Waiting For The Smoke To Clear

Tobacco retailers are chugging along as regulatory questions remain unanswered

Category management is defined as a systematic, disciplined approach to managing a product category as a strategic business unit. It is the responsibility of the category manager to lead that unit — in theory, making decisions on what works and what doesn't, and then making the necessary changes. However, when it comes to the tobacco category, theory and reality are two very different concepts.

In reality, much of the decision-making process in the tobacco category is dictated by regulations (from the federal level on down to the municipal level), taxation issues and the tobacco companies themselves. So, how do you manage a category when much of the management process has been taken out of your hands? Tobacco retailing executives from across the convenience store channel came together for the Convenience Store News 2012 Tobacco Roundtable and tried to answer that very question.

Sponsored by Logic Technology Development and Swedish Match, the March event brought together category leaders from 7-Eleven, CF Capital Assets, Circle K Florida, Circle K Southeast, Jubilee Food Stores, Mac's Convenience Stores, Nice N Easy Grocery Shoppes, Quick Chek, Royal Buying Group and The Pantry.

The Food and Drug Administration (FDA), which regulates tobacco at the federal level, drew the lion's share of attention from the group given its regulation of flavored cigarettes, the still-up-inthe-air status of menthol in the marketplace and the question mark surrounding possible regulation of cigars.

However, state and local policy decisions and decision makers should not be ignored, attendees said. For example, individual municipalities in California have been pushing for specific tobacco retailing licenses. As one retail leader noted, the licenses would not be transferable, so where does that leave franchisees who want to sell their businesses? And in New York State, Madison County officials are working on a tobacco display ban that would force tobacco retailers to essentially go dark.

Canada is not immune to government regulations, either. As of June 30, three-quarters of every cigarette pack in the country will be covered by a graphic image. A similar regulation in the United States is expected to have its day in a federal appeals court this month.

Despite the obstacles at every turn, though, the category managers are managing to keep the tobacco business as one of the mainstays in the convenience channel. CSNews 2012 market research shows c-stores have wrestled away cigarette market share from other retail outlets. In fact, cigarettes still reign supreme in the channel, even though some operators are admittedly looking to beef up other in-store areas — notably foodservice — to compensate for the decline in cigarette sales in recent years.

But even as cigarette volume is forecasted to dip about 1.8 percent per store in 2012, the other tobacco products (OTP) category continues to pick up the slack. Specifically, CSNews research forecasts OTP volume to grow 14.1 percent per store this year, with smokeless and cigars leading the pack.

Retailers Debate Who Controls Cigarette Category Management

With the exception of regional abnormalities caused by state tax increases and local smoking bans, retailers at the CSNews Tobacco Roundtable agreed that overall cigarette sales volume (in cartons) will remain flat or slightly down in the coming year. Factors contributing to that tepid outlook include:

• Lack of clarity and "over-reaching" by the FDA;
• Increased taxes on the product;
• Increased bans on smoking in public places;
• Fewer adult smokers due to educational efforts by anti-smoking groups; and
• Smokers turning to alternative nicotine products like smokeless, snus, dissolvables and electronic cigarettes.

On top of these volume growth challenges, retailers noted that profit margins are being severely stressed by highly restrictive and less-lucrative-than-ever manufacturer contracts. Given these conditions, retailers at the roundtable frequently questioned whether such a large part of their total business (tobacco represents 30 percent to 50 percent of many c-stores' sales) should be controlled by either the government or large manufacturers.

The future of FDA regulation greatly concerns tobacco category managers.

"I'd just like to know that any regulations that come down the pike apply to every retailer in the country, not just some," said Matt Paduano of New York-based Nice N Easy Grocery Shoppes, noting that the problem of illegal and untaxed cigarette sales at Native American reservations needs to be solved at the federal level because states have been woefully inadequate at addressing the matter.

Peter Chappell of Canada's Mac's Convenience Stores, a division of Alimentation Couche-Tard Inc., provided a broader perspective of government influence on the tobacco and convenience store business. "In North America and Europe, it seems the function of government is becoming that of a Nanny State to protect consumers, which ends up putting roadblocks in front of capitalism," he said. "It's becoming like 'Nineteen Eighty-Four' and George Orwell."

Potential bans on menthol cigarettes and flavored cigars would also be extremely disruptive to the entire tobacco market, both retailers and suppliers said at the roundtable. The ultimate worry — though admittedly not an immediate concern — would be "if the FDA declared tobacco an addictive substance and said it has to be regulated and sold at a pharmacy," according to John Call of CF Capital Assets.

"The overall political climate and government regulation of a legal product is very disturbing," agreed Dave Williamson of Jubilee Food Stores, based in Louisiana.

As a progressive retailer, one has to think and plan what you would do if you lose cigarettes as a product to sell, Paduano added. "You don't rely on cigarettes and fuel. You develop other portions of your business," he said. Nice N Easy stores have developed a robust foodservice business.

Paduano also noted that one of the upstate New York counties in which Nice N Easy operates proposed that retailers "go dark" with cigarettes (i.e., be banned from displaying them openly in the store). "That would have affected legitimate retailers only, not those on the reservations," he said.

