Concerns Abound for Cigars

The war over tobacco taxes to pay for an expansion of the State Children’s Health Insurance Program (SCHIP) ended on February 4 when Congress passed the Senate’s version of the bill and new President Barack Obama signed it into law.

What that means for c-store operators who sell cigars in an era of a rough economy, state tax hikes and creeping smoking bans is tougher times ahead, as well as a stronger reliance on manufacturers to provide advertising and promotional support and even repackaging to increase value.

SCHIP is a federal program that gives matching funds to states in order to provide health insurance to families with children. It was designed to cover uninsured children in families with incomes that are modest but too high to qualify for Medicaid. At its creation in 1997, SCHIP was the largest expansion of taxpayer-funded health insurance coverage for children in the U.S. since Medicaid began in the 1960s.

The $32.8-billion program will see cigarette smokers paying $1.01 more per pack. Cigar smokers will also bear some of the brunt. The federal taxes on large cigars has jumped from 20.719% of the wholesale price with a tax cap of 4.875 cents per cigar to 52.75% of wholesale with a tax cap of 40.26 cents per cigar. That means that the tax increases as of April 1 are:
• $1.77 on a pack of five cigars
• $3.54 on a box of 10
• $7.08 on a box of 20
• $8.85 on a box of 25

The law lumps little cigars in with cigarettes, raising the federal tax on a pack of 20 little cigars to $1.01. According to estimates by the U.S. Treasury Department and the Congressional Budget office, retailers can expect a sharp decline in sales.

“This level of federal cigarette and tobacco tax increases will mean at least, if not greater than, a 10% reduction in sales amongst all categories of tobacco products across retail,” said Tom Briant, executive director of National Association of Tobacco Outlets (NATO) Minneapolis, Minn. “That 10% reduction will be significant because convenience stores generally have about 35% of their revenue generated by a tobacco product sales. This will impact them significantly and negatively.”

Steps to Take
Retailers who sell cigars can do a variety of things in the face of SCHIP to drive cigar sales, according to Frank Armstrong, president of Blue Ridge Tobacco, an eight-store tobacco retailer based in Winston-Salem, N.C.

“If you say you can’t do anything you might as well close up shop,” said Armstrong, whose stores aggressively marketed pre-SCHIP tobacco promotions to let customers know that prices were going to increase after April 1.

That kind of planning, Armstrong said, “helped us reduce our inventory and saved money from the April 1 floor tax. We used the increase in that regard to help out our consumers a little bit.”

Beyond that, Blue Ridge works hard on marketing programs, which includes partnering with manufacturers. “We bring them in once a month to have an event. What that does is keep them top of mind, and lets (consumers) feel like they are getting a deal,” Armstrong said. His stores do, in fact, offer discounts in the form of buy-three-get-one-free or 25% discount offers.

As for little cigars, which Armstrong referred to as “a different animal,” some smokers have begun using them as substitutes for cigarettes. The increase will put the average price of a pack of small cigars at around $2.19, he said, which, though higher, compares favorably with his lowest-price cigarettes, which range in North Carolina from $2.70 to $2.80.

Armstrong is also concerned that manufacturers may stop their buy-one-get-one-free programs because “they would be responsible for the taxes on free product, which would be too expensive to promote,” he said, calling any such move a “devastating blow to his cigar business.

Market Madness
“Everyone is going to have to charge more because of the taxes,” said John Eichberger, vice president of government relations for NACS. “Most of our interest is in making sure operators know what the taxes are and pass them through at the proper time.”

From a marketing standpoint, Eichberger said the tobacco companies have to step up with additional support. “I would look to manufacturers to provide a lot of materials on how to maintain or boost sales in an environment in which product is going to be more costly,” he said.

Operators may well decide to switch down to smaller packages of domestic-made cigars to keep them at a price point “where customers are still comfortable purchasing them,” Briant said. “But instead of five at the time they may go look for a three-pack or even individuals.” As such, operators may need to look to smaller packaging just to make the product sellable and move it through their inventory.

“There is going to be a percentage of customers who will still enjoy tobacco as a general statement,” said Mike Zielinski, president and CEO of Royal Buying Group in Lisle, Ill., a marketing association for convenience store operators and jobbers, which negotiates pricing and promotions for independent and multi location chains. “I think that the operators who do the best job in offering selection and value will win over that customer. So in some ways this is a big challenge, but for the right operator it really actually can be an opportunity.”

Those retailers that fail to keep an eye on legislation that comes up “or what the true needs and wants of their customers are will be the ones who will get hit the hardest by legislation like this,” Zielinski said.   

