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Supermarket GROCERY Business: Smokes and mirrors

Banning smoking in the workplace, restaurants, and bars is the latest government move to stamp out the habit. Throw in legislation regulating how cigarettes burn, ever-increasing excise and sales taxes, illegal cheap foreign imports, and increased competition from drug stores, convenience stores, tobacco superstores, Indian reservations, and Internet sites, and a supermarket operator really needs to light up a cigarette, or at the very least pour a drink--until they put the kibosh on that too.

Instability in the cigarette industry is definitely having an impact on sales. According to Information Resources, Inc. in Chicago, for the 52 weeks ended Jan. 26, supermarket sales of single-pack cigarettes dropped 3 percent to $3.02 billion, while unit sales plunged 8.8 percent to 851 million packs. By comparison, drug store sales increased 8.3 percent to $1.14 billion, while drug store volume dipped 2.2 percent to 296.5 million packs.

"Our overall cigarette sales are down, but I'm not sure if it is because of price or because of the laws and regulations," says Mark Oerum, partner at HOWS Markets, a Pasadena, Calif. operator of four stores in the greater Los Angeles area. Last year Los Angeles introduced one of the strictest anti-smoking laws in the country, banning smoking in bars, restaurants, and nightclubs. Similar legislation has just been implemented in New York City and Nassau County on Long Island.

"The items that are selling is what is on promotion," says Oerum. "The off-brands, the generic-type cigarettes, have picked up for us. Prices keep going up. We know we are going to be faced with more taxes here."

Those high taxes are causing many smokers to seek out cheaper cigarettes on the Internet. Some of the most popular sites are those run by Indian reservations. "We only deal through the Internet; we have no store," says an operator at the Drive Thru Smoke Shop, which operates out of the Tuscarora Reservation in Lewiston, N.Y. There a carton of Marlboros retails for $27, plus $6.50 shipping and handling, compared to $63 in a Manhattan Duane Reade drug store. "We can sell our cigarettes cheaper than a supermarket because we don't have all of the sin-tax on it that New York State puts on the products," the operator says, quickly adding that at Drive Thru Smoke Shop, "We ship nationwide, but we pay all federal taxes."

But not all Internet sites are as honest. "We've seen an increase in the illegal sales of cigarettes over the last couple of years," says Tom Ryan, a spokesman for New York-based Philip Morris USA. "Many Internet sites are looking to sell product where the excise tax is not being paid."

Another major problem is illegally imported foreign cigarettes. Citing the U.S. Foreign Trade Office, Ryan says import volume rose steadily in 2002 and reached 13 billion units through August, a 54-percent increase from the same period in 2001.

"Any retailer who is selling cigarettes legally is at a competitive disadvantage to someone who is breaking the law," says Ryan. To help combat illegal sales, Philip Morris has set up a brand integrity hotline at (800) 343-0975, prompt # 8. "This number is for retailers to call if they suspect illegal activity," he says.

Manufacturers are working hard to stamp out illegal activity. "We've filed hundreds of lawsuits against retailers who we found to be selling counterfeit cigarettes," says Ryan. "We've also filed a series of lawsuits against Internet retailers who are violating our trademarks, like using Marlboro in the domain name."

While some smokers are buying their cigarettes from questionable sources to save a few bucks, others have turned to generics and smaller brands. In 1997, the four largest manufacturers controlled 97 percent of the market; today their share has dropped to 90 percent. "You've had very rapid growth in the deep discount category, and there are about 100 manufacturers," says Ryan.

New smokes

To fight back, the big manufacturers continue to develop new brands. This month Philip Morris introduced Marlboro Blend No. 27. "This is a brand that reinforces Marlboro's flavor heritage and has been described as a smooth, rich, and mellow flavor choice," says Ryan. "We have been successful in the past with new product introductions and line extensions. Historically, they have helped Philip Morris USA to gain market share."

Brown & Williamson has repackaged and repositioned its Kool and Pall Mall brands to great success. "Kool and Pall Mall have been doing very well. Last year they both showed good growth, and Kool is America's fastest-growing cigarette brand, with wholesale shipments increasing 13 percent," says Stephen Kottak, manager, corporate communications, at Brown & Williamson Tobacco Co. in Louisville, Ky.

To further build sales, Kool has introduced its Efficient Premium Price Delivery (EPPD) program, reducing the price of a carton by $7.50. "Now when retailers, including supermarkets, receive Kool, it is already at a competitive price," Kottak says. "That will enable our sales team to focus more on equity and sales-building activities, as opposed to administering discounting programs and being caught up in a lot of administrative costs."

One product seeing huge sales-building activities is the Santa Fe Natural line. "The cigarette that does well for us, especially in our Malibu store, is the American Spirit," says HOWS Markets' Oerum, adding that they've become especially popular with his movie star customers.

They were also incredibly popular at, of all places, the Natural Products Expo West organic and natural food show in Anaheim, where Santa Fe operated a booth because it uses all-natural tobacco in its product. "The Natural American Spirit brand continues to capture market share with its premium quality organic tobacco and 100-percent additive-free, whole leaf natural tobacco cigarettes and loose tobacco products," says Dan Miller, director of brand equity at Santa Fe Natural Tobacco Co. in Santa Fe, N.M., a division of R.J. Reynolds.

"We believe our tremendous growth—and the numerous copycat products that Natural American Spirit has spawned—are proof positive of the strong consumer demand for natural tobacco products," says Miller. "While there may be a trend toward upscale packaging and stylized tipping papers, we believe that the quality and consistency of cigarettes is what best distinguishes premium smokes."

Miller says retailers can take a number of steps to increase sales and profitability. He recommends using manufacturer-supplied merchandising materials, including neon signs and display units, where allowed. "Retailers should also ensure that their employees are educated about what their store carries so they can guide and assist their patrons," he says.

Philip Morris also has a purer cigarette in development. "Some time late in 2003 we hope to launch a first generation of reduced-exposure product that would potentially reduce a smoker's exposure to carcinogens in tobacco smoke," says Ryan.

Safer cigarettes are also in the works. New York is working on legislation that would mandate that all cigarettes sold in the state be wrapped in paper that poses a lower risk of igniting fires than the paper currently used. The law is designed to reduce the number of structural fires and severe burns and deaths caused by careless smoking. From 1997 through 2001, fires from careless smoking resulted in 199 deaths in the state.

"While we do support a standard that would reduce the chances that a carelessly handled cigarette could cause a fire, we also believe that should be done on the federal level rather than a state level," says Ryan of Philip Morris. "Otherwise, there will be a patchwork of laws." He says that would require Philip Morris to make different batches for different states, wreaking havoc on its delivery system. The end result would be higher prices, spurring more consumers to drive across state lines or search out bargain deals on the Internet, and turning more smokers away from supermarkets and other legitimate channels. That's a habit the entire industry is working hard to kick.
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