Savor the Flavor

Flavored cigars resilient amid regulation and taxation, but is a ban on the way?

By
Linda Abu-Shalback Zid, Senior Editor

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Nobody would ever say it’s easy to be a tobacco manufacturer or retailer. And to drive home that point, the industry recently has been hit by another bunch of shakeups. This round particularly affects cigars, including:

Game Changer 1: Heavy taxation on small cigars, some equal to cigarette taxes, continues to take a toll at the state and federal levels.

Game Changer 2: In June 2009, the U.S. Food and Drug Administration (FDA) became tobacco’s regulating body. As one of its first acts, in September 2009, the FDA banned cigarettes “with a characterizing flavor” (other than tobacco or menthol), with confusing wording that brought panic to the cigar industry as well.

Game Changer 3: In July of this year, Canada banned flavored cigarillos, cigarettes and blunt wraps. Through it all so far, the cigar industry has continued to thrive. When it came to taxation and the Canada law, manufacturers simply bumped up the sizes of their cigars to make them unaffected large cigars. And the FDA’s confusing verbiage regarding cigarettes “even if they are not labeled as ‘cigarettes’ or are labeled as cigars or as some other product” was deemed to not actually apply to cigars after all.

The cigar category has shown that it can withstand the test of time—and regulation and taxation—so far. But the worst is far from over, according to many:

Earlier this year, the FDA issued a notice on the Federal Register that said a proposed rule “would deem cigars to be subject to the Tobacco Control Act [the act that gives the FDA the power to regulate the tobacco industry], and include provisions to address public health concerns raised by cigars.”

And during a September 2009 media briefing, Lawrence Deyton, director of the FDA’s Center for Tobacco Products, said, “Other flavored tobacco products are issues which we will be studying.” Greg Mathe, spokesman for Richmond, Va.-based Altria Group, addressed the Federal Register notice: “As we take it, that’s a pre-notice of a pre-notice. It just means that it’s something that they will do in the future. “Right now we’re concentrating on what we do know is in the bill, which is the regulation of cigarettes with filters, and working to comply and engage the agency on those issues,” he continues. So far the regulation has gone smoothly, he says, “and I hope that any of the regulation on any of the products will go in the same manner.”

IS IT INEVITABLE?

So will Mathe and other manufacturers be hit by FDA cigar regulations, and if so, when?

In an e-mail response to CSP inquiries, Kathleen Quinn, spokesperson for the FDA, says, “At this time, all we can provide is the following: Cigars are considered tobacco products under the FSPTCA [Family Smoking Prevention and Tobacco Control Act]. However, the act does not automatically apply to cigars. FDA must issue a regulation deeming cigars to be subject to the law.”

Tom Briant, executive director of the National Association of Tobacco Outlets (NATO), further explained the status: “At this time, no such regulation has been either proposed or adopted.” He said the FDA would have to conduct a proposed rule-making procedure, and it would give time for the public to comment. Then the agency reviews all of the comments, and it may change or amend the proposed regulation based on public comment. “The important thing is the FDA would not need any congressional action in order to extend regulations to cigars or pipe tobacco, since the new law gives them the authority to do just that,” Briant says.

And many are certain the FDA will take advantage of that authority. According to David Price, vice president of marketing for Richmond, Va.-based Swedish Match North America, speculating on the effects of any regulation would be premature. However, he says, “Since [the] FDA has authority over all tobacco products, we anticipate regulation of cigars at some point.” Any effect would depend on the specifics of the regulation, he says, and likens it to the recent health-care bill. “Even after passage, there remains a significant level of uncertainty as to the impact on businesses and the consumer.”

Lou Maiellano, president of tobacco group TAZ Marketing and Consulting Group, Sevierville, Tenn., agrees that regulation is likely, but it could take as long as several years, due to the long list of items the FDA already is monitoring and trying to enforce. “The reality is that it’s just something that I think that will happen, but right now they’re still trying to get their hands around all the other components,” he says. It’s “staggering” when one considers that the industry moves a minimum of 4 million units of cigars per day (with approximately two-thirds of that in cstores), per his research, Maiellano says. “I don’t think you can worry about what you don’t know to the point that you become motionless,” he says. “You should still focus on growing the business.”

WORLD WITHOUT FLAVOR

Some efforts at more local levels already have worked toward banning flavored cigars, but they also show how difficult it would be to enforce a total ban.

The date is July 1, 2009. In accordance with a new Maine law, banning flavored cigars and cigarettes, Rick Yost pulls all his flavored cigars off the rack at his 21 Dead River Cos. locations, all of which happen to be in Maine.

The Maine law bans cigars with a “characterizing flavor” that appeals to or is likely to appeal to youth. It exempts large or “premium” cigars and those introduced prior to 1985. The attorney general also can exempt cigars that don’t directly or indirectly target youth or encourage the initiation of smoking. (Violation is punishable by a fine of $1,000 for a first offense and $5,000 for subsequent offenses.) Several months later, Yost, director of operations, restocked many of the cigars he had pulled because they became exempt from the law. And while he says the exemptions mean the law hasn’t had much of an effect on sales, he has gotten a taste of what a world without flavor might be like. “Had they stuck strictly with the original intent of the law and said no flavors, no chance, I think it would have impacted us a great deal,” Yost says. Yost manages seven flavors and about 20 SKUs in varying sizes. Dead River did lose clove cigars, but the company never was a big clove seller anyway, he says. The real effect the law had, according to Yost, was the need to spend a lot of time managing inventory. Today, it means certain flavors might be OK in one brand, but not others. “To manage the product became a little more difficult than it needs to be,” he says.

