smokeless tobacco review and outlook

Over the last few years, moist smokeless tobacco (MST) has increased in importance to convenience retailers as witnessed by its growing contribution to both in-store dollar sales and gross profits. During the same time period, the Sub-Price/Value (S-P/V) segment rapidly grew, changing the dynamics and strategies associated with MST.

As the S-P/V segment began to build, many retailers entered the segment primarily as a defensive tactic intended to protect their base business. However, their entry fueled even more growth, which prompted other retailers to introduce the segment in an effort to capture their fair share of the growing segment, according to David Bishop, vice president of Willard Bishop Consulting (www.willardbishop.com) in Barrington, Ill.


“Retailers that focused on delivering consistently fresh products to the consumer appeared to outperform retailers who focused on expanding assortment.”
David Bishop, Vice President of Willard Bishop Consulting

“This product cycle made consumers more price-sensitive, which triggered them to begin trading down through the price segments,” Bishop said. “While it’s easier to understand the impact of this trend today, the issue was less clear then as the robust growth masked the underlying issues.”

As 2006 unfolded and the S-P/V segment began to slow, so did the focus and strategies retailers employed to build the MST category. Hindsight being what it is, here’s what Bishop derived from 2006, and how it will impact the market in 2007.

Lessons Learned in 2006
In general, retailers have begun shifting their focus away from emphasizing selling more cans of MST to making more gross profit per can sold. In addition to this shift, through talks with retailers, Bishop has analyzed the industry and learned:

  • Delivering fresh products is more important than stocking more products. Expanding variety can create operational issues with core products that more than offset the value of adding SKUs to sets. “In fact, retailers that focused on delivering consistently fresh products to the consumer appeared to outperform retailers who focused on expanding assortment,” said Bishop.
  • Offering fair prices drives both volume and stronger profits. Lower prices do not automatically translate to increased unit volume since prices are not typically communicated off-site or outside of the store. As a result, retailers that had competitive, but not the lowest price points, usually had stronger profit growth as they didn’t sacrifice margin for potential lifts in volume that didn’t materialize, Bishop found.
  • Increasing the visibility of the category communicates that you’re in the business. While it sounds obvious, a number of retailers reinforced the positive impact that shelving had on the overall business. Whether it was installing new display fixtures, changing the orientation of the product or improving the category’s placement on the back counter, some retailers expressed these activities drove strong single-digit gains for MST.
  • Managing the price gap is critical for more profitable category growth. In 2006, retailers widely credited U.S. Smokeless Tobacco (USST) and its promotional strategy for improving the profitability of the MST category. However, the broader lesson is that the gaps need to be managed effectively to sustain the positive volume trends. “It is for this reason why a larger number of retailers are supporting efforts to level the playing field in terms of how states levy excise taxes on MST products,” said Bishop.

Expectations for 2007
Based on the state of the category, manufacturer focus and current merchandising strategies, Bishop would expect unit volume growth in the mid-single digits (4% to 6% range) in 2007.

“In fact, some specific markets could grow faster if local governments push for tougher restrictions on smoking in public areas as it creates consumer demand for smokeless products as cigarette consumers searched for tobacco alternatives.”

The renewed strength of the Premium segment signifies that Bishop would also expect that gross profit growth would exceed unit volume growth in 2007 (8% to 9%). More importantly, retail profitability could improve further if Reynolds American International (RAI) adopts some of the following strategies for its recently acquired Conwood brands in 2007:

Bishop expects Conwood to reinvest in its Kodiak brand because the growth in Grizzly is slowing, which will make profitable growth for this brand more challenging and expensive next year.

“A shift to a Premium-brand focus is also more consistent with RAI’s overall business strategy. It has learned in cigarettes that an effective Premium growth strategy is based largely on being able to manage the price gaps with value segments,” said Bishop. “Simply put, you can’t manage the top without managing the bottom. And RAI’s acquisition of Conwood would allow them to achieve that goal. Why is that important? Because RAI can make significantly more profits selling a can of Kodiak than it can from selling a can of Grizzly or a pack of Camels.”

Retailers would welcome this strategy as it would deliver stronger profits through higher gross profit per can sold associated with stronger Premium volume.

Bishop hypothesizes a list price increase in 2007 on the Grizzly brand, if it’s not taken in 2006, and this would be beneficial for several reasons:

  • Profit growth from distribution gains will be more limited in 2007.
  • It would allow Conwood to realize additional profits with minimal downside risks due to likely competitive response from Husky.
  • The price increase would allow Conwood to reinvest the incremental profits into reinvigorating its Kodiak brand.
  • The increase would reduce the current price gap that exists between Premium and S-P/V, thus providing a cost-effective strategy to build Premium volume and its Kodiak brand.

Retailers would benefit from additional margin potential in the S-P/V segment and stronger Premium volume, which would drive stronger profit dollars.

Bishop also sees the issue coming back to state taxations of the tobacco category.

“We’d expect that Conwood would embrace a similar position on excise taxation as USST,” he said. “Not doing so could potentially put RAI in a difficult political position. Changing Conwood’s position on taxes would support the rebuilding of the Kodiak brand. And helping to convert to a weight-based tax would quickly reduce price gaps by nearly one-third, making the Premium segment and Kodiak more affordable and appealing relative to lower-priced alternatives.” The benefit to retail is that this would be a very effective way of managing price gaps, which could return and sustain stronger gross profits for the category in 2007.

Bottom Line
In summary, Bishop feels the category’s fundamentals are in a much better position today versus a year ago, and the outlook for 2007 appears even more promising.

“Declining gasoline prices should stimulate demand for Premium products as consumers’ discretionary income improves,” Bishop said. “Successfully converting more states to a weight-based excise tax structure will help make Premium products more affordable in relations to the S-P/V alternatives. And, shifting strategic focus at Conwood will create an environment where retailers, and even wholesalers, can make even more profit across all MST’s price segments.

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