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Smokin' Aces

Don Longo

The impact of the latest federal excise tax (FET) increase on tobacco retailing was one of the hot topics discussed during the annual Convenience Store News Tobacco Best Practices Roundtable, held in New Orleans the day before the start of the Tobacco Plus Expo in May.

Guest speaker David Bishop, managing partner of Balvor LLC, a leading c-store consulting firm, presented the results of a new Balvor/CSNews Tobacco Retailing Survey that polled convenience retailers on their expected reactions to the April 1, 61-cent FET increase to $1.01 per pack of cigarettes.

When adding in the mean average state excise tax of $1.20 per pack, cigarette consumers pay $1.44 more per pack in taxes compared to what they paid as of Jan. 1, 2001, which doesn't even reflect the increased cost associated with changes at the county or city level.

Near term (within the current calendar year) implications cited by Bishop included:

Retailers, especially smaller ones, will likely reduce tobacco inventory as higher inventory cost puts a strain on cash flow. The reductions will come from a combination of SKU rationalization and inventory optimization across all brands;

There will be greater attention paid to value brands as consumers respond to increased prices, especially during such a tough economic time; and,

Shelf space will be reallocated as retailers primarily attempt to capture further growth from the other tobacco products (OTP) side of the business.

For the longer term, Bishop told retailers at the roundtable to expect shifts in market share as some lower volume traditional retailers, namely supermarkets, exit the category at an accelerated pace. There also will be further supply side consolidation, whether via acquisition or internal restructurings, as U.S. manufacturers leverage further synergies to strengthen their bottom lines, he predicted.

Retailers discussed best practices in merchandising, promoting and staying in stock. Retailer guests included representatives from BP/ampm, Certified Oil, Mac's Convenience Stores, Mother Hubbard's Cupboard, Plaid Pantries, Royal Buying Group, Smoker Friendly and Worsley/Scotchman Stores.

The 2009 Tobacco Best Practices Roundtable was sponsored by McLane Co.

Retailers at the roundtable were highly vocal in their opposition to the government's intrusion on the freedom of businesses to sell and people to use a legal product. They didn't have to use their imagination to see where the cigarette category could go in the near future, and only had to look north to Canada, where much of the country has "gone dark" -- meaning no tobacco product or signage can be visible to customers within or outside the store.

Peter Chappell, senior category manager for Mac's Convenience Stores, based in Ontario, shared the "going dark" experience with roundtable participants from the perspective of someone who lived through it.

Displaying tobacco product or point-of-purchase advertising is now banned in almost every province and territory in Canada -- with the product usually hidden from view behind blank flaps, cupboard doors or, in some cases, curtains. By the end of this year, only New Brunswick and Labrador are expected to still allow visibility of tobacco products in the store.

Chappell said Mac's, a division of North America's largest company-operated convenience store chain, Alimentation Couche-Tard, experienced some negative impact on sales for the first three months after going dark. He advised against decreasing the number of tobacco SKUs carried in the store, as this action just accelerated the sales decline after cigarettes were hidden in the Canadian stores.

Another frustration for Canadian retailers today is the decreasing opportunities for merchandising activities, noted Chappell.

The frustrations for customers are also obvious: longer service time than before as clerks have to search for the brand and product ordered, and the uncertainty of the product's availability before ordered.

Chappell said Mac's experience varied by province. In Saskatchewan, which went dark in 2006, the chain had a marginal sales decrease in the first four weeks following the effective date of the dark market. Four weeks after, sales remained on the national trend.

With the product now behind flaps, Mac's utilizes the space for more promotional signage of other products, such as chips and beverages, said Chappell.

Other advice from Chappell:

Make the store a destination for tobacco.

Do not cut down the selection of brands. Keep the same listing as before the dark market because product availability will become the first criteria in the store selection for a customer, followed by price.

Instruct store staff on legislation to avoid fines.

Set retail prices low prior to the dark market because customers will remember the low price and return for future purchases.

