Not Your Father's Tobacco Event

NATO Show scores with new products, latest in legislation news.

Mitch Morrison, Vice President of Retailer Relations

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Fad No More

Retailers see e-cigs achieving mainstream status, with robust trajectory

“It’s a little bit like the wild, wild West,” said Michael Shannon,Lorillard Inc.’s vice president of external affairs. “It’s been very exciting and, as they say in politics and policy, it’s evolving.”

“It” is electronic cigarettes. And for Shannon, a policy specialist for the country’s third-largest cigarette maker, with Newport as its beacon, e-cigs are creating a fresh landscape.

It was a year ago that Greensboro, N.C.-based Lorillard repositioned electronic cigarettes from a thrilling fad to a credible trend. It was then, at the 2012 NATO Show, that word emerged of Lorillard’s acquisition of blu e-cigs. Andin the 12 months since, the soaring e-cig sector has seen sales surge to more than $1 billion, according to some estimates, with anywhere from 200 to 300 manufacturers getting for brick-and-mortar and online space.

“Is it a fad? Is it going to be around?”Shannon asked rhetorically. “We believe-cigarettes are here to stay.”

Shannon spoke at the 2013 NATOShow, joined by Rick Staley, merchandising manager for 75-store Tri Star Energy LLC, based in Nashville, Tenn. Their session was titled “Demystifying Electronic Cigarettes,” and they tackled numerous concerns, including:

  • How they classify e-cigs within the total tobacco set;
  • What role they believe FDA will take;
  • Whether e-cigs are a tobacco cessation product or a less-harmful extension of cigarettes; and
  • How many brands and SKUs retailer should carry to be considered invested in the e-cigs segment.

Shannon, for his part, considers e-cigs a harm-reduction production, not one that boasts therapeutic solutions to tobacco addictions, but rather an entity that is meant for recreational purposes and is clearly less dangerous than tobacco-based products.“There is an advantage of taking people from a more risky product down the ladder to less risky [products],” Shannon said. And to that end, he was encouraged to hear Mitch Zeller, new head of the FDA’s Center for Tobacco Products, express “interest” in e-cigs during an earlier session at The NATO Show.

“Everyone has acknowledged that cigarettes are the most harmful because of the combustion,” Shannon said. E-cigs, on the other hand, may look like cigarettes and distribute vapors but are free of the most harmful components found in cigarettes.

A Line Extension?

As for Tri Star, Staley said the company continues to ramp up its e-cigarette set and is expanding its space at the expense of some single cigars.“Right now we treat it as its own category, “he said. “But in the future, we see it as a line extension of cigarettes.”That positioning may be somewhat controversial over time, according to suppliers and operators, as the industry lobbies the FDA on the point that e-cigarettes are far safer than cigarettes and not a gateway to lure e-cig users tactual cigarettes.

That said, Staley, like other operators, acknowledges the company is still assessing e-cigarettes’ long-term positioning and placement. Today, Tri Star offers a three-tier pricing scheme, with blasts premium brand retailing at $9.99, the regional Clayton e-cig at $7.99 and a third line at $5.99.

“We definitely want to make a stand, “Staley said in underscoring the company’s investment in e-cigs. He expects the Daily’s and Twice Daily stores to eventually carry as many as five or six brands and 20 to 30 SKUs of e-cigarettes.

Also, Staley pointed out that e-cigs are actually growing total tobacco revenue, as opposed to cannibalizing from other segments.

“This is a new customer coming in[to our stores],” he said. Tri Star’s leading e-cig demographic is the 18- to 24-year old male, followed by the 25- to 34-year old male.

Some vendors privately shared that their data also shows a high percentage of older, traditional cigarette smokers testing electronic cigarettes.

Channel and Category Blending

Important considerations for building a profitable OTP set

Cigarettes—once perhaps the single most important category in the c-store—are on the decline; OTP—once an afterthought—is on the rise. While not news, this shift means that c-store tobacco sets are more reflective of the type of variety once only found in a tobacco shop, meaning tobacco shops must strive to be more convenient to compete with the channel.

It’s a topic that was discussed in the “Channel Blending: Convenience & the Tobacco Outlet” session, moderated by John Mayer, product director for Temple, Texas-based McLane Co.

“Shoppers demand convenience, and convenience can sometimes break with tradition,” said Mayer. “We all know that cigarettes are decreasing and that OTP is increasing; the question is what blend of products to carry.”

The right product mix is extremely important, especially to the c-store market, which relies heavily on customers seeking such products. “The OTP and cigarette shopper is one of the most important shoppers to go into a convenience store,” Mayer said. “Data shows cigarette consumers visit a c-store an average of 11.5 times a month, and 11.1times a month for OTP consumers.”

Joining Mayer in the session were Darren Collett, a tobacco store retailer and president of Seymour, Ind.-based Collett Enterprises; John Zikias of Holmes OilCo., Chapel Hill, N.C.; and Steve Sandman, president of North America for Glenview, Ill.-based Republic Tobacco Co.

With blending occurring between the c-store channel and tobacco shops, Mayer asked, “How does any retailer differentiate itself from all the competition?”

For Collett, it’s not about differentiating his stores, but establishing what customers can expect from his locations.“We’ve taken the stance that we’re going to be the tobacconist in any of our communities, “he said. The number of retail tobacco shops has increased by an impressive 41% since 2001, according to Mayer. Collett believes this growth could be a response to regulation.“With any challenge comes opportunity, “said Collett. “As more regulations are enacted, the more tobacco consumers are looking for a ‘safe haven.’ I think that’s responsible for tobacco store growth.”

