No doubt, Tobacco is still an important category in the overall C-Store business today, representing more than 30% of Net turnover according to different sources from different countries in the world, such as the SINDICOM in Brazil, or NACS USA (decreasing from 42% back in 2011). In some stores in Latin America without Food Service, this percentage nowadays still is above 40%.
Tobacco industry has been declining in volume for the past 50 years, so effectively government restrictions are causing a reduction in the number of regular smokers in the world. However, looking at the share price trend of the biggest players of the industry, PMI in Blue, BAT in Red compared against the index S&P 500 in green, it is clear that despite all the difficulties, they have been able so far to overcome difficulties, reduce costs and deliver sustainable profit and dividends.
It is obvious that to deliver the cost reduction objectives, one of the variables affected was the Trading Terms and conditions, which means in practical terms, that retailers are making less money than before for selling the category.
There is no question about the current relevance of Cigarettes in the overall income of a regular convenience store. However it is more frequent to hear that retailers are stopping or considering stopping dealing with the category, either for image related or business reasons. In October 2014, the big US pharmacy chain CVