The Impact of Tobacco Federal Excise Taxes

The increase of federal and state cigarette excise taxes will have a far-reaching, negative impact on the convenience store industry. With the exception of petroleum products, no other category is more vital to the industry’s success than tobacco products. Given that cigarettes represent 30-45% of c-store inside sales, the deterioration of this category will have devastating consequences.

The Federal Excise Tax (FET) will dramatically increase the cost of doing business. Inventory cost will increase by an average of $6,000 per store—$1 million for a chain of 166 stores—resulting in higher interest expenses.

Credit card transaction fees will increase due to soaring cigarette retails. Internal shrink dollars will escalate due to the higher cost per carton. External theft will rise due to the value of cigarettes and the amount of inventory dollars carried. In addition to the FET, Kentucky Legislators are proposing an incremental 30- to 45-cents-per-pack State Excise Tax (SET), compounding these issues.

The FET is a direct tax on the middle-class, as 80% of cigarette smokers are in lower-income brackets, and in Kentucky the average annual household income for cigarette smokers is less than $32,000. During these difficult economic times, it is impossible for the average cigarette smoker to assume a higher tax burden. As a result, increased cigarette taxes will significantly alter the purchase behaviors of our core consumers.

Declines Expected storewide
The cigarette industry is ratably declining at 3-4% annually. Excise taxes at these levels are unprecedented, and it is difficult to project the potential sales loss. Nonetheless, many industry experts are predicting additional 6-10% declines on top of the current 3-4% trends. In addition to the reduction in cigarette sales and gross profit dollars, retailers will also lose sales and gross profit dollars associated with affinity purchases—other products purchased with cigarettes.

If the convenience store industry experiences double-digit sales declines in its largest inside-sales category, it will have an epic impact on the way the indusry does business, which will influence the total retail strategy. With unit sales predicted to decline by more than 10%, retailers will need double-digit percentage increases in average retails to make up the loss in revenue dollars. While retail increases associated with the FET will make up the revenue shortfall, they will not make up the deficit in gross profit and net income dollars.

With chains facing reduced gross profit dollars, reduced affinity sales, increased interest expense and increased cigarettes shrink dollars, storeowners will be forced to look to this category and others to make up the loss in net income. It is unfortunate that consumers will most likely absorb additional increases above and beyond the excise taxes.

This daunting economy has already made it difficult for most retailers to maintain shareholder value, and the impending FET and SET will place an additional burden on the convenience industry. This burden will challenge the industry to evaluate its cigarette categories and possibly re-engineer its overall strategies. In time, prudent retailers will overcome this adversity and prevail with a much stronger business model.

Tony Miller is the senior vice president of sales and marketing for Thorntons Inc. in Louisville, Ky. The company operates 158 stores in six states.

 

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