A Taxing Time for Tobacco

Last year was truly a difficult time for tobacco. The State Children’s Health Insurance Program (SCHIP) increased tobacco taxes from a “modest” 158% increase on cigarettes up to a hideous 2,000 plus percentage increase on roll your own tobacco and small cigars. (RYO went from $1.10 per pound to $24.68 and small cigars went from four cents a pack to $1.01)

Since the new taxes hit last April, it skewed some of the sales towards the beginning of the year as both stores and, in turn, consumers loaded up. The new taxes have impacted cigarette sales across the board. But many operators are seeing increases in other tobacco products (OTP) such as large cigars, snus and snuff.

Imports of large cigars (as defined by the government as a cigar weighing over three pounds per thousand) were up last year to a total of 1.8 billion units, an increase of more than 100% from 2008. The increase could be seen as retailers increased buys prior to the SCHIP tax but, in fact, December’s imports were up more than 132%. Little cigars, meanwhile, fell by about half for the year. (In the latest figures for January, that trend continued with large cigars up about 390 million units while little cigars fell by 382 million units.) Part of the reason for that was the tax. Once the SCHIP tax hit little cigars, some manufacturers added more tobacco to reclassify them as large cigars by getting them over the three pounds per thousand threshold to cut the tax from the $1.01 to around 11 cents per pack, depending upon the import value.

John Archer, who operates the Shell brand in Hinsdale, Ill., is a prime example of how tax policies impact c-stores. When SCHIP hit, Archer was smoking mad because cigarette sales were 25% of his business. However, he quickly noticed his numbers going up. He was selling more cigarettes and OTP. Turns out, Archer operates a store just inside the DuPage county line. Neighboring Cook County had doubled its cigarette tax in 2006 to $2 a pack. DuPage does not have that tax.

Further, nearby Cicero added another 16 cents a pack with a 10.5% sales tax. Hinsdale straddles Cook and DuPage counties with a 9.25% sales tax on the Cook County side and only 7.25% in DuPage. Archer realized the new SCHIP tax was the tipping point.

“Cook County was already $8-$9 a pack prior to the SCHIP tax, which was a lot higher than we were. Once the tax hit, prices went to $9-$10 a pack in Cook versus our price of $6 per pack,” Archer said. “That savings of $20-$30 a carton caused me to literally double my sales.”

Cigarettes are now 50% of Archer’s total sales and are bringing in new customers. “I am doing record store sales. My profit percentage is lower because of the cigarettes, but I am making more money because I am selling more of everything,” he said.

Cigar Sales Lift
Like many owners, Archer is seeing growth in the cigar market as well. He has a four-foot run of cigars out on the floor for the multipacks, and recently added the new foil packs of Dutch Masters and Phillies, which are a buy two, get one free offering. Archer has several customers who come in and buy 10 multipacks at a time of Dutch Masters Presidentes or Panatellas. Individual cigar sales are also doing well, but he keeps the individual cigars behind the counter.

For Tulsa, Okla.-based QuikTrip, Mike Thornbrugh said across the company’s 543 stores in nine states cigarette sales are either flat or declining. But the company is seeing increases in OTP.  Thornbrugh explained, “you can see the sales increasing not only in terms of sales, but also through the manufacturers bringing out new and different offerings.”

About 10 years ago, QuikTrip made a conscious decision to move all tobacco behind the counter, so it is not planning any changes or resets. But with the physical size of its stores, QuikTrip carries about 4-5 times the smokeless selection of average c-stores.

In the cigar area, Thornbrugh said customers are in transition from blunts to cigarillos with single sales very strong. The stores carry about 25 different offerings from Swisher and Altria’s Black and Mild. The sales of multipacks at QuikTrip are flat, possibly because of price theorizing and previous multi buyers who are now coming in more often for singles. R.J. Reynolds’ Camel snus is another destination that is attracting customers.

Privately owned Stinker Stores in Idaho is also seeing a change from multipacks to single sales. Lon Audet, the chain’s director of marketing and merchandising, said he is not sure if it is a reaction to price, but sales for single cigars are doing well. He added that Swisher gave the chain a four-tier add on which houses the single cigars.

In Stinker stores with bigger back bars the company is using the Altria or UST three-foot chew rack with the bottom two shelves displaying different OTP items. “We’re constantly evaluating and know that OTP is the category that is growing, with cigars doing well,” Audet said. “We are always looking for opportunities and ideas. But Altria, Swedish and Swisher are all saying if you don’t have the room for proper displays, then singles are probably the best way to go.”

The stores do continue to have multipacks in some of the cigar offerings. Audet said they will not get into premiums because the stores really do not have the space and, more importantly, in their area they have a unique situation. Boise, he explained, has more tobacco stores per capita than almost anywhere in the country.

“Here you go about a quarter mile and you will hit a tobacco store with walk-in humidors and all, so premiums do not make sense for us,” Audet said.

Mass Appeal
Cigar manufacturers have dedicated sales forces for c-stores and are seeing growth in the segment, mostly for mass market. However, some c-stores are moving into premium cigars on a very limited basis. These stores have a humidor on the counter,  and a few independents even have a wall humidor. Yet the problem with premium and other cigar sales for c-stores remains one of space.

Terry Kailey, the tobacco category manager for 7-Eleven Inc. in Dallas, agreed. The company is looking to increase its OTP products. Kailey said cigars are showing good growth, even though the flavors seem to be slowing down. The challenge even for 7-Eleven is space. Like other retailers, the company is contractually bound to certain display materials, but FDA guidelines may force a change.

If the point-of-purchase (P-O-P) materials are reduced, it could provide additional back bar space for OTP. 7-Eleven is looking at a major reset in the tobacco category in 6,000 stores this year to take advantage of sales trends in OTP.

One reason for resets is the FDA regulations. In mid-March, the agency announced that by June 22, smokeless tobacco must be placed behind the counter.  The rule says self-service displays are prohibited except in places where nobody under 18 is allowed to enter. Archer, of Shell in Hinsdale, Ill., said that also applies to his RYO products, which is going to create a headache in an already tight space. His three-foot RYO display will have to leave the floor and, as a result, he will cut product as he tries to find space on the back bar.

The good news is cigars are exempt from the FDA ruling and Archer expects continued sales increases in those skews.

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