Cigar Alert

Manufacturers prepare for the worst from FDA's OTP announcement.

By  Melissa Vonder Haar, Tobacco Editor

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Will the FDA assert its authority over cigars? What about the small but growing electronic-cigarette segment? What regulations will it enact, and when?

Such speculation has occupied the tobacco industry ever since President Obama granted the Food and Drug Administration authority to regulate the tobacco industry with The Family Smoking Prevention and Tobacco Control Act of 2009. While the FDA currently regulates cigarettes, roll-your-own and smokeless tobacco products, many within the industry have felt it’s a matter of when—not if—the organization will wield authority over OTP success stories such as cigars and pipe tobacco, not to mention the uncharted territory of electronic cigarettes.

But all they could do was speculate—until now.

The FDA’s 2013 Regulatory Agenda indicates that the agency intends to issue a proposed rule to regulate other tobacco products. The agenda goes on to state that the FDA should issue a Notice of Proposed Rulemaking (NPRM) no later than April 2013.

It doesn’t, however, say which other tobacco products it intends to propose regulations for. That means the guessing game continues for tobacco suppliers and retailers.

“I don’t think anyone really knows anything for sure,” says Bonnie Herzog, senior analyst for New York-based Wells Fargo Securities LLC.

Still, cigars are at the center of most speculation. And with Nielsen reporting that cigars accounted for 34% of c-store OTP sales in 2011, there’s cause for concern over what those regulations might be—especially when it comes to the lucrative subcategory of flavored cigars.

“No one knows for sure how a potentially flavor ban would impact the category, or even if cigar flavors would be banned should FDA choose to regulate cigars,” says Joe Teller, category management director for Richmond, Va.-based Swedish Match. “But the smart thing to do is to get ready with products that you believe would be allowed should a ban occur.”Or, as the saying goes, the best defense is a good offense. Leading cigar manufacturers, including Swedish Match, are employing this strategy, looking at areas the FDA might regulate and taking action now to ensure long-term success.

A Flavorful History

A ban on flavored cigars is just one of many possible regulations the FDA could propose in April. But it serves as a good example of how manufacturers are preparing to deal with what could be significant changes to the industry. After all, the first tobacco regulation issued by the FDA was a ban on flavored cigarettes in an attempt to curb youth smoking rates.

“These flavored cigarettes are a gateway for many children and young adults to become regular smokers,” said FDA commissioner Margaret A. Hamburg when announcing the ban in 2009.

Will the FDA apply the same logic to cigars? Those who make their livelihood in the cigar business hope the agency will look at the difference in cigar and cigarette consumers before making such claims.

“Cigar consumers are completely different from cigarette consumers, with little overlap between the two,” says Teller.

And considering consumers have enjoyed flavored tobacco products for hundreds of years, manufacturers such as Prime Time International question how effective flavor prohibition would be in a market that demands such products.

“You can’t legislate demand,” says Paul Marquardt, vice president of marketing and operations for the Phoenix-based company. “When there’s a demand, there will be a supply to fill that demand. You take a supply from an FDA-regulated manufacturing world and drive it to the black market or tribal outlets. Hopefully, the FDA will regulate cigars based upon scientific data and not on preconceived perceptions by anti-tobacco organizations.”

Herzog echoes this sentiment. “From the cigar user standpoint, I think flavors are something they’re accustomed to,” she says.“Would those people leave the category or would they just switch? My assumption is that consumers would adjust to other alternatives, assuming it’s not a complete, 100% ban on any kind of flavoring.”

It’s a risky move given the importance of flavored products to the cigar industry: Swedish Match estimates that flavors represent 60% of the segment, which is significantly more than flavored cigarettes represented before they were banned.

“That was relatively such a small part of the (cigarette) market,” Herzog says.“[Flavored cigars] are a larger portion.”That’s not to say the cigar industry would be devastated by an outright ban on flavored products.

“While this part of the category is growing now and has been growing for many years, it is only driving about 20% of total cigar category growth,” says Teller, estimating the current growth percentage of flavored cigars to be less than 1% in units or sticks. “In other words, while flavored is a huge part of the category and is still growing, it is not growing as fast as it used to.”

Meaning, despite the prominence of flavored cigars, there’s an opportunity for retailers and manufacturers to develop and promote products less likely to face scrutiny from the FDA.

A New Tomorrow?

For many cigar manufacturers, this means devoting efforts toward natural and unflavored cigar products.

Because Herzog believes that there’s a high probability of a flavored cigar ban, “There could be an opportunity there for the natural flavorings,” she says. Swedish Match has explored that opportunity, developing unflavored products such as White Owl Black Cigarillos, White Owl Silver Cigarillos, White Owl Gold Cigarillos, GAME Black Cigarillos, GAME Silver Cigarilos and GAME Gold Cigarillos. According to Teller, such moves have already paid off for the company.

“By far the fastest-growing part of the cigar category has been unflavored cigars,” he says. “As Swedish Match and other cigar manufacturers get ready for potential FDA regulation of cigars, we are introducing cigar brands that do not have flavor callouts on the package and don’t have strong characterizing flavors in the cigars.

“Unflavored cigars represent nearly all cigar category growth in convenience stores,” he continues. “Retailers should carry these newer unflavored cigars in both single-stick versions and also in multi-stick foil pouches. “Marquardt reports that Prime Time is looking not only at cigar products, but also a broader portfolio overall to prepare itself for a regulated future.

“From a product development and marketing side, we’re definitely making sure that we have a product portfolio and options that will fit into whatever regulatory environment is coming down the pipeline,” he says. “We ... [are] making sure that our portfolio is broad enough that it can handle anything.”

Still, there’s only so much that can be done in advance from a product development standpoint. Which is why, at times, it pays to be small. “From a manufacturing perspective, there is only a limited amount that can be done until the proposed regulations are issued,” Marquardt says.“Smaller companies like us have five years to phase in most of the changes. That gives us some time to figure things out.”

An Upside to Regulations

Even with companies such as Swedish Match and Prime Time confident in their ability to thrive in a post-regulatory environment, those who manufacture and sell tobacco are apprehensive at best about what the FDA has in store.

But is there a silver lining? It may not be a popular line of thinking, but after so many years of guessing when and if the FDA might assert further authority over OTP, April’s announcement could offer some much-needed clarity.

“No one likes uncertainty,” Herzog says. “Whatever the decision is, that’s better for the industry broadly because then they know how to operate. Everyone can move forward under the new operating environment.”

Such operating guidelines are crucial in establishing which companies are tough enough to thrive and which will fall to the wayside, making for a stronger industry overall.

“The tobacco industry is very resilient, very creative and can move faster than some of the other industries,” says Marquardt.“Once the rules are laid out and everybody is on a level playing field, I think that the good companies will continue to execute and will have an options going forward. It’s going to make it harder and harder for the companies who aren’t compliant or established to exist.”

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