Behind the Counter: Trends and Tremors

CHICAGO — Most of the world has eagerly anticipated a return to normalcy after years of pandemic interruptions.

But for tobacco, which remains the single largest driver of convenience in-store sales, “normal” might not be such a good thing. Especially when tobacco consumers are returning to normal a little worse for wear.

“There are many things going on in the macro environment and in tobacco specifically,” said Nik Modi, managing director of New York-based RBC Capital Markets, during a recent CSP-hosted Tobacco Update webinar.

For one, rates of employment among workers in the bottom wage quartile decreased 27.9% between 2020 and 2021.

“The core tobacco, core convenience consumer? Those are the consumers that got impacted the most,” Modi said.

Moving into 2022, those already-squeezed customers are even more pressured by the growing cost of goods.

“An exceptionally powerful inflationary environment has begun to weigh on purchase decisions,” Bonnie Herzog, managing director for Goldman Sachs, New York, wrote in a recent research note.

Herzog said nicotine consumption began to slow in fourth-quarter 2021, and tobacco retailers and wholesalers surveyed by Goldman Sachs were concerned about inflation and wages, as well as stiffer regulations and potential excise tax increases.

But the outlook isn’t all doom and gloom: Some retailers are managing to hold onto gains made during a particularly strong sales year in 2020.

“I’m still up 1% for the total tobacco category, and I was up a lot last year,” says Ray Johnson, operations manager for Speedee Mart Inc., Las Vegas.

The tobacco category frequently faces daunting challenges, yet it keeps producing, Herzog said

“Retailers and wholesalers are broadly unchanged in their generally constructive view of the tobacco category,” she said. “It tends to perform well during periods of uncertainty or economic/personal stress.”

Here’s a look at the challenges and opportunities within the specific behind the counter segments ...

When looking for evidence the world is returning to normal, one need look no further than cigarettes.

“In the early days of the pandemic, total cigarette household penetration spiked nearly 48%,” Modi said. “It has moderated to basically where it was before COVID started. Now that things have opened up again, we’re getting back to a sense of normalcy in smoking rates.”

NielsenIQ data ending April 9 shows cigarette sales across all channels of retail were down 2.7% and units were down 9.4% year over year.

“Retailers and wholesalers expect cigarette category volumes to revert to historical declines,” Herzog wrote, estimating cigarette volumes to decline 5.6% in 2022 after being flat in 2020.

Respondents of Goldman Sachs’ “Nicotine Nuggets” retailer and wholesaler survey cited several reasons for the expected declines: tough year-over-year comps to 2020, inflationary pressures, poly-usage with cheaper or more discreet nicotine options and a higher frequency of cigarette price increases.

The Gas-Price Conundrum

Inflation has perhaps been felt most acutely at the pump. Herzog said gas prices have been above the “all-important $3-per-gallon psychological threshold” since late 2021. AAA reported the national average was above $4.40 as of May.

That’s a problem for the cigarette category, as Herzog said core tobacco consumers tend to fall in lower income brackets. Low-income households spend an average of one-fifth of their income on gasoline, three times that of the average household.

“Higher gas expenditures often mean cutting back on other discretionary spend or downtrading to more affordable products,” she said. “Our recent 2022 Staples Outlook suggests that discretionary cash flows among consumers in the lowest income quintile will be most pressured, declining 24% year over year in 2022.”

And it’s not just gas that has risen in price. Goods, services and even cigarettes themselves have all seen prices soar in the face of supply-chain challenges and a 40-year-high inflation rate.

“When gas prices start to creep north, so do sales of price-value tobacco products,” says Jessica Fratarcangelo, marketing director for Cheyenne International Inc., Grover, N.C.

There is, however, some hope in the face of tough economic headwinds for smokers.

“The rise in inflation was partially offset by improved labor market conditions, increased wage growth and higher federal tax refunds,” says Jennifer Kelly, spokesperson for Richmond, Va.-based Altria Group Distribution Co.

Downtrading and Poly-Usage

Despite some reasons for positivity, Kelly acknowledged downtrading to lower-priced options is an expected trend for the category.

