core of your tobacco consumers, and all for nothing.”
Havana Honeys, to be released later this year by Scandinavian Tobacco Group Lane, are machine-made cigars but have natural-leaf wrappers and binders.
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