Nik Modi is a bit of a time traveler when he talks about tobacco.
As he shared his views at CSP’s Eighth Annual Tobacco Category Review Meeting, Modi, the thoughtful senior research analyst for UBS Investment Research, navigated through tobacco’s past to better position where things stand right now— and are likely to go in the coming years.
For instance, today’s talk about smokeless is not without historical precedent. While smokeless tobacco, for example, currently accounts for 20% of the market with a positive trajectory, in the 1940s, it accounted for 30% of tobacco sales.
And in the 1800s, when things such as communal snuff boxes existed, smokeless represented more than 70% of the market. Cigarettes accounted for only 2%. Back then, as tuberculosis ran rampant, anti-spitting bans were put in place. “Kind of like the smoking bans that are causing smokeless to rise now,” Modi said. And as smoking bans increase, he pointed out, there are no bans on nicotine. “Will history repeat itself?” Looking ahead, Modi believes the seesaw will continue tilting in favor of other tobacco products. By 2015, cigarettes will hold 69% of the market, smokeless 17% and cigars 14%.
And by 2025, cigarettes will no longer hold the lion’s share, falling to 45% of the market, while cigars and moist smokeless will collectively seize the majority, respectively garnering 22% and 33%. “That’s a long time away, and my sense is that this will happen sooner than 2025,” he said.
‘Very Active Year’
Back in the present, Thomas Briant, executive director of the National Association of Tobacco Outlets (NATO), said 2011 has been a “very active year,” both legislatively and with FDA tobacco regulations. Some recent highlights include:
Taxation. Of 18 states that proposed cigarette and tobacco tax increases at the time of the meeting, only Vermont and Connecticut adopted higher cigarette and OTP tax rates. Connecticut increased cigarette taxes 40 cents to $3.40 a pack, and its OTP rate from 27.5% to 50%. Vermont raised its cigarette tax rate 38 cents to $2.62 a pack, and roll your own increased from 11.2 cents to 13.1 cents per .0325 ounces.
Department of Justice Corrective Statements Litigation. In 2006, a federal judge issued a remedial order that required tobacco manufacturers to provide retailers with 18-inch-by-30-inch signs containing tobacco “corrective statements” for their store counters. Manufacturers are appealing that order.
NATO has submitted a brief encouraging the order’s dismissal, due, in part, to a violation of retailers’ free-speech rights.
“The right to have free speech under the First Amendment also includes the right not to speak,” Briant said. In essence, he said, the signs force retailers to tell customers why they should not smoke cigarettes. The order also violates due-process rights and constitutional property rights, as well as creates a security risk by obstructing the view of clerks behind the counter, he said. The industry is awaiting a decision.
FDA Faces Forward
Two years since President Obama signed into law the Family Smoking Prevention and Tobacco Control Act, granting the U.S. Food and Drug Administration (FDA) authority to regulate tobacco products, the agency has been busy working on retailer tobacco compliance, menthol cigarettes and graphic warning labels.
Trying to separate fact from fiction, Ann Simoneau, director of compliance enforcement for the FDA’s Center for Tobacco Products (CTP), was on hand at the meeting to keep the lines of communications open between tobacco stakeholders and the agency.
For example, she shared that there is no such thing as a “quota” when it comes to FDA tobacco compliance inspections that uncover violations. In fact, she said, “Nothing would please me more than to have no violations. That means everyone’s in compliance and they’re following the law.”
Violations of the tobacco compliance checks could include not asking for ID of anyone under the age of 27; selling to minors; having self-service displays of cigarettes, roll-your-own tobacco or smokeless tobacco when minors are allowed in stores; selling individual cigarettes, or “loosies”; providing free samples of cigarettes or smokeless tobacco; or giving gifts in exchange for buying cigarettes or smokeless tobacco.
And while tobacco retailers are not quite at the “no violations” stage, Simoneau shared that of 16,836 of the inspections completed through July 21, only 532 warning letters were issued—meaning 97% of retailers were compliant.
If a retailer has a violation, they currently receive a warning letter, which Simoneau said she personally signs: “I can just tell you, because I sign and review each and every one of these, that the majority of them are for selling to minors.”
Part of the review process prior to signing is to ensure consistency and that there is, in fact, a violation. “We designed this so that before my name goes on any warning letter, I ensure that this is the violation and that it is sufficient evidence and that it supports it,” she said.
The list of violations in a warning letter might not be exhaustive, however, according to Simoneau. “We go in and check, but there are things we could miss,” she said. “So everybody is under responsibility to review their practices and review what they’re doing to ensure they’re in compliance.”
The FDA eventually plans to do follow-up inspections of retailers who had violations the first time around. Subsequent violations could mean a civil financial penalty, ranging from $250 to $10,000, depending on the number of violations. “I don’t expect that we’re going to get many repeat violations, because just on the response to the warning letters, people want to comply,” Simoneau said. Retailers have been very responsive in saying they’re retraining their staff and taking measures to ensure they are in compliance going forward, she said. The FDA plans to have contracts in all states, tribes and territories by the end of fiscal 2012.
