Despite the slow decline in smoking U.S. smoking rates, cigarettes remain the largest in-store category for convenience retailers in terms of sales, contributing 26.18% of inside sales in 2021.
People are looking for any way to trade down, which means going to off-brands, generic brands and private-label brands.”
In 2005, 20.9% of U.S. consumers, or 21 of every 100 adults, were smokers. By 2020, that figure was 12.5%, or 13 of every 100 adults. While tobacco sales increased a modest 1.2% during the stressful months of the pandemic, “so far, 2022 monthly sales are trending lower than 2021,” said Jayme Gough, research manager at NACS.
Cigarettes accounted for 10.38% of in-store gross margin in 2021, ranking third in terms of gross margin contribution behind prepared food and packaged beverages, according to the NACS State of the Industry Report of 2021 Data. Margins decreased year over year 0.86 point from 14.40% in 2020 to 13.54% in 2021, while gross profit declined 4.8% year over year.
The tobacco category has long been a legal product, as well as a target for change. That situation will continue into 2023—the result of inflation, rising prices and possible legislation, both local, state and federal.
Prior to the COVID-19 pandemic, the U.S. inflation rate was slightly below 2%. Today, it hovers above 8%, four times greater than the Federal Reserve’s 2% target, reports the Bureau of Labor Statistics. That puts a big dent in overall consumer spending, but industry insiders say smokers are still smoking.
“I don’t think there is any less nicotine consumption based on what we’re seeing, but consumers have less to spend, and they’re willing to switch brands,” said Sharan Kalva, president of C-Store Master of Huntsville, Alabama. “People are getting more creative with their nicotine intake. They are using pouches and choosing more price-conscious options.”
Don Stuart, managing partner at Cadent Consulting Group, agrees. “As we’re seeing in food and consumables, people are looking for any way to trade down, which means going to off-brands, generic brands and private-label brands,” he said. “Smokers are going to look for ways to cut costs because they don’t have anywhere else to turn.”
In response, retailers are working to provide shoppers with value and options.
“Our subgeneric cigarettes are now double the units, as well as double the profit, of premium cigarettes,” said Regan Bartley, director of marketing and COO at Smoker Friendly, a smoke-shop chain. “Of course, we still have roll-your-own, but those sales don’t amount to much anymore. I think people are most definitely switching to electronic.”
HIGHER PRICES? MORE TAXES?
Prices of tobacco products keep going up, thanks to tax increases and regular price hikes from manufacturers. For now, manufacturer price increases are expected to continue.
“With a declining cigarette market and stockholders to answer to, we anticipate that the majors will continue to take frequent price increases,” said Ernie Teague, vice president of sales and marketing at Cheyenne International, a North Carolina-based tobacco manufacturer.
The industry continues to push back on tobacco taxes, which have been part of U.S. history almost since the nation’s founding. In fact, the government attempted to tax products, such as snuff, as early as 1794, a proposal that proceeded introduction of the federal income tax by almost 120 years.
“The industry and all of its stakeholders were successful recently beating back a large federal excise tax threat that would have impacted nearly all forms of tobacco and nicotine products,” said Matt Domingo, senior director external relations at R.J. Reynolds Tobacco Company. “The language was pulled from the broader omnibus spending package in late 2021. As we look forward, much of the threat potential will depend on how the upcoming midterms go, specifically on the House side.”
C-store retailers should balance their space between traditional cigarettes and non-combustible products.”
But smokers and the industry can’t rest easy. There’s growing concern about legislation at the local and state levels, such as citywide bans that prohibit smoking in enclosed workplaces and the 2021 ban on all tobacco sales within the city of Beverly Hills.
“While we can talk about the federal taxes not being imminent, the single biggest issue that the retailer must monitor is the actions that can occur at the local level,” said Teague.
“Cities and counties are continually looking at tightening their regulations on the sale of tobacco products,” he said. “Changes at the local level can impact the retailer at any time. We strongly suggest that retailers remain diligent in monitoring their local governments and ensure that their voices are heard. Sure, federal taxes will have a big impact on the retailer, but these local changes hurt and are happening across the country.”
During the 2022 state legislative cycle, 25 states introduced tax legislation designed to bump up taxes on tobacco items. However, only Indiana approved a new tobacco-related tax of $.40 per ounce on alternative nicotine products.
Bartley would gladly welcome fewer price hikes of every type on tobacco. “It’s been hard on our customers and hard for employees to explain all these increases,” she said.
In June, the FDA announced plans to establish a maximum allowable level of nicotine in cigarettes and other combustible tobacco products. The regulation hasn’t been drafted, and the proposed nicotine cap is unknown. But observers see the idea as impractical and nearly impossible to enforce.
“I don’t know how you’d control that,” said Stuart, noting that the same amount of nicotine would probably impact a 100-pound woman differently than it would a 250-pound man. “But it might be a good way to sell more cigarettes. People would consume more of the basic amount.”
Kalva anticipates any nicotine cap would go through a long period of litigation and scientific review before implementation. “For every cigarette to go through the process and get certified, I don’t think the government has the resources to do that,” he said. “It’s not realistic in the short term.”
According to Teague, before any nicotine limit can take effect, the FDA would need to establish product standards and good manufacturing practices, plus allow manufacturers ample time to create new products.
“The devil is in the details,” he said. “The FDA has already cleared loads of cigarette products to remain on the market through its substantial equivalence process. What would happen to those approvals? Could any new product then come to market so long as they meet the new product standards? Again, we see this as a major issue that the FDA must carefully consider before proposing their regulation.”
The same can be said of the FDA’s proposed rules to ban the manufacture and sale of menthol cigarettes and all flavored cigars. The agency took public comments on the menthol ban over the summer and received more than 175,000 that must now be reviewed.
“We anticipate that this review, which must conclude before the next step of the rulemaking process can occur, could span multiple months or even years,” said Domingo. “While we don’t anticipate a ban of menthol at the federal level anytime soon, we feel strongly that such a rule would have numerous unintended consequences, such as illicit sales and additional pressure on law enforcement.”
An underground market for a banned tobacco product would be inevitable, said Stuart. “Every rule that the government puts in place will inspire entrepreneurial activity. It’s a slippery slope they’re heading down with these restrictions,” he said.
Our subgeneric cigarettes are now double the units, as well as double the profit, of premium cigarettes.”
Experts say tobacco retailers should stay the course but be prepared to manage changes that may be coming.
“We have to do [back bar] resets more often and be more engaged with the manufacturers and the industry in general,” said Kalva. “The more engaged you are with the manufacturers, the more you’ll get out of the relationship,” he said.
“It’s also important to stay informed of regulatory changes and issues,” said Teague. “There are many great resources available to retailers, such as NACS.”
Because combustible tobacco products receive the most scrutiny from lawmakers, “c-store retailers should balance their space between traditional cigarettes and non-combustible products,” said Stuart.
“Given the proliferation of pot shops, I can see [convenience stores] at some point integrating THC and regular marijuana products, depending on the state,” he added. “Retailers must start transforming themselves to a broader array of nicotine delivery systems as state laws permit. It’s too important to walk away from. We must be nimble and prepared to evolve.”
The Power of CSX Data
CSX, the engine behind category metrics and NACS State of the Industry data, provides current and customizable tools for financial and operational reporting and analysis in the convenience industry. Retailers can measure their company by any of the myriad metrics generated via our live database. Contact Chris Rapanick at (703) 518–4253 or email@example.com for a complimentary executive walkthough.