“Adult tobacco consumers are more likely to select premium brands during economic upswings and more likely to trade down in tougher economic situations,” she says.

This sentiment was certainly reflected in the Goldman Sachs survey: Half of retail respondents said downtrading pressures increased in fourth-quarter 2021, and 69% reported that deep-discount cigarettes had improved “somewhat” or “substantially.”

“In this environment, fourth-tier cigarette brands have emerged as winners while branded/premium cigarettes are lagging,” Herzog said.

Retailers can easily tap into the value of fourth-tier products, Fratarcangelo says.

“They should do the basics: ensure they have the right mix of SKUs, price it properly, merchandise well on the shelf and advertise with storefront and point-of-purchase advertising,” she says.

But cigarette smokers aren’t just turning to discount brands; they’re looking at the entire tobacco/nicotine category for lower-cost, more discreet options.

“They’re moving to other tobacco categories, which I wouldn’t have thought would happen,” says Johnson of Speedee Mart, noting his vape, smokeless and cigar numbers have all gone up. “It’s not new people deciding they’re going to try tobacco; it’s the cigarette smokers who were run out.”

Still others are seeing the opposite, indicating cigarettes are not one size fits all.

“This year, we’ve actually seen some groups of smokers trade up in the brands they are smoking,” says Lonnie McQuirter, director of operations for 36 Lyn Refuel Station, Minneapolis. “There are more American Spirit smokers, and it’s not just the stereotypical [customer].”

As some consumers trade up, others trade down and still more expand to using cigarettes alongside other tobacco products, analysts anticipate the category will return to its version of normal.

“As we fast-forward through 2022, I think we’ll be back at that 4% to 5% decline rate,” Modi said. “I do think we’ll see more downtrading pressure because gas prices will be higher, and the big manufacturers will remain focused on getting their revenue growth through pricing.”

As many of the largest players in the rechargeable market wait for overdue decisions by the U.S. Food and Drug Administration (FDA) on premarket tobacco product applications (PMTA)—or the outcome of lawsuits regarding already-issued marketing denial orders (MDOs)—growth slowed.

“Retailers and wholesalers expect the category to grow but decelerate in 2022,” said Herzog. “MDOs and uncertainty about pending PMTA decisions for market leaders like Juul and Vuse Alto continue to weigh on growth.”

Indeed, the two-week NielsenIQ data ending April 9 shows that deceleration, with dollar sales up just 3.5% and units down 3.6%.

PMTA approvals for major players have moved the needle some. Vuse, the first electronic cigarette brand to receive a marketing granted order (MGO), saw its dollar and unit sales grow by more than 50% between April 2021 and April 2022, per NielsenIQ data.

“In 2021, Vuse was comfortably the fastest-growing vapor brand in the U.S. by both value and volume share,” says Matt Domingo, senior director of external relations for Reynolds American Inc., Winston-Salem, N.C.

Disposable and Synthetic Flavors Soar

Rechargeable vape sales have struggled since the FDA banned flavor options in early 2020, stating that such products could only be sold if approved through the PMTA pathway (the agency has not, to date, issued any flavor approvals).

Disposable vaping products, however, were allowed to stay on the market while waiting on PMTA decisions. And synthetic nicotine vaping products were not under FDA jurisdiction until recently. They now must also submit PMTAs to remain on the market (flavored or not). “[Synthetics] avoided the FDA’s PMTA process for a while,” says Mike Sullivan, trade development manager for Darien, Conn.-based E-Alternative Solutions. “That’s all going to change now.”

For the time being, disposable and synthetic vaping products remain hot sellers. NielsenIQ shows disposable dollar sales up 22.3% year over year as of April 9.

“Disposable flavors are by far dominating the category,” Johnson says. “I consider myself lucky that Juul is basically flat. It’s all the synthetic nicotine, disposable flavors [causing that].”

In terms of which specific flavors are driving the category, there’s no one clear winner; it can depend on the consumer’s age and maturity in the category.

