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The changing face of tobacco: the signing of the Master Settlement Agreement has let new manufacturers into the cigarette industry. Will that decision help or hurt the grocery channel?

For a category always in the midst of controversy, a new struggle between tobacco manufacturers could be classified as small potatoes. Yet, this battle could have a big impact on the way cigarettes are sold at grocery stores and how much money retailers will be able to make from them.

A dispute overseas could result in the removal of certain imported cigarettes and lower priced domestic cigarettes from U.S. retail shelves. Industry observers say that supermarket retailers should pay attention to any new legislation in their states regarding cigarette manufacturers and the Master Settlement Agreement (MSA) to avoid getting caught with unauthorized import product. At the same time, knowing how to spot legitimate discount brands will help grocers keep their growing group of price-conscious smokers happy.

The controversy began on Nov. 23, 1998, when the major tobacco companies and 46 states signed the MSA, agreeing that tobacco companies would pay up to $246 billion to the states over the next 25 years. This money would be used to support antismoking efforts. Almost immediately, the agreement created waves in the industry as new, smaller entrants in the cigarette marketplace seized their opportunity to compete with the majors on price. A new pricing tier, known as the fourth tier, was created.

Apparently, no facet of the industry previously anticipated "the kind of complexities [the MSA] would lead to," says Bhavani Parameswar, vice president and CFO of King Maker Marketing Inc., an importer and distributor of tobacco products, based in Paramus, N.J. "It has totally changed the tobacco landscape."

Part of what Parameswar refers to is the fact that the non-Big Four manufacturers' share of the U.S. cigarette industry has increased from 2.4% at the time the MSA was signed to between 10% to 14% in 2003, according to varying industry statistics. Many of these fourth-tier manufacturers are non-compliant to the MSA (amendments to the MSA require that they contribute to an escrow fund, but many do not), making litigation messes for the major tobacco companies, which previously believed trey had buried their largest litigation risks with the MSA. Because it owns leading brand Marlboro, Philip Morris has been involved in more than its fair share of lawsuits against fly-by-night companies that manufacture counterfeit Marlboro products.

LETTING NEW PLAYERS IN

The major industry concern is that the MSA unintentionally opened a door to new, fourth-tier entrants that are dramatically changing the marketplace. The exponential growth of the non Big Four, and often non-compliant or non-participating tobacco manufacturers, "is due to the wide price gap between the premium and deep discount brands, which is exacerbated by the MSA structure," says Bonnie Herzog, a tobacco analyst at Salomon Smith Barney, based in New York.

But where do grocery retailers fit into all of this? Right now, the MSA has posed risks to their tobacco business, primarily in the form of fourth-tier ambiguities. Because MSA legislation and amendments are always at the state level, retailers are advised to pay close attention to the laws governing the individual states in which they do business.

Many retailers say they will pay close attention to the issues facing tobacco products and respond in ways that make sense for their stores in terms of sales and liability. Consumers tend to look for well-known brands of cigarettes most often, but retailers are realizing that they must have a mix to ensure maximum profitability.

Inquiries about unfamiliar products can be addressed to individual state attorneys general offices and departments of revenue, so retailers can steer clear of any non-compliant, non-MSA products. A little common sense goes a long way, too, in the battle against risky products. "One can easily tell by too-good-to-be-true prices if a cigarette brand is compliant or not," explains Paraineswar. "If retailers want to build a long-term cigarette business, they have to be watchful of this."

But it isn't always easy. Under pressure from consumers looking to pay cheaper prices for cigarettes, manufacturers demanding huge amounts of shelf space and states requiring strict scrutiny of fourth-tier product, it's now "increasingly difficult for retailers to carry noncompliant manufacturers' brands," says Herzog. "They're being forced to take more of a slake in the issue from all sides, but if they give in to consumer demand and sell more deep discount brands, they have to know there is going to be increased risk."

Some non-major manufacturers recognize the problem and are trying to lessen that risk. Cheyenne International, based in Grover, N.C., this year has begun selling its new cigarette line, Cheyenne, positioning the products as top-quality cigarettes that are effectively priced. "We have done our best to try and provide a product that will meet what we think is a growing need--cigarette smokers are tired of paying high prices, but they don't want junk; retailers want to offer them cheaper cigarettes that are legal," maintains Bill Greiwe, CEO. "We are MSA compliant in all the southeastern states we're selling into, and have gone through great lengths to become so."

Cheyenne is especially sensitive to the grocery channel. "Fourth-tier cigarettes are proliferating in the smoke shops and convenience stores, and a lot of cost-conscious business has gone their way at the expense of the grocery channel," maintains Greiwe. "Supermarkets are more conservative, but they don't have to suffer and lose cigarette customers because of it. It's time for the grocery sector to work with companies like us and see what we can do for them. It's been a while since they've introduced new product in the category--we can help them do that, while at the same time providing ethical business within this difficult marketplace."

