Looking back over 2007, it’s easy to see that the outlet industry is undergoing a sea change. Along with the usual perils of state and local tax hikes and tobacco-use regulations, outlet owners faced down potential federal legislation and watched consolidation threaten to reshape their supplier base. Amid these waves of change, what’s on the minds of retailers as we look to the New Year?
To get a sense of the current climate—and where the industry winds will blow in 2008—TOB spoke in depth with three merchants, each of whom who outlined the challenges facing today’s tobacco outlets and discussed his strategies for survival and growth in the turbulent tobacco retail market. Here’s what they had to say:
Going for Growth
Frank Armstrong,Blue Ridge Tobacco
8 Stores, North Carolina and Virginia
Trends in Cigarette Sales:
Cigarette sales are doing pretty well in our neck of the woods. Our carton sales are flat, but that beats a decline. We have a lot of great promotions from majors, and good penetrating promotions from smaller manufacturers also. The major manufacturers have been coming out with good contractual programs where participation entitles you to the kind of buydown and carton promotions that allow us to keep competitive. There was a period where it was tough to balance your agreements in order to have all the manufacturers represented in the store. Today, we are able to do that. We are contracted with five different major manufacturers.
We’ve seen a nice uptick in specialty cigarettes. We fostered that a few years ago by creating a specialty cigarette area in our stores. When people can’t smoke as often they want to smoke better.
Smokeless Status:
We’re experiencing great growth in the smokeless category. Business is up and all the companies have been very aggressive this year. Smokeless tobacco is growing faster than cigarettes. There is a lot of excitement around snus. I think it’s the next generation of tobacco, and it will help offset some of the declines in the cigarette area. I’m not sure that it will totally offset the declines that will occur with the big increases in taxes, restrictions on smoking, and anti-smoking efforts out there, but it will definitely help.
Cigars on the Rise:
In our market, we’re experiencing a 10 percent increase in import cigars. We’re very pleased with the category. People who have traditionally enjoyed them are enjoying them more, and there have been a lot of adopters. It’s probably because the ability to smoke is more limited these days so when people do smoke they want quality and taste. We’re in the process of expanding a few of our humidors from 8 by 12 to 8 by 20.
Accessories Assessment:
Sales of accessories have been relatively flat. Overall, we are seeing improved margins over last year and a slight uptick in overall dollar sales. Having lottery come into North Carolina helped tremendously. We continue to look for and try new emerging profit centers in our stores. We have had a candle line for a while now that’s done well for us. In one store in rural North Carolina, we even experimented with a tanning bed that made a nice little profit center for us. But that’s not something we would try in our other stores.
Our Biggest Challenges in 2008:
Unfortunately, tax issues, from SCHIP on a national basis to local and state tax increases, can always affect your business. Right now, we’re in good shape in both North Carolina and Virginia, but that can always change.
Taxation will be our biggest challenge next year and for the next few years out as they continue to try to fund all different government programs with cigarettes. That’s something we all need to be proactive about. You owe it to yourself to fight. We all need to support NATO financially and also physically by organizing our customer bases from a grass roots perspective. You can look back and say, “I did or I didn’t stand up for myself,” and I want to be able to say that I did. And if it does go through, you have to be positioned for a hefty increase in price. That means having a strong assortment and a strong RYO department, because you will get quitters, switchers to cheaper cigarettes, and switchers to RYO. After that, it’s about maintaining good margins and keeping our service level up.
C-stores and gas stations continually challenge our margins on cigarettes. But as the price of cigarettes continues to increase c-stores are challenged to offer the assortments people want. And that pushes folks to us because we are able to get the products they want. That service-oriented part of our business is what sets us apart.
We continue to have personnel challenges and to try to do a better job on the hiring side. We have trouble with turnover at the associate level as associates find better paying jobs and move on. We’ve found that middle-age and older associates in part-time positions stay longer and perform better overall so we now seek out that profile in filling our associate spots.
