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Pick-Up Sticks
Today’s tobacco business is a bit like a game of pick-up sticks – take each challenge one stick at a time, and make each move carefully so the whole thing doesn’t come tumbling down.
By Traci Carneal
At the risk of being extremely redundant, it’s accurate to say the tobacco industry, especially cigarettes, is in the midst of a significant turning point in its history. Simply put, everything is changing. And manufacturers, distributors and wholesalers are faced with a host of challenges that are eating away at volume and profits – illegal sales of tobacco, excise taxes, price gaps, new regulations and lawsuits, to name a few.
This scenario is not likely to stabilize any time soon, according to Darryl Jayson of the Tobacco Merchants Association (TMA). He says clearly the economic state is difficult as the major cigarette manufacturers face a smaller domestic market and increased competition. "While cigarettes are generally recession-proof, the recent price hikes due to increased excise taxes have reduced the market."
The industry can’t ignore the declining volume of the big cigarette manufacturers, according to Tommy Payne, executive vice president, executive relations, R.J. Reynolds Tobacco Co.
"The low-end products have gone from a 2 share to a 12-14 share of market. Imports have increased from 2 to 19 billion sticks [cigarettes]," Payne states. He adds that enforcement of laws requiring nonparticipating manufacturers (NPM) in the Master Settlement Agreement is an issue that is heating up, and one that has the most direct impact on both manufacturers and distributors.
"Those who didn’t sign the MSA in 1999 are supposed to make escrow payments to the state where they do business. So far, the states have lost $450 million in settlement payments," he says. For details on NPM legislation, see "The Beltway Buzz" in this issue.
As this article went to press, a flurry of activity by various states was underway involving legislation that increases the excise taxes on cigarettes, or enforces compliance by NPM manufacturers. For example, in Maryland legislation was approved to enforce NPM compliance; in Minnesota, a fee was imposed at a rate of 35 cents per pack on 20 "non-settlement" cigarettes; in Nebraska, a law was enacted that makes permanent the temporary cigarette and other tobacco products excise tax increases enacted in 2002; and in Nevada, it’s no longer acceptable for cigarette vending machines to be located in any public area where minors under the age of 21 are permitted to loiter. At the same time, some states are enforcing "double-decker" taxes by raising taxes for a second time in two years in order to meet budget deficits.
Consumer Issues
It’s important to remember that consumers actually make the purchasing decisions. With prices continuing to rise, many are looking for cheaper alternatives to their favorite brands or, in some cases, buying cigarettes on the black market or going to a nearby state to purchase them for less money.
Although the industry has seen its share of lawsuits related to consumer smoking and health issues, the industry scored a major victory in May when a Florida appeals court threw out a $145 billion verdict in the Engle class action case.
According to John Kiser, vice president and general counsel for Brown & Williamson Tobacco Corp., "The Engle case was one of the few remaining smokers’ class actions against the industry. This sweeping decision should finally close the door on smokers’ class action litigation. We’re pleased that the court agreed with our position that a smokers’ class action lawsuit is unworkable, unmanageable and unconstitutional," Kiser said in a statement.
R.J. Reynolds Tobacco Co. also scored a significant win with the Engle verdict, stating that "this opinion should prove, once and for all, that class actions are inappropriate in smoking and health cases."
RJR and Philip Morris USA both won a suit in Florida in February concerning the death of James Robert Allen, a smoker whose wife claimed that he developed lung cancer from smoking the companies’ products. That win marked the 7th consecutive verdict in favor of U.S. tobacco companies in smoking and health lawsuits.
"This verdict shows once again that jurors who have seen the evidence generally use their common sense and conclude that smokers have long been aware of the well-known risks of smoking, and that people who choose to smoke in the face of these known risks should not be financially rewarded," says Benjamine Reid, RJR’s lead attorney in the case.
However, public smoking bans continue to crop up worldwide, with recent actions including a Florida ban on smoking in all restaurants and bars, and in Vietnam movies have just been banned from showing any scenes that involve people smoking.
An exception is occurring in New York, where legislation was introduced in May that would allow smoking in certain rooms open to the public and would provide for tax deductions and tax credits for the construction of such rooms.
