CSD: The Impact of Tobacco Federal Excise Taxes

Nov 19, 2009

Commentary by Tony Miller, SVP of sales and marketing for Thorntons

Through a special arrangement, presented here for discussion
is a summary of an article from Convenience Store Decisions magazine.

The increase of federal and state cigarette excise taxes will have a far-reaching,
negative impact on the convenience store industry. With the exception of petroleum
products, no other category is more vital to the industry’s success than tobacco
products. Given that cigarettes represent 30-45 percent of c-store inside sales,
the deterioration of this category will have devastating consequences.

The Federal Excise Tax (FET) will dramatically increase the cost of doing
business. Inventory cost will increase by an average of $6,000 per store–$1
million for a chain of 166 stores–resulting in higher interest expenses.

Credit card transaction fees will increase due to soaring cigarette retails.
Internal shrink dollars will escalate due to the higher cost per carton. External
theft will rise due to the value of cigarettes and the amount of inventory
dollars carried. In addition to the FET, Kentucky Legislators are proposing
an incremental 30- to 45-cents-per-pack State Excise Tax (SET), compounding
these issues.

The FET is a direct tax on the middle-class, as 80 percent of cigarette smokers
are in lower-income brackets, and in Kentucky the average annual household
income for cigarette smokers is less than $32,000. During these difficult economic
times, it is impossible for the average cigarette smoker to assume a higher
tax burden. As a result, increased cigarette taxes will significantly alter
the purchase behaviors of our core consumers.

The cigarette industry is ratably declining at three-four percent annually.
Excise taxes at these levels are unprecedented, and it is difficult to project
the potential sales loss. Nonetheless, many industry experts are predicting
additional six-10 percent declines on top of the current three-four percent
trends. In addition to the reduction in cigarette sales and gross profit dollars,
retailers will also lose sales and gross profit dollars associated with affinity
purchases — other products purchased with cigarettes.

With chains facing reduced gross profit dollars, reduced affinity sales, increased
interest expense and increased cigarettes shrink dollars, storeowners will
be forced to look to this category and others to make up the loss in net income.
It is unfortunate that consumers will most likely absorb additional increases
above and beyond the excise taxes.

This daunting economy has already made it difficult for most retailers to
maintain shareholder value, and the impending FET and SET will place an additional
burden on the convenience industry. This burden will challenge the industry
to evaluate its cigarette categories and possibly re-engineer its overall strategies.
In time, prudent retailers will overcome this adversity and prevail with a
much stronger business model.

Discussion Questions: How should c-stores respond to the likely steep drop
in sales in its core cigarette category as well as the impact of higher cigarette
prices on its core customer? How does the c-store business model change with
a smaller cigarette business?

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10 Comments on "CSD: The Impact of Tobacco Federal Excise Taxes"

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Max Goldberg
11 years 5 months ago

Every time the cigarette tax increases, the number of smokers drops, which means that c-stores can look forward to their customers living longer, healthier lives. Let’s celebrate government taking steps to decrease smoking, rather than bemoaning how this will effect a retail segment.

Jonathan Marek
11 years 5 months ago

It’s been obvious for years that c-stores need to find a way to wean themselves from cigarettes over time. (Fortunately for them, they don’t need to go cold turkey.)

One immediate idea is to proactively test cigarette price increases along with the tax increase. To some extent, the price increase can get “lost” in the tax increase. Gross margin is preserved. And the most marginally price-sensitive customers will already be lost with the tax-driven price increase. This may not work for everyone (depends on their core customer segments), but I have seen it work for certain c-stores in the past.

Doron Levy
Doron Levy
11 years 5 months ago

The tobacco industry in Canada is a tough one to navigate. Their products are heavily taxed at the federal and provincial level. C-stores in Ontario can’t even display tobacco products out in the open anymore (see related discussion). Prices are now pushing $8-$9 per pack. Yet C-stores are still reliant on tobacco products for revenues. I spoke to a local C-store owner about this issue and he has plans to bring in more high velocity merchandise and change his layout to combat slowing tobacco sales. The bottom line is that it’s a product solely designed to get you hooked and sick. I’m all for taxing smokes (I quit when they hit $5 a pack). As with my merchant mentioned above, C-stores need to plan for the inevitable. Tobacco companies are putting their focus on Europe, Asia and Africa where there are no regulations for tobacco. C-stores are on their own with this one.

