The E-volution of Vapor

Anne Baye Ericksen
April 3, 2015
CSDecisions

Electronic cigarette (e-cigarette)As e-cigarettes continue to generate headlines, c-stores are addressing a maturing product category.
By Anne Baye Ericksen, Contributing Editor
In 2006, retailers were unsure as to how American consumers would react to a non-combustible smoking product. Would it catch on or taper off as an unsuccessful experiment?
Nearly a decade later, the category has more than caught on. It’s expanded from the limited offerings of one or two types of e-cigarette pens to a broad selection of offerings, including vapor/tanks/mods (VTMs) and liquids. There is also a growing selection of flavors and nicotine levels from which consumers can choose. In fact, the category has grown at such a fast pace that industry analysts predict it could surpass traditional cigarette sales in next few years.
“Bottom line, the industry is entering its next generation of growth and we continue to believe reduced-risk vapor products will accelerate combined profit pool growth over the next decade,” said Bonnie Herzog, senior analyst for Wells Fargo Securities LLC.
CATCHING ITS BREATH
When fourth quarter sales figures of vapor products were released earlier this year, the numbers indicated a slight downward turn. The overall category came in at 17%, down from 21% in the third quarter, and the e-cig segment recorded 5%, a remarkable decline from 19% for the same period the previous year. Despite slower growth rates, the market continues to expand. According to research by Wells Fargo, retail sales of electronic smoking devices could top the $3.5 billion mark by year’s end—and $10 billion by 2018—thanks in part to ongoing interest by both manufacturers and consumers.
The Wells Fargo research also stated manufacturing capacity for non-combustibles most likely will increase by 26% over the next nine months. This comes on the heels of traditional tobacco companies—and their massive distribution network—conducting national rollouts of e-cigarettes—with R.J. Reynolds debuting Vuse about two years ago, and Altria Group introducing MarkTen in 2014.
“We were among the test sites for both, and they did well. Now we have Vuse across all our stores,” said Jeff Arnold, customer benefits manager for Maverik, a c-store chain based in North Salt Lake, Utah, with 250 locations in 10 states throughout the West.
ENTER VAPOR
Some industry observers point to the growing popularity of VTMs as the next big thing in the evolving non-combustible category. In 2013, VTMs comprised 35% of the market share, but by 2014, that percentage climbed to more than half. In fact, Wells Fargo research indicated nearly all retailers currently carry some mix of mods, tanks and liquids, or plan to add them to shelves in the near future. What’s more, VTM sales are expected to grow three times faster than e-cigarettes in 2015 and beyond.
“We believe the vapor battleground, particularly in traditional retail channels, will heat up especially as Big Tobacco pushes further into the category,” Herzog said.
Mike Gancedo, category manager for Parker’s convenience stores, has seen impressive numbers for this segment in all 36 locations in Georgia and South Carolina. “Actually, [2014] was a great year compared to the previous year. As a whole, we were up in sales close to $800,000, whereas the year before, we were less than $300,000. We were one of the first [in this area] to go to market with vape mods, and we reaped the benefits of that,” he said.
One of the reasons analysts are so positive about future VTM performance is that producers continue to introduce new options. There are open and closed systems, liquids and cartridges, and of course, new flavors.
“We’ve seen customers typically start in tobacco and menthol, then [get into] fruits and different nicotine levels. With the liquids, there are a variety of flavors and customers can mix flavors if they want,” said Gancedo. “Now it’s about customization. It’s like folks who go to Starbucks every day; they spend what they need to get the product the way they like it.”
Of course, most people like their vapor flavorful.
“With blu, the No. 1 flavor is cherry, and with vaping juice, watermelon is our No. 1,” Arnold said. “We’ve held focus groups, and within the focus groups, it varies in how they view taste and flavor. The key is flavors people will try and products and packaging that will appeal to them.”
ADDRESSING COMPETITION
One of the challenges with a young product category is retaining customers. Although Parker’s, headquartered in Savannah, Ga., recorded impressive sales following its initial offering of mods and liquids, sales dropped early this year. Gancedo attributed it to a limited shelf selection.
“We primarily carried entry level kits, so we weren’t retaining folks who moved beyond the kits. Once they were beyond the entry level kits, they were going to vape shops,” he explained. “It’s retailers’ responsibility to keep up with trends and offer a variety of products to keep [customers] in the store. We don’t want them to leave the convenience stores that got them started.”
In this regard, Gancedo plans to add higher-end vapor items under a private label this spring. “We’re working on bringing in customized kits that you normally see in the vape shops, but can buy in our convenience stores for a lesser price,” Gancedo said.
Although, retailers, including c-stores, account for approximately three-fourths of non-combustible sales, evidence shows vape shop openings have accelerated over the past six months. A Wells Fargo survey found 62% of retailers believe consumers choose these specialty businesses for their greater assortment of products.
“While a lot of independent vape shops are opening, we’ve seen a lot close, too,” said Arnold. “The thing we learned from our customer base is that they don’t entirely trust vape shops that mix their own flavors.
At convenience stores, they see the liquids are in sealed packages and that they come from a reputable source.
“Also, there are a lot of off-brands out there and we have to be cautious who we take on from a safety factor,” Arnold continued. “We want to use viable companies that follow safety regulations and are not mass producing without quality assurance.”
Another characteristic of a maturing product category is attrition.
“We have had trouble maintaining some liquids because they were discontinued. That’s why we’re really excited about bringing in a proprietary product. No way can someone else discontinue it,” said Gancedo.
LEGISLATIVE LOOKOUT
Proposed legislation also may affect the manufacturing landscape. More than 40 states already have banned e-cig sales to individuals younger than 18, according to the National Conference of State Legislatures. Additionally, several states are contemplating vaping bills, everything from age restrictions to taxing and labeling noncombustibles as tobacco products to limiting where enthusiasts can vape. As of last month, only Minnesota currently taxes e-cig sales; North Carolina will begin taxing in July, as reported in USA Today.
Of course, retailers and manufacturers alike await news from the U.S. Food and Drug Administration (FDA) regarding federal regulations of non-combustibles. Until that happens, Wells Fargo’s Herzog said the industry has assumed a wait-and-see stance, the consequence of which is that companies may stall further innovations.
“We have become more concerned that lack of FDA regulations has caused a ‘paralysis’ in the industry as retailers and wholesalers are afraid to get stuck holding product they cannot sell or return,” Herzog said.
But as time has shown, electronic smoking devices are not a passing fad and should continue to attract and retain customers for c-stores, even as the industry matures.