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    Up in Smoke

    The slumping economy wreaks havoc for some retailers, as cost-cutting smokers make dollars go further by trading down.

    By Mehgan Belanger

    The adult cigarette smoker's brand loyalty is legendary in the convenience industry. However, this renowned fidelity is being tested, and in some cases broken, as the slumping economy creates cash-strapped smokers coping with a combination of record gas prices, elevated food costs and increasing taxes on cigarettes.

    Evidence of trading down to lower cigarette tiers was apparent in the recently released Convenience Store News 2008 Industry Report, which found branded discount and generic cigarette brands increased market share by 2 and 0.3 percentage points, respectively, while premium brands fell in market share by 3.1 percentage points. Meanwhile, average sales per store for premium brands -- which include Philip Morris USA's Marlboro, R.J. Reynolds Tobacco Co.'s Camel and Lorillard's Newport -- declined more than $15,700, while branded discount, like Doral, Pall Mall and Basic, grew nearly $6,000 per store and generic brands, such as Gold Coast and private label, increased $800.

    Adult smokers began trading down from premium to mid-priced cigarette brands more than two months ago at Worsley Cos.' 200-plus convenience stores, according to Rich Mione, vice president of marketing for the Wilmington, N.C.-based company. He attributed the activity to customers' lack of disposable income in the current economy.

    The premium tier's share of the category in Worsley's stores dropped from 84 percent to 80 percent year over year, Mione said, noting that while the financial impact of smokers trading down is "little at this time," it will be of serious concern if the trend continues and grows.

    The increasing state excise tax on cigarettes is the primary factor causing trade downs for Canastota, N.Y.-based Nice N Easy Grocery Shoppes. In early June, the state's cigarette tax increased $1.25 per pack, making it the highest in the nation at $2.75 a pack. Matt Paduano, vice president of information for the more than 80-unit chain, told Convenience Store News this increase, like those in the past, will cause adult smokers to change their buying habits.

    "In the last 10 years, we've seen three price increases from taxes," he said, noting the last increase in 2002 was $5 a carton, significantly lower than the most recent $12.50 per carton increase. And in 2002, smokers were noticeably changing their habits "either by quitting, buying less or coming in and asking 'What is the cheapest thing you have?'" he said.

    Just days after the latest tax increase was implemented, Paduano said the chain has already seen habits change. "We hate to trade them down to a lower price, because sales and gross margin are not as good [as premium brands], but we can't have them walk away either. It's a little dance between sales and profitability."

    Premium brands hold 61 percent of Nice N Easy's category sales, followed by discount brands at approximately 32 percent, and fourth tier at about 8 percent. Commonwealth Brands' USA Gold, a third tier product, is the No. 2 seller in his stores, surpassing both R.J. Reynolds' and Lorillard's sales combined, according to Paduano, who attributed the strong performance of USA Gold to the state's 2002 price increase, when sales of the product began taking off as consumers traded down.

    For the most recent tax increase, Paduano said he noticed smokers "loading up" the week prior to its enactment, followed by a big drop immediately after and a continued decline in the weeks since. As of press time in late June, unit sales of his top-sellers were down 20 percent, due to customers either quitting or going to alternative sources, including Native American retailers, which do not charge state taxes, resulting in about a $20 difference in retail price.

    Another signal smokers are stretching their dollars is an increasing demand for cigarette promotions. Both Paduano and Mione reported smokers are seeking out promotional savings through multi-pack discounts or buy-two-get-one deals on premium brands.

    "Consumers have gotten savvy -- they know our distribution schedule better than we do," Paduano said. "They know Camel has a promotion so many times a quarter and they buy whatever they can. [Promotions] don't last more than a few hours in a lot of stores."

    At Worlsey's stores, the promotional segment of the cigarette category has been growing by double-digits, which Mione attributed to bargain-hunting cigarette smokers.

    To retain consumers looking for cheap alternatives, Nice N Easy refocused its efforts on a Master Settlement Agreement-compliant fourth tier brand made by King Maker Marketing Inc. called Checkers. It was originally introduced four years ago in the chain's corporate-owned stores, and was kept in sets if it performed well. Now, with the brand in about half of its company-operated stores, the chain is reintroducing Checkers with a two-pack price of $10 including tax.

    "We don't want to shout it out to customers to trade down, but for those who want to know what is cheaper, we have something to offer them," said Paduano, noting that soon after the latest tax increase took effect, there was a bump up in unit sales of the brand.

    However, trading down to lower cigarette tiers is not happening everywhere. Several retailers said that while smokers are not trading down, they may be purchasing less.

    "We skew very high on premium and these consumers tend to be very brand loyal," said Chevron Corp. category manager, Jeff Hersh. "They may be smoking less but it looks like they are sticking with their brands."

    While unable to see if smokers are trading down elsewhere in the store, Hersh said his gut feeling is that those customers are purchasing less overall.

    Wayne Wills, merchandising manager for Columbus, Ohio-based Certified Oil, also said smokers have remained loyal to major brands at the company's 90 stores, but are purchasing less frequently. He attributed it to the state's smoking bans.

    "Since Ohio is really aggressive in its no smoking laws, people have to go through a maze to find a way to smoke," he said.

    An aggressive pricing strategy ensures Certified Oil's premium customers remain in the top tier. Last fall, the chain realigned its pricing to take advantage of its competition's weakening sales.

    "We saw an opportunity to attack their premium sales at an aggressive pace," he said, explaining that the chain lowered its price for premium-tier cigarettes and raised the price for lower tiers, thus closing the potential savings gap for smokers looking to trade down. Wills said the strategy has paid "big dividends" by shifting sales to higher rings.

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