Working through another industry challenge--timely product delivery--Cheyenne also promises its retail customers that if they order product one afternoon, they can usually get it shipped out by the next morning. "That's a big benefit of a smaller company," says Greiwe. "With us, retailers hold inventory for a shorter time and there's less money out of pocket."

Ease of distribution is one of the retailer/wholesaler benefits that Kentucky's Best is bargaining with, too. Manufactured by Farmer's Tobacco Company of Cynthiana, Inc., based in Cynthiana, Ky., Kentucky's Best is awaiting MSA membership, which the company hopes will occur this fall. Founded by fourth- and fifth-generation tobacco farmers, father Bob Ammerman and his son Mike, Farmer's Tobacco offers 21 varieties.

"We had always hoped to join the MSA when the time was right; changes in state law tell us the time to apply is now," says Bob Ammerman, president. "We may be a small company owned by family farmers, but we believe this move puts us on record as being in this industry for the long haul. Kentucky's Best may not be a big player, but we're a serious one."

Reputable distributors also offer solace, to retailers cautious of a fourth-tier cigarette shakeout that is predicted for next year, as legislative changes take place across the country. "Supermarkets absolutely don't want to put themselves in a position where they pay for product that the states will later confiscate," says Parameswar. "There is no recourse with these fly-by-night companies. We stand behind every product we sell."

MEANWHILE, BACK AT THE BIG FOUR

Price wars are still a factor for major cigarette manufacturers feeling the pressure from the discount brands. For example, Philip Morris has once again extended its 65-cents-off program until September 28th. This program, which started on a trial basis, was originally intended to last just two months, from February 3 to March 30. But it has been extended multiple times. On July 28, the cigarette giant announced to wholesalers that it would extend its off-invoice promotional allowance on its four core brands. "We would not be surprised to see this program extend indefinitely," says Herzog.

It's not all about cigarettes. Supermarkets that want to be seen as more serious tobacco players are wisely starting to pay more attention to the smokeless tobacco category. Industry figures support this direction. According to the Smokeless Tobacco Council, the smokeless category rose 3.5% in 2002 to nearly $3 billion at retail.

Supermarkets that want to be known as destination stores for cigarettes usually don't think twice about carrying a full assortment. Likewise, retailers that want to be known as destination spots for smokeless tobacco carry a more complete category assortment here as well--including loose leaf chewing tobacco.

"Carrying a complete line of smokeless SKUs is the only way retailers can strategically position themselves as a strong destination to the smokeless consumer," says Jim Murray of UST Inc., based in Greenwich, Conn. "The value of the other tobacco products in consumer shopping frequency alone merits courting and attracting as many as possible. Furthermore, in the most recent out-of-stock study available, nearly 50% of tobacco shoppers would leave the store if their brand was not available. Put more positively, retailers that carry a wider assortment produce significantly greater sales. Specifically, loose-leaf studies have shown that retailers that offer a wider variety of SKUs report up to 60% higher sales per SKU than those that offer a more limited assortment."

Of course, it makes sense to identify high consumption markets for the product first. "We have worked with a select number of supermarket retailers with high category development index (CDI) to create in-store promotions and programs, such as temporary price reductions, and we have enjoyed excellent growth within those stores," says Dave Savoca, president of Smokey Mountain Snuff, based in Darien, Conn. "Grocery retailers need to work with the category captains, as well as the various niche manufacturers such as ourselves, in developing a consumer-friendly smokeless tobacco section. They should focus on seasonal and regional trends by working with these players, in concert."

In a category as developed as smokeless tobacco, true innovation has been said to be a daunting challenge for smokeless manufacturers. Nevertheless, "the next round of innovation will likely come from products that are specifically targeted to smokers, offering them a smokeless alternative product," says Roy Reynolds, brand manager for Swedish Match North America, based in Richmond, Va. Swedish Match is now launching Exalt, a smokeless tobacco product that is "spit-free." This item will compete against UST's Rovel, which is still being test marketed.
SMOKING OUT THE OTHERS

For the past five years, the moist smokeless category is
the fastest growing segment of domestic tobacco.

FIVE-YEAR GROWTH:

MOIST SMOKELESS TOBACCO 9% *
CIGARETTES 17%
CHEWING TOBACCO 23%

* Adjusted for category's 20% upsize

Source: ACNielsen

Note: Table made from bar graph.

THE IMPACT OF IMPORTS

IMPORTED CIGARETTES: PRE/POST MSA

 Total imported cartons: 4.35 billion/25 billion
 Deep discount import category: 3.5%/14+%
Roll your own (RYO) import market share: 0.5%/1.5+%
 Import players: 15/100+
 Average price per import pack: $1.85/$3.50
 Promotional import spends: $6 billion/$10 billion
 Cartons in legitimate market: 460 billion/423 billion

Source: King Maker
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Title Annotation:Nonfoods For Profit
Author:Kruger, Renee
Publication:Grocery Headquarters
Date:Sep 1, 2003
Words:1808
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