While going dark on tobacco is not an immediate concern to most U.S. convenience store retailers, the panelists at the roundtable were certainly not totally discounting the possibility -- especially under the current Obama administration and its very aggressive stance in favor of increased government regulation of practically everything -- from the auto industry, banking and even food ingredients.

Jesus Delgado-Jenkins, CEO of Mother Hubbard's Cupboard, a regional c-store chain in the Quad Cities area of Illinois and a former government official himself at the Treasury Department, was at a loss to explain the rationale for the ever-increasing taxes on tobacco products. "If you keep increasing the tax on cigarettes, fewer people will buy them, which means sales in the store will decrease," observed Delgado-Jenkins. "Retailers have to make up that sales decline somewhere. What are they going to do, raise gasoline prices? By taxing cigarettes, you're also supporting an indirect gas tax hike -- is that something you want to do in this economy?"

Of almost equal concern to retailers as taxes was the likelihood of increased theft and security issues as the value of a carton of cigarettes skyrockets -- CSNews' 2009 Forecast Study projects the manufacturer list cost for a carton of cigarettes to top $31 this year, with retail prices in high tax states such as New York soaring above $95 per carton.

To combat shrinkage of this expensive inventory, Mother Hubbard's started doing surprise audits of the category in April. "Every shift there's a cigarette count," said Delgado-Jenkins.

In the process, Mother Hubbard's reduced inventory by $10,000 to $15,000 per store and taken days of supply down to an average of about three to four weeks for the 13-store chain, although three or four of the stores are operating at two-and-a-half weeks supply, which is the goal.

On a similar note, Worsley/Scotchman Stores also instituted new security policies for better oversight of deliveries in an effort to reduce theft, said Karl Beem, marketing manager.

Asked to name a few of the best-selling new products in the category, most retailers seemed to agree on Camel Crush, a regular cigarette that contains a small capsule in the filter that when crushed, transforms the cigarette into a menthol. However, one retailer said the novelty of the product appears to be waning in his markets.

In terms of pricing strategies, Delgado-Jenkins reported how his strategy has turned 180 degrees from what it was a year ago. "In 2007, we did a lot of promotions. The previous owner took every allowance he could get. Last year, we decided not to promote as much and we saw our total transactions and volume in cigarettes dip," explained the convenience store retailer. "This year we are going back to the old way and taking every allocation. So far, sales are up 2 percent to 3 percent -- not including the price increase."

Jeremy Weiner of Smoker Friendly said value packs, such as "two-fors," are selling out for the Colorado-based tobacco chain. Bishop noted many retailers are successfully offering a third pack at a price of $3.99 when the customer buys two at regular price. Chappell said Mac's in Canada promotes two packs for $17.99, while single packs sell for $10.25. "Fifty-five percent of my cigarette sales are in two-packs," he noted.

Wayne Wills, merchandising manager for Columbus, Ohio-based Certified Oil, said his convenience stores offer state minimum pricing on cigarettes.

Retailers also discussed the growth of the OTP category (see story, page 35) and the newest category sensation, the electronic cigarette or e-cigarette.

Available from a handful of suppliers, the e-cigarette is a battery-powered device that provides inhaled doses of nicotine through a vaporized solution. It also provides a flavor and physical sensation similar to smoking a regular cigarette, but no tobacco or smoke is involved.

Weiner of Smoker Friendly noted even at the high price of between $57 and $70 for a starter kit containing the device and several refill cartridges, e-cigarettes are "flying off the shelf." Smoker Friendly sold 67 starter kits in a recent three-week period, said Weiner, who added margins on the starter kit are about 20 percent and margins on the cartridge refills are as high as 40 percent.

Wills said Certified Oil -- a more traditional convenience store format than the tobacco outlet Smoker Friendly -- sold 80 of the starter kits in its 45 top stores.

Retailers did express concerns that FDA regulation of tobacco could put the brakes on the sale of the product as the government agency investigates it more.

Given all the other governmental and regulatory hurdles in the tobacco category, such a move would hardly surprise these convenience and tobacco retailers.
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