“Consumers between the ages of 24 and 28 are favoring sweeter, larger devices,” says Andrew Laron, a partner with San Francisco-based Ziiplab.com. “[Consumers] 28-plus are looking for devices that yield less sweet flavor profiles, with an emphasis of a solid throat hit similar to the sensations of a cigarette.”

What’s Next for Vape

The regulatory process isn’t just causing problems for what’s on the market today, it also slows down technological upgrades for the category moving forward.

“The PMTA process hinders innovation with respect to new tobacco products,” says Sullivan, noting that to introduce a new product based on a current market trend, a manufacturer first needs to go through the multiyear PMTA process. “By the time you get that product on the market, that trend could be gone. You spend all that time, effort and money and it’s all for nothing.”

Johnson says such innovation may not come from tobacco, nicotine or synthetic nicotine products at all, especially if flavors are eventually pulled from the market.

“If the government takes away flavors, vapers will go to something else,” he says. “CBD, caffeine, it’s not that hard. Once you’ve done synthetic nicotine, it’s really easy [for manufacturers] to change the formula so it’s not nicotine anymore.”

Brand loyalty—beyond “any product that offers flavors”—will also likely be a big part of the vaping category as it grows.

“There’s some brand loyalty, but not a lot,” Sullivan says. “I think the consumers are still somewhat new to the market and are still searching out what works for them: a product with nicotine that is really satisfying.”

Reynolds data shows when cigarette smokers look to switch to a “new generation” product such as vape, there are three drivers that account for more than half the decision-making process.

“First, it is essential that brands fit with their identity and values,” Domingo says. “Second, they want highly satisfying products. And third, consumers are looking for high-quality products that they can trust to reduce risk to themselves and others.”

One thing is for certain: The vaping category, however it evolves, will remain a key part of the behind-the-counter experience.

“In the U.S., vapor is the largest new category by far, both in terms of consumer numbers and value,” says Domingo. “[It’s] forecasted to be the key driver of new category value growth over the next five years.”

“Ultimately, you have a product that could be a viable alternative to combustible cigarettes for adult smokers, and you have a good margin for your store,” says Niraj Patel, president and CEO of Bidi Vapor LLC, Melbourne, Fla. “As long as you have stringent youth access prevention measures in place, you’re looking to have a strong tobacco section, that includes vaping.”

The entire smokeless category remained slightly up as of April 2022, with NielsenIQ showing sales up 2% and units down 0.8% year over year. Retailers, wholesalers and analysts alike agree that smokeless gains have been driven almost exclusively by modern oral nicotine (MON) products (also known as nicotine pouches or oral nicotine), even though traditional moist smokeless tobacco (MST) remains most of the category.

“Dip and chew are nowhere near where they used to be after flavors were banned [in Minneapolis],” says McQuirter of 36 Lyn.

Johnson of Speedee Mart is seeing massive modern oral growth in his 35 c-stores, noting that while some MST brands are “still up there,” it’s actually a modern oral brand—Zyn—that is his “No. 1 smokeless seller.”

This is reflected in nationwide data: MST brands Copenhagen, Grizzly and Skoal remain the top-selling smokeless products. However NielsenIQ shows all three are down year over year; Zyn was up nearly 40% in dollars and units.

Other nicotine pouch brands are also growing, thanks to promotional incentives from manufacturers but also a growing consumer base.

“It provides a flexible alternative for adult consumers that are looking for a modern, convenient way to enjoy nicotine,” says Greg Schmidt, senior director of business intelligence and advanced analytics for Swisher, Jacksonville, Fla. “This category has reignited life back into the overall tobacco/nicotine segment.”

Meet the MON Shopper

The modern oral consumer offers a unique profile for behind-the-counter retailers.

For one, they’re dedicated convenience shoppers: Numerator data from Swedish Match shows that modern oral shoppers make 131 convenience trips per year (2.5 per week) vs. the average c-store shopper, who makes 47 trips per year (1.0 per week).

“That’s almost three times the trips of the average c-store shopper,” said Joe Teller, director of category management for Richmond, Va.-based Swedish Match, while speaking in a CSP Tobacco Update webinar. “These shoppers love to go to c-stores.”

