The convenience industry has been concerned about cigarettes and the fate of the tobacco category for years. Declining unit sales and perceptible decrease in adult smokers has and will continue to have a negative impact on the top of retailers’ P&L ledgers.
To help protect profits, retailers focused on generating new revenue through fresh foods and improving market basket size. With these tactics, we’ve managed to endure over the years.
The cigarette category, albeit declining, still generated substantial revenue and gross profit dollars. Moist products and cigars maintained steady increases, and e-cigarettes came along, giving the total category a healthy boost. However, in my view, prudent owners/managers should be preparing for the inevitable radical changes to the tobacco category. Whether it be the government ban on flavors, or the anticipated restriction on menthol or new-product application policies and ongoing legislation—and just as significant, the continual cost increases to cigarettes and general nicotine products—these mounting concerns will now have a greater impact on the business than previously experienced.
A Losing Battle
Reading the tea leaves would suggest that the perfect storm has begun: Not only will legislation and the cost of a pack of cigarettes drive smokers to find alternative nicotine products, but also the manufacturers will be forced to recognize the fate of the combustible carcinogenic product. They will have to work overtime on the conversion tactics to hold on to the current and future nicotine users. Ignoring the inevitable and continuing to invest in the traditional cigarette business will eventually force manufacturers to acknowledge a losing battle.
Therefore, considering the points outlined above, what do we potentially see occurring in the near future? Can we anticipate:
- A significant and more dramatic decrease in combustible cigarette users?
- Consistent migration to alternative nicotine products? And if so, which products?
- Heavy research and development in e-cigarettes and vape products? Assuming so, will there be a game changer?
- And on the whole, is the traditionally reliable revenue and gross profit dollars of the tobacco category becoming less reliable?
Learn From the Past
We’ve already seen a healthy migration from cigarettes to e-cigarettes. In addition, it appears the life-long premium smoker is finally checking out different tiers. The modern oral subcategory is seeing significant growth, which is the telltale sign that change is underway and fast approaching.
A question remains: If the conversion rate from combustible to alternative forms of nicotine use is significant, can the alternative products generate enough revenue/gross profit to make up for the loss on cigarettes? Likely not, in my estimation, as the alternative products need to maintain affordability and the trips to purchases will probably be fewer than those reliable every-other-day cigarette smokers.
With this in mind, perhaps the traditional methods of managing the category need to change.
Regardless of experience, it may be better to be a student of the category versus the tenured expert. Keeping a close eye on the unit volume changes within the tobacco category and minimizing excess inventory just may be the best way to maximize profits and cash flow. Considering the overall cost of inventory in cigarettes, if the current unit declines continue, managing toward the 80/20 rule may become more important than ever.
Will the conversion from combustibles to alternative products be the pathway to the future as the cost for a pack of cigarettes (let alone a carton) escalates? Should this projected state of conversion occur quickly, managing the subcategory product assortment and ROI will need to become the primary focus.
To be sure, some retailers are already reacting to the inevitable revenue changes within the category. To their credit, they appear to be managing inventories and margins more carefully, versus simply broadening the backbar in hopes of serving every nicotine appetite.
The tobacco category is transitioning rapidly, and it is a good time to seek opportunities to manage carefully and wisely in order to protect the category’s profitability.
Bill Nolan is a partner with the Business Accelerator Team. Contact him at wnolan@thebateam.com.