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[ Feature Story]
Top 10 tobacco trends
Even though many CTS retailers, by necessity, have been diversifying their product offerings in recent years, cigarettes remain far and
away their No. 1 in-store product. The ongoing trends for the product category are vitally important to the future of CTS retailing. Here are 10.
by Tom Osborne
When David Letterman starts one of his “top ten” lists, the Late Show audience knows it’s a joke. However, the trends affecting CTS tobacco sales, specifically cigarettes, are no joke. While a few of the trends might be viewed as relatively neutral and one is even a positive development, most are clearly negative trends, spelling loss of sales, loss of margin or a need for heightened vigilance.
We spoke to a cross-section of cigarette manufacturers, distributors, consultants, retailers and consumers in developing this list. Here, in a nutshell, are the tobacco trends they identified that have the greatest impact on retailers.
#1 The MSA and Taxes Are Pushing Prices Higher
The Master Settlement Agreement between tobacco manufacturers and the states imposes payment obligations from those manufacturers, based on market share. Those payments are a cost of doing business and must be passed on by the manufacturers.
“Last year, for the first time in several years, the industry took a price increase,” noted Peter Gregorio, sales manager Eastern United States for Englewood Cliffs, N.J.-based JT International, the third-largest cigarette manufacturer in the world. “Other than that, most price increases to the retailer are taxes.”
Most of those tax increases are, and will likely continue to be, at the state level. Lou Maiellano, president of TAZ Marketing & Consulting Group in Levittown, Pa., said, “20 states are considering some kind of tax increase this year and probably 10 or so will actually adopt one. Kentucky, one of the friendlier tobacco states, passed legislation to increase its tax from 3 cents to 30 cents per pack. While that may be a low tax rate from the perspective of many other states, it’s still a tenfold increase.”
Maiellano pointed out that the pattern of tax increases means shifting volume to nearby states with lower taxes, probably the biggest impact on retailers. Confirmation of that came from John Schaninger, vice president sales and merchandising for Quick Check Food Stores of Whitehouse Station, N.J.
“New Jersey has the second-highest cigarette tax in the nation. The last two Julys, we’ve had a tax increase. All of the neighboring states have lower taxes. It’s easy for customers to go across the border to New York, Pennsylvania, Delaware, or even down to Virginia. It’s had a tremendous impact on our business over the past couple of years.”
#2 Taxes Are Seen as a Cash Cow for States, More Than for Their Smoking-Reduction “Purpose”
The purported purpose of raising cigarette taxes is to discourage smoking, most specifically to discourage underage smoking. But the reality is that the debates over raising cigarette taxes are usually done in the context of state or local budget requirements for more funding.
John Jenkins of Alexandria, Va., a consumer who smokes two packs of Carlton 100s a day, complained to a politician in a recent public meeting.
“If this was really about reducing smoking, you would take some of the tax money and some of the settlement money and use it to pay for quit-smoking programs for those who smoke and would like to quit,” he said. “You don’t do that, though. Quit-smoking programs aren’t covered under health insurance and aren’t even tax-deductible as a medical expense on our income taxes. We smokers are just an easy target to raise tax money from. You don’t really want us to quit, because if we did, you’d have to raise taxes on everyone else!”
Industry spokesmen wouldn’t go that far, but they agree that “smokers pay a disproportionate share of taxes,” as Gregorio noted. It seems that the driving forces for tax increases are both political and economic. As long as states are looking for more money, given the political climate, cigarette taxes are always going to be an attractive option.
#3 Higher Prices May Be Starting to Threaten Brand Loyalty
“Consumers are generally brand loyal, but due to tax increases, some get priced out of their tier and some eventually get priced out of an entire category,” said Carl Ioos, president of Republic Tobacco, Glenview, Ill., America’s leading roll-your-own and make-your-own tobacco company.
Gregorio added that “premium brand smokers are 80 percent or better brand loyal, but once you get past those, brand loyalty begins to decrease.”
Different markets may be affected differently. “New Jersey is a premium cigarette market,” Schaninger said. “If somebody is out of stock on a cigarette, half of the people will leave. The other half may trade off once or twice, but beyond that, if you’re out of a specific brand and type or stop carrying it, most consumers will go somewhere else.”
Sometimes, though, a desire for brand loyalty is countered by economic reality. Michael Newman, executive vice president of NOCO Energy, a retailer headquartered in Tonawanda, N.Y., sees it in some of his markets. “We are seeing some trading down. It’s not a huge trend, but in fixed or lower income demographics, it is happening some.”
Maiellano agreed. “Typically the premium brands, the higher end, are what consumers are loyal to,” he said. “Low-end smokers, who are buying on price, have less loyalty.”
