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    Tobacco Roundtable

    Convenience stores are king in tobacco sales, but rising taxation and other issues threaten future profits for retailers

    By Convenience Store News Staff

    Despite numerous challenges, the convenience channel remains in the best position to adapt to the future of cigarettes and other tobacco products (OTP) as retailers in other channels continue to abandon the category, according to research figures and trends discussed at Convenience Store News' 2008 Tobacco Roundtable, held earlier this year in New York.

    Retailer guests debated the long-term effect current events will have on the tobacco category -- including tobacco industry consolidation, major cigarette companies' expansion into the other tobacco products (OTP) category and state and federal taxation -- and discussed strategies to stay competitive, yet profitable, in tobacco's ever-changing environment.

    "I think we're always going to be in the best position for anything," John Call, managing partner for CF Capital Assets, said on the future of tobacco. "We can turn our battleship faster than anyone. Unfortunately, we won't make any money."

    During a discussion on cigarettes, David Bishop -- partner at the Barrington, Ill.-based retail consultancy firm Willard Bishop -- noted, "C-stores are well-positioned to gain volume and share because other channels, mainly supermarkets, continue to abandon the tobacco market."

    However, while the convenience store industry may come out on top when compared to other industries, it is not without its own challenges. One that sparked concerns at last year's roundtable involved major cigarette companies' nonsmoking tobacco product introductions and the resulting impact on OTP merchandising, and this year the concerns evolved into fears. Retailers at the roundtable agreed major cigarette companies will include their new snus and other OTP products in their merchandising contracts as early as 2009, thus eliminating existing category management practices from the OTP segment.

    There may be justification for their fear. The OTP category holds the No. 8 spot by percent of in-store sales, and is forecast to see double digit growth in both per-store sales and unit volume in 2008, according to CSNews' 2008 Industry Forecast. See Fig. 2 for more details on OTP performance.

    On the positive side, one retailer looked to the benefits of Philip Morris USA's (PM USA) acquisition of Black & Mild manufacturer John Middleton Inc. Dave Stukus, category manager for TravelCenters of America, noted that while sales of the Black & Mild five-packs and singles are 20 percent of his cigar sales, "out of stocks are astronomical," he said, adding that he hoped the vast resources of PM USA will help the company maintain a better in-stock position at the store level.

    Retailers also admitted some elements of the OTP section are still suffering from out-of-stocks and disorganized counters. Lee Maxwell, Circle K tobacco category manager for the Southeast, explained his stores have a problem maintaining an in-stock position with cigarette papers.

    "It's a good margin category, but too far down the pecking order to get the attention of the largest categories," he said, adding that he didn't know how much of a sales increase stores would see if papers stayed in-stock.

    Meanwhile, Stukus said that in general, the counters are "a cluttered mess," noting it is hard to promote OTP items on them. "It would be nice to see something similar to a multi-vendor endcap in which there was one small display piece that could be used to feature the various brands on a monthly rotating promotional cycle," he said.

    Conversely, Bishop explained the growing presence of non-self-service in the OTP section. In 2007, more than 90 percent of convenience stores utilized non-self-service sections to merchandise OTP. This percentage will likely increase as a result of the effects of manufacturer consolidation on retail programs and the growing pressure from public and/or political groups, he said.

    Approximately four years ago, Circle K Southeast stores consolidated the entire OTP category into the back bar and placed the smokeless segment in the back bar on U.S. Smokeless Tobacco Co. (USST) showcase shelving. Soon after, the company developed its own shelving, Maxwell said. "Now, we are starting to treat it as a category using the basic P's -- promotions, pricing, etc.," he said. "We've seen tremendous growth in both flavored and traditional cigars from this."

    Moreover, all retailers at the roundtable agreed USST's showcase shelving for the OTP section is a merchandising best practice.

    For more roundtable coverage on the challenges to the OTP category, including snus' impact on merchandising contracts, visit CSNews' Special Features section online at www.csnews.com.

    Legislation -- one factor that impacts the entire tobacco category -- drew the ire of all attendees. The past year made threats of state tax increases a certainty for some, while all retailers must face the possibility of an increase on cigarettes' federal excise tax in the upcoming year, and still battle tax increases in their home states.

    While the State Children's Health Insurance Program (SCHIP) bill -- which proposed a 61-cent increase in the federal excise tax on cigarettes to fund an expansion of low income children's health care -- failed to come to fruition in 2007, retailers identified several lawmakers who will push for the bill in 2008.

    For more roundtable coverage on legislation's impact on tobacco, visit CSNews' Special Features section online at www.csnews.com.

    In spite of lawmakers' efforts to thwart the segment, the cigarette category remains relatively stable. It strengthened its spot as the top category by percent of in-store sales in 2007, growing 0.2 percent to 33.2 percent, although its 2007 unit volume per store declined 3.7 percent, according to CSNews' 2008 Forecast Study.

