It’s been a tough year as far as government regulations go for the tobacco industry.  Roll over and die?  Never.  The roll-your-own/make-your-own, smokeless and little cigar segments are not only staying afloat, but in some cases thriving.  

by Lisa White

KEY TAKEAWAYS:
•    First outrageous tax increases; now a flavorings ban for many tobacco product categories.  
•    Manufacturers are redefining the RYO/MYO tobacco and little cigar categories to circumvent the higher tax rates.
•    New product launches have transformed the RYO/MYO, little cigar and smokeless categories.

First the SCHIP legislation handed the tobacco industry a huge blow by increasing taxes on tobacco products to unimaginable levels.  Now the U.S. Food and Drug Administration (FDA) is shaking things up again with the recent surprising ban on all tobacco products with certain characterizing flavors that meet the definition of a cigarette.

The FDA’s alarming move is the first step in a 36-month plan to overhaul regulation of tobacco products, the result of FDA’s new authority over tobacco manufacturing, sales and distribution.  This was on the agenda of newly-elected President Obama, who acted swiftly early in his term to ensure passage of such legislation.   

According to the FDA, this includes any form of tobacco that is functional in the product, which, because of its appearance, the type of tobacco used in the filler or its packaging and labeling is likely to be offered to or purchased by consumers as a cigarette or roll-your-own (RYO) tobacco.

The ruling was not anticipated by most companies in the industry, who believed that the ban would not apply to individual rolling paper packages. In fact, the Federal Food, Drug and Cosmetic Act (FDCA) has established that a cigarette or any of its components, including the tobacco, filter and paper, are prohibited from containing artificial or natural flavor, including herbs and spices. Tobacco and menthol flavors are exempt from this ban.

“As one of the first provisions of the new tobacco law to be implemented, the flavored cigarette ban caused significant confusion within our industry,” says Anne Holloway, AWMA’s vice president of government affairs.  “AWMA pressed the FDA to provide greater clarity with respect to the ban, specifically calling on the agency to submit a listing of the actual brands to be banned.”

AWMA participated in a “listening session” with top FDA regulators during which Holloway and AWMA President Scott Ramminger urged the agency to clarify its intentions with respect to the cigarette flavor ban and asked the regulators to provide a listing of banned brands.  

AWMA also urged its members to send their own letters to the FDA on this issue.

“AWMA will continue to promote distributors’ interests as the FDA works to implement the new tobacco law,” Holloway says. “And our association will be following this implementation process very closely, taking every opportunity to let that agency know of our concerns and reporting to our members any new developments.”

All this follows the 2009 SCHIP expansion legislation, which was passed by Congress and signed by President Obama on February 4 of this year, which mandated a 2,159 percent tax increase in the RYO tobacco category, while small cigars experienced a 2,653 percent increase. Both chewing tobacco and snuff saw tax increases of 158 percent each.  The industry is still reeling from the significant tax increases; now it has to deal with FDA’s new authoritative role over tobacco marketing and sales.

Though it may be too early to determine the full impact of these new tax rates, which became effective April 1, 2009, manufacturers and distributors aren’t anticipating a big drop in sales.

In the convenience channel, moist snuff dominates the OTP segment, comprising 55 .1 percent of sales, according to New York, NY-based AC Nielsen Company. Cigars, including little cigars, made up 37 percent of the category, while loose leaf is at 4 percent, RYO is at 2.4 percent, pipe tobacco makes up .2 percent and all other smokeless products comprise 1.4 percent of c-stores’ OTP segment.

RYO/MYO
RYO segment growth averages 11 percent annually, which is small relative to tobacco products in general, according to Greg Mathe, spokesperson for Altria Sales & Distribution, based in Richmond, VA.

The recent taxes implemented from SCHIP and the FET (Federal Excise Tax) have resulted in a huge influx of new pipe tobacco lines that compete with the RYO and MYO (make-your-own) products.  

“Since SCHIP, the traditional RYO tobacco category has been transformed,” says K.D. Hayer, president of OK Sales, a Fresno, CA-based distributor. “Instead, what we’ve found in the last few months is that pipe tobacco sales have grown phenomenally.”

Because the older pipe tobacco products included larger bags at a heavier weight that are deeply taxed under the new rates, these manufacturers have compensated by offering lighter RYO/MYO product packaging.

