Managing Tobacco's Volatility

Retailers ponder whether and tobacco category; should be changed to &;nicotine category.

By  Melissa Vonder Haar, Tobacco Editor

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Evolving the Tobacco Set

From legislation to store operations, retailers are participating in a rapidly changing landscape. Even the largest of makers concede that the future tobacco set must be more balanced, equipped with an array of cigars, moist smokeless and emerging segments.

“The world’s most important mega-trend is evolution,” UBS Securities senior analyst Nik Modi said to begin his presen­tation. He offered a historical snapshot, beginning two centuries ago when ciga­rettes accounted for only 2% of a tobacco category dominated by smokeless. And with cigarette units on the decline, Modi believes it’s time for the tobacco industry to evolve again, focusing on the real reasons smokers consume tobacco products.

“The reasons for consumption stay consistent. It’s the way we con­sume the products that changes,” he said. “Tobacco is just the delivery system for nicotine.” The proof? While tobacco consumption (especially cigarette consumption) is falling, the amount of nicotine consumed in the United States has not changed in 40 years.

With products such as smoke­less and e-cigs offering consumers more nicotine for their dollars and higher profit margins than cigarettes for retailers, Modi says the time has come for the category to rebrand.

“Reframing the ‘tobacco category’ into the ‘nicotine category’ is the biggest oppor­tunity for everyone in this room,” he said.

Why the makeover? Image, for one. “Tobacco has long had a bad reputation and nicotine gets lumped in with it,” said Modi, pointing out that while tobacco can undoubtedly be linked to cancer, nicotine actually has some medical uses, similar to caffeine.

Such image elevation could offer even more upside if and when the government acknowledges the lower risks associated with low- to no-tobacco products. It’s already happened in Swe­den: After the Swedish government rec­ognized the reduced risk of snus, it grew to outsell cigarettes.

“I do believe in the next five years the FDA will endorse relative-risk products,” Modi predicted. “And that will be huge for everyone.”

And while the move from cigarettes to other tobacco products has not been rapid, it has brought in impressive revenue.

“OTP is just more profitable [to manu­facturers] than cigarettes,” said Modi, cit­ing that a mere one-point migration from cigarettes equals $1 billion in sales. “Even small changes make a big difference.”

It explains why Lorillard was keen to invest in e-cigarettes, why Altria is explor­ing low-tobacco and tobacco-free prod­ucts such as Verve, and why RJ Reynolds has made the bold move to enter NRT.

“We need to redefine how we talk about the category,” Modi said. “ ‘Total tobacco category’ is yesterday’s phrase. It’s now the ‘total nicotine category.’ ”

A Retail Perspective

The fact that there’s a lot of buzz sur­rounding e-cigarettes is not exactly groundbreaking. Right now, e-cigs represent a miniscule part of the total tobacco pie, with an estimated 2.5 million e-cigarette smokers in the United States, compared to an estimated 45.3 million cigarette smokers.

However, the nascent segment por­tends outstanding growth potential: UBS reports e-cigarettes have experienced triple-digit sales growth since their incep­tion, and Modi predicts sales to at least double in 2012.

In fact, Wells Fargo analyst Bonnie Herzog has said she believes e-cigarettes sales could surpass tobacco cigarette sales in as little as 10 years. Such enthusiasm has prompted Kristi Prior, CSP’s director of EduNetworking, to dub e-cigarettes as “the new frontier of OTP.”

But this fervor of tomorrow means little today for retailers in the trenches actually selling e-cigarettes. Instead of wondering about utopian growth, opera­tors are vexed with fundamental ques­tions such as which e-cig brands to carry, how many facings, how to effectively merchandise offerings, and where to find real, concrete sales data for a new and often inaccurately tracked segment.

The three retail participants of the Tobacco Category Review Meet­ing’s culminating e-cig panel have all faced these questions—and all have different solutions.

“I wouldn’t characterize it neces­sarily as a line extension,” said Trey Powell, director of national pro­curement and national accounts for Alimentation Couche-Tard, Laval, Quebec. As one of the largest company-owned c-store operators, with more than 6,000 Circle K and Mac’s sites across North America, Couche-Tard is focused more on the total tobacco category than on isolating e-cigs, Powell said.

“We’re committed to succeeding [in tobacco], whether it be through e-cigs or another subcategory,” he said. “In terms of viable nicotine products, we’re bullish on anything the customer wants to buy and is both legal and ethically sound.”

Chris Colon offered a different per­spective. “We definitely consider e-cigs to be its own category,” said Colon, category development manager for Cary, N.C.- based The Pantry’s more than 1,600 stores.

Tracee Danchak serves as the market­ing director for Fremont, Calif.-based Vintners Distributing, which operates 200 locations in California. Danchak offered a sentiment shared by many operators in the convenience channel: “We didn’t have a really good response to the first e-cigs we brought in,” she said, admitting that at least part of the problem was how Vintners handled the new products. “Now that we’ve brought in two to three more brands, it’s picking up.”

Determining the right number of e-cig brands to carry is still a mixed bag for most retailers: Of the operators in attendance, 50% carried one to two brands, 33% carried three to five, and 17% offered more than five e-cigarettes.

For larger operators such as Couche- Tard, the number of e-cigs could vary from region to region, based on demand. “We have three national suppliers [of e-cigarettes] throughout the chain,” said Powell. “However, each division has the autonomy to select additional brands.”

Perhaps more important than how many is which brands to carry. With the number of e-cig companies expanding, all claiming to have the best product on the market, it’s not easy—especially consider­ing traditional data is hard to come by.

“Data is worthless right now. It reports all over the place,” said Colon of The Pantry, pointing out that many smaller stores don’t report to Nielsen, which also doesn’t track Internet sales. “Having the largest market share doesn’t really matter right now either, as there are smaller brands that perform better against those that have been around for a few years.”

So how does Colon choose which e-brands to stock? “I personally try them all,” he said. “If it tastes gross to you, it will taste gross to your customers.”

That works as long as the buyer appre­ciates subtle (and sometimes not-so-sub­tle) differences in quality, a differential that’s increasingly difficult with so many products on the market. Although one of Danchak’s co-workers tries out the various options, “with everything com­ing from China, there’s not a real differ­ence in products,” she said. Instead of the products themselves, Danchak focuses on “the brand equity and looking at what’s behind it.”

“Ultimately, we are resellers of brands,” agreed Powell. “In most cases, a suc­cessful brand already exists and as the retailer we are simply positioned to resell it. However, I don’t think any e-cigs have really distinguished themselves in terms of brand.”

This focus on brand doesn’t nec­essarily mean retailers should auto­matically jump on board when big companies invest in e-cigs, as Loril­lard has done with blu. “It doesn’t [make a difference] for me,” Colon said of such moves, referencing Red Bull’s success in the energy category compared to Pepsi’s and Coke’s offerings.

Powell sees the lack of brand reputa­tion in e-cigarettes as a unique opportu­nity for c-store operators. “The c-store channel consists primarily of loyalists,” he said. “If the consumer smokes Marlboros, there’s often little opportunity to convert them to another brand. But it’s not to that point with e-cigarettes yet.”

And though Colon acknowledged that there is certainly an opportunity to sway consumers (and, therefore, the category), he prefers to let consumers take the lead: “What the customer likes is what’s important to me.”

While there are no easy or universal answers when it comes to e-cigs, one area the three panelists agreed upon was the importance of a strong brand presence supporting e-cig programs, especially with costly FDA and state regulations looming.

“Long term, everything we do is very brand-centered,” Powell said. “I’d bet on companies that are focused on building their own brand.”

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