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    Blazing a New Tobacco Road

    While government regulators and health advocates try to extinguish smoking, retailers an suppliers work to keep this key category alive and well.

    By Mehgan Belanger

    Tobacco. It has been called a "sunset" category, described as past its prime and in some cases, been given the boot by retailers in other trade channels. But for all the challenges it faces -- regulation, taxes, reduced consumer spending and more -- its largest segment, cigarettes, remains the No. 1 category in c-stores, with more than 30 percent of in-store sales in 2008. Other tobacco products (OTP) meanwhile, is the fastest growing segment in c-stores outside of the foodservice category.

    Given these figures, and the Centers for Disease Control's estimate of 45.3 million smokers present in the U.S. -- where c-stores hold 63 percent of the tobacco market -- the influence of this category is difficult to ignore.

    In this special report featuring exclusive interviews with retailers and executives from Altria Group -- the industry's largest tobacco supplier -- Convenience Store News analyzes how recent tobacco supplier consolidation will affect retailers' sets; the current challenges facing the tobacco category in convenience stores; what these hurdles mean to the future of the tobacco category; and whether or not the demise of tobacco has been pronounced prematurely.

    Putting aside the issues of onerous taxation and FDA regulation for the moment (see CSNews' Tobacco Roundtable coverage for more on those topics, page 31), consolidation of suppliers could be one of the biggest retailer concerns.

    Facing a 3 percent to 4 percent annual decline in U.S. cigarette consumption, some major cigarette makers began to look elsewhere in the past few years for growth. In April 2006, R.J. Reynolds Tobacco Co. (RJRT), the second largest cigarette maker in the U.S., made its big move into the smokeless tobacco category with its acquisition of Conwood. By 2007, manufacturer consolidation was in full swing, with Philip Morris USA, the nation's largest cigarette producer, buying cigar maker John Middleton Co. In early 2008, it reorganized Altria Client Services, a company that handles the human resources, legal, finance and other corporate functions for the two tobacco companies, following the spinoff of Philip Morris International. Middleton's sales and distribution company was also folded into Philip Morris USA's (PM USA).

    In another diversification effort, Altria bought UST and its subsidiaries, including U.S. Smokeless Tobacco Co. (USSTC), at the start of this year, and wrapped USSTC's corporate functions into the Altria Client Services Group. That acquisition was completed in four phases, the last of which -- rolling out retail trade programs -- is currently underway.

    For Altria, the acquisitions forced the company to focus on creating synergies between the three organizations. The most noticeable change for retailers -- effective June 1 -- was the creation of Altria Sales & Distribution, a new organization that will serve as the sales force for all three tobacco companies.

    "We thought this was the time to create a structure that would more efficiently and effectively focus the departments on what they were responsible for," Pete Paoli, senior vice president and general manager for the newly created Altria Sales & Distribution, told CSNews in an exclusive in-person interview where he and other Altria executives offered a preview of a presentation on the reorganization.

    Under the new business model, the single Client Services group will be responsible for human resources, investor relations and other corporate functions for the tobacco companies. The Sales & Distribution company will cover everything relative to its trade customers, including wholesale and retail programs, and category management, while the three tobacco companies will solely be responsible for brand management and manufacturing.

    Paoli, who leads the Sales & Distribution team, was previously senior vice president of sales for PM USA, and joined the company in 1979, working for several of its companies over the years. In his new role, Paoli sees both the tobacco companies and retailers as his clients.

    "We have a big responsibility to retailers to represent these brands in the best way, so retailers can maximize every dollar of profitability and revenue out of the category," said Paoli. "We know retailers are demanding more. We know alignment is more important to us than it ever has been, given that we now represent big brands in three significant categories."

    That responsibility requires employing a sales force educated in the brands, products and programs of three tobacco companies, and one that understands the challenges and opportunities retailers face. The consolidated sales force is made up mostly of PM USA representatives with only a few USSTC employees, according to Paoli, who is training the team to bring retailers new options.

    "Every time a salesperson walks into the store, [he or she] will have an opportunity to assist the retailer in ways to grow its business," he said. "We are building a category management infrastructure that deals with all the things customers demand when we walk into their stores."

    Retailers will be called on more often under this new model. The USSTC sales force served between 100,000 and 125,000 stores, with twice the amount of accounts per territory compared to PM USA, which resulted in store visits about once per quarter, Paoli said.

    "Our new workload is very different across the three categories. We cover more than 200,000 locations, which means we're going to contact those stores roughly one and one-half times per month," he said. "In the end, a retailer wants us to be in their stores with greater frequency and greater efficiency. And this model does that in a much more significant way."

