Tobacco sets to evolve as demand rises for e-cigs, OTP, but not as fast as you might think .
Is there a crack in the firmament of shelf space allotted to cigarettes?
With the seemingly sudden and dramatic rise of e-cigarettes, along with the steady encroachment of other tobacco products (OTP), many are wondering what effect these trends will have on tobacco sets—and, specifically, cigarettes. For some retailers, these trends have already meant change.
At Cumberland Farms, New England’s largest c-store chain with 600 stores, moist smokeless tobacco (MST), loose product and cigars have expanded by 2 to 3 feet of shelf space in recent years, resulting in a scaling back of cigarettes. And now comes e-cigs, a “game changer,” says Anne Flint, senior category manager for Cumberland Farms. Ane-cig test late last year in one state resulted in an expansion into the Framingham, Mass.-based chain’s 11-state network. Flint repositioned e-cigarettes “from clip strips to top shelf, bringing cigars down lower.”
Those analyzing tobacco trends are not surprised. “Cigarette [demand] is not growing,” says Bonnie Herzog, managing director of equity research and senior beverage and tobacco analyst for Wells Fargo Securities, New York.“Other products are turning faster, growing faster and have higher margin: cigars, smokeless and electronic.”
But don’t write off cigarettes, despite single-digit annual sales declines. Realistically, contracts and the sturdy—though eroding— demand for cigarettes is keeping change at bay. In a recent Wells Fargo study of industry contacts representing 45,000 c-stores, 65% of respondents said despite rapid growth of e-cigarettes, the innovation has not taken up cigarette shelf space—yet. “This could change as sales continue to rapidly grow,” the study concluded.
Wells Fargo reported fourth-quarter cigarette sales down by 3%, which is on trend, while e-cigarette growth is expected to be more than 20% this year. Also, the firm reports that retailers are continuing to carry more SKUs, with more than 50% of respondents saying their e-cigarette purchases are repeat vs. trial.
Figures like that bode well for the industry, with those on the growing e-cigarette side of the equation feeling optimistic.
“We’ve always had the philosophy that if you make a product good enough, people would choose it,” says Ryan Coalson, sales ambassador for e-cigarette brand blu, based in Charlotte, N.C., and the e-cigarette arm of Lorillard Tobacco Co., Greensboro, N.C. “Right now, it’s in its infancy. Having said that, I’ve sold a lot of products across the board and I’ve never seen something grow this quickly.”
While Coalson can’t measurably predict what effect e-cigarettes may eventually have on traditional cigarette-space allotments, he points out an obvious truth:“C-stores are about profit per square footage.”
“We believe the back bar is going to evolve to standard category management principles as more and more retailers look at per-unit sales of electronic cigarettes vs. traditional cigarettes,” says Vito Maurici, senior vice president of sales and distribution for NJOY, Scottsdale,Ariz.
As retailers can attest, one of the strongest reasons cigarette sets will remain largely unchanged for the time being is contractual agreements with manufacturers.“Cigarette companies are going to keep a hold on their displays,” says Larry Gerosa, owner of Jud’s Food Stores, basedin Seguin, Texas.
Gerosa believes the major manufacturers will produce or acquire their own e-cigarette lines and design them into their larger tobacco sets.“Contracts have been around a longtime and have become more complex, “says Herzog of Wells Fargo. “They’re frustrating but part of the business, and I don’t see it changing.”
The system does give the larger manufacturers an advantage, she says, and retailers should expect companies such as Altria and Reynolds to develop responses to emerging product innovations and technologies. In terms of the big three, Lorillard purchased blu eCigsin 2012. Winston-Salem, N.C.-based R.J.Reynolds Tobacco Co. is developing an e-cigarette product to bring to market, while Richmond, Va.-based Altria seems to be in a holding pattern.
On the topic of cigarette space, the major manufacturers emphasize the strength of what is undeniably the channel’s largest and highest-traffic inside category.
“In considering any pressures that may be on cigarettes as a result of other tobacco products, it’s important for c-store retailers to recognize that cigarettes are still and will continue to be a key category, representing upward of 30% of all in-store sales,” says Richard Smith, lead manager of communications for R.J. Reynolds. “The challenge for c-stores is to understand the opportunities and take full advantage of the growth OTP can offer.”
The larger issue is how to respond, making decisions based on science vs. intuition. With Altria, “our programs—whether in cigarette or smokeless or cigar—are built on core category management principles,” says Brian May, spokesperson for Altria. “It’s been that way foursome time and will be that way for the foreseeable future.”
According to May, these principles include allocating how much space a brand or category gets and making sure brands are in stock, and that the premier brands land premier positioning. Then there are product rotation and freshness to consider, and communicating promotional offers to consumers.
“Each retailer needs to make those determinations for their own markets, “May says. “It goes back to meeting [customers’]expectations and their needs coming into the store.”
From Herzog’s perspective, e-cigarettes are a profound and significant development within the category. “I’ve suggested the consumption of e-cigarettes could surpass cigarettes in the next decade, “she says. “It’s new, but growing by leaps and bounds.”
Estimated sales in 2012 were close to half a billion dollars, she says, with projections of double that this year. “This is a great opportunity for retailers, because it’s offering the consumer the taste, the experience and the nicotine [of cigarettes]with far less perceived risk.”
While initially e-cigarettes are initially displayed on store countertops, Herzog says the product is gaining more shelf space behind the counter. “That’s the way this will evolve, and it will only continue,” she says. “There’s still a need for a strong presence in cigarettes. It’s a core part of your store display, but expanding the tobacco set to include fast-growing and high-margin products is a smart decision.”
For at least one brand, blu, growth within the c-store channel was quick and decisive. Founded in 2009, the company held back on getting into retail until federal regulatory agencies decided whether e-cigarettes would be a prescription product. With a favorable decision from the Food & Drug Administration (FDA)in 2011, it initiated efforts, first breaking into the drug-store channel with Deerfield, Ill.-based Walgreens. Regional c-store powerhouse Sheetz, Altoona, Pa., followed in November 2011, giving bluan influential advocate in this channel.
Lorillard’s acquisition of blu a year ago opened the floodgates. Access to the tobacco manufacturer’s sales force and retailer client network prompted a spurt that catapulted blu’s presence from 12,000 stores to 50,000, Coalson says. The company has developed counter displays and shelf solutions for the product and its parts, with both brand-only options as well as broader category alternatives. Coalson says many clients have brought in temporary display solutions, waiting for the next reset before making longer-term changes.
Like Lorillard, the major manufacturers understand the gravity of thee-cigarette trend. “More recently, certain consumers—adult smokers—have been expressing interest in innovative or other forms [of tobacco] and possibly switching or using multiple [forms],” says May of Altria, citing that the company does not have an e-cigarette product on the market. “We’re monitoring that space with high awareness.”
“For years, I’ve believed that technology will play a great role in this industry,” Herzog says. “With this disruptive innovation, we are there.”
Bigger Box, More Space?
Overall, space in the store for the tobacco category has held constant, Herzog says, even as leading-edge chains develop larger-format stores. “Larger chains[that are increasing] store size … are getting more profitable and generating higher, faster same-store sales growth,” she says. “But it’s a percentage of overall foot space, so I don’t get the impression that [tobacco sets] will be increasing on a relative basis.”
To that end, retailers have to be mindful of consumers’ needs, says May of Altria. “They need to be thinking about how much space to allocate to cigarettes and to the cigar category, and potentially other categories that are emerging soon,” he says. “If they’re not, one of their competitors will be.”