A Tale of Two Ciggies

4/8/2016

Approximately five years ago, a new product burst onto the scene and began demanding space on the backbar. Many, at the time, saw electronic cigarettes as the “great disrupter” — a product that would usher in a whole new era of tobacco products.

And for a time, they did.

E-cigarettes really gained legitimacy when the former Lorillard Inc. acquired blu eCigs in April 2012, and sales in general began to skyrocket in the convenience channel. One industry analyst even went so far as to predict e-cigarettes would outpace the demand for traditional cigarettes within the next decade.

But then, 2015 happened and the story appeared to be rewritten: Traditional cigarette volume declines began to moderate and, conversely, e-cigarette volumes hit the brakes — hard.

In a recent Convenience Store News poll, respondents overwhelmingly pointed to lower gas prices (68 percent) as the key driver behind the positive shift in their cigarette sales lately. Spending less money at the pump is seemingly leaving c-store customers with more money to spend in the store, particularly when it comes to their choice of smokes.

But does that tell the whole story? Not necessarily, according to David Bishop, managing partner of Barrington, Ill.-based sales and marketing firm Balvor LLC.

When trying to explain what happened on the backbar in 2015, Bishop said many industry insiders will point to the impact of lower unemployment rates among core tobacco consumers. He added that “last year caught many people by surprise.”

“When you have jobs, you have money; when you have money, you can spend that money,” he explained.

However, he also echoed the CSNews poll respondents, dubbing lower fuel prices “significantly more of a contributing factor than unemployment.”

“If you look at the effect of lower fuel prices in 2015 vs. 2014, you can equate it to almost saving $1 a gallon for every gallon filled up. Whether the fill-up was eight or 10 gallons — typically the average fill-up is 10 — the consumer had more money back in their wallet,” he said.

Of course, not every consumer is a tobacco user. Still, when you consider purchase frequency, customers are purchasing tobacco more frequently than they are fuel. According to Bishop, that, without question, helped. Yet it still doesn’t fully answer the question of what happened.

THE STORY BEHIND THE STORY

To understand what happened in 2015, you have to look at what happened in 2014.

And what happened in 2014 was in part driven by what happened in 2013: the expiration of the federal payroll tax reduction, Bishop cited. This was significant to the core tobacco consumer, costing them somewhere around $600 to $700 per household per year, he said.

The 2013 expiration meant the tobacco consumer was under that much more pressure. In addition, wage growth and income growth have not kept pace with inflation in tobacco products — trailing it by probably two-thirds, explained Bishop.

“So, consumers were under a lot of pressure [in 2013], but then 2014 comes in. 2014 was not the first year we had electronic cigarettes, but it was 2014 that marked the national expansion of [The Altria Group Inc.] and [Reynolds American Inc.] into e-cigarettes,” he noted.

With the national rollouts of Altria’s MarkTen and Reynolds’ VUSE products came strong promotional support, which helped build awareness and trial of those products.

“It was driving a lot of trial for those items and that’s where we saw e-cigarettes really start to take off for the second time,” Bishop said.

As a result, throughout 2014, e-cigarettes really benefitted from expansion of the category, from what previously had been mainly disposables to now disposables and rechargeables.

While the interest for e-cigarettes was, without question, very high — and continues to stay very high — a major obstacle facing e-cigarettes became clear at the end of 2014 and heading into 2015. And that obstacle is how well the products satisfy tobacco consumers.

“Repeat purchases started to slide” because of low satisfaction, said Bishop.

SATISFACTION GUARANTEED?

Many tobacco industry insiders have acknowledged the right product is not out there yet.

Altria, through its Nu Mark LLC operating company, and Reynolds, through its recently formed RAI Innovations Co. subsidiary, continue to search for the right formula for the next generation of e-cigarettes and vapor products.

“According to our research, approximately 50 percent of adult tobacco consumers are looking for alternative tobacco products. As we’ve said, we don’t think today’s e-vapor products are fully meeting adult smoker and vaper expectations,” said Brian May, Altria’s senior manager of communications. “For us, we continue to believe category growth hinges on product innovation.”

May declined to go into specifics on Nu Mark’s research and development, but said it is taking a disciplined approach, looking at technologies and investing in technologies that will satisfy adult tobacco consumers. It’s also taking a very holistic portfolio approach to innovation.

“That’s what we see as the opportunity in the e-vapor space, the innovative products in general,” he stated.