    Helping the sales force in its mission to assist retailers is a new retail trade program for the USSTC brands, which began rollout to retailers last month and includes a new product-freshness element.

    Like PM USA's and Middleton's retail trade programs, the new USSTC program centers around the retail management principles of having the best brands in the best positions, allocating space to share and maintaining in-stock inventories. It also focuses on freshness, new USSTC products, price communication and brand equity, and encourages non-self-serve merchandising.

    It is important for retailers to understand participation in one of the tobacco company's retail programs does not require participation in another program, Paoli said. Moreover, the level of participation in one program does not dictate the level of participation in other trade programs.

    Similar to PM USA's retail trade program, the USSTC program includes an optional in-stock guarantee for the top products. Participating retailers are given incentives with an order entry requirement to remain in-stock on the top four USSTC SKUs -- Copenhagen Fine Cut Natural and Long Cut Natural, and Skoal Fine Cut Wintergreen and Long Cut Wintergreen.

    The program also addresses a critical factor of OTP success -- freshness -- which is "hugely important in the moist snuff business," said Paoli, describing it as the "essence" of USSTC's Copenhagen. "Freshness is a brand product attribute of significant importance to both the retailer and consumer, so we want to make sure we invest in a trade program that supports it and gives ways for the retailer to execute that," he said.

    To that end, the new product returns system for USSTC products will vary greatly from the past, according to Paoli. The sales force will be minimally involved in the processing of returns -- a task the former USSTC sales force spent 33 percent of its time doing, according to Paoli. Instead, returns will be shipped by the retailer through UPS to a reclamations center.

    Another change for USSTC's trade program includes offering five-pack logs of the top seven SKUs, reduced in size from 10-pack logs. The goal: to provide the freshest product while minimizing returns, and giving retailers the ability to manage inventories better.

    In addition to the new retail trade program, retailers will have access to a password-protected category management tool called CatMan, which provides store level revenue and contribution sales data for the entire tobacco category down to the item level, as well as marketplace data for benchmarking. Through this tool, which will be initially accessed through Altria Sales & Distribution representatives, retailers will be able to easily identify opportunities to maximize the tobacco business in stores, and see new areas of growth relative to their markets.

    As of press time, the online resource was being internally tested. CatMan will be rolled out to a few retail locations in September, with a future goal of potentially merging the tool with Altria's Insights c3m tobacco category management Web resource.

    With the acquisition by Altria, changes are coming to USSTC brands' promotions. The shift is evident in the price reductions for Skoal and Copenhagen that USSTC conducted just days after closing the acquisition.

    "While their volume was stable, their brand share was beginning to slip," explained Paoli. The company reduced the price of these brands in the southeast U.S., then followed on a national level in April.

    "[The markets] saw the best prices on Skoal and Copenhagen in several years," Paoli said, noting the southeast business stabilized as a result.

    USSTC's promotion model -- which was based on multi-can sale prices -- was replaced with a price reduction because consumers overwhelmingly told USSTC the single can price for the products was too high, according to Paoli.

    The USSTC promotion model is not the only one being updated. As the price of tobacco products rise, the tobacco companies' promotions are being adjusted to offer value to consumers.

    "We take a very strategic and thoughtful approach to the way we parse out value in the marketplace," said Paoli.

    The differing economies of various markets also plays a factor in promotions. "Different consumers are feeling different effects in different marketplaces," he said. "We may structure out value differently when the economics are different and how much consumers have to put down on the counter."

    Moving forward, the main goal for Altria Sales & Distribution is to roll out the new trade program and freshness system. "The retailers benefit when we implement such programs," Paoli said. "I'm providing direction to the sales force that selling the program should be among their top priorities for August. With that will come improved business performance for the retailer."

    Retailers can also expect more new products from the three Altria tobacco companies. PM USA is testing L&M roll-your-own tobacco in Michigan and Maine, while it also unveiled Marlboro No. 54 -- a menthol cigarette line extension in King and 100s sizes. John Middleton will also release line extensions for its Black & Mild brand of machine-made large cigars. In addition, USTTC's Red Seal, a value-positioned moist snuff, will see its distribution expanded to new markets.

    Future new products will address "pure consumer expectations and needs," which is a benefit to retailers, since they won't carry an item that won't sell. Meanwhile, Altria can put more effort into its new products, knowing they will sell, according to Paoli.

    And Altria's research and technology facility, which opened in 2007 and operates under Altria Client Services, will facilitate research for all three tobacco companies.