Impact on Distributors
Distributors also are affected by the changing tide for tobacco.
Scott Ramminger, AWMA president, says tobacco manufacturers are "being squeezed in a variety of ways – on the litigation front, by their inability to market their products to consumers in order to maintain or grow their share, by the emergence of fourth-tier product, and by increased taxes that are driving up the ultimate price of their products to consumers – to name just a few things. That has led some of the major manufacturers to severely change their distributor programs."
So distributors not only have to cope with most of the same external forces facing the manufacturers, they have to operate their businesses in the face of huge changes in these manufacturer programs, on brands that typically account for a big part of their sales, Ramminger adds. "Many distributors have been forced to literally turn their businesses on a dime to maintain their viability."
Jode Bunce, vice president of merchandising, cigarettes, for distributor Eby-Brown Co., LLC, says the emergence of numerous new cigarette products has made it more difficult for "us to manage our shares with the big four to maximize funding. A lot of our customers want one of the major brands, but we for the most part refer them to companies that deal in that product line. Also, with the consumption declines, we have had to offset that with new business."
Bunce says he now has to market specific manufacturer’s brands to be able to maximize or remain whole "on our funding. We have no control over what a consumer buys and we have not control over what our retailers buy. They need what the consumers want."
What should the manufacturers do? Bunce thinks they are doing some of the right things now – working with the states to adopt model legislation for the non-participating manufacturers (NPMs) to pay escrow or not be allowed to be sold in their states. They are also working hard to eliminate contraband
"If they continue to reinvest in their core brands, they should be fine, but that’s a tough nut in itself to crack," he says. "Money needs to come from somewhere. Manufacturers are cutting back in many areas to come up with the funds."
Bunce also believes that somehow the advantage that NPMs have needs to be eliminated.
"Maybe the FDA regulations will take care of that and force them out of business due to the expense of adhering to the new laws," he states.
Payne notes that legislative and regulatory activity in Washington, DC, on tobacco issues has been quiet in recent months, perhaps due to international issues taking a front seat. Whatever the reason, he would rather not raise the question with lawmakers – better to let sleeping dogs lie.
Fire-Safe Issue Gets Heated
New York, home to one of the trendiest cities in America, surprised everyone when it enacted a law banning public smoking. Now the state is sparking controversy over proposed regulations to implement a law that would force cigarette makers to manufacture products that would automatically stop burning when they are not smoked (i.e., this is an effort to hinder accidental fires that start when smokers fall asleep, for example, and the cigarette continues to burn).
Philip Morris USA is one of many companies that has submitted comments on this issue. According to Michael Pfeil, a company spokesperson, the company seeks a final regulation that reduces the likelihood of fires "caused by carelessly handled cigarettes, [but] can be met by cigarettes that are acceptable to adult smokers and minimize the challenges of compliance for the state, cigarette manufacturers, wholesalers and retailers."
"[We] believe that the regulations proposed by the state would likely result in consumers seeking to purchase cigarettes that are not compliant with New York state’s ignition propensity law, severely reducing tax revenues for New York state and New York City," he said in a company statement.
He also noted that Philip Morris USA is willing to commit to the effort required to meet its proposed performance standard, which the company believes is "stringent, but workable."
While R.J. Reynolds Co. finds reducing fires a worthy goal, the company cautions against labeling cigarettes as "fire-safe" because it could instill a false sense of security in consumers who may erroneously believe they can carelessly handle cigarettes without concern for starting a fire.
"Extensive testing with commercial upholstery fabrics demonstrates that laboratory tests for fire-safe cigarettes have little, if any, relationship to how cigarette-related fires occur," says RJR’s Payne. "Cigarettes that pass various laboratory tests, and thus could be potentially labeled fire-safe, do not necessarily reduce the likelihood of ignition when dropped on the wide variety of upholstered fabrics used in real-life situations."
He adds, "Careless behavior and mishandling of cigarettes causes fires."
What Manufacturers are Doing to Stay Ahead
Relying on the way things used to be doesn’t work anymore. Manufacturers are turning to new strategies, marketing programs, promotions and line extensions to rev-up sales and improve cost efficiencies.