Our Biggest Opportunities:
We are looking at expanding by adding two or three stores next year. In new stores, you need the right location, the right people, and the right market. We look in small markets for good traffic flow and a large customer base. We have been on hold waiting to see how SCHIP and taxation issues shake out. It looks as if there will be a hiatus now, so we are feeling more confident that we can move forward. We are getting into a position to do that.
We’ll continue to aggressively manage our inventory to make sure we get the proper turns. We tried a new POS system that we liked and we will evaluate two others before making a decision on a new updated system to help us manage our orders and take care of customers’ needs better. We want to make sure we are spending our money properly, and have right quantity on hand while also minimizing out of stocks.
Excelling with Events
Kevin Paige, Butthead’s Tobacco
3 stores, Connecticut
Outlook for 2008
With [SCHIP] we have what could potentially be an extremely onerous tax upon us. I think that will continue to cast a bit of a shadow over the industry in 2008. Our industry has done a great job of coming together and communicating in a unified voice to legislators who were not aware of the significant impact that such a huge increase in taxes could have on us as an industry.
For my stores, it could represent upwards of $100,000 in taxes to stay in business at the same levels of inventory. I don’t know that a smaller shop can survive what could be as much as a $30,000 increase—some of them would probably have to cut back to keep their investment in inventory at the same levels. Plus, there would be a reduction in business because people will find alternative ways to buy tobacco without paying the tax.
Our Cigar Story
Our strategy is to focus primarily on growing the cigar business. I think our cigar business will continue to grow. We drive that business in part by holding events at least three times a month where customers can sample cigars and enjoy assorted beverages and appetizers. We’ve had cigar masters like Ernesto Perez Carrillo and Benji Menendez of Partagas here to talk about blending tobacco and the construction of cigars. The manufacturer representatives who attend actually develop relationships with our customers. We’ve had customers take tours of Cusano in Bradenton, Florida. We get increased customer awareness of our stores and differentiation from other tobacco retailers.
Major manufacturers are seeing the viability of what I call “quasi-premium” cigars, or mass-marketed brands that you now see in gas stations, bodegas, and c-stores as those channels try to grab a little of the cigar business. We are seeing two-foot-wide cabinets placed in c-stores. Altadis has a program, and Swedish Match has a number of representatives dedicated exclusively to the c-store channel.
That is both good and bad. The good part is that it boosts awareness of the social use of tobacco. On the downside, it’s competition for us. But manufacturers have been introducing ultra premiums that are even higher in price, which can help outlets that carry them distinguish themselves. The true premium customers have to come to us to get ultra premium cigars.
Strategies for Sales
We move our items around much more than we ever did before to increase awareness of different brands. Our stores are all humidified throughout, so we have the ability to merchandise cigars everywhere. That’s a strength we have over other shops. We just converted our third store to be an all-humidified location. We also make sure items that will be highlighted at event are moved to the front of the shop well before the event. That way the customers can see what cigar will be featured at the next event. Our displays talk about the future instead of about the past when it comes to our events.
In cigarettes, we promote at the same level that we always have and try to get the best contracts that we can with the most buydown money to keep our prices competitive. We watch inventory levels and turns closely to keep inventory dollars churning as fast as possible while avoiding out of stocks. We are expanding our smokeless products for use in workplaces where there are objections to smoking.
One new hot product is snus, which are a spitless product that gets you away from the stigma of longleaf snuff and chewing tobacco. We started carrying the Swedish Match snus last month. I wanted to beat Philip Morris and RJR to the punch in my area by offering it before their versions came out. Another potential upside is that it is a less dangerous product made through pasteurization instead of fermentation. We are excited that it will give us a competitive edge over those not offering it yet.
We also recently held a cigarette event where RJR representatives came in, engaged customers, and gave out coupons for a free pack of cigarettes. It was the same format as our cigar events, with appetizers and drinks. It was a value-added event for customers, who got to try a new cigarette and received a coupon. And it ties into a change taking place at RJR, which is looking for its representatives to be engaged with consumers. My understanding is that that is a fundamental shift coming down from Susan Ivey at top and that we will be seeing more of that sort of thing in the future from all the cigarette companies.