“These redesigned product lines have received a good response from consumers,” says Monroe Munford, COO and general manager of De Soto, MO-based distributor A.E. Wease. “Because Missouri is a very low tax state, we are seeing the affect of the FET on cigarettes. Here, consumers are switching to RYO/MYO products to save money.”

Distributors and retailers who predicted that this category would completely disappear have been pleasantly surprised. On the contrary, some of the larger tobacco companies have seen the potential and entered the RYO/MYO segment.

“Fortunately, we’ve found that it is not going away. In fact, we’re scrambling to get more RYO/MYO product back into inventory,” Munford says.

Superior Wholesale Distributor in Lima, OH, is doing a strong RYO business with tubes, filters and tobacco.

“With cigarettes being taxed so high, we’re seeing more people enter the RYO category, [despite the tax increase],” says Cheryl Wehner, Superior’s product manager.  

Some manufacturers are taking advantage of what can be called a loophole in the FET. Distributors say that some brands of RYO/MYO tobacco have been cut differently and re-labeled as pipe tobacco. This is because the tax increase on pipe tobacco is $1.73 per pound versus $23.68 per pound for RYO tobacco.

“RYO tobacco has experienced the highest tax increase of any U.S. product ever,” says David H. Redmond, president and owner of Carolina Tobacco Company, located in Portland, OR. “Because pipe tobacco is typically more expensive and the market is smaller than RYO, these products were exempted from [higher] tax.”

The RYO/MYO segment also is contending with increased cigarette promotions from competing manufacturers, who are trying to stem their losses from the tax rate increases.

Despite these issues, the overall trend for RYO/MYO products has been one of continued growth.  

“The most accurate barometer of this trend is the amount of cigarette-making machines we sell, which has continued to grow,” says Steve Sandman, vice president of sales and marketing for Glenview, IL-based Republic Tobacco. “We've been especially successful with our new TubeCut Cigarette Making Machine and have had difficulty maintaining an in-stock level on this product.”

Republic Tobacco also has invested heavily over the past 18 months in a variety of permanent merchandising and has maximized sales of the market basket through products bundling.

“We've upgraded our tobacco bags, which now include a gusset-bottom that allows the product to stand alone on the shelf, a thicker plastic that improves the integrity of the product while shipping and a higher moisture barrier to maintain freshness,” Sandman says. “We’ve also invested in new pouch manufacturing equipment that produces a style of pouch that consumers prefer for our Top and Gambler products. In addition, we've modernized our graphics on all of our product lines.”

Many concur that the RYO segment will remain viable, despite the unprecedented tax increase.

“Even with more adult smokers considering entering the RYO segment, it is still very small compared with cigarettes. Still, even though the category is not showing tremendous growth, it has been performing consistently for awhile,” says David Howard, spokesperson for Reynolds American, the parent company of Conwood Company, a smokeless tobacco manufacturer based in Memphis, TN.

Further proof of the potential is the entrance of major players into the arena.

Altria is currently test marketing RYO products with its Phillip Morris division under the L&M brand in Maine and Michigan.

“Sales of our 1- and 2-lb. bags of RYO/MYO tobacco are still strong, even with the tremendous price increase,” says Jeff Martin, general manager of Rouseco, based in Kinston, NC. “However, we’re not selling as much as we once were.”

The company offers point-of-sale materials, spinner racks and a demo program where its reps educate customers and store managers on RYO/MYO products.

Earlier this year, Commonwealth Brands of Bowling Green, KY, introduced its revised portfolio of loose tobacco products. The new Rave, McClintock and Premier blends are designed to offer value.

“We have point-of-sale materials available, including large and small premium floor displays that can be customized to highlight the brands,” says Tim Jones, Commonwealth’s vice president of marketing.

Smokeless
Like the RYO/MYO segment, the smokeless category is holding steady.

AC Nielsen c-store sales data for four weeks ending August 8, 2009 showed retail industry sales for smokeless tobacco were up 1.2 percent. Smokeless was supported by 2.5 percent volume growth, offset by pricing that was down 1.3 percent.

Hayer at OK Sales attributes this steady increase to manufacturers’ new flavor and cut introductions.

“Major manufacturers are constantly increasing their SKUs, and this is driving the sales increase,” Hayer explains. “In addition, an increased number of RYO and cigarette users are switching to smokeless products as cheaper alternatives that are more acceptable with today’s stringent smoking regulations.”

Superior Wholesale’s snuff and chew lines are selling well, according to Wehner.