Even though retailers were highly critical of current cigarette category contracts being offered by the major tobacco companies, they agreed that three-quarters of the price inflation is due to taxes. States, looking to close wide gaps in their budgets, see tobacco as "low-hanging fruit" for generating increased revenue, they said, and it's "politically expedient to vilify people who sell smoking products."

David Bishop, managing partner of retail marketing and research firm Balvor LLC, presented the results of an exclusive Balvor/CSNews retailer study on tobacco category trends (see story, page 40). He advised the retailers that they should get more involved with their state trade associations, as these groups are often active in the fight against restrictive anti-business legislation and regulation at the local level.

"The best advocates for the industry are the smaller, independent operators," said Bishop. "Politicians respond most to those smaller retailers."

7-Eleven's Terry Kailey noted that the c-store giant has successfully fought off local anti-business initiatives through the involvement of its local franchisees. "We fought back against initiatives in six different California cities on cigarette taxes, licensing fees and bans on transferring licenses," said Kailey, noting that the retailer succeeds when a franchisee "gets up and talks to a city council."

On a national level, though, the retailers lamented that they don't see the same industry engagement for tobacco issues that they saw with the industry's battle to reform swipe fees.

Switching to the topic of tobacco company contracts, the conversation centered on retailers' fear of losing control of their business.

"What happened to category management in the tobacco category?" asked Chappell.

The desire to regain control of a critical product category, along with the company's ingrained independent streak, was the driving force behind Alimentation Couche-Tard's launch of its own cigarette brand, called Crown, earlier this year, said Lee Maxwell of Circle K's Southeast division.

The company, which operates both Circle K and Mac's stores, has publicly reported that it exceeded its yearly sales target in just the first six weeks following the launch of the product.

As for effective cigarette marketing strategies, Call, whose franchised Convenient Food Marts are located in the greater Cleveland, Ohio, area, noted that smaller retailers don't have the money to participate in national or regional marketing programs.

"We put all our money back into the hands of the franchisees to market to their local communities," he said. "A lot are doing nothing more than simple 'We Match Competitive Coupons,' but it's the best way for single-store operators to use their marketing dollars effectively."

IT'S FULL SPEED AHEAD FOR OTP

While cigarettes have long been the target of regulation and taxation, OTP is starting to feel the heat, too. Since receiving the power to regulate tobacco products in 2009, the FDA has systemically been working its way through the category. The agency's initial focus centered around cigarettes — a ban on flavored cigarettes, new warning labels for cigarette packages and advertising, and a possible ban on menthol — but now OTP is under the FDA's microscope.

The agency's Tobacco Products Scientific Advisory Committee (TPSAC) recently finalized its report on dissolvable tobacco, and there have been some rallying cries for the committee to take up the issue of flavored cigars — though TPSAC has not taken any steps in that direction yet.

In addition, this month marks a year since the FDA said it would regulate electronic cigarettes as tobacco products. Once again, the industry is still waiting on those marching orders.

OTP is not standing still, however, and neither should tobacco category managers. As Williamson said, convenience stores need to constantly try new things with their tobacco business.

The CSNews Tobacco Roundtable featured discussions on the individual OTP segments:

Smokeless Tobacco

Maxwell, with Circle K Southeast, said his division experimented with some dissolvable products when they came into his market as a pilot in the spring of 2011. And while those particular products have not gained traction in Circle K Southeast's stores, snus is a viable product for the division.

Joe Teller, director of category management for OTP supplier Swedish Match, explained that snus is growing less than 5 percent per month on a per-can basis. The just-OK performance may be because the product does not seem to deliver the same amount of nicotine as other products on the market.

One retailer noted that part of the problem may be the lack of consistency in merchandising snus, and Teller agreed. "Other categories are grouped together. It makes it hard for somebody to know something exists when you scatter it all over the place," Teller acknowledged, adding that cigarette contracts dictate where products go, no matter what is easiest for the shopper.

He said putting up signs highlighting snus is not enough. On the other hand, too much signage isn't effective either, as it is easy for consumers to ignore signs when there are too many.

Snus and dissolvable products aside, the numbers point to smokeless as the leader in the OTP segment. And not surprisingly, the majority of the retailers at the roundtable said they offer multi-can deals. One chain even ties in multi-can deals with multi-pack cigarette deals through signage.

Cigars

Ranking just behind smokeless tobacco in the OTP category is cigars. CSNews 2012 market research, shared at the roundtable, shows cigars account for 36.7 percent of OTP dollar sales, second to smokeless tobacco's 53.7 percent. However, the cigar industry could be pushed off balance if some lawmakers get their way and the FDA extends its ban on flavored cigarettes to the cigar arena.

Industry leaders know regulation is likely coming down the pike, but when or what form it will take is anyone's guess. Cigar insiders are keeping an eye on the FDA's final menthol ruling because the general feeling is that the decision will signal which way flavored cigars will go, as well.

