Crossing the Intersection

Are you ready for the cigarette-OTP interchange?

By  Linda Abu-Shalback Zid, Senior Editor

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And now, a look at 2025: The man glances behind the counter, quickly eyeing the small section in the corner that houses cigarettes. Not this time—he’s got too much going on this weekend. Tonight’s a trip to the movies, so he picks up some snus. Tomorrow is date night, and his girlfriend isn’t a fan of the tobacco smell, so he’ll need some more nicotine hand gel. Sunday’s golfing with the buddies, so he grabs a pack of small cigars.

And if UBS analyst Nik Modi’s prediction is correct, this 2025 Bubba won’t be alone in passing up traditional cigarettes for other tobacco products (OTP).

In 2010, cigarettes accounted for 79% of the tobacco profit pool, with OTP making up the rest. Assuming profits grow in line with volume trends of declining cigarettes and increasing OTP, Modi predicts that cigarettes’ piece of the pie could shrink into the minority, at 45% by 2025.

Modi taps into the past to predict the future. In the 1800s, he says, cigarettes were only 2% of tobacco consumption. But later that century, anti-spitting laws were enacted due to concerns about snuff spittoons contributing to tuberculosis. By the 1940s, cigarettes had ramped up to more than half of tobacco consumption, and by 1980 they accounted for roughly 80%.

“Sound familiar?” Modi asks, pointing out the plethora of nonsmoking regulations throughout the country, driving smokers to turn to alternative forms of tobacco. “I think the same type of pattern can play out here.”

A look at the two major manufacturers that play in both cigarettes and OTP already points to the shift:

Reynolds American Inc. estimates the industry’s cigarette volumes declined 3.5% in 2011. And as the company saw its cigarette volume fall by more than 5% (excluding the company’s decision to exit its private-label offering), its moist smokeless tobacco (MST) can volume, via the company’s American Snuff Inc., jumped 7.3%. In late 2009, Reynolds American completed the acquisition of Niconovum AB, a Swedish-based nicotine-replacement- therapy company. And earlier this year, the company moved American Snuff into a new facility capable of doubling the company’s production.

David Sutton, spokesman for Altria Group Inc., tells CSP that “MST volumes continue to grow while cigarette volumes continue to decline,” although he would not speculate on how future volumes in each category could play out. According to the company’s latest earnings release, Altria Group Inc.’s cigarette volumes fell 4% in 2011, while the company’s smokeless products increased 1.4%. Also, earlier this year, the company announced an agreement with Okono, an affiliate of Danish company Fertin Pharma, to develop products containing noncombustible nicotine. “It’s no secret,” says Reynolds American spokesman David Howard. “You look at the past two decades, and cigarette volumes have been going down. And in recent years, moist snuff or smokeless volumes have been increasing. If you look at those basic trends, then yes, there will be a time when those lines cross.”

Into the Wild

Behind this shift are a blend of movers and shakers, from local to federal anti-smoking initiatives and evolving consumer tastes to economics. Put bluntly, two of the biggest growers of the past decade, moist smokeless tobacco and cigarillos, cost less than cigarettes, thanks in large part to state and federal excise taxes.

One “wild card” that could drastically accelerate the growing intersection of cigarettes and OTP, says Modi, is modified risk. If makers can convince the FDA scientifically that MST, orbs, snus and the litany of non-inhaled products are less hazardous to one’s health to the point that they can legally market them as such, sales could skyrocket. (For more on modified risk, see story on p. 37.)

Modi points to Sweden as the paragon of that effect. With reduced-risk communications permitted in that country, snus accounts for 70% of tobacco consumption. “Could a similar thing happen here?” he says. “Certainly it won’t happen overnight, but it’s going to happen over time.”

Communicating that relative risk could also translate to cheaper products, with some states, such as Kentucky and Indiana, examining whether taxes should coincide with harm. “It’s an interesting dynamic, and I don’t think people are paying enough attention to this whole reduced-risk debate that’s going on,” Modi says, “but it could literally change the dynamics of this industry at the backbar in a very short amount of time.”

Christopher Collins, director of Chicago-based Fitch Ratings, also looks to the past—to a 1970s phenomenon— for the effect modified risk could have. “Light cigarettes gained share as a result of people perceiving lights to be less harmful,” he says.

In the 2011 CSP Category Management Handbook, Marlboro Gold Box King (formerly lights) actually was king in 2010, having the highest share of cigarette carton sales at nearly 15%. (The next closest share was Marlboro Box King at 8.7%.) “As long as the product is actually less harmful, that would be appealing to certain segments of consumers,” Collins says; dissolvables, in particular, could gain traction. “If they become widely available, it’s a familiar way to consume an item, appealing like a sort of candy.” Flavors also could encourage trial, he says.