“As a result of the tax increase, c-stores have lowered inventory of these products to unprecedented levels. And there also is a price reduction of these products at the retail level,” says Dave Savoca, president of Darien, CT-based Smokey Mountain Chew. “It’s taking time for retailers, distributors and manufacturers to get product levels back up to satisfy consumer demand.”

Because Smokey Mountain Chew’s products are tobacco- and nicotine-free, they are not subject to the new tobacco taxes.

“Smokeless and snuff have been growing categories for us,” says Keith Joubert, purchasing manager at Church Point Wholesale, based in Church Point, LA. “We’re expanding our lines to include tobacco-free snuff and brands that help increase energy.”

Larger players in the tobacco segment are stepping up their efforts in this category, as well. Phillip Morris has been test marketing Marlboro Snus in the Arizona, Indianapolis and Dallas-Fort Worth markets, with plans to extend those test markets later this year.

Altria’s U.S. Smokeless Tobacco division also recently announced a line extension with its Copenhagen brand.

Little cigars
Due to a 2,653 percent tax increase, the little cigar segment also has been redefined, with many of these products sold as filtered cigars.

Manufacturers have transformed the little cigar category by focusing on cigar products that weigh more than 3 lbs. per 1,000 to avoid paying the additional SCHIP tax on little cigars.

“This segment has taken a beating. Because little cigars are taxed so heavily, manufacturers are bringing the weight of these products up. As a result, little cigars are now being referred to as filtered cigars,” Joubert says.

Since SCHIP’s implementation, cigar manufacturers are focusing on marketing filtered cigars, and the category has come into the forefront.

“I started out ordering the minimum amount, but now order every week,” Wehner says. “I believe this is due to the value, because these cigars smoke like cigarettes, but the price is cheaper.”

OK Sales initially experienced a significant decline in little cigar sales after the implementation of SCHIP, but now sales are on the rise.

“There are new filtered cigar brands popping up every month, and we’re increasing our SKUs to half a dozen,” Hayer says.

Although A.E. Wease isn’t selling as many little cigars as in the past, the new tax did not kill the category as expected.

“Because little cigars changed weights and sizes, the products we had a year ago no longer exist,” Munford says. “Instead, manufacturers are coming out with new lines that fit into the traditional cigar category.”

Little cigar maker Cheyenne International in Grover, NC, has expanded its advertising significantly, due to the potential of this growing segment.

“OTP in general is up, and there are opportunities that everyone should take advantage of. This is a growth segment,” says Bill Greiwe, Cheyenne’s CEO.

Phoenix, AZ-based HBI International recently launched organic rolling paper and organic hemp paper, catering to people looking for natural products.

According to Joe Teller, director of category management for Richmond, VA-based Swedish Match, the FET price point has resulted in an accelerated shift from pack to single cigars.

“Little cigars are different now,” says Paul Marquardt, senior brand manager at Phoenix, AZ-based Prime Time International Company, a maker of premium filtered cigars. “They are now a machine-made filtered cigar that’s multi-segmented like cigarettes.”

Although the FET and SCHIP have definitely impacted the OTP category, it’s a tough call to say what the long-term impact will be on the tobacco category as a whole.

Pelican Cigar Company, based in Lake Charles, LA, has experienced a big uptick in RYO and smokeless sales in the Southwest, according to Julie Broussard, general manager.

“Distributors, retailers and manufacturers must pay attention to what is happening on both regional and local levels, so they can set pricing and promotions accordingly,” Savoca notes.

Resources
•    Altria Sales & Distribution, Richmond, VA, (804) 484-8611
•    Carolina Tobacco Company, Portland, OR, (503) 244-5313
•    Cheyenne International, Grover, NC, (704) 937-7200
•    Church Point Wholesale, Church Point, LA, (337) 684-5411
•    Commonwealth Brands, Bowling Green, KY, (270) 781-9100
•    HBI International, Vancouver, B.C., (866) 420-4372
•    OK Sales, Fresno, CA, (559) 229-1565
•    Pelican Cigar Company, Lake Charles, LA, (337) 439-4193
•    Prime Time International Company, (623) 780-8600
•    Republic Tobacco, Glenview, IL, (847) 832-9700
•    Rouseco, Kinston, NC, (252) 522-2783
•    Smokey Mountain Chew, Darien, CT, (203) 656-1088
•    Superior Wholesale Distributor, Lima, OH, (419) 227-2436
•    Swedish Match-North America, Richomond, VA, (804) 302-1700
•    A.E. Wease, De Soto, MO, (636) 586-3955

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