Brown & Williamson Corp., for example, is working on streamlining its discounting process at the retail level. Through the program, deemed Efficient Premium Price Delivery (EPPD), B&W builds in a $7.50 per carton consumer promotional discount into its list price for KOOL menthol cigarettes. According to Stephen Kottak of B&W, "It allows consumers to get a competitive price throughout retail outlets, and throughout the country, and frees up our sales folk from being bookkeepers and administrators of these buy-down type programs so they can concentrate more on selling and relationship building."
Kottak adds that this program also helps to reduce supply chain complexity and streamline the current discounting practices. "Our sales force can work on distributing our brands, eliminating out-of-stock, our products and supporting promotional activities on our strategic brands."
While consumers will not see a price change, the program does mean that consumers at all retail stores will see a more uniform price since the discounts will be figured into the lower factory price.
"This is a huge step-level change in the way things are done in this industry," says Ludo Cremers, divisional vice president responsible for KOOL brand marketing. "Our program will vastly reduce supply chain complexity and streamline our current discounting practices. We’ll be able to deliver a competitive price in the premium segment of the market."
Kottak adds that retailers who partner with B&W’s signage and communications programs will qualify for an additional discount of $1.50 per carton.
Cremers says KOOL has seen the best results the company has experienced in 30 years due to the successful launch of a new pack design, trial-generating bar programs, and promotions such as KOOL MIXX, a national DJ competition, and KOOL Spades Slam, which linked a national tournament for the popular card game with a free-gift-with-purchase at retail.
Philip Morris USA continues to focus its spending on venues and markets that allow it to interact directly with adult smokers. "Events like Marlboro Ranch, Marlboro Racing as well as communications via direct mail, all allow us to reduce the overall visibility of our advertising in response to society's concerns and responsibly market to adult smokers," says Mike Pfeil.
The Company continues to work with all trade classes to identify and develop innovative ways to help it succeed responsibly in a competitive marketplace. Pfeil says PM’s sales force is in the marketplace every day talking with people to understand what challenges they face so the company can make sure it's developing solutions to effectively address them. Initiatives include the continued development and improvement of merchandising programs, line extensions, and the implementation of initiatives to address the challenging issues facing the industry.
"Our Retail Leaders program continues to assist retailers by employing key principles of category management and responsible tobacco retailing. By adhering to these principles, retailers can build their business and grow profits, while meeting society's expectations of how tobacco products, products that are intended for adults, are sold.
"This program encourages retailers to further limit youth access to cigarettes and reduce the profile of Philip Morris USA tobacco advertising in general. In addition, the company has been offering promotions on its four focus brands via on off-invoice promotional allowance. This has helped to improve retailers' cash flow while helping to expand the reach of the company's price promotions to a greater number of stores," Pfeil continues.
At the end of last year, our Philip Morris’ CEO announced that during 2003 there would be three line-extensions. All three have been announced and Marlboro Blend No. 27, a Marlboro line extension, and Parliament Ultra Lights have hit the marketplace as of June. The other extension will be four new Chesterfield offerings available in select markets in July.
RJR is also rethinking its strategies according to Tommy Payne, who says the company is reallocating internal resources to get more competitive with the low-end brands – for example, no longer supporting the Winston Cup or the Camel brand bar program. "We’re using these funds to change our go-to-market strategy."
"We are looking at such questions as how do we price it? How do we take it to market? You’re seeing much more of this across the board…premium price brands rethinking how they market their product," Payne says. "There are major forces pushing the big manufacturers to reassess marketing and pricing strategies."
The Future?
What does the future of tobacco look like? A few good bets are that smokeless tobacco products will increase, along with lights and less-nicotine brands and taxes, but the rest is a guessing game.
Says Eby Brown’s Jode Bunce, "I’m not even going to try and guess on this one…this industry changes every week. There’s never a dull moment."
AWMA is working on the government relations front to help improve the external environment.
"We are working to ensure manufacturers understand the very real concerns of our distributor members – and trying to bring about constructive dialog between distributors and manufacturers on industry issues," Ramminger says. For example, when Philip Morris recently announced major changes in its distributor program AWMA took a group of distributors to New York to meet with senior management of the company to discuss the changes.
