The 1998 Master Settlement Agreement continues toimpact tobacco sales. Since the agreement went intoeffect almost a decade ago, tobacco retailers continue to be shackled by heavy regulations and constantly increasingtaxes.
While taxation is hurting convenience store retailers andtobacco manufacturers by making products more expensive topurchase, regulation is the force that is really bringingheadaches to an industry already facing an ever-increasingamount of laws and class-action suits that are driving smokersout of restaurants, bars, hotels and many other previouslysmoker-friendly venues.
As part of Convenience Store Decisions‘ ExecutiveRoundtable Webcast series, sponsored by United StatesSmokeless Tobacco (USST) and Swisher International, CSD
presented “Tobacco 2007: Issues, Insights and Implications FromLessons Learned in 2006,” to discuss the salient taxation andregulation points retailers need to know in order to maximizetobacco sales. Presenters included:
- Jim Calvin, President of the New York Association ofConvenience Stores (NYACS)
- Thomas Briant, Executive Director of the NationalAssociation of Tobacco Outlets (NATO)
- Nik Modi, Tobacco Analyst for UBS Warburg
- David Bishop, Partner of Willard Bishop LLC
A Taxing Issue
Calvin, who declared New York as the “cigarette tax evasioncapital of the U.S.,” discussed how lawmakers at both the stateand federal levels are attempting to reduce the number ofsmokers by deterring them with higher taxes. This strategy hasresulted primarily in hurting legitimate tobacco retailers.
While convenience store operators are playing by the book toobtain the appropriate licensing needed to sell tobacco, thereare a number of alternative sources in the state that don’tadhere to the taxes legit retailers are required to collect. Sincethese alternative sources sell tobacco products much cheaper,honest retailers are losing tobacco customers and profits, andthe ancillary selling opportunities that come with them.
“If you have a product where one-third of the price consistsof taxes, and there’s a place where consumers can buy theproduct without paying that tax, where do you think all the business is going to go?” said Calvin, whose group is constantlypetitioning against the high taxes proposed by New York Statelawmakers.
Under former New York Gov. George Pataki, NYACS thought ithad won a key legislative battle that would force the state tocollect taxes from Native Americans on sales of fuel and tobacco, but inexplicably, Pataki refused to enforce the law. Undernew Gov. Eliot Spitzer, Calvin is cautiously optimistic the statewill obey the measure and level the playing field for legitimateretailers.
After hearing how the tobacco legislation can be potentiallyfatal to the c-store industry, NATO’s Thomas Briant was able tobring a little more optimism to the situation, sharing the factthat 90% of all tobacco bills introduced in 2006 were defeated.More than 200 tobacco bills were introduced on topics rangingfrom taxation to restrictions to bans on certain flavors.
“There is a very real contrast between the number of billsintroduced and the number that actually passed this year,”Briant said.
While cigarette sales are under fire, the Webcast revealedjust how strong the outlook is for other tobacco products (OTP),moist smokeless tobacco (MST) in particular. MST is continuallygaining strong momentum in the c-store market, consistentlybringing its sales up higher each year, thus making it a stapleamong the variety of other tobacco products. David Bishop,partner of Willard Bishop LLC, said smoking regulations and taxation are very likely facilitating the rise inMST sales.
“The new regulations that are beingput on cigarettes relative to smoking inpublic facilities is hurting the cigarettecategory because it reduces usage occasions,” Bishop said. “In some situations,it’s a positive for MST because tobaccousers are seeking alternate products.Because of that, MST continues to grow.”
Bishop also said that 2007 is expected to bring even higher numbers for MSTgrowth. Due to factors such as pricing,product innovation and the growingemphasis retailers are putting on productplacement, Bishop forecasted MST tohave a gross profit increase of 8-9% in2007.
The gathered sales statistics for MSTsupported Bishop. According to ChrisRebello, manager of category development strategy for USST, MST has beensteadily on the rise for a number ofyears.
“There are now 1.3 million more MSTconsumers now than there were in 2001,” Rebello said. That number is justa fraction of the six million adult MSTconsumers counted in 2006. Rebelloalso revealed that MST is the fifth-largestdollar sales category in the c-store industry and was determined by ACNielsen tobe the fastest growing category in consumer-packaged goods.
Robert Maples speaking on behalfof Swisher, said MST competitivenesshas benefited the category overall,which is especially challenging during atime when tobacco companies seemingly have large bull’s eyes on theirbacks.
“Swisher’s stance is that we’re consistently opposed to higher consumerexcise taxes, smoking bans andunworkable restrictions as well as defacto product prohibitions via tobaccoflavoring restrictions,” explained Maples.
In order to do this, Maples explainedthat Swisher supports state ad valoremtaxation. He explained Swisher’s vow tocontinue to make customer voices heardon state legislative matters, as well as tocontinue campaigning to protect competition and maintain a robust OTP category.
While MST is showing strong numbersdue to being a smokeless alternative, cigars—the flavored variety, in particular—are also showing signs of reaching newsales peaks. Because of the myriad offlavors available, many regular cigar smokers are reaching for the flavoredracks for a sweet change of pace to theirconventional cigars.
While OTP and MST were key topics ofdiscussion, much of the dialoguerevolved around the tobacco industry asa whole, focusing on the challenges itfaces in the upcoming year in particular.
Modi, USB tobacco analyst, describedthe concept of equilibrium. Modi recommended applying Le Chatelier’s Principle,the Theory of Equilibrium, to the tobaccomarket in order to get a better understanding of what it takes to keep the tobacco market stable and profitable. Thetheory states if a system’s equilibrium isdisturbed by shock, the system will tendto overcompensate against the shock toright itself.
“I see cigarette sales at c-stores to beundergoing various shocks,” Modi said.”As a result, retailers are starting to suffer given that cigarettes are such a bigpart of their overall portfolios.”
While admitting there are a number ofthese shocks that could shake things upfor retailers, Modi focused on three thatare particularly tumultuous to the state ofequilibrium in cigarette sales.
The first shock Modi discussed wasdemographic shifts, which is a problemdue to the mass amount of cigarettesmokers who are entering the babyboomer phase and purchasing their cigarette at other outlets, such as drugstores. Another shock is net pricing,which is on the constant rise leading tosolid price increases for all brands. Thethird shock discussed was the slow downof channel migration, which shows thec-store channel losing even more customers to other markets, such as drugand grocery stores, over the course ofthe next five years.
Because of these shocks, Modiexpects cigarette sales for the averageretailer will drop drastically, completelydisrupting a store’s bottom line. Modisuggested that OTP is going to be key forretailers looking to make up the difference.
“MST is the third most profitable category in the c-store market [when taxesare taken into consideration], but isranked 20th for space” Modi said. “The
energy drink category had the same kindof dynamic many years ago, however, thatgap is now closed.”
Modi suggested that the energy drinkboom and the growing potential of MSThave many similarities—such as higherpenny profits, retailers accommodatingmore shelf space, consumer migrationand the involvement of bigger manufactures—that imply that the OTP categoryis about to reach its most profitableperiod ever.
To listen to the tobacco Webcast inits entirety, visit www.csdecisions.com.The next installment in CSD’s Webcastseries will take place on Feb. 28 whenCSD presents “Building and Integratinga Loyalty Program.” Registration is freeat www.csdecisions.com