    The multitude of changes to Altria's businesses as a result of these acquisitions will have an impact on the tobacco category in convenience stores. Paoli said it will improve attention paid to the category, especially to cigars and moist snuff, which will ultimately drive additional sales and profits as the space at retail becomes more organized.

    Convenience store retailers, however, don't all agree. Lee Maxwell, tobacco category manager for Alimentation Couche-Tard's Circle K Southeast Division, told CSNews Altria is implementing the same strategies it holds for cigarettes onto OTP, "which is concerning because it would remove category management principles from OTP -- ones we lost in cigarettes a long time ago."

    He continued: "One of the successes of the OTP category is the flexibility retailers have … to move product based on customer demand. We will have less flexibility when we're strapped in by SKU count, share of space and point-of-purchase, which we weren't saddled with earlier."

    Despite this, Maxwell, who oversees the tobacco section for more than 280 convenience stores, said he most likely will sign one of the USSTC retail programs, but not at the highest level of participation, due to store configuration and existing equipment in Circle K stores.

    "The program is one-size-fits-all," he said. "Without a fixture similar to the one the program requires, you can't [participate in the highest level]."

    The changes involved in USSTC's new freshness system is just one concern held by Butch Fulton, merchandising manager for Plaid Pantries, the Pacific Northwest convenience store chain. The retail trade program "does nothing but hurt retailers," he said, giving as an example sales representatives' lack of car stock to instantly replenish out-of-date snuff products.

    "They are trying to treat it like cigarettes, but it's more of a hands-on category," Fulton said, adding that unless the USSTC retail trade program changes, he will not sign it. Some elements he'd like to see altered include an "unreasonable expectation for lower return rates." The program's return rate on moist snuff is a "very hard thing to reach, and almost impossible to do when you carry the amount of SKUs they require," he said.

    Meanwhile, the recent price reduction taken on Skoal and Copenhagen have slowed their growth, according to Jared Sturtevant, director of category management for Nice N Easy Grocery Shoppes, who acknowledged that in the long run, things could improve.

    There are some retailers who don't share these concerns. Wayne Wills, merchandising manager for Certified Oil, cited Altria's research and customer resources as positives for the OTP category.

    "Altria is very good at knowing turns and levels, and keeping products fresh. The information they can give to stores will help our managers with in-stock positions and ordering," he said.

    Similarly, "There is an opportunity for new sources of revenue in OTP and [Altria] will help c-stores continue to be the dominant channel choice for tobacco," Mike Zielinski, president of Royal Buying Group, told CSNews, adding Altria's separation of the three retail trade programs was a plus that "addresses retailer concerns about space demands that might not be in their best interests."

    Another positive change as a result of the USSTC acquisition is the standardized five-pack logs for moist snuff products, according to Wills, who said the package size makes it easier to keep track of the weekly quantities needed in stores.

    Adhering to the return policy will not be a problem for higher volume stores, but lower volume stores will have to be more selective in the items carried, he said, adding, "If you don't have the turns, it won't be profitable to carry the items."

    Wills was still reviewing the details of the new USSTC trade program as of press time, but from what he has seen, there's "nothing unreasonable" in the contract, he said, explaining he will want to capitalize on all the rebate dollars available.

    Retailers also told CSNews they didn't have the same concerns when RJRT acquired Conwood in 2006, since the two companies were kept as separate entities.

    "[OTP] is not being dealt with by the cigarette side of the business, which works better," explained Maxwell.

    Similarly, "We have a Conwood representative, a Reynolds representative and an American Spirit representative -- three people who aren't treading on each other's jobs," Fulton said.

    However, several retailers interviewed for this article told CSNews they thought RJRT planned to consolidate Conwood into its operations.

    David Howard, spokesman for RJRT, said the company is exploring a potential merger, but no plans to do so exist as of press time.

    "We are exploring efficiencies and complexity reductions on an ongoing basis, not only in one tobacco company, but across subsidiaries as well," he told CSNews. "It is just exploratory, to see what efficiencies we may achieve by having a merged or unified sales force."

    While concerned about category management, legislation, taxes and other challenges the tobacco category faces, retailers are confident OTP and cigarettes are still alive and will continue to perform well within the convenience channel for some time.

    "Convenience stores are positioned to be the only channel in the tobacco category in the future," said Sturtevant, noting the increasing incidences of grocery and drug retailers abandoning the products.

    "There's still a lot of growth potential in OTP," said Circle K's Maxwell, who noted growth will come from tobacco consumers entering the OTP segment for alternatives to higher-priced tobacco products and items they can use in locations where cigarettes are prohibited.

    "We have to work through some of the restrictions that the contracts will provide, but the future is still bright," he concluded.

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