The fact that tobacco is the sole focus of his stores has also helped Collett be able to offer what many c-stores cannot: unlimited space for tobacco products, and educated employees. “You can bring the products in, but if you don’t take the time to train your associates, it won’t take off,” Collett said.

Adult Education

As a c-store retailer, Zikias agreed that it’s more difficult for the channel to properly educate its store associates on new tobacco products. While it may not be possible to train staff on every new product on the back bar, Zikias believes it’s absolutely crucial they are properly trained when entering a new tobacco category.“If you’re going to get into a category, be the grizzly, not a little cub,” Zikias said of properly bringing a new segment into stores. “You have to make sure your team understands the category. ... Otherwise it’s just inventory on a shelf.”

Even if a retailer can get all the staff up to speed on new categories and products, with a limited amount of space on the back bar and more tobacco products entering the market, it’s increasingly difficult to decipher the right product mix to carry, which may not be the same at all locations.

“What OTP mix to carry varies by market, especially with Big Tobacco getting into OTP,” said Sandman. “It’s important to get out into the retail environment and look at what the competition is doing.”

It’s something Sandman says manufacturers can help with, describing how he has done ride-along with various retailers to offer input on their OTP sets. Having spent his entire career in the tobacco industry, Sandman can provide valuable insights. “The key is a logical progression in evaluating what your total tobacco category looks like,” he said. “Nicotine consumption is the same as it was 40 years ago; that nicotine user has progressed (from cigarettes). If you’re not in a given category, why not look at your (back bar) space and have it reflect the changing consumer?”

The advice Collett had on selecting the right product mix was simple: Look at the data. “Stay focused on the growth categories, “he said. “If you’re carrying the top products in any given category, you’re going to satisfy 95% of consumers.”

For Tobacco Regulations, Check Your Hometown

A slew of proposed tobacco restrictions are crossing the country at a feverish pace. Dozens of proposed ordinances—from banning tobacco displays in New York to banning the sale of electronic cigarettes in remote Rock County, Minn. —are under consideration throughout local townships, small cities, counties and states as governments of all sizes struggle to plug budget shortfalls.

“There is a general lack of awareness on the part of our folks about the potential impact local regulations can have on our industry,” said veteran NATO legislative consultant Tim McKinney.

McKinney was joined by Jacqueline Cohen, president of Washington, D.C.-based consulting firm GO Squared, which the trade association contracts to track state and federal legislation and regulation.

In their session, McKinney and Cohen exhorted operators to take an active role in educating local and state lawmakers about the harm further tobacco restrictions could bring to businesses. McKinney outlined the range of proposals being considered in various communities: raising the minimum legal age from 18 to 19 or even 21; requiring packs to be a minimum of four cigars, thereby eliminating many popular flavored lines sold in singles or smaller packages; and state measures(notably Oregon) that would empower counties to impose new tobacco taxes.

“Local governments are strapped for cash, so what’s the easiest way to fix that?” McKinney asked rhetorically.

The federal government isn’t much better. Ironically, Cohen said, today’s hyper partisanship may indirectly benefit tobacco operators. “As we know, Washingtonis totally dysfunctional,” she said, “and it’s probably a good thing that nothing is going on.”

She cited President Obama’s recent proposal to increase the Federal Excise Tax across tobacco segments, saying that it is but one of many proposals in the president’s budget that still must work its way through both the Senate and the Republican-controlled House.

That said, Cohen urged retailers to engage their local legislative bodies. Quoting President Lyndon Johnson, a master of inside politics and deal making, Cohen said, “The best time to make friends is before you need them.”

Pricing to Offset Decreasing Volumes: Herzog

Price increase: It’s a phrase few retailers want to hear when it comes to cigarettes, especially with the Obama administration proposing a 94-cent increase to the Federal Excise Tax in his most recent budget.

As managing director of tobacco and consumer research for New York-based Wells Fargo, Bonnie Herzog sees modest price increases differently.

“Pricing power has been critical and key to this industry,” she said during her “Tobacco Trends and Insights” session.“In terms of the bottom line, one point of pricing offers three times the leverage compared to one point of volume.”

Yes, cigarette sales are declining—but more than 20% of the population still smokes and, most likely, modest increases will not deter the majority of them, she said.

“Mid-single-digit price increases more than offset cigarette volume declines, driving top-line growth and higher margins for some,” said Herzog.

She anticipates that these kinds of price increases will continue to occur in 2013 based on recent earnings calls by major tobacco companies. At the time of the session, Lorillard and Reynolds had released their first-quarter 2013 earnings, with Altria soon to follow.

“I’ve predicted that pricing will accelerate by 4 points this year,” she said.

The year 2015 presents an interesting opportunity for tobacco manufacturers, shareholders and retailers alike: The fourth quarter of 2014 marks the end of the Federal Tobacco Buyout Fee (also known as the Tobacco Transition Payment Program).

“This 10-year, $10.1 billion program costs approximately 6 cents per pack,” Herzog said. “This should result in significant upside potential to operating margins and earnings growth in 2015 for all three of the leading tobacco manufacturers in the U.S.

“Therefore, in just a few years, we anticipate that tobacco operating margins will be re-based upwards by approximately 250 to 300 basis points, “she continued.

Herzog said manufacturers likely won’t use the savings to lower cigarette prices that consumers have already become accustomed to. Some possibilities on how the funds could be used: funding internal growth initiatives, offsetting potential tax increases, funding higher promos to drive volume, stepping up share buyback programs, acquiring or investing in a growth business and/or increasing dividend payouts.


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