Dipping Into New Profits

In a market plagued by high taxes, declining gross margin profits on cigarettes and the likely possibility of FDA restrictions on tobacco, retailers more than ever need to manage the tobacco category more closely.

It’s no secret that the smokeless category has been growing, with big year-on-year gains in new product sales, flavors and line extensions as more tobacco companies are exploring opportunities in smokeless. For example, Reynolds American Inc. (RAI) reached a $3.5-billion agreement to acquire Conwood, the nation’s second largest manufacturer of smokeless tobacco products. In January, Altria added smokeless tobacco to its portfolio when it acquired UST Inc., the top U.S. maker of moist snuff.

“The smokeless category is still growing, but probably a little slower than it was last year,” said Lou Maiellano, a former retailer with more than 20 years of tobacco category management experience and president of TAZ Marketing & Consulting Group in Levittown, Pa. “A lot of that has to do with the economy, and because there were a lot of out-of-stocks out there at the end of the first quarter.”

Many chains avoided loading up on products because of the April 1 floor stocks tax that was part of the Children’s Health Insurance Program Reauthorization Act of 2009 (S-CHIP).

Still, just because smokeless sales are up, it doesn’t necessarily mean more smokers are ditching cigarettes in favor of chewing tobacco or dissolvable products. Smokers in states where cigarette taxes are high are more likely to find alternate places to purchase cigarettes, including online.

In New York where the state excise tax is $2.75, some smokers have been avoiding the tax by buying at Native American reservations, and some New Jersey smokers have been crossing state lines to find less expensive cigarettes in neighboring states. But that shouldn’t preclude smokeless retailers from growing sales.

“I think there is an opportunity that folks, especially dual users, might make the switch (to smokeless),” Maiellano said. “If a gentleman dips Skoal or Copenhagen and also smokes Marlboro, there’s a strong variance in the difference in pricing between the two products. Consumers that are dual users will probably exercise their right to purchase cheaper products, and they could end up using more smokeless because of the higher (cigarette) taxes.”

Snus or Lose
When it comes to cigarette loyalists, Maiellano suggested the bigger opportunity is converting them to snus by educating them that unlike chewing tobacco and moist smokeless tobacco, it does not require spitting and allows smokers to get a nicotine fix, even in venues that no longer allow smoking.

“Snus is not going to replace cigarettes anytime soon, but it certainly has some strength so far” in the market, agreed Steve Kidd, tobacco category manager for Village Pantry in Indianapolis, which has 146 stores.

Kidd said he has been pleasantly surprised by the growth he’s seen in the smokeless tobacco category overall, and especially with snus products.

Rutter’s Farm also has seen increases in smokeless tobacco sales this year, similar to the last two years. “Lately there have been a lot of price changes, retail changes and changes within the program,” said Robert Perkins, director of marketing at Rutter’s Farm Stores, which operates more than 55 stores in Pennsylvania. “We have been doing a good moist smokeless business. Some of the pricing has actually come down on Copenhagen and Skoal. They decreased the price on the premium moist at the end of March.”

Despite the price changes, Perkins has not seen a major shift in consumer interest from cigarettes to smokeless. Consumers, he said, are becoming more price conscious, however, and are opting for more generic and value brands when buying tobacco products.

Perkins also noted that snus has been a big seller. “We’ve done fairly well with snus, which we introduced in February, and it is showing movement. Skoal, Copenhagen and Grizzly, at least for us, continues to drive the moist category,” he said.

Maiellano has observed a lack of retail promotions on multi-packs in smokeless this year compared to last year. “Retailers, if they can put two cans in consumers’ hands instead of one, have a better chance of getting consumption to go up,” he said.

While volume growth for smokeless was at 7% last year this year’s numbers could be around 6%. While 6% is still a positive growth number and shows the category is progressing, one reason for the slight dip could be the lack of these promotions, as well as the current economy.

FDA and Taxation
As more smokeless options flood the category, such as electronic cigarettes and dissolvable smokeless tobacco in the form of sticks, strips and lozenges, only time will tell if pending FDA regulation would continue to allow these new products.

“One of the biggest opportunities for retailers in the OTP category, especially smokeless tobacco and alternative tobacco products, would be if there the FDA allowed statements to be made regarding the reduction in harm of different tobacco products,” Maiellano said. “That would affect how a lot of how these categories grow.” Such a move by the FDA is unlikely, he added.

Experts agree it’s too soon to tell how excise taxes on cigarettes may influence smokeless tobacco sales. While state excise taxes have increased on smokeless, they have not grown to the extent of cigarettes taxes.

“Currently, states tax smokeless tobacco products in several different ways,” said Tom Briant, executive director of the National Association of Tobacco Outlets (NATO). One method is to apply a percentage tax to the manufacturer’s price, which is what some 30 states do. Another 14 states apply a percentage tax to the wholesale price of the product. In addition, up to 14 states tax moist snuff at a flat rate per ounce, which means the price of a product varies greatly depending on where it is purchased, he noted.

When it comes to federal taxes, chewing tobacco is taxed at 50.33 cents per pound and Snuff at $1.51 per pound, compared to cigarettes, which are taxed at $1.0066 per pack.

More than the excise taxes, what will influence the future of the category most is a bill currently pending in the U.S. Senate. Retailers and tobacco manufacturers alike are waiting to see if the FDA regulatory bill introduced in the U.S. Senate by Sen.Ted Kennedy (D-Mass.) on May 5, called the Family Smoking Prevention and Tobacco Control Act, is passed.

The bill would give the FDA control of the manufacture, marketing and distribution of tobacco products. If the bill passes, changes would include new warning labels on smokeless tobacco .

“The labels and warning statements would need to be on the two main display panels of a smokeless tobacco product package and comprise at least 30% of the area of each display space on the package,” Briant said. “There would also be a set of rotating warning labels that would need to appear in this package space, similar to the rotating warning labels that appear on cigarette packages.”

On May 19, the U.S. Senate Health, Education, Labor and Pensions (HELP) Committee marked up the bill and debated some 40 to 50 amendments. Sen. Jeff Merkley (D-Ore.) introduced an amendment that calls for the FDA to review of what he called “gateway tobacco candy dispensers,” according to the Tobacco Merchant’s Association (TMA). Merkley’s amendment was accepted after a vote, the association reported. On May 20, the HELP Committee passed the bill by a 15-8 vote, sending it onto the next step, which will be a full Sena
te vote.

Even if the bill passes, retailers will not be inundated with huge changes to the smokeless category overnight. “It will take a while for the FDA to get up to speed with the huge task of regulating tobacco, so retailers should have some time to prepare,” Kidd said.

Best Practices
Whatever the outcome of the legislation, in a struggling market it is imperative for retailers to use best practices to drive smokeless sales. 

Making sure smokeless tobacco products are fresh, in-stock and displayed in a prominent place in the store is an important place to start, Kidd said. Smokeless consumers will shop where they can find their product, so if a store is out-of-stock, they are apt to take their business elsewhere.

With so many new smokeless products being introduced, cashiers and c-store employees can play a big part in educating consumers about the new products they may not have seen before and getting them to try new promotions.

“If I was a marketer today, I would be out there trying to build a very prestigious section around this product and letting people know there are other products out there other than cigarettes,” Maiellano said. “Leading retailers will set the stage for the success of the future. Retailers need to take control of the category, focus on the shopper and be good marketers.” 

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