"Ironically, the time when it is toughest to come together and participate in the association," asserts Ramminger, "is the time when distributors and manufacturers absolutely need to do it – need to redouble their commitment. Our Summit in September will provide a great venue for us to come join minds and discuss tobacco issues, share concerns, and look for common ground. Every distributor should plan to be there."
Traci Carneal is editor of Distribution Channels.
Tax-Right: Right on Target
New stamping system promises to eliminate costly errors and labor.
Ask any cigarette distributor, and most likely he or she will refer to cigarette stamping as a time-consuming, expensive and error-laden responsibility. Right now distributors and wholesalers must make sure each cigarette carton is picked and stamped correctly for the right tax jurisdiction. This usually entails a full time employee, or order checker, to stand with a clipboard and look at each carton for accuracy. Problem is, the method is highly inaccurate.
To solve this challenge, Steve Stomel and Mark Neuwirth, both 25-year veterans of the distribution industry, have developed Tax-Right, a software system that fits right into the industry standard machine for affixing tax stamps – the Meyercord. Stomel has had first hand experience with tax stamp errors and tedium, which led him to work with Neuwirth to develop this new industry product.
Tax-Right uses state-of-the-art technology to compare the bar codes on the cartons with customers’ orders, thereby eliminating the need for the "order checker" employee as well as costly overages and mispicks.
"We’ve taken the industry standard for cigarette stamping, the Meyercord stamping machines, and incorporated a sophisticated checking system that can save distributors significant time and money," says Stomel.
Tax-Right functions exceptionally well in post-stamping operations. Tax-Right technology establishes a connection between a company’s cigarette stamping equipment and the order file that resides on the company’s computer. Tax-Right positions a high-speed scanner inside the machine. The scanner reads each carton’s bar code and, when an error is detected, Tax Right stops the Meyercord and prompts the operator to correct the error. The error is identified and corrected before the carton is stamped. The system notifies the operator of any mispicks or overages, and cartons that may be missing are identified at the end of each order. New jurisdiction alerts insure the correct stamps will be used for every order.
Tax-Right also works in pre-stamp operations. After orders are picked, the cartons are run through a device that holds the Tax Right System. Any errors are identified and corrected, and then the cartons are repacked. In pre-stamp operations the order checking function is not eliminated, but changed, so it is now 100 percent accurate.
"Agents can now have 100 percent confidence that perfect orders are leaving their buildings," Stomel adds.
Tax-Right is being introduced at a time when many stamping agents are again considering moving from pre-stamping to post -stamping operations. The cost of maintaining separate stamped inventories for each jurisdiction continues to climb with every price increase, tax increase, and new SKU introduction. Post-stamping is clearly more cost effective from a capital standpoint.
Stomel notes many stamping agents have been hesitant to move to post-stamping because of operational concerns. With the introduction of Tax-Right, stamping agents will now be able to make the transition to post stamping with confidence. Tax-Right is designed for today’s diverse cigarette distributors. With an introductory cost of about $30,000, plus an annual software license fee, Stomel thinks Tax-Right is a worthwhile investment since the "payback on the system is less than 12 months."
Stomel says the company has been working on Tax-Right’s development since August and is about to perform its first installations in several wholesaler firms in July.
"We have built the prototype, people have seen it, and they are excited about it. We are ready to start installing systems," says Stomel. "Order checking is a very tedious process, with only about 50 percent of the errors ever caught. I’d say going from 50 percent to 100 percent accuracy is a huge improvement.
For more information, contact Steve Stomel, Tax-Right, LLC at (856) 751-2249; stevestom@aol.com.
— TC
AWMA Members Can Log-On to www.tmalive.com
AWMA’s partnership with the Tobacco Mechants Association, formed last year, provides AWMA members with up-to-date tobacco news and information. If you haven’t already logged-on, visit www.tmalive.com today and set up your account. All you need is a password, and you’re live!
All AWMA members can receive AWMA’s weekly tobacco e-mail, which contains information that would cost more than their membership if purchased directly from TMA. All you need to do to sign up for this FREE service is e-mail Jennifer Moulton at AWMA at jenniferm@awmanet.org.
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