They are also uniquely female compared to the rest of the category. Altria reports that women make up approximately one third of consumers of its modern oral brand On.

“In comparison, women represent just 5% of the MST category,” says Kelly of Altria.

The demographics of modern oral shoppers don’t just differ from other smokeless shoppers, but cigarette shoppers as well. Swedish Match data shows 29% of pouch consumers are 25 to 34 years old (vs. just 14% of cigarette shoppers) and 42% have incomes over $100,000 per year (vs. 25% in cigarettes).

Assessing Opportunities

Kelly points out that, like e-cigarettes, most modern oral products are waiting on PMTA approval—and potentially the ability to market them as less harmful alternatives to cigarettes through the modified risk tobacco product (MRTP) pathway, which Altria is “actively working on” for On.

“We believe the FDA should determine that the marketing of these products is appropriate for the protection of public health,” she says. “MRTP claims will provide important tools in educating and ultimately transitioning smokers.” Until then, there are other ways retailers can attract the modern oral consumer. Swedish Match was one of the earliest modern oral brands on the market, launching Zyn in markets west of Colorado more than five years ago. Teller said based on sales in the West, it’s key to have a dedicated section for nicotine pouches, ideally near the fixture header, and to leverage creative marketing and signage to drive awareness.

“Give it more space,” says Johnson. “If you can have a separate rack, I think you’re crazy not to.”

Teller said the western states provide a good preview of where this segment could go. In those states, modern oral accounts for 17% of OTP sales, which is more than vape (14%) and closing in on MST (20%).

“This category didn’t exist five years ago,” Teller said. “It’s still growing like crazy—it’s got legs.”

Like most categories, cigars faced some tough comparisons vs. late 2020/early 2021. Overall, the category was slightly down year-over-year as of April 2022, but when you look at NielsenIQ’s two-year stacked basis data, category dollar sales were up 11.1% (units down 2.2%).

“Volume and velocity remain high in comparison to pre-pandemic levels, which does indicate healthy engagement by adult consumers,” says Schmidt of Swisher.

When asked about category trends, both retailers and manufacturers agreed it’s all about having the right variety.

Johnson cited flavors—“whatever the new one is”—natural leaf wrappers and smaller package sizes as current category drivers.

“It used to be that five-packs were the package; now it’s twos and threes,” he says, adding, “I try to stay away from singles unless it’s an in-and-out.”

“Retailers can continue the momentum by reintroducing a variety of assortments (including flavors, pack size and brands) that were limited by previous COVID supply-chain issues,” Schmidt says.

Looming Regulations

Unfortunately, cigar retailers may soon be severely restricted on the kind of variety they’re allowed to offer. When the FDA announced in April its proposed rule to ban menthol in cigarettes, the proposal included a ban on all flavors in cigars and cigarillos, as well.

“Within the tobacco category, cigars are one of the main segments impacted by governmental restrictions and regulations,” Schmidt says. “It is critical to contest this initiative as it would be an injustice and bias imposed upon retailers, suppliers, adult consumers and manufacturers alike.”

Some retailers have already faced that reality: Since 2016, Minneapolis has limited the sale of flavored cigars to adult-only locations, specifically tobacco and liquor stores.

“It made up a significant proportion of our baskets, being able to sell flavors,” says McQuirter, noting that his stores lost both flavored and tobacco cigar sales when the ban went effect. “We are no longer convenient for the cigar customer. Cigar stores in Minnesota have seen their business grow.”

McQuirter has been able to preserve some of those lost flavored sales through cones and wraps, tobacco-free options often used for roll-your-own tobacco or marijuana. Johnson says the same will happen in his stores if the FDA bans flavors nationwide.

“Cigar sales will tank, and wrap sales will skyrocket if flavors go away in cigars,” he says. “I’m not sure they can say ‘you can’t have a flavored wrap’ because not all wraps are made of tobacco.”

Kelly of Altria encourages retailers to remain involved in the regulatory process due to the importance of cigars in the convenience channel.

“Combustible products, both cigarettes and cigars, accounted for 76% of tobacco volumes last year,” she says. “Retailers and OTP manufacturers continued to embrace category management integration despite continuing headwinds from COVID-19-related (supply) issues (for cigars), as well as federal, state and local government (actions),” Schmidt says.

