Despite the wild nine-month ride that saw a large federal tax increase and the Food & Drug Administration gain control over the category, cigarettes continue to dominate in-store sales, accounting for nearly one in every three dollars spent in stores, according to NACS’ 2009 State of the Industry report.
However, cigarette gross margins continued to plummet, falling to 15.3%. These low margins dropped the category to third in terms of gross margin contribution (16%) behind foodservice (23.9%) and packaged beverages (16.6%).
Margins promise to continue falling following the overwhelming taxation of the category at the local, state and federal levels. Most notably, beginning April 1 when the expansion of the State Children’s Health Insurance Program (SCHIP) went into effect. SCHIP is a federal program that gives matching funds to states in order to provide health insurance to families with children. The $32.8-billion program requires cigarette smokers to pay $1.01 more per pack.
“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,” said Tony Miller, senior vice president of sales and marketing for Thorntons Inc. in Louisville, Ky. The company operates 158 stores in six states. “Given that cigarettes represent 30-45% of c-store inside sales, the deterioration of this category will have devastating consequences.”
To continue to keep the category profitable, retailers more than ever are relying on support from cigarette suppliers on everything from information on FDA federal regulations to product promotions. According to CSD’s 2010 Brand Preference Study, the category’s top performers were Altria Sales & Distribution (Philip Morris), R. J. Reynolds and Lorillard. Honorable mentions were Liggett Vector, Natural American Spirit/Santa Fe and Commonwealth Brands.
Unlike some of the other key in-store categories tracked in the Brand Preference Study, retailers reported a high number of sales visits. Less than 4% of the nearly 70 cigarette buyers that participated in the study reported no sales presentations from cigarette suppliers in the last two months. However, 59% of buyers reported less than five presentations from the 13 companies in the market, a number that is too high considering how much the category has changed since April 2009. Retailers continue to express a need for better two-way communication with their tobacco suppliers.
For example, in addition to SCHIP, the FDA in October banned flavored cigarettes and promised it would employ a range of enforcement and regulatory tools to address violations of the ban.
With the scrutiny of traditional cigarette mounting, smokers are testing cost-effective tobacco alternatives, such as roll your own (RYO).
“Overall, the entire market saw RYO as the up and coming tobacco category and all of a sudden the government realized that as well and slapped a tax on us,” said Jazz Patel, president of Smoker’s Express Cigarette Outlets in Fairless Hill, Pa. “It’s the category retailers saw as a way to still make a profit in the face of more expensive cigarettes.”
Still, even with the whopping tax, RYO remains more economical compared to cigarettes. “If you bought a one-pound bag of premium tobacco, you could still make two-and-a-half cartons, depending on how dense you pack it. Buying a carton of prepackaged cigarettes is going to be more either way,” Patel said.
The reduced cost associated with RYO is attracting the attention of the big tobacco companies. Lou Maiellano, president of Taz Marketing & Consulting, said Philip Morris USA is jumping into the roll your own category under the L&M brand and are now test marketing those products in Maine and Michigan. “They’re looking to gain some control in that [section of the category] and offer full service across the gamut.”