Revising at Retail

The shift toward OTP continued well into last year. For the 52 weeks ended May 15, 2011, according to the CSP Midyear Category Data Report (CSP—Sept. ’11, p. 51), smokeless-tobacco units were up 7% to 1.1 billion, and cigars surged 11.4% to 1.5 billion units. (The two combined surpass the performance of industry stalwart energy drinks.) Cigarette unit sales were flat, holding at 9 billion.

And Jeremy Weiner, marketing manager for Boulder, Colo.-based Gasamat, dba Smoker Friendly, says more customers have recently come into the company’s 84 corporate stores asking about alternative products. “Whether they want to quit or try something different,” he says, “they’re pretty open to trying a lot of different things these days.”

That’s not surprising. Through his research, tobacco consultant Lou Maiellano has found that 40% of smokers are looking for options. “I’m not saying they’re looking to quit; they’re looking for a viable alternative or an option for when they choose not to smoke or cannot smoke,” says Maiellano, president of TAZ Marketing & Consulting Group.

And Smoker Friendly, known for its robust OTP offerings, recently added SmokinGel, an alternative tobacco product (ATP) that touts a “cigarette experience in a hand gel.” Weiner has prepared for customer questions about the product, recently testing it himself to ensure that it works.

That extra effort toward understanding a product can go a long way. As Modi points out, with manufacturer advertising restrictions, retailers need to be able to explain product attributes. “Imagine trying to sell a new car without being able to market it; it would be hard to recognize it,” he says. “That’s why I’ve always talked about the retailer and how important they become in educating the consumer.”

With newer products, Howard of Reynolds says, “There’s going to be some of that learning curve, because the adult tobacco consumer is not as familiar with them.” He suggests a “five P’s” approach, including product availability, promotion, pricing, product placement and personal selling.

While most products are self-explanatory, personal selling is about education and being aware of attributes such as smoke-free or spit-free. “You don’t have to go in-depth,” Howard says, “but just simple things to make that adult tobacco consumer think and ultimately consider that product.”

In that spirit, c-stores have much to learn from tobacco shops, says Steve Montgomery, president of b2b Solutions LLC, Lake Forest, Ill. “It may be that what will happen is these [alternative] products will get acceptance through other channels, and then people will choose to buy them from c-stores because of the convenience,” he says.

But c-stores shouldn’t wait on the sidelines; instead they should look to master the field of ATP, Montgomery says: “It means that your sales associate goes from being someone who exchanges a known product for money to having to be a knowledgeable person and sell.”

Along with knowledge comes marketing. Maiellano of TAZ says the tobacco set should evolve much like the cold vault, which has grown in doors and selection over the past two decades.

“The tobacco space should actually be growing,” he says. “Unfortunately, they’re trying to fit all this stuff in less space, and it’s not fitting. You’ve got to be in the business.”

And just as cooler doors are now dedicated specifically to dairy, energy, waters, enhanced waters and the like, Maiellano says retailers should use proper category-management principles, offering consumers variety as they segment the tobacco space.

Maiellano says that in the past he might have suggested at least a 9-foot section for cigarettes and a 4-foot section for OTP. But today’s mix, depending on volume, would be more like a 7-foot section for cigarettes; a 4-foot section for moist smokeless, cigars and pouch tobacco; a 2- to 3-foot section for RYO; and another 2-foot section for what he calls a “no-smoke zone,” filled with ATPs, including traditional Scandinavian snus. “Clearly communicate to the consumer that you have options,” he says.

Obviously, it is premature to relegate cigarettes to that tiny corner of the backbar. John Mayer of McLane Co., Temple, Texas, agrees that there’s “no smoke and mirrors,” that OTP is a “true growth category,” having shown growth year after year. But that doesn’t mean cigarettes are becoming negligible. “The decline of cigarette volume at some point is going to reach an amount where it levels off and stops.”

And retailers such as Weiner of Smoker Friendly plan to continue catering to those customers. “We do carry a wide variety of cigarette brands still,” he says. “That’s kind of what makes us unique—a lot of the items that currently aren’t carried in a supermarket.”

As Montgomery puts it, with cigarettes continuing to be a driver at c-stores, “I fully expect that if cigarettes ever do go out of business, the convenience store will be the last place the last pack of cigarettes in the United States is sold. We are the channel of choice.”  

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