Mel Kleiman
11 years 5 months ago

Smart c-store operators are supporting and maintaining the category for as long as they can; it still is and will be a major contributor to the bottom line for a long time.

It is past the time to be proactive in looking for and building other categories and much time, money, and effort has been spent in all of the areas listed in your survey question. Now the question is, does one area offer greater potential than any other? Recent history is showing that the move to food service seems to be the area with greatest potential. Everyone has to eat and most of us do it at least 3 times a day…and often more.

David Livingston
11 years 5 months ago

I’m usually all for stores being able to sell what they want to earn a profit. But in this case I think C-stores need to focus their selling space on something healthier and just get out of the cigarette business. Tobacco seems to have drawn in sort of a seedy element and I think other customers would feel more comfortable if those tobacco customers were going someplace else. I wish they would get out of the lotto ticket business, too.

W. Frank Dell II, CMC
11 years 5 months ago
The c-store industry is facing the same thing that drug stores tackled some years ago. For drug stores, it was the decline in gross margin on prescriptions. This forced drug stores to re-think what they call the front-end of the store. Walgreen and others started putting food and other products into the store. Their goal was to keep the convenience factor they had while increasing the transaction size. Of all the retail formats I have reviewed, c-stores are way behind the times. Walk into any c-store and you will find plenty of products that don’t sell. Once when I was riding with a bread route man, we stopped at a c-store where he took two loaves out and put two loaves in three times a week. This store had not sold one loaf of bread in years. C-stores need to define a target customer and then completely re-merchandise the store. Except for gas, cigarettes, and coffee, few c-stores have a reason for being. They are not top-of-mind as a destination. Until products are stocked and… Read more »
Li McClelland
Li McClelland
11 years 5 months ago
No one in my family is a smoker and I wish, for health reasons, no one anywhere smoked cigarettes. I will not own stock in tobacco conglomerates. That being said, the punishing new federal excise tax (and in some cases new state taxes) on tobacco have economic consequences far beyond the article’s several well-outlined ones affecting c-stores. This is why elections have consequences–and why potential legislators need to be better educated on the broader issues and also much better vetted by voters. In my area, the pols touted/justified the excise taxes ‘as a wonderful way to get desperately needed, long-term new tax revenues, AND, as a wonderful way to discourage smoking.’ Well, which is it? They seemed completely oblivious to the very obvious schizophrenic double talk they were spouting. As for c-stores, there will still be the appeal of 24/7 lottery tickets, gas, soda and milk sales to keep some of them going. But there will be a lot fewer of them, a lot more empty eyesore retail spaces, a lot less property tax revenue… Read more »
Craig Sundstrom
11 years 5 months ago

Despite all the happy talk offered here, convenience stores concentrate on tobacco sales because that’s what’s most profitable, and by inference whatever else–if anything–that “replaces” them will be less profitable…perhaps substantially so. If tobacco truly represents a third and a half of sales, I expect a great many convenience stores will be closed. And, ironically, since many such stores are in urban or marginal areas, would-be consumers there will end up with even fewer choices; legislators should put that in their pipes and smoke it…where it’s still legal, of course.

Tony Orlando
11 years 5 months ago

I know a lot of my customers who drive up to the Indian reservation lands in New York to buy tons of cigarettes for the whole neighborhood. It’s only 11.00 a carton every day.

How are you going to combat that?

M. Jericho Banks PhD
M. Jericho Banks PhD
11 years 5 months ago
Rolling tobacco. Loose tobacco designed for individual cigarette rolling is highly taxed. Pipe tobacco, on the other hand, is taxed at a rate just one tenth of that for cigarette rolling tobacco. Major tobacco producers are now re-categorizing their cigarette rolling tobacco as pipe tobacco. Makes sense. C-stores can sell pipe tobacco and rolling papers. I see in-store and online rolling instructions and demonstrations. And of course, many of us in all age groups are already adept at using rolling papers for, well, stuff. I had a girlfriend who grew up on a Nebraska farm, and her mime of her father rolling ciggie-butts was both hilarious and informative. From her mime, her dad was practiced, fast, and accomplished, constructing his coffin nails from “makins'” carried in a small bag in his shirt pocket. Hard to get those filters in there, though. Research suggests that smokers are as invested in the process of smoking as in the actual smoke-sucking. That is, the process of opening the cigarette pack, extracting one, tamping (for some), handling, lighting, and… Read more »

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