Cigarettes Still King

John Lofstock
June 21, 2013
CSDecisions

While electronic tobacco products and OTP have experienced sales gains, cigarette sales in convenience stores still accounted for more than $54.3 billion in 2012.

Cigarettes have long been a staple at convenience stores, accounting for billions in pack and carton sales and boosting the profits from the average smoker’s market basket. And while sales may be down, the value of cigarette customers to the convenience store industry cannot be overstated.

But can convenience retailers maintain sales and drive new cigarette business?

The stakes are high. Cigarettes, along with other tobacco products (OTP), combined to account for 40.7% of average in-store sales at c-stores. Overall, cigarettes alone accounted for $54.3 billion in industry sales or an average of $51,863 per store per month, according to the 2013 NACS State of the Industry (SOI) Report. As Bonnie Herzog, managing director for beverage, tobacco and consumer research for Wells Fargo Securities in New York, noted in her U.S. Tobacco Trends report, total cigarette volume—representing $85 billion in total retail sales—is trending downward by 3% to 4% per year.

The decline has accelerated over the past few years due to factors like smoking bans, health concerns, pricing and other government regulations.

Premium brand share has dropped, Herzog added, from 91% of industry volume in 1984 to approximately 74% last year. In 2012, Wells Fargo reported, cigarette volume was down about 3%, while smokeless tobacco volume increased by 5%.

Herzog’s research also found, among other things, that:
• Marlboro, Newport and Camel now represent about 60% of total cigarette industry volume, up from 29% in 1984. Including Pall Mall, the big four brands represent 70% of total volume.
• Convenience stores continue to dominate the retail landscape, accounting for 65% of market share.
• Mid-single-digit price increases more than offset cigarette volume declines, driving top-line growth and higher margins for some.
• Consumption of e-cigarettes could outpace traditional cigarettes over the next decade. “A majority of respondents from our Tobacco Talk survey think e-cigs are ‘here to stay’ and not just a fad,” Herzog said.

Marginal Profits
Wells Fargo is predicting that gross profit margins on cigarettes will continue to decline for retailers, and all levels of government are a big part of the reason (see more on taxation in Tom Briant’s Legislative Overview column).

President Obama’s proposed budget for 2014 included a 94 cent-per-pack tax increase on cigarettes, which currently stands at $1.01. Herzog and her colleagues do not believe this will pass, for two reasons. “For starters, Congress is more divided now versus 2008 when the last tax was passed. Two, it would unfavorably impact some of the most economically vulnerable households,” she said.

Despite the smoke swirling around the category, Leo Vercollone, president of VERC Enterprises with 26 convenience stores in Massachusetts and southern New Hampshire, said cigarette sales will remain strong in the c-store channel.

“If someone were asking the question and I wore the hat of a supermarket or drug store executive I’d probably be talking to my people about how we’re going to get out of this product category,” he said. “We have a minimum mark-up in Massachusetts of 20%, so how are you going to sell more cigarettes? I don’t know. Have a better location, have better service, that kind of stuff. But that’s getting tougher and tougher. I think that where you have a state minimum you can’t do a lot, which is why convenience stores are in a prime position to sell tobacco.”

Vercollone said he believes that sales of cigarettes in the U.S. overall will continue to decline. “However, within our trade, gasoline/c-stores, it will continue to be a strong category. Is it going to decline 1% or 2%? Sure. But it’s not going to decline 10-15%, because we are the primary destination for cigarette smokers. We’re who they come to and as supermarkets, pharmacies and big- box chains pull out it’s just going to strengthen us.”

Always a Profitable Customer
There have also been many studies, Vercollone said, to show that the relatively high price of cigarettes will dissuade fewer and fewer consumers. “The price increases that we have seen have pretty much impacted the cigarette customer already, so they’re not going to be as effective on price shock anymore. There may be a little at $10, but up to that? The people who wanted to stop because of price have basically stopped. Smokers today want to smoke. As adult consumers, they enjoy cigarettes, they legally have the right do it and they are going to continue to do it.”

Those consumers could move into other types of nicotine delivery systems such as e-cigarettes or cigars, he acknowledged. “So you might see a little drifting. But where is that clientele going to go for that nicotine, for the cigarette or the e-cigarette? They should be coming to our venue.”

How does Vercollone advise c-store colleagues around the country to handle this category? “That’s a tough one,” he conceded. “We really can’t advertise and promote it and the market for specific tobacco products varies very much locally. If a chain sees its cigarette sales declining, one of the first things they should consider doing is start looking at other items that are attractive to tobacco customers, whether it’s electronic products, foodservice or even gasoline. Develop a hook to continue attracting those customers.”

A Matter of Economics
“Despite all of the health warnings, spiraling product costs, social stigmatization and draconian limits on where people can and can’t smoke, cigarette sales continue at what some critics might find to be almost irrational levels,” said Ryan Mathews, founder and CEO of Detroit-based Black Monk Consulting and a globally recognized futurist and consultant. “What’s behind it? Young people clearly see smoking as an act of rebellion and an expression of ‘cool.’ Celebrities smoke. Rock stars smoke. Still other users are clearly just plain addicted and can’t quit, even if they wanted to.”

How long this will continue, Mathews suggested, remains to be seen. “It’s hard to say, but it seems likely that, in the end, it will be economics rather than health concerns that will rob c-stores of sales in one of their historically strongest categories. As health insurance coverage becomes mandatory, and more insurers and employers force smokers to pay escalating insurance premiums, a significant portion of the customer universe may just toss in the nicotine-stained towel and quit once and for all.”

If these economic forces can be kept at bay, Mathews is convinced, the category will remain strong. “If not, smoking could become a memory in our lifetimes. In any case, smart c-store operators ought to be thinking today about alternative revenue streams.”

The most likely candidates, according to NACS’ SOI survey, are foodservice, which accounts for 15.8% of store sales (and 27.1% of gross profit dollars); packaged beverages at 14.7%; center-of-the-store items like candy and sweet, salty and alternative snacks, at 10.4%; and beer at 7.6%.