With concerns over taxation and cigarette profitability, cigars and moist smokeless continue to drive revenues.
The long-predicted demise of cigarettes has not come to fruition, nor is it likely to. But the effect of tobacco taxation and smoking restrictions has made it much more difficult to rely on cigarette sales as the primary category for driving in-store profitability.

But don't read that to mean tobacco is suffering. Retailers are reporting strong sales gains in moist smokeless tobacco (MST) and cigars, driven primarily by innovative new products and flavors and mega manufacturers such as Philip Morris and RJ Reynolds jumping into the segment.

According to the NACS 2007 State of the Industry Report (SOI), cigarettes made up 18% of the gross margins for c-stores in 2006, down almost a percentage point from the year before. While NACS still reports cigarettes as the largest segment for in-store sales--pulling in more than 34%--that's only on a national level. For stores in states with particularly high state excise taxes, such as New York and New Jersey, the percentage is much lower, hurting not only the segment itself, but also damaging other in-store sales segments.

Keeping the cigarette segment profitable has been a fleeting task over the past several years. In the state of New York, it's been estimated that cigarettes only make up 20% of in-store sales, that low percentage caused primarily by smokers scared off by high excise taxes who often find other sources to purchase cigarettes.

More than half of the cigarettes sold in New York State are purchased without the collection of any state excise taxes, said Jim Calvin, president of the New York Association of Convenience Stores (NYACS). Those purchases are going primarily to one of three places: the Internet, Native American reservations or the black market."

The problem has been steadily growing over the past 15 years, pulling business away from c-stores. The real damage didn't begin to occur until 2000 when, in a two-year span, the state raised the excise tax from 56 cents per pack to $1.11 per pack and then a staggering $1.50 per pack. Add those taxes to local and state taxes and the total price tag for a pack of smokes could float between $6 and $8.

New Opportunities
Though there's no telling what kind of future is on its way for the cigarette industry, some retailers are taking matters into their own hands. Many stores like Smoker Friendly, based in Boulder, Colo., have been keeping a keen eye on the changes in their markets. Since Colorado and many of the other states that the 100-store chain serves issue local and statewide bans on public smoking, Smoker Friendly has been taking advantage of the recent surge in smokeless momentum.

"We've had double-digit growth in the moist smokeless tobacco (MST) and other tobacco products (OTP) over the past few years," said Mary Szarmach, vice president of trade marketing for the store and a member of the National Association of Tobacco Outlets (NATO). "We've benefited from a lot of dual users who purchase cigarettes and smokeless tobacco at the same time. The pouches, in particular, are very popular with cigarette smokers since it's cleaner and easier than MST."

Flavored Products
Cigars are also hot. According to the NACS SOI, cigar sales increased 5.2% to represent 30.48% of the Other Tobacco Product (OTP) sales. As their popularity and subsequent sales grow, retailers are finding that this category has been excellent for complementing rather than cannibalizing cigarette sales.

" A lot of our smokers are looking for variety. It's not that they are switching exclusively to cigars," said Keith Martin, owner of Tobacco Outlets Inc., a chain of c-store in the Chicago area that caters to smokers. "They just come in and purchase the flavored cigars for a change of pace, and then go back to cigarettes."

Over the past two years, Martin has watched cigar sales grow beyond his expectations in his eight stores. One of the major reasons the category has been selling so well is the price, which for a pack of 20 little cigars is often $2 or $3 dollars cheaper than a pack of cigarettes, depending on the taxes of a given area.

"Our top-selling cigars have sold much better now that they are aggressively priced," said Martin. "The price isn't causing them to be used as a cigarette alternative, but it's opening the customer to a larger selection of tobacco products."