Couple the satisfaction quotient with the high rate of dual usage — or sometimes, even triple usage — among adult tobacco consumers, and e-cigarettes have work to do. Bishop points out that nearly 70 percent of adult cigarette smokers have an interest in quitting, and government-sourced data shows only about two-thirds of adult cigarette smokers exclusively use cigarettes.

“There is a lot of dual usage or crossover in what consumers use. It’s no different than what you see in alcohol. Occasions and preferences drive consumption patterns,” the Balvor executive explained. “People consume wine in different occasions than they consume beer. It’s no different with large cigars and cigarettes, to a degree.”

In short, the answer to the question of “What happened?” is this: The industry saw demand transfer from cigarettes to e-cigarettes in 2014. Then, in 2015, it saw a significant return of volume to cigarettes mainly because the experience and satisfaction levels that e-cigarettes were delivering weren’t high enough to keep the interest in the segment and drive the repeat purchase cycle.

THE STORY INSIDE THE C-STORE

The story that Kevin Campbell, marketing director of Fremont, Ohio-based Beck Oil Co., tells about his specific chain’s tobacco category experience over the last few years mirrors the overall industry tale. Electronic cigarette sales started to soften in the fourth quarter of 2014 at Beck Oil’s FriendShip Food Stores. The chain then saw a decent drop-off in 2015.

Today, Campbell said the retailer has condensed its e-cigarette and vape sets to only include the blu, MarkTen, VUSE, Vapin Plus and Cig2o brands.

At the same time as it has pulled back on e-vapor, FriendShip Food Stores has seen positive growth in traditional combustible cigarettes, including a trend toward premium brands.

“With the gas prices low, premium brands are just another item people can afford to purchase. We have seen nice buy-up into the premiums, specifically Marlboro. We were pleased with the growth seen on the Marlboro core for 2015,” Campbell said. And he reported that the first two months of 2016 continued the same trend of premium trading-up.

He also noted that R.J. Reynolds Tobacco Co.’s marketing efforts behind the Newport cigarette brand, which Reynolds acquired last year, are starting to pay off.

“Overall, we’ve had growth in cigarettes in 2014 and 2015 as a chain, which has been wonderful,” Campbell explained. “Certainly, we’re focusing — as is everybody else — on developing our own proprietary foodservice. But we’re never going to forget about the tobacco category as a whole. We’re still going strong with promoting it, and getting the signage and the message out to our customers has paid off.”

Duxbury, Mass.-based convenience store chain VERC Enterprises Inc.’s tobacco category manager spins a similar yarn. “Last year, we saw a better year than we had for cigarettes previously. E-cigarettes in 2015 were not where it was the previous year and, so far, the first few months of this year indicate the same,” said Anna Bettencourt, a VERC category specialist.

She believes it’s unclear whether adult tobacco consumers are making the switch from e-cigarettes to cigarettes, but said news reports and social media posts questioning whether e-cigarettes are better for you than traditional cigarettes could be playing a role.

The lack of innovation in e-cigarettes could also be driving users toward more advanced vapor products and vape shops, Bettencourt surmised.

“I think, as far as traditional e-cigarettes, we haven’t seen a lot of changes in product and innovation, so I think people tend to gravitate more to the vaping side,” she said. “But even that is losing some traction [in c-stores] due to vape shops. It is still growing, but not as much in the c-store market as in the vape shop market. It’s tough to know where the business is going.”

GET OUT YOUR CRYSTAL BALL

What does all this mean for 2016 and beyond?

Bishop’s crystal ball says: “We will return to the long-term decline rate, to a degree, in cigarettes simply because the correction was made last year. Absent a significant innovation in e-cigarettes being introduced in the immediate near term, given we are already a quarter through the year, consumers have pretty much moved back to their preferred consumption patterns.”

He predicts cigarettes are likely to move back to their traditional decline volume rate of between 2 percent and 4 percent, depending on what happens in other areas like legislative activities and tobacco taxing at the state level.

Altria’s May agrees, restating company CEO Marty Barrington’s prediction that over a period of time, cigarette volume will return to its normal pace of decline, which he puts at 3 percent to 4 percent.

“That’s the reality until we see the next major innovation,” said Bishop. “I’m not sure if we have the next major innovation in the pipeline already. I think the next disrupter comes at the end of 2016, or more likely early 2017.”

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