Will flavored cigars be next on the chopping block? The industry doesn't know, so some are prepping for it already and beginning to roll out unflavored cigars, Teller reported. Still, some mainstay flavors are continuing to do well. White grape is the strongest selling, by far, and sweet is holding up well.

There also has been movement in cigars to two-and three-pack pouches. The momentum is primarily because they stay fresher longer, according to Teller. Some pockets in the Northeast and Southeast are seeing large cigars sell well, but other areas of the country are experiencing the shift.

Overall, the cigar segment is still a little soft, with stick volume down about 1 percent, Teller cited. However, he expects this year "will be a pretty good year for cigars — and moist snuff — in part, because last year's numbers aren't too hard to overlap."

Tim Holiday of New Jersey-based Quick Chek shared that multi-pack cigars are closing the gap, but single, larger cigars are outselling all others at the company's New Jersey and New York stores. In addition, the chain's No. 1 seller is not a flavored cigar, he said.

"We are going on our sixth year of double-digit cigar growth," Holiday said, adding that Quick Chek has expanded the section in three-quarters of its stores. "We're bucking the trend when it comes to cigar growth, as well as moist [snuff]."

Convenience Store News 2012 Tobacco Roundtable

In March, Convenience Store News assembled its 2012 Tobacco Roundtable in Jersey City, N.J. Retailer and supplier guests got a first look at the findings of an exclusive retailer tobacco survey conducted jointly by CSNews and industry consulting firm Balvor LLC. They also weighed in on the major issues facing the tobacco category, including regulation, taxation and the growth of segments such as other tobacco products and electronic cigarettes.

RETAILER ATTENDEES

John Call, CF Capital Assets

Peter Chappell, Mac's Convenience Stores (Alimentation Couche-Tard Inc.)

Chris Colón, The Pantry Inc.

Tim Holiday, Quick Chek

Terry Kailey, 7-Eleven Inc.

Kevin Kite, Circle K Florida (Alimentation Couche-Tard Inc.)

Darrin LiCausi, Royal Buying Group

Lee Maxwell, Circle K Southeast (Alimentation Couche-Tard Inc.)

Matt Paduano, Nice N Easy Grocery Shoppes

Dave Williamson, Jubilee Food Stores (Hill City Oil)

GUEST SPEAKER

David Bishop, Balvor LLC

SPONSORS

Eli Alelov, Logic Technology Development

Joe Teller, Swedish Match

Sponsored by

Electronic Cigarettes Seeing a Charge

Making a significant jump in convenience store presence this past year has been electronic cigarettes, with dollar sales hitting $82.9 million for the 52-week period ending Feb. 18, 2012, according to Nielsen. That equates to a 290.8-percent increase from the previous year.

One c-store chain seeing a booming e-cigarette business is The Pantry Inc., operator of Kangaroo Express stores. The company carries three brands: NJOY, Metro and Logic. Being a relatively new category, The Pantry uses a variety of point-of-sale (POS) and merchandising techniques to promote the product, according to Chris Colón, category development manager for the North Carolina-based chain.

Having multiple brands helps as well. Colón said consumers continue to shop with their wallets, so they tend to try e-cigarettes at a lower price point and then work their way up to find a product they like.

Eli Alelov, CEO of Logic Technology Development, recommended that retailers carry a variety of brands — just like they do with other products such as cigarettes, energy drinks or potato chips.

"Retailers need to offer more variety," he said, pointing out that consumers buy e-cigarettes based on flavor, packaging, design and the quality of the product. "In our markets, there are different levels of products and different price points as well. Like in any other category, there is a market for premium/expensive tobacco cigarettes and lower price point cigarettes. There are also different customers with different financial capacity, so the stores must be able to provide for all."

Retailers also need to educate their employees, so they can better explain the product to consumers, he said, suggesting that appropriate POS is a good place to start for consumer education.

"The more we educate our consumers, the better buyer they will become," Alelov stressed.

In addition, he said the decision-makers at c-store companies need to select e-cigarette products wisely and not be driven by a 50-cent discount. Compromising higher quality for lower-standard products hurts the industry and could drive a potential consumer away, Alelov concluded.

John Call of CF Capital Assets said now would be a good time for c-store retailers to make a profit from e-cigarettes, before major tobacco companies move into the space. That is possible, he said, as the segment continues to grow.

Roll Your Own: A Non-Issue for C-stores?

The roll-your-own (RYO) phenomenon has gotten a lot of attention lately. NACS, the Association for Convenience and Fuels Retailing, even targeted the tax disparity associated with RYO as one of its top issues at last month's 2012 NACS Day on Capitol Hill. However, some convenience store retailers contend that in the grand scheme of things, RYO is such a minor issue.

Part of the reason for this belief, according to John Call of CF Capital Assets, is that the cost of RYO machines — ranging from $30,000 to $40,000 — is prohibitive for convenience store retailers. Also, there is still a learning curve when it comes to consumers. "Those two barriers are prohibiting growth," he said. "And before it gets too big, it will get squeezed by regulations and taxes."

Call acknowledged that there is some interest among industry players, but he questioned if retailers would be able to make a return on their investment before regulations and taxes take hold.

The cost is just too high, he concluded.