More FDA Concerns
Speakers touched on several other subjects of import, including:
FDA Retailer Training. Guidance issued by the FDA recommends elements of an employee compliance training program, including informing customers about the health and economic effects of tobacco use and providing bonuses, time off or additional compensation for employees who pass tobacco compliancecheck inspections. Briant said that NATO has submitted comments objecting to those recommendations, including that tobacco compliance should be part of an employee’s job (without need for additional compensation). NATO has also requested that the FDA send out computer-generated letters to stores that pass the FDA’s compliance checks. As of now, letters go out as warnings only to retailers that have violations.
“That’s huge from a morale standpoint, and a pat on the back for your employees for not selling tobacco products to minors,” Briant said.
Menthol. Several manufacturers have sued the FDA about the Tobacco Products Scientific Advisory Committee (TPSAC), because three members of TPSAC have testified against the tobacco industry as paid expert witnesses. If the court rules that there is a conflict of interest, the FDA may not be allowed to rely on TPSAC’s menthol report, which had concluded in March that the “removal of menthol cigarettes from the marketplace would benefit public health in the United States.”
Modi used Newport cigarettes as an example that menthol doesn’t necessarily skew toward African-Americans, one of the factors the CTP is examining as it looks at the fate of menthol. He said that while 50% of Newport menthol consumption does come from African- Americans, as much as 40% of Newport menthol consumption is by Caucasians.
Another portion of the FDA’s research focuses on youth consumption of menthol. Modi said that in areas where menthol has an above-average market share of more than 30%, youth smoking rates are actually lower than where menthol use is below average. Another reason that might deter the FDA from moving on menthol cigarettes is that they contribute $5 billion in tax dollars. The industry is awaiting an FDA ruling on menthol cigarettes, although there is no deadline for such a ruling.
Ban on Color Advertising.The Family Smoking Prevention and Tobacco Control Act required the FDA to republish its 1996 rule allowing only black text on a white background in advertisements for cigarettes and smokeless tobacco products.
In August 2009, manufacturers and a NATO retail member sued the FDA for a violation of First Amendment free-speech rights. In January 2010, a Kentucky federal district court judge ruled that the ban on color advertisement was unconstitutional.
“Commercial speech is advertising, and you can’t take away the right of a manufacturer to tell adult customers about their product,” Briant said. The FDA has appealed the decision.
Graphic Warnings. The color advertising case also deals with the nine text and graphic warnings set to replace current surgeon general warnings in September 2012 [CSP—Oct. ’11, p. 143]. And while other countries have adopted graphic warnings, Briant points out that “most countries don’t protect free speech like we do.”
A second lawsuit was filed by manufacturers in August, challenging the constitutionality of the nine graphic warnings that the FDA has now chosen. Both suits were in the court system at press time, and in a preliminary injunction, R.J. Reynolds Tobacco Co. wrote that complying with the graphics could cost the company $11.5 million.
According to the CTP’s website, the graphic warnings seek to “increase awareness of the specific health risks associated with smoking, such as death, addiction, lung disease, cancer, stroke and heart disease; encourage smokers to quit; and empower youth to say no to tobacco.”
But they could have another effect. Modi’s look to the future included discussion that some of the FDA requirements, such as graphic packaging, can be “very burdensome, very costly” for manufacturers, and that not many companies below the Big Three have the scale or resources to keep up. Returning to the future fate of tobacco, he said, “I think the big will get bigger, and we’ve already seen some smaller players go out of business.”
Behind Brands
Not all of the discussion at CSP’s Eighth Annual Tobacco Category Review Meeting focused on regulations and legislations. UBS senior research analyst Nik Modi examined how two cigarette brands fared in a recent exclusive UBS-CSP tobacco survey, representing 55 chains and at least 7,500 stores.
While 35% of retailers in the survey said they thought Philip Morris USA’s Marlboro Leadership Price program, which asks operators to forgo part of their typical markup in exchange for incentives, has helped Marlboro’s share, Modi believes that figure corresponds to approximately the percentage of retailers that have signed onto the program. Modi shared that one retailer in the survey, who opposes the program, points customers toward other brands. “The worst thing you could have as a brand manufacturer is have your customers telling other consumers to buy someone else’s product,” he said.
As reported exclusively in CSP’s October issue, Philip Morris USA has extended the program through the end of the year. As for Newport, Lorillard’s brand has 74% of market share in its core states in the premium full-flavored menthol category; in other states, its share is only 40%. “So just think about the opportunity that this company has with this brand,” Modi said.
Modi also touched on how Newport Non-Menthol cigarettes have earned an entire share point since their launch last year, and how 61% of retailers in the survey say their sales of the product are improving: “It’s pretty clear to me that this brand is maybe more sticky than people may have thought originally.”
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