Taxes, cost increases, age verification, regulations that go so far as to outright ban the sale of current products ... the tobacco category is not for the faint of heart.
Premium is not just the biggest category, it was the only subcategory that saw positive sales growth in 2021.
I really am blessed to run this category,” joked Kevin Majewski, senior category manager of cigarettes for 7-Eleven, while presenting the cigarettes and OTP data at the NACS State of the Industry Summit. “It’s so easy, [it] practically runs itself!”
The year 2021 was certainly interesting for cigarettes, thanks to the continuation of remote work and government assistance that helped boost sales in 2020.
“In 2021, cigarettes built on the strong momentum we saw in 2020,” he said. But “strong headwinds started appearing toward the end of the year.” Specifically, the fourth quarter of 2021 saw cigarette dollar sales down 1.5% and units down 8.6% year over year, trends that Majewski said continued into the first quarter of 2022.
The other part of the back bar was more positive. “OTP was up double digits, with smokeless and cigars growing the most dollars year over year,” said Majewski, noting that smokeless sales were driven by nicotine pouches.
Here’s a look at the NACS State of the Industry numbers, as well as challenges and opportunities, within cigarettes and OTP.
PREMIUM CIGARETTES DOMINATE
Cigarettes are undoubtedly an important but complicated category for the convenience channel. In 2021, they remained the largest driver of in-store sales (27.7%) but contributed far less to in-store gross profit margins (11.04%).
“It’s a difficult conversation to have from an operational perspective: 28% sales vs. 11% margin,” Majewski said. “But cigarette consumers are frequent, loyal shoppers—they probably shop convenience every other day.”
In terms of the subcategories, premium cigarettes continued to dominate (84.7%), followed by subgeneric/ private label (8.5%), branded discount (3.4%), imported (2.7%) and fourth tier (0.7%).
Cigarettes contributed 27.77% of in-store sales and 11.04% of in-store gross margin
“Premium is not just the biggest category, it was the only subcategory that saw positive sales growth in 2021,” Majewski said. Premium cigarettes were up 7.6% compared with 2020, leading all cigarettes to be up 4.2%.
While some of the other subcategories have higher gross profit margins—cigarettes come in at a 13.4% margin—Majewski pointed out that premium cigarettes almost always have a higher penny profit for retailers.
“Sell a subgeneric pack at four dollars making 19% margin, that premium pack at $8 per pack is still going to generate more money,” he said. “You can make $1.10 a pack or 90 cents a pack. Which would you prefer?”
Premium will likely remain the majority of cigarette sales, though inflation and gas prices could shift dynamics toward lower-priced options in the short term, Majewski said. “If economic conditions do show that consumers are trading down, we may see total cigarette margins go up, but overall profitability go down.”
SMOKELESS LEADS OTP
From a sales dollar vs. profit margin perspective, OTP fares much better than its back-bar counterpart: The category accounted for 7.6% of in-store sales dollars and 6.43% of gross profit margins. Promisingly, it was up 10.2% year over year.
“The biggest challenge with OTP is we don’t have the trips yet,” said Majewski. “But they’re coming. 2022 should be very solid with people returning to offices.”
Smokeless continues to lead OTP sales (33.1% total), followed by e-cigarettes (27.7%), cigars (18.9%), “other” (12%), papers (0.9%), pipes (0.7%) and pipe/cigarette tobacco (0.7%).
Smokeless—which includes snuff, moist and nicotine pouches—was up 17.2% compared with 2020, thanks to nicotine pouches. Majewski described the spitless alternative as a “great unifier” with cigarette, e-cigarette and dip consumers all exploring pouches.
Majewski said deep promotions and distribution by major manufacturers, coupled with pouches’ unique ability to be used without social stigma means “continued growth is all but assured, provided possible taxes and flavor bans don’t impact too greatly.”
E-cigarettes had a drastically different experience in 2021, down 8.6% year over year.
“2020 saw a double whammy of Tobacco 21 and flavor bans,” Majewski said, adding that the U.S. Food and Drug Administration was expected to rule on premarket tobacco applications that would have allowed flavors back in 2021. “Well, the PMTA approvals are still pretty much pending, and we don’t have any flavors back,” he said.
Even with all the challenges, Majewski expressed optimism about the segment. “E-cigs still come in with the largest margin percentage,” he said. “Couple that with their high average retail and your e-cigs still provide the highest profit per pack of anything on the back bar.”
Majewski described the cigar customer as also “very important for us,” which is welcome news as the subcategory grew 19.7% year over year, thanks to improved supply chain dynamics. While cigars accounted for slightly less than 20% of OTP sales, cigar units made up nearly 50% of OTP volumes.
“What that means is lots of small trips with low rings, but lots of trips equals a lot of associated sales,” he said. “You may be able to recover from the 99-cent cigarillo purchase, but can you sustain the loss on the 20-ounce Dew or Doritos or the fuel they used to purchase?”
OTP contributed 7.60% of in-store sales and 6.43% of in-store gross margin
CHALLENGES AND OPPORTUNITIES
In terms of challenges, regulatory concerns remain “a constant” for tobacco. “We had a couple issues that were really big,” Majewski said, specifically pointing to:
• Taxes: “For 2022, nicotine pouches and e-cigs (to a lesser extent) are most at risk for either net new taxes or increases,” Majewski said. “That being said, there’s always that possibility of increases to state and federal excise taxes on cigarettes.”
• Menthol bans: Certain parts of the country have reached “epidemic levels” of local menthol bans, but Majewski also cited a statewide referendum on menthol proposed in California, and the possibility of a nationwide ban. “Don’t be afraid to speak up to your local representatives,” he said. “They may not be aware of how their decisions impact your local business.”
• Synthetic nicotine oversight: Recent congressional action granted the FDA oversight of synthetic nicotine products, which had allowed synthetics a “loophole” to keep flavors on the market without submitting a PMTA. “Manufacturers will have until mid-May to submit PMTAs,” Majewski said. “Once submitted, the FDA will have until mid-July to approve—if they don’t, manufacturers will have to remove from retail.”
For all the headwinds, Majewski sees a slew of opportunities for retailers to “win” in these important categories, including:
•Walgreens/Walmartexits: Recent reports suggest both Walgreens and Walmart may nix tobacco sales in their many stores nationwide. “There is some opportunity to pick up share depending on your geographic location,” Majewski said.
• Poly-usage: As Americans return to in-office work, there is a huge opportunity for cross-category usage. “I can’t stress it enough: Poly-usage is a huge win for OTP (and even cigarettes),” said Majewski. “Customers moving into OTP are primarily coming from cigarettes—this is a huge customer base that you cannot lose!”
OTP was up double digits, with smokeless and cigars growing the most dollars year over year.
• Nicotine pouches: Pouches continue to gain distribution and usage, though Majewski noted a lot of growth is coming from promotions. “This heavy promotion can’t go on forever, and many chains are already destinations for these pouches,” he said. “Now is the time to begin capturing this customer base if you haven’t already started.”
• Loyalty: Majewski described “loyalty” as not just loyalty programs but also leveraging store and brand loyalty. “Loyalty is your best defense against downtrading,” he said. “Customers knowing that you’ll always have the best deals, the best prices and their brands keeps them coming in.” Majewski said that when executed properly, loyalty can help grow store trips, basket size (both in tobacco and cross-category purchases), market share and opportunities for poly-usage.
Amid a challenging environment, Majewski encouraged SOI Summit attendees to remember one thing:“It’s still a $60 billion business. We have challenges, but we still have opportunities to ‘win’ this category.”