Advice for Outlets:
Stores need to hold social events and not be discouraged when an event attracts 10 people. You won’t get 100 people the first time out. But those 10 people will tell friends and you will build a community—and a loyal customer base—over time. That’s how you compete with the gas stations and c-stores on margins. They cannot provide that experience and service to customers. It gives you a little pricing power and is probably the best way to grow your business.
Advertising & Promotion
We created and ran a pricey cable TV ad this year. I’m not sure it was worthwhile. We ran into problems with the willingness of the station to run the ad and with the time slots they would make available to us. We figure that we have about 1,500 cigar smokers in our area, and our mailing list is already at 800 people, so our market penetration is pretty good. So one debate we went through was: Do we invest this significant amount of money to get maybe 100 more customers? How much per customer are we spending to get that customer?
On the other hand, a surprising number of people come in and specifically mentioned that they saw the spot, which aired on a 90-day run. I’ve had five good customers who drop $200-plus at a shot walk in and specifically tell me that they had never been to the store, but saw the ad. These were not $15 bundle customers. And we also placed the ad on our web site, Buttheadstobacco.com, so people can look at it there.
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We communicate with our customers through weekly emails and constant updates to our web site. For what it costs it is an extremely effective tool to disseminate information about products and events.
We’re looking for economical store value card program this year. I haven’t found one with acceptable long-term maintenance costs yet, but I hope to have on in place in 2008.
Our Biggest Challenges in 2008
Tobacco-use restrictions are always a challenge. We don’t have anything new coming up in my area. But I was just reading that cruise ships are starting to restrict smoking and that the Indianapolis airport just banned smoking on the property.
From a competitive standpoint, I don’t see anyone trying to encroach into markets in our area. I have three very strategically placed stores that would make it extremely difficult for someone to come in and compete in a formidable manner. That’s a defensive mechanism I put in when I chose my stores; they aren’t too far apart, and they aren’t too close together.
Our Biggest Opportunities:
Staying committed to premium cigars and customer relationships is our best opportunity for growth. We strive to show our commitment to the social use of tobacco and the lifestyle that surrounds that through our cigar events. That dissemination of knowledge at the store level creates loyalty among customers where even if a box of cigars is $10 cheaper on Internet, they are willing to pay more here for the knowledge and service we provide.
We are going to keep doing the things we do best and ride the year out. I think the overall state of the economy and issues like the subprime mortgage market and rising cost of oil are all pressures that will weigh upon us in next year. Business has been good despite $3/gallon gas, but I don’t know how big an impact those things will have going forward. Cigars are a discretionary product. If people don’t have that income, it’s possible we could see some slower times and then it becomes the art of competition and doing the things we do better than our competition.
Lessons in Lounging
Dan Gallagher,Vice President of Operations, Smoker Friendly Colorado
Outlook for 2008:
It continues to be survival of the fittest. It’s such a changing environment and market right now that if we see flat or slightly declining sales in domestic cigarettes and major manufacturer products, that’s a victory. We are seeing growth in RYO/MYO and other tobacco products (OTP) like cigars and smokeless tobacco—that’s where the real opportunities are today and what makes outlets a viable business. We have to have cigarettes, but the growth is elsewhere.
Local Challenges and Opportunities:
Thankfully, in our areas of operation right now we don’t have any pending state tax increases. In terms of use regulation we continue to see different municipalities thinking about or trying to enact smoking bans. The state of Colorado has already enacted a complete smoking ban. We were one of a few exempt operations—outlets, casinos and cigar bars—and they amended it later to take away the casino exemption.