Bill Greiwe, CEO of Grover, N.C.- based Cheyenne International, a fullline tobacco product manufacturer, also says the law initially was a concern. “I think it’s highly unfortunate when laws are constructed to benefit one company over another, and the Maine law is like that,” he says. “This idea that certain products are grandfathered in, but other products have to go through a screening process, is an unfortunate situation that gives benefit to some.”

New York City also issued a ban on all flavored tobacco products in October 2009, which Norman Sharp, president of the Washington, D.C.-based Cigar Association of America, says hasn’t been enforced because the regulations designed to enforce the ban have not yet been made available. A similar proposal in the state of New York went in another direction, according to Sharp. “Flavored cigars are 75% to 80% of the cigars sold in the state,” he says. “To lose all that tax money didn’t resonate.” As of press time, no such law had been passed.

Similar considerations wouldn’t be likely with the FDA because, in his opinion, agency policy is driven by health issues and not revenue, he says.

BUSINESS AS USUAL

Meanwhile, cigar sales continue to excel. According to Chicago-based SymphonyIRI Group numbers, cigars are one of the top 10 categories in c-stores in terms of dollar share (2%) and have increased in dollar sales vs. a year ago by 25.4%.

Joshua Kesselman, co-director of Phoenix-based HBI International, a tobacco-product wholesaler, says that right now, all the FDA can do that could have an immediate effect would be to say that small cigars are being sold as cigarettes, as outlined in the previously mentioned FDA verbiage.

“It’s a reach,” he acknowledges. “However, if they wanted to pass a new regulation, we would all have fair warning of that.” In the meantime, according to industry insiders, there are several things the industry should be doing to take advantage of current opportunities:

Become a destination. “Aggressively market so that you can secure your market share today, and become known as a place you can get tobacco products,” Maiellano says. Key retailers are taking advantage of the fact that cigars can still be out on the floor at cstores in many states.

Work together. Greiwe of Cheyenne says that everyone—including suppliers, manufacturers, retailers and even consumers—needs to be aware of what is going on with the regulatory side. “They need to stand up and be heard,” Greiwe says. “You can’t sit back and not comment or not educate yourself. No one has that luxury anymore.”

Mathe says Altria is already communicating with and working with retailers: “We’re making sure that they understand our compliance activities and the changes that we feel need to occur, based on the law and what’s going on.”

Roll with the punches. When flavored cigarettes were banned, many reported seeing an increase in small flavored cigars. As Kesselman points out, “The key thing is, you’ve got to roll with the punches. In the end, demand and consumption is relatively flat.” While smoking is always decreasing overall by 2% to 3% a year, he says, “If they ban one product, then other products go up. … Consumption doesn’t drop; it doesn’t die. People aren’t going to quit smoking over these sorts of things. Instead, they just switch from one product to another. You just have to be very fluid, always looking for the new product. Talk to your vendors, and ask them what’s new.”

New products are one way to jump on the opportunity. HBI has introduced a bluntarillo, which is a large flavored cigar using four wrappers to pump up its flavor. “So the way we responded, our newest product is literally the most flavorful cigar we’ve ever made,” Kesselman says. While he declined to share sales numbers, he says the product consistently has been selling out. “The [retailers] who do the best and thrive in this ever-changing market are the ones who are the most flexible and the most immediately willing to switch to new products.”

Live in the present. Andrea Myers, executive vice president of Seymour, Ind.-based Kocolene Marketing, dba Smokers Host and Fast Max, says she’s learned to take advantage of windows of opportunity before they close. “You have to in this business, because things change,” she says. For now, flavored cigars are selling really well, she says. The company sells about 10 types of flavored cigars in its 19 tobacco stores, and three or four in its 12 c-stores. The retailer is flexible enough to add new products at any time, although it typically does full resets in the c-stores twice a year.

 As cigarette prices increased, Myers says, many of her cigarette smokers also switched to filtered cigars. “We might be down 200 packs of cigarettes a month at that store, but if you’ve converted them to little cigars or filtered cigars, I’d rather them buy that because I make more margin on those,” she says. According to figures from the NACS SOI Report of 2009 Data, while cigarettes provide 15.7 gross-margin percentage, other tobacco products (OTP) including cigars had 30.3%. And while Yost of Dead River says the FDA will continue to be a concern, “The truth is as long as the playing field is level, we’ll compete on whatever playing field we’re on,” he says. “As long as we have a demand for them, we’ll provide them.” 

‘Science, Not Conjecture’

The intent of FDA regulation concerning cigarettes so far has been to prevent youth smoking by taking away flavors that might be deemed appealing to them. When it comes to cigars, Bill Greiwe, CEO of Grover, N.C.-based Cheyenne International, points to a recent Substance Abuse and Mental Health Services Administration (SAMHSA) report.

According to the SAMHSA report on “past month tobacco use among youths,” cigar use has declined among youth ages 12 to 17, from 4.5% in 2002 to 3.8% in 2008. According to the report, the use of any tobacco products among adolescents has generally declined since 2002.

“There are fewer underage people smoking cigars, not more,” Greiwe says, pointing out the increase in cigar volume means increased adult usage. Cigar sales in convenience stores increased in units 8.1% in 2009, according to data from The Nielsen Co. in the NACS State of the Industry (SOI) Report of 2009 Data. Cigars gained 3.8 share points in category sales to account for 36.5% of other-tobacco-product sales, according to the report. “The regulations should be based on fact and science, not conjecture,” Greiwe says  

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