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    Navigating Today's Winding Tobacco Landscape

    Regulatory uncertainty is driving the category.

    By Melissa Kress, Convenience Store News

    NATIONAL REPORT — For convenience store operators, the tobacco retailing business can often feel like a tornado, a disorienting swirl of taxes, legislation, regulation, product evolution, and changing consumers.

    Two years ago, the industry saw combustible cigarette volumes rebound, but it was short-lived, as the past year-plus saw the market settle back down to historical deceleration rates.

    Calling it "an industry in secular declines," Bonnie Herzog, managing director of tobacco, beverage and convenience store research at Wells Fargo Securities LLC, puts the cigarette volume deceleration rate at roughly 2 percent to 2.5 percent for 2016, and a predicted 3.8 percent for 2017. The latest Nielsen Co. all-channel numbers, released in early March, show cigarette dollar sales increased 0.7 percent during the four-week period ended Feb. 25, an uptick driven by solid pricing and a slight moderation in volume deceleration, according to Herzog.

    On the other hand, smokeless tobacco, cigarette's backbar neighbor, remains a bright spot in the tobacco business as consumers continue to respond positively to brand expansions, she noted. According to the same Nielsen data, dollar sales in the smokeless segment grew 4.9 percent during the four-week period, compared to 3.3 percent for the 12-week period.

    Then, there’s the electronic cigarette segment, which has proven to be the biggest headscratcher. Not that long ago, many industry players were getting ready to proclaim the end of the e-cigarette boom as consumers turned back to combustible cigarettes — presumably driven by a combination of increased disposable income due to lower gas prices and a dissatisfaction with the e-cigarette products on the market. However, all-channel e-cigarette dollar sales increased by "an impressive 29.9 percent in the recent period — and 28.2 percent for the 12 weeks — driven by a solid 8.8-percent pricing increase and a 19.4-percent volume increase," Herzog said.

    The vapor segment as a whole — including electronic cigarettes — could be in for some more interesting times as reduced-risk products (RRPs) emerge onto the scene.

    Speaking at Tobacco Plus Expo 2017, the Wells Fargo analyst explained that in the approximately $900-billion global tobacco market in retail sales, vapor accounts for just 1 percent. The United States tops the list of global markets. "The U.S. is the largest market and the most lucrative opportunity," stated Herzog.

    Consumer sentiment remains lukewarm at best, though, and retailers are weary of having "dead inventory" on their shelves under the black cloud of the U.S. Food and Drug Administration’s (FDA) final deeming rule and the regulations to come. 

    That being said, Herzog remains bullish on vapor. She predicts that by the end of 2017, the vapor industry will grow to $4.4 billion in retail sales. She also believes retail sales of vapor and RRPs could eclipse $10 billion in retail sales by 2020.

    BEYOND THE NUMBERS

    Despite what the data tells us about the "now," convenience store operators have to be on the lookout for what headwinds may be around the corner.

    The tobacco category at c-stores is not so much being driven by trends as it is by regulatory uncertainty, noted Albert Jose, senior brand manager at Kretek International Inc., a supplier of tobacco products and accessories, including Djarum and Dreams cigars, and DjEEP lighters.

    “Data can show you that cigars are holding their own and cigarettes are declining slightly with overall decreased consumer uptake of tobacco. The flavor trend in cigars was to get as many different trial flavors into the market by last August. This was due in part to the fight for facings. I think that created a false exuberance for flavors that still may be banned by FDA,” Jose said.

    “Overall, I think retailers are waiting to see what the next guidance from FDA will bring. Why waste money changing out your store when you may have to do it again in six months,” he continued.

    Similar to concerns about the effects of the FDA’s final deeming rule, retailers are bracing themselves for the impact of the $2-per-pack hike in California's state cigarette excise tax. Known as the California Healthcare, Research and Prevention Tobacco Tax Act of 2016, the measure also places an equivalent tax increase on other tobacco products and electronic cigarettes containing nicotine. It went into effect April 1.

    As Wells Fargo Securities' latest Tobacco Talk retailer survey found, retailers anticipate the levy increase will accelerate the cigarette segment's return to historical volume declines of 3 percent to 4 percent, despite a relatively strong adult tobacco consumer.

    And California is by no means the only state to be affected by legislative and regulatory changes. "Nationally, I expect volume decreases in the 3.5-percent range," one Tobacco Talk retailer told Wells Fargo Securities. "Individual markets, however, will get hit worse. Not only the California tax, but also several areas have recently passed 21 age requirements, and I expect this to become more common. As you remove part of the potential market, there will be an impact on overall consumption averages."

    In fact, efforts to push the legal age to buy tobacco products to 21 are gaining momentum across the United States. According to Vivien Azer, director and senior research analyst at Cowen and Co., 22 states as of March had introduced “Tobacco 21” legislation this year. Measures already failed in four states, leaving the possibility alive in 18 others.

    To date, only Hawaii and California have passed legislation making 21 the minimum legal buying age statewide. Hawaii's regulation went into effect Jan. 1, 2016, and California followed in June 2016. Washington, D.C., also passed a similar bill last year.

    "Indeed, we've seen similar legislation introduced at the state level over the past few years, but the pace of bill introduction has increased meaningfully, as just 15 states introduced bills to increase the tobacco purchasing age in 2016," Azer cited. "Of these states with proposals introduced this year, many have not seen a Tobacco 21 bill proposed in recent years, including Florida."

    STRATEGIES FOR SUCCESS

    The unending winds of change around tobacco could easily overwhelm convenience store retailers, who have high stakes in the business. However, there are some key strategies they can leverage to not just stay grounded, but rather ride the currents successfully.

    Remember the three R's from schooldays (reading, writing and arithmetic)? For today’s tobacco retailers, it's all about the three E's: educate, evolve and engage, according to David Bishop, managing partner of sales and marketing firm Balvor LLC.

    "With everything retailers are going through, the industry is harder to understand. What can retailers do in a proactive way — or an active way — to ensure they are not only complying with regulations and laws, but also positioning their businesses to win?" he posed.

    There are no guarantees and there are a lot of questions out there; however, retailers should be doing — or doing more of — the three E's, Bishop advised.

    Kretek’s Jose also points out that c-store operators need to determine how they want to define being “successful.” By store count? By consumer traffic? By the number of consumers who come inside from the pump? By productivity of their tobacco section?

    If it’s the latter, he advises that the success of a tobacco section is driven by data, right down to individual market and neighborhood demographics. “A solid data partnership with key manufacturers leads to a more productive tobacco section. The right SKUs in the right shelf position in the right store. One size doesn’t fit all,” he said. “Second, keeping the tobacco section clean and organized for the consumer’s quick view. If they don’t see it right away, impatience is bound to set in. Then, it has to be at the right price.”

    Jose also sees c-store tobacco retailers making the same mistakes. He believes the biggest misstep is not training and retaining their front-end employees.

    “We are an increasingly mobile society. Our retail loyalty is based on daily or weekly trip routes. A tobacco consumer is more likely than someone else to come inside from the pump, and that person is on the way to somewhere else. The store clerk’s brand and SKU knowledge, knowing what you stock and where it sits on the rack or shelf, is the key to a happy customer,” he said.

    By Melissa Kress, Convenience Store News
    • About Melissa Kress Melissa Kress joined EnsembleIQ's Convenience Store News in November 2010. Her primary beats include alcoholic beverages and tobacco. Kress has been a professional journalist since 1995. A graduate of West Virginia University, she began her career in community journalism before moving to business-to-business publishing in 2000, covering commercial real estate.

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