    "Consumption of cigarettes in the United States has continued to decline over the past seven years, at the same time the percentage of smokers has also declined. With that said the cigarette category is still a huge industry in the c-store trade," said Jim Papis, host account manager for McLane Co. "The c-store business needs to continue to chisel away at alternative trades, taking market share away from drug stores, supermarkets and big box merchandisers."

    In spite of the category's challenges, retailers noted some opportunities, such as promotions and direct mail marketing.

    Retailers approved of manufacturers' move from "buy one, get one" promotions to per pack discounts when purchasing multiple packs. Not only does it allow retailers to use existing inventory, but it also creates value for consumers and provides less chance of tradedowns from premium brands, attendees noted.

    "We have it ingrained in our sales associates to tell customers: 'Hey, if you buy two, you can save a buck,'" Maxwell said. "This type of upselling lets the associates feel like they're giving the customer a deal, as opposed to upselling a lighter, which they hate to do because they see it as a nuisance."

    This pricing tactic allows retailers to quickly show consumers per-pack savings, according to Bishop, who noted many retailers have used multi-pack discounting as a way to reduce the effective everyday price per pack without discounting the everyday single-pack price. This strategy also helps retailers price more competitively in the market while motivating more multi-pack purchasers, creating more value for the consumer and the retailer, he said.

    Meanwhile, all attendees voiced a desire for more direct mail coupons using manufacturers' consumer databases. "It will be the only way to advertise and communicate with the consumer," said Mary Szarmach, vice president of trade marketing for Smoker Friendly, who described a recent direct mail piece done with a major OTP company. The promotion -- 50 cents off a five-pack, co-opted with two of the manufacturer's cigar brands -- was sent out to 37,000 tobacco user customers provided by the manufacturer. She noted that the program had a "great" redemption rate of 24 percent, and added that this month, the chain is partnering with a different OTP supplier for an MST promotion, which includes a loyalty punch card where consumers will get $6 off a three-can purchase.

    Similarly, one retailer asked for the cigarette companies to promote the core brands. "Philip Morris has been out of that for a long time," Maxwell said. "Too often, it's Marlboro Mediums on promotion."

    However, Christine Brown of Royal Buying Group noted that direct mail pieces based on zip codes could miss their mark, due to a core customer's location outside of the store's neighborhood. Instead, she suggested retailers should do promotions at the store, such as car washes, barbecues and charity events.

    No matter the approach, the effectiveness of a promotion ultimately relies on the store's front line, as any efforts can be diminished by inexperienced or poorly trained help at the register, attendees agreed.

    One segment of the OTP section -- cigars -- is seemingly unaffected by the challenges running rampant in other tobacco segments.

    "Fifty-six percent of the market share for OTP is in the c-store industry," said Papis of McLane, noting the cigar category alone had an impressive increase of 159 percent in units. He also recommended retailers merchandise the ever-important single-sell cigar segment next to the five-packs, but in its own case.

    "At one retailer we worked with, there were 22 single-sell SKUs on a rack behind the counter, and by keeping it separate and clean, it paid off and continues to do very well," he explained.

    Single-sell cigars are a low-risk consumer option for trying new flavors, according to Bishop. Additionally, cigar smokers are similar to smokeless users in that they like to sample new products, he said.

    "The challenge for retailers is balancing between introducing new SKUs to drive excitement and trial while maintaining an in-stock position of the core SKUs," he said. "This is especially critical in cigars since many retailers can't easily expand the sales space necessary to support both existing and new products."

    Additionally, flavored cigars and natural wrap are still doing very well as a whole. "It still has legs," said Papis, noting that if retailers stick to the basic flavors like grape, banana and peach, they can do "a solid business."

    There is one caveat to flavored cigars -- the category must frequently be rationalized, attendees agreed. "It's too important [not to]," Maxwell said. "You can't fall behind the curve, for example, when [flavors'] sales start to transition from blunts to small cigars."

    Moreover, cigars are not a category where chains should follow a cookie cutter approach, as selection and popularity vary per region.

    "Our Northeast stores sell a lot of blunts, but it is very different in the Midwest and West," Stukus said. He noted that after doing resets in mid-2007, where one shelf was added for single cigars on the sales floor, single cigar sales increased to 13 percent of total cigar sales.

    Retailers should have a flexible planogram, attendees said. Papis recommended dedicating the top shelf to flavors and leaving at least one shelf to the store manager's discretion. This is the approach taken at Circle K.

    "We have a core assortment for the stores, but the remainder of the category is up to the store manager to supplement or change," Maxwell said. The same goes at Smoker Friendly stores, according to Szarmach, who worked with manufacturers on a set planogram, but the stores still offer "a lot of flexibility" in it, she said.

    For comments, please contact Mehgan Belanger, Associate Editor, at [email protected].

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