That actually tied into an opportunity for us. About a year ago, we started installing smoking lounges in as many stores as we could. Some are as simple as adding a couple of chairs to the layout, for others we took back rooms where we had dead space and created a separate smoking room. We now have four or five full-blown separate lounges and maybe more than 20 other stores where we have lounges within the store. Some are directed at cigar smokers, others at any smoker. In one store we took over an adjacent 1,200-square-foot space and combined it with our store to expand our walk-in humidor for premium cigars and create two lounges, one for cigar smokers and another for cigarette smokers. We’re putting our best foot forward to our consumers by giving them a place where they can sit down and enjoy a smoke.
Industry Challenges:
The biggest challenge for tobacco outlets is definitely government intervention of business. The continued tax problem, the SCHIP issue, potential FDA regulation and how it would be crafted are all huge concerns. Within both our company-operated and our dealer stores we try to drive communication from trade organizations and lead a grassroots lobbying effort by getting our employees and customers to write letters and make phone calls. There is power in numbers, and when legislators hear form a large number of constituents they take note. All retailers have to continue to push that grass roots level.
The Internet continues to be a hot button issue. We feel there needs to be a level of regulation placed on Internet sales with regard to tax evasion. Some states have really stepped up and had their revenue department go after purchasers. Montana, for example, tracks down people who buy cigarettes on the Internet and issues tax bills. That’s what needs to happen. They have to clamp down on that because it is plain and simple tax evasion. We have taken an active role in all the states we operate in to encourage that.
Manufacturer Consolidation:
We are concerned about some of the consolidation going on in business and what it will mean for outlets down the road. The big concern is how it will affect us planogram-wise, if Philip Morris and R.J. Reynolds continue to buy other tobacco companies. We will be very vocal about what kind of programs are being put out there by major manufacturers. We feel strongly that we need to be able to merchandise products in a consumer-friendly way—that forcing products behind the counter will make it hard to be a tobacco merchant. To be a true tobacco retailer, product has to be out there where customers can pick it up and look at it and shop the store. We will be watching that issue very closely.
We also have great relationships with Swisher and Swedish Match and other manufacturers, and there is a lot of value for us as retailers in having those relationships with companies as independents. Obviously, the dynamics will change as they are bought up by these major companies. We don’t know exactly what will happen or whether those changes will be good or bad. But when something is good you hate to see it change.
Opportunities for Growth:
We continue to really focus on OTP products and the premium categories, both in cigarettes and premium cigars. We’ve seen tremendous growth in both categories. RYO/MYO obviously ties back to price, and the biggest growth we are seeing is in the value brands. There is a tax advantage for customers to buy their own. The growth in premium is the “smoke less, but smoke better,” line that Nat Sherman coined. A lot of consumers are saying, “I am not going to smoke as much as I used to, so I will buy something more expensive and enjoy it a little more.”
Product Trends:
We’ve seen a sustained boom in the premium cigar business. It appears that it is a different demographic than the mid-’90s boom. There are more younger smokers, 25 to 35, and also a lot more blue-collar customers. I think that ties back to a lot of the smoking restrictions. They can’t smoke a pack of cigarettes a day so they are switching to or supplementing with cigars.
In 2007, we built five additional walk-in humidors in stores that we didn’t have prior to that. We are looking at other stores for the opportunity to add more humidors. That’s been our biggest inventory change. As we see cigarette business flatten or decline in some areas we’ve been able to decrease inventory in those products and free up capital for other products.
Smokeless also continues to grow. We are keeping our eye on the snus trend. We know they have strong share in Europe, so it will be interesting to see what opportunities those products provide down the road.
Goals for 2008:
In terms of store openings, we’ll continue to actively look for opportunities to grow through acquisitions of independent operators looking to get out of the business. We think that’s an easier path than building a customer base from scratch. We made two acquisitions in 2007 and several in 2006, so the opportunities are out there.
On the dealer side, we want to continue to sign up strong retailers across the country who want to become part of the Smoker Friendly family. We grew by 250 stores on that side of business in 2007. So we are coming in at the high 500s now. I don’t see any reason we shouldn’t be able to add between 200 and 300 stores again in 2008. •
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