“Adult consumers have been demanding their favorite cigars and now is the time to restock the shelves and remain in stock with previously unavailable SKUs.”

The newest behind-the-counter category is still in its infancy, with hemp sales only being legalized as part of the 2018 Farm Bill. But four years in, trends are starting to emerge in terms of both product formats and cannabinoids (chemical compounds found in cannabis and hemp products).

Vince Gillen, vice president of sales for Tampa-based Global Widget, says gummies remain a format that “everyone loves,” though the hemp and cannabidiol (CBD) producer has also seen more interest in vaping products this year.

“I think overall with cannabis products, you see people gravitating toward gummies and vape,” he says.

“Consumers want product formats they’re familiar with,” says Sullivan of E-Alternative Solutions. “The trends that we’re seeing are in drinks, vape pens and gummies. Those are going to make the biggest gains.”

Topical CBD products—including lotions, salves, balms and more—have not fared as well.

“From our data, I think it’s pretty much proven that the whole topical wave of CBD is dead right now,” says Gillen. “There’s so much product just sitting there.”

Another major category trend has been the shift toward intoxicating hemp-cannabinoids. While CBD does not have any intoxicating effects, consumers have been gravitating to delta-8 and delta-9 products, variations on cannabinoids that are intoxicating compounds, making them an easier value proposition for consumers to understand.

“CBD is something that should be taken every day; it’s regimental,” says Gillen. “Delta-8 or delta-9 you feel right away. That’s been a big needle-mover for our business.”

As more states have enacted bans on delta-8—which is typically made from isolating CBD from the hemp plant and synthesizing it into delta-8 in a lab—delta-9 products that meet the Farm Bill’s standard of coming from hemp and containing less than 0.3% THC by dry weight have grown in popularity. Johnson, for example, is not legally allowed to carry delta-8 products in Las Vegas so he’s rolling out delta-9 options in his stores.

“There doesn’t seem to be any end to what’s in cannabis,” he says. “It seems to be an endless amount of options.”

Another Category Without Clarity

Like many of their tobacco counterparts, CBD and hemp products operate in a regulatory gray area. Officially under FDA jurisdiction, the agency has yet to create a legal pathway for ingestible CBD products to come to market.

While FDA also maintains that delta-8 products are not allowed, the only actions it has taken to date (for CBD and delta-8) have been a handful of warning letters to manufacturers.

In the meantime, a patchwork of state and local regulations has popped up across the country. This is especially true of intoxicating products: As of May, 19 states had restricted or banned delta-8 sales and four are considering such measures.

Manufacturers and retailers, however, continue to sell various kinds of hemp-based products.

“I watched so many people when vape came out that didn’t carry anything because they were waiting to see what FDA would do,” Johnson says of his risk calculus. “They didn’t want to take a chance; getting up in the morning is taking a chance.”

“You have to take action in an aggressive, but low-risk way,” Gillen says. “If we’re all waiting on the FDA, you won’t be selling anything.”

Ways to Win

For the hemp/CBD category, Sullivan suggests retailers look at what he calls “the four P’s”:

• Product availability: Multiple brands and forms.
• Presence: Display products in a prominent location.
• Price: Offer products at a competitive price point.
• Promotion: Work with manufacturer partners to promote.

“CBD as a category, for us, is steady when you have the right assortment,” Gillen says, saying Global Widget regularly conducts resets with its retail chains, pulling out SKUs that are slow in lieu of something new.

Pricing is also improving, according to Johnson. “We had products two years ago that were $40-$60, now I’m trying to get everything at $19.99 or less,” he says. “There’s CBD stores and marijuana dispensaries, so I need to compete on price.”

One final key to succeeding in hemp/CBD: Whether it’s CBD-only or a full hemp portfolio that includes delta-8, delta-9 and other cannabinoids, Gillen says the entire retail team needs to be educated and on board.

“Transitioning to a whole-hemp category is easy if everyone in your organization knows what these products are and you aren’t trying to hide them,” he says.