Getting rid of the slowest sellers is step one. “First of all, SKU rationalization doesn’t just apply here; it applies to the whole store,” said Zielinski. “But those who have not taken an active role better do so, real quick. If you’re not selling products you need to get rid of the dead weight in your store.”

Analyzing sales reports through point-of-sale (POS) terminals or back-office computers will quickly show an operator “where the trends are for each of their stores, and then they’ve got to compare it to what is selling around their area,” Zielinski said. “One of the services we provide is to help them know what things are selling and what planograms they should be using. They can definitely do it by themselves, (but it) will take some time and research in order to get it set for their store.”

Zielinski agreed that operators “absolutely” need to move promotions and merchandising to the fore. Specifically, they must be able to tell customers, “first, that you are in the business, and second, you have to show them that you offer the best selection and value versus your competition.” That goes for everything, he added, from the ambience of the store to the professionalism of the clerk and suggestive selling.

There are still things that can be done even in a bad economy, even in a bad taxation situation that will minimize the effects of it. It’s still going to affect them. “Moving customers over to a value type product or multi-product purchase will drive revenues and create a loyal repeat business,” Zielinski said. “These are fairly easy steps to take that can have a big impact on the bottom line.”

Floor Stock Tax
In addition to the SCHIP tax, retailers, wholesalers and manufacturers were slapped with a floor tax on cigarettes, little cigars, roll your own tobaccos, pipe tobacco, chewing tobacco and snuff in stock on April 1.

“For a number of years, whenever there was a federal tax increase the federal government imposed what is called a floor stock tax,” Briant explained. The goal has been to prevent wholesalers and retailers from obtaining a windfall. “The federal government imposed the extra tax on everything that wholesalers and retailers have in inventory at 11:59 p.m. March 31 to capture the price increase that went into effect the next day.”

That means retailers who sell tobacco “were responsible to do an inventory overnight on March 31 going into April 1 and file a separate floor stock tax return,” Briant said.

Operators who have not done so should visit the Alcohol and Tobacco Tax and Trade Bureau’s Web site, www.ttb.gov, to download the form.

Golden Goose
Perhaps the best strategy is to impress greedy legislators with the fact that they have, in effect, placed a knife at the neck of their golden goose.

“Most of the data I have seen indicates that when you increase taxes on cigarettes you succeed in driving customers to the black market and to unregulated markets,” said Eichberger. “We’ll also see an increase in tobacco theft at the stores, which gets converted to the black market. Tax hikes certainly do not accomplish what (politicians) hope they will.”

There are going to be a lot more battles to be fought on the state level, Eichberger predicted. “I have seen a couple of articles that raise the question, ‘Will passage of the significant federal tax increase kind of stymie some of the state efforts?’” he said. “We have seen reports that it has not slowed some states down at all.”

In recent weeks Kentucky has doubled its cigarette tax from 30 cents to 60 cents per pack and doubled the tax on other tobacco products. Arkansas has increased its cigarette tax from 59 cents a pack to $1.15.

Zielinski is similarly less than hopeful that states will acknowledge that taxing tobacco leads to diminishing returns. “They never learn with cigarettes do they?” he asked. “I would very much doubt they will have any other choice here. Most of the states now are spending MSA (Master Settlement Agreement) money before they even get it. If they are spending more than they are even going to take in then we should expect every state could be in financial disarray.”

Zielinski firmly believes states will continue to tax “whatever they can get away with, and obviously a tobacco product is kind of like open season for them,” he said. “Due to the amount of pressure put on, not only from the health industry but from environmentalists and others who want to protect their own health, it is way too easy to tax tobacco.” CSD

SCHIP Cigarette and Tobacco Tax Rates

ProductCurrent rates through March 31, 2009Cigarettes and tobacco
tax rates on April 1, 2009
cigarettes39¢ per pack$1.0066 per pack
Large Cigars20.719% of manufacturer’s price;
cap of 4.875¢ per cigar
52.75% of manufacturer’s price; cap of 40.26¢ per cigar
Little Cigars4¢ per pack$1.0066 per pack
Pipe Tobacco1.0969¢ per pound2.8311¢ per pound
Chewing Tobacco19.5¢ per pound50.33 per pound
Snuff58.5¢ per pound$1.51 per pound
ryo; Cigar Wrappers$1.0969 per pound$24.78 per pound
cigarette Paper1.22¢ per 50 papers3.15¢ per 50 papers
cigarette Tubes2.44¢ per 50 tubes6.30¢ per 50 tubes
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