There’s potentially a flip side, however, when pricing is done on a fixed markup.
“In high-tax states, a lot of the generic cigarette volume declines,” said Maiellano. “The smoker apparently figures that the difference from $5.60 to $5.30 a pack doesn’t justify switching to save money. He may even think, ‘For an extra 30 cents, I can treat myself to a premium cigarette.’”
From a retailer’s perspective, the switching can cut both ways. Typically, retail markup is a flat cents-per-pack, meaning the margin percentage is lower for a premium product.
“You’ve gotta do both,” Gregorio noted. “Carry specific brands for certain customers, but also carry generics and lower tiers for better financial returns.”
#4 The Availability of Promotional Incentives to Retailers is Declining
Most everyone in the business is aware that, when prices were increased in 2004, the rates for premium brands were generally not increased. Instead, a roughly equivalent amount of promotional money was taken away from them.
“Majors still have promotions out there, but at a reduced monetary rate. A promotion worth $7 or $8 last November may be worth only $5.50 to $6 now,” Gregorio said.
“There’s not as much promotional money as we used to get,” Newman agreed. “But they’re still doing a lot of consumer discounts — lower prices if you buy two packs — in our markets.”
That isn’t true universally, apparently. “We see a lot less of ‘buy one get one free’ here in New Jersey,” Schaninger observed.
Ioos suggested that promotions for roll-your-own and make-your-own cigarettes are developing as the category develops.
“The industry still markets its products, but just more selectively,” Gregorio said, talking about the various contests and giveaways that come and go and seem to get recycled in the industry. “Everyone appears to be legitimately trying to honor their commitments under the MSA.”
#5 Tribal Interests, Bootleggers and Other Untaxed Competitors Increasingly Threaten Tax-Paying Businesses as Tax Rates Go Up
Because taxes are such a high percentage of the total cost of cigarettes, those who can find a way to evade taxes have a real competitive advantage against legitimate, tax-paying businesses.
For more than a decade, some retailers have been battling untaxed cigarettes sold on Indian reservations and in other tribal operations. Indian tribes are supposed to be exempt from state taxes, but only for sales within the tribe; sales to non-Indians are supposed to be subject to state taxes, although the courts have limited the weapons available to states in attempting to collect those taxes, and many state officials are reluctant to pursue the funds.
Newman recounted that “people would drive out, take an order, and buy 20 cartons to distribute to all their friends and people who worked at their factory.
Then in 1997, during a brief time the governor (of New York) was trying to enforce taxation, we saw our volumes double throughout the system. Collection of the taxes is once again on the agenda in New York; it’s included in the budget, and Gov. Pataki has indicated he’ll begin enforcing through his tax office, but his threats in the past have been empty threats.”
Quick Chek, in New Jersey, doesn’t have the problem of nearby Indian reservations, but has another problem: bootleg cigarettes.
“If a guy takes a tractor-trailer down to Virginia and loads it up, there’s a $1 million discrepancy in the retail price when he gets them back to New Jersey,” Schaninger said. “There’s a lot of that going on, and it’s a big issue we face every day.” A second big issue for his company is Internet sales, both from a tax-advantaged perspective and on the issue of age restrictions.
“Online sales are generally in the low-tax states,” noted Gregorio, “and their clientele is generally in high-tax states. They’re selling at the low tax rates applicable in their home state,” so although not totally untaxed, the product has a tax advantage.
“I did an informal survey in January of last year,” Gregorio continued. “At the time, there were just short of 500 Web sites offering cigarettes for sale. The majority of them were tribal sites, but some were from outside the country - including a Swiss company that was even avoiding the federal excise tax!”
#6 Online Sales Have Taken a Hit, but Don’t Count Them Out Yet
In the one trend reflecting good news for retailers, online sales have definitely suffered a setback.
Part of that momentum is a series of voluntary agreements by credit-card companies agreeing to stop processing Internet tobacco sales, and by UPS and FedEx agreeing to stop accepting such shipments.
“When the credit-card companies stopped doing business over the Internet, we saw an immediate increase in business of close to five percent,” Schaninger observed.
“Enforcement is strong and getting stronger,” added Gregario. “But are there ways around it? Of course. One exception is the U.S. Postal Service; they’ll deliver anything. They don’t want their people to be law enforcement officers.
The federal government will have to step in on that at some point.” There are also ways around the credit-card boycott.
#7 Fourth-Tier and Other Discount Brands Are Affected by the MSA, Higher Taxes and the Question of Brand Loyalty
There are several currents of trends regarding fourth-tier cigarettes. Many fourth-tier cigarettes, particularly those that are greatly reduced in price, are from companies that are not paying into the MSA. In some states, companies that aren’t participating in the MSA can’t do business.
“Pennsylvania has a registry act and everyone has to pay into the MSA,” Maiellano said. “States are enacting legislation so that lower-end companies pay their share of the MSA. Some fourth-tier companies will have to raise their prices to pay the MSA payment just to stay in business.”
Second, there are a lot of such brands, but they tend to be regional and are found in small pockets.
“I don’t see it diminishing,” said Gregorio. “I know the states have gone to stronger enforcement of the MSA in the last couple of years, but I’m always seeing a new brand and they’re not part of MSA. With enforcement, that should diminish. But it won’t mean the products will go away. The only thing it will do is raise the price of the fourth-tier cigarettes, reducing the big gap in price.”
Newman indicated that, while NOCO Energy offers a fourth-tier or other discount cigarette, they’re “not getting quite the demand we expected. Most people are brand loyal. Also, people are worried about the quality.”
Finally, it should be noted that there are other options to provide a cost savings to customers who are looking for lower prices.
“Republic Tobacco is a participant in the MSA,” Ioos pointed out, so his company’s products, RYO and MYO, aren’t fourth-tier, even though typically priced lower than factory-made cigarettes. “Different brands have different price points, but generally a consumer can ‘trade down’ in price first to make-your-own cigarettes and then to roll-your-own. The category is still emerging in terms of price points, though.”
#8 Marketers Continue to Have Primary Responsibility for Enforcing Age Restrictions, With Heavy Penalties for Failure
Retailers report extensive efforts to prevent underage sales of tobacco products, but even so can’t guarantee they’ll be 100-percent effective. Particularly galling to them is the problem of Internet sales, where age-checking at the delivery end is virtually impossible.
“We are at great risk that if an underage person buys cigarettes at one of our facilities in a sting operation, we can be out of the cigarette business entirely,” Newman said. “In remote sales, they can do so without age verification and without consequences.”
NOCO Energy has even had situations where they were blamed for a sale done over the Internet. “We’ve had customers complain because their children say they bought the pack from us, but when they bring in the pack, it has no tax stamp, so we know they got it online. Who are the most savvy people about the Internet? Young people!”
Schaninger reported that Quick Check “does a tremendous amount of training. Every team member takes it seriously. On our registers, every time someone buys a pack of cigarettes, the clerk is reminded to check for ID. We also have in-house mystery shoppers. We are very aggressive because one of our core values is being a good neighbor.”
“The number of retailers who are being cited, warned or fined in sweeps is greatly reduced from what it was just a few years ago, which indicates that retailers are doing a better job,” said Gregorio.
Ioos agreed that “retailers are becoming more sophisticated in enforcement, but there are always those out there who are willing to sell to minors, and it should not be allowed.”
#9 Continuing Lawsuits Against the Tobacco Industry, Plus the Prospect of Future FDA Regulation of Tobacco, Require Marketers’ Vigilance
Many retailers are quite concerned about FDA regulation of tobacco, and have been part of the coalition that has headed it off several times in the past decade.
For the most part, lawsuits against the industry are directed at manufacturers. Retailers need to remain aware of them, but they’re not the top-burner issue. Although the MSA precludes some lawsuits against the industry, it doesn’t close off all of them. Some states aren’t part of the MSA. Some tobacco companies aren’t participants. And there are some issues that are still open to litigation even in those states and involving those companies that are parties to the agreement.
One issue of significant concern to retailers should be their potential liability in the case of companies that are non-participants in the MSA.
“Many of those companies are here today, gone tomorrow,” Ioos pointed out. “Their products are not backed by companies with staying power, so retailers and wholesalers take a risk. The risk of litigation is the biggest issue. Will the manufacturer be there when the lawyer comes knocking on my door?”
#10 Tobacco Use Is Declining, but Nowhere Near As Rapidly as the Federal Government Wants
“The overall demographic is a shift away from cigarette smoking,” Newman observed. “We’re looking for something to replace cigarettes as the major contributor to our bottom line. The increasing health consciousness of our society, as well as greater awareness of the implications of tobacco among young kids, are pointing in that direction.”
According to an article by Marc Kaufman in the Washington Post, “22.5 percent of U.S. adults described themselves as smokers in 2002, down slightly from 22.8 percent in 2001. The decline is too slow to achieve the federal government’s goal of reducing the number of smokers to 12 percent of the adult population by 2010.”
And because it is too slow to satisfy the opponents of smoking, the No. 1 trend for tobacco is this: Expect more of the same, only more so, in terms of all of the other nine trends: more and higher taxes, more and greater pressure on retailers, more and greater regulations, and more and greater competition from non-tax-paying competitors. |
