Dominating At The Top

4/2/2012

While some retailers are rationalizing their cigarette SKU count, the top quartile is selling a significant number of cartons

It's no secret that the cigarette category has faced more than its fair share of challenges in recent years. But despite all the battles convenience retailers have had to wage, some are managing to win the war.

The recent Balvor LLC/Convenience Store News 2012 Tobacco Retailing Survey found that, on average, 115 cartons of cigarettes are sold per convenience store per week. When it comes to the top quartile of retailers, though, the average number of cartons sold jumps significantly to 273 per store per week, according to David Bishop, managing partner at Balvor LLC. All other quartiles report an average of 85 cartons. The survey fielded responses from 156 retailers between Feb. 22 and March 6; 77 percent of the respondents operate between one and 10 stores.

"The top -quartile retailers dominate cigarette retail. It may not be a new headline, but it continues to underscore that a select few are outselling all other retailers, primarily convenience retailers, by a factor of more than three to one," Bishop said. "We know there are a few retailers out there that are truly destinations for the adult tobacco consumer and these results highlight that point — at least relative to the cigarette category."

However, just because the top quartile is clearly outselling all others, that does not mean it is growing the fastest in terms of cigarette dollar sales. In fact, the survey found that sales growth was comparable across all quartile segments. "It is a little more complicated than to say the retailers that sell the most are the ones who are going to grow the most," he said.

Top-quartile retailers that have a strong base business may have to deal with issues that are outside of their control, such as Proposition 29 in California, changes in taxes at the state level or differences between the excise tax in their state as compared to neighboring states, Bishop explained.

Smoking restrictions can also factor into sales, he said. For example, when Indiana's statewide smoking ban goes into effect this June, it will likely have a dramatic and immediate effect on personal consumption which, in turn, will impact demand for cigarettes.

Drilling down into the numbers, the survey revealed that retailers operating more than 50 stores are reporting "real growth" when compared to smaller chains. Real growth, he said, means their dollar sales growth is exceeding the price inflation occurring in cigarettes year over year.

"One potential factor we identified as to why larger chains are twice as likely to report real growth is most likely attributed to how they are marketing that business," Bishop said. "We see significant differences in use of direct mailing across retailer sizes and that may be one critical reason why larger retailers are growing."

When taking a look at other convenience store staples, it is apparent that the annual inflation rate for cigarettes is putting a crimp in the category. According to Bishop's analysis, the annual inflation rate for cigarettes over the past 10 years would average around 7.5 percent. The average price per pack in the United States is now more than $2.50 higher than it was in 2001 — and more than three-quarters of that increase is related to taxes, he noted.

"That is a significant difference compared to the overall CPI [consumer price index] by a factor of at least two. The overall CPI during that timeframe is around 2.4. Bringing it closer to home, beer had an average annual price inflation rate of only 2.5 percent," he said. "Cigarettes are becoming more expensive more quickly than other products."

He pointed out that a large chunk of that increase was driven by the federal excise tax increase in 2009. Yet even without it, cigarette inflation would still stand above other goods. "Even if we removed that increase, during the past 10 years, cigarettes still would have run at an annual inflationary rate of about 5.6 percent," he added.

Price inflation is not only impacting the consumer's ability to spend on cigarettes — leading to volume declines — but it is also affecting the retailer's ability to carry inventory — leading them to rationalize the category. The Balvor/CSNews 2012 Tobacco Retailing Survey showed that, overall, almost half (48 percent) of the retailers indicated their SKU count has decreased vs. two years ago. The retailers most likely to have lowered their assortment are those that experienced year-over-year declines in dollar sales.

This suggests, Bishop said, that volume is decelerating in their stores at a fast rate and these retailers have to manage this business more aggressively because they can't keep up with overall market trends and are losing business. On the other hand, retailers that have been growing over that time were about half as likely to decrease their cigarette stock, and approximately 30 percent were much more likely to have increased their SKU count.

As a result of the SKU count reduction, inventory levels are tightening. Retailers experiencing sales declines indicated, on average, that their inventories have adjusted downward by almost 3 percent. Meanwhile, retailers with positive, or slightly weak growth, report their inventory levels were down just under 1 percent.

Retailers that are growing volume right now are actually keeping inventory levels fairly stable this year, whereas retailers that have seen their volume decline are really reducing their exposure to the category in two ways: the amount of inventory and the range of products, Bishop explained.

"What's been clear to me this year is not that you have been able to sell the most cigarettes, but that you have been able to grow in a difficult environment. Your ability to grow in a difficult environment is part good fortune, by which I mean location and specifically state or market. It's a little more broad than are you on the drive home or drive to work side, but which state are you in, what states are next to you and how such variables as excise taxes and smoking bans come into play," he said.

This year's survey also reveals a correlation between manufacturer programs and sales. Specifically, the results showed that 84 percent of the top quartile has signed on to Philip Morris USA's (PM USA) Marlboro Leadership Price (MLP) program, which was introduced about a year ago.

This makes sense, Bishop pointed out, because those retailers sell a lot of cigarettes and a major component of the MLP program is price leadership and having a strong opening price point on those products. Among the other quartiles, the survey found 53 percent are part of the MLP program.

PM USA also offers a flex option as an alternative to the MLP program. By comparison, only 8 percent of the top quartile said it signed on to the flex option, while 28 percent of retailers in the other quartiles participate in it, he added.

Getting down to dollars and cents, retailers on the MLP program were four times more likely to say the program has helped dollar sales grow as opposed to retailers on the flex option (54 percent vs. 13 percent). However, when it came to gross profit dollars impact, the two programs offered similar results. Of the retailers participating in the MLP program, 21 percent said it has helped category gross profits compared to 19 percent of the retailers participating in the flex option.

"One in three is saying the MLP program helps drive dollar sales, but only one in five says it helps drive gross profit dollars. Retailers are seeing a benefit on the top line, but not seeing as much of a lift on the bottom line," said Bishop.

Cigarettes, though, are only a part of the tobacco category — albeit the largest part — and when it comes to other tobacco products (OTP), approximately 30 percent of the respondents said they have increased shelf space. Of that number, 43 percent indicated they took the space from cigarettes.

"Why? What was going on with cigarettes? Of those retailers, 94 percent were experiencing sales declines in the cigarettes category," Bishop explained. "A retailer was very much inclined to take space from cigarettes if they were already rationalizing the category. Retailers have taken space from cigarettes where it made sense."

Electronic cigarettes are also gaining ground in c-stores. Last year's survey (fielded in January 2011) found that 24 percent of retailers were selling e-cigarettes. This year, the percentage of retailers surveyed who currently offer e-cigarettes jumped to 53 percent. Bishop said he was impressed with that growth rate, but not surprised.

"I wasn't surprised that it jumped up because we surveyed in January 2011 when the FDA [Food and Drug Administration] was deciding how to regulate e-cigarettes," he said. "A lot of retailers were not quite sure what was going to happen. You were dealing with an unregulated market that had no clear definition as to what business it was: medical device or tobacco? It wasn't until the courts decided in the spring of 2011 that the FDA should regulate e-cigarettes like tobacco products."

Of those retailers carrying e-cigarettes, 34 percent said they've sold them for more than 12 months; 22 percent for less than six months, and 44 percent for between six and 12 months.

"There is a lot of opportunity here, but what percentage of the stores?" Bishop questioned. "Of the retailers who sell [e-cigarettes], the product is available in roughly half of those stores. Retailers are not putting them in all their stores primarily because they can't find the space for them."

This is a challenge both to the retailer and the suppliers, he added, because they haven't been integrated into the tobacco set yet.

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