smoke signals

Besieged by taxes and a decline in gross profit margins, there are signs that import and specialty brands could be the key to tobacco profitability.

Though there have been calls by industry expertsfor convenience store companies to reduce their dependencyon cigarettes, the industry overall is becoming more reliant ontobacco sales. The National Association of Convenience Stores’2006 State of the Industry report shows that cigarettes accountedfor 34.4% of total in-store sales last year, virtually unchanged from2004.

Though cigarettes are by far the leading in-store category interms of sales dollars, its profitability is steadily diminishing.Cigarettes had the lowest gross margin percentage among the channel’s top 10 product categories last year at 18.2%, down more thana point from 19.5% in 2005—the category with the next lowestgross margin percentage was beer at 21.5%.

The gross margin performance in terms of sales dollars wasequally poor for cigarettes ringing up $9.1 billion in sales last year, aweak 1.1% increase over 2004. By comparison, beer (9.1%) was theonly other top 10 in-store category not to experience a double-digitgross margin dollar increase.

While $9.1 billion in sales is still a hefty number, it marks thefirst time cigarettes have fallen out of the top spot in gross margindollar performance. Foodservice, with a 30.4% hike in 2005,accounted for $10.3 billion in industry gross margin dollars lastyear.

The slight increase in cigarette sales dollars in 2005 is fool’sgold and hardly an indication of overall product movement. Higherstate and federal taxes were largely responsible for the increase inrevenue.

“We expected rising prices and legislation to cut into our cigarette sales, but effective marketing and innovative promotions haveallowed us to keep prices steady and manageable for consumers,”said Ron Freeman, president of Jay Petroleum Inc, which operates

38 Pak-A-Sak locations in Portland, Ind. “It’sa volatile category to manage, but, all thingsconsidered, we could be doing a lot worse.”

Diversified Offering
One effective strategy for boosting salescould come from specialty and importedtobacco brands. Specialty tobacco shopshave already come to realize that brands likeDjarum, American Spirit, Dunhill and NatSherman are attracting a new base of consumers that expect quality and value.

Frank Armstrong, who owns and operates eight Blue Ridge Tobacco shops inNorth Carolina and Virginia, said the numbers speak for themselves. While overall cigarette consumption is down about 10%nationally over the past two years, theNational Association of Tobacco Outletsreports the number of retail outlets with distribution of specialtytobacco brands jumped 7.2% to64,400 stores. Those stores soldan average of 121.2 cartons in2005, up 10.4% from 2004.

Armstrong believes tobaccoshops will continue to garner thelion’s share of specialty tobacco primarily because they own the marketon leading brands, which currently havelimited penetration in conveniencestores and drug stores.

“The potential in all trade channels isenormous,” Armstrong said. “When you consider price, quality and value, specialtybrands are quietly building loyal customerswith moderate levels of disposable incomeand an appreciation for upscale products.”

And Armstrong is hardly a novice attobacco retailing. He spent nearly two yearsin sales and marketing with R.J. Reynoldsand another four years as vice president ofretail operations with Quality Oil Co., managing its chain of Shell-branded conveniencestores in Winston-Salem, N.C.

Study the Market
Armstrong offered the following tips forgrowing the specialty tobacco business:

  • Start with leading brands.
  • Survey the competition (other c-stores, drug stores and tobacco shops) to find out what specialty and imported cigarettes they are carrying. “Visit your competitors as often as possible to get sense of how the products are moving or buy a few packs and ask employees how well the products are selling,” Armstrong said.
  • Price competitively. “If retailers in your area are already carrying specialty brands, make sure your pricing is no higher than theirs,” Armstrong said. “Underpricing by as little as 25 cents a pack could be the boost you need to get the business.”
  • Improve the display presentation. If competitors have older tobacco displays, contact specialty tobacco distributors and manufacturers like Kretek International, Nat Sherman, Santa Fe Natural Tobacco and JT International to request the latest point-of-purchase [P-O-P] dising materials. Armstrong recommends multi-brand display racks in three- and six-foot sections.
  • Have better knowledge of the category.“Become the local expert,” Armstrong said.

Demographics for Success
The market for specialty tobacco is a little different than traditional cigarette smokers, Armstrong said. For example, instead ofattracting the 18- to 25-year-old male demographic, specialty brands reach both malesand females from ages 21-60. Other characteristics of the specialty shopper include:

  • An average Household income of approximately $45,000;
  • Smokes an average of two packs of specialty cigarettes per week;
  • Relatively brand loyal, but will expand brand usage within the category;
  • Great word of mouth ambassadors for the brand” and
  • More likely to shop where selection, service and product knowledge exists.

Armstrong is hardly alone in his beliefthat specialty and imported tobacco brandsare keys to growing the cigarette business.Terry Gallagher, president and CEO ofSmoker Friendly International, a 300-storechain of tobacco store licensees, is alsobullish on the segment.

When it comes to marketing specialty cigarettes to the consumer, Gallagher, who alsoserves the board of the Tobacco MerchantsAssociation, stressed the need for knowledgeable employees that really understandthe products like tobacconists and winestore employees. “Customers are influencedby employees that are confident and knowwhat they are talking about,” he said. “Ifthey sound unsure of themselves or hesitantto promote a brand, customers willsense that and avoid the category.”

Just as significant, Gallaghersaid, is growth opportunities. Hebelieves the specialty segment willdevelop similar to other adult consumer product categories like beerand wine, distilled spirits, coffee andeven bottled water. “This provides significant cross-marketing occasions togrow the business across several prominent categories in the conveniencestore,” he said.

One proven marketing strategy, Gallagherpointed out, is to work with manufacturers tofeature brand styles monthly, weekly or evendaily. This makes sure a brand is out in frontof the customer every time they enter thestore. Other marketing tips include free product sampling in markets where it is legallyallowed and local store specific-brand specific advertising in daily or weekly newspapers.

Another crucial detail to remember whenconsidering whether or not to carry thesespecialty brands is that they are much moremature than typical third or fourth tier tobacco brands, which boast a range of problemsfrom inconsistent quality, inferior ingredients, poor distribution and many of the manufacturers are constantly dogged for theirlack of participation in the 1998 MasterSettlement Agreement (MSA).

“As a whole, specialty brands have thesame quality and consistency customershave come to expect from the major tobaccobrands, and when priced effectively, that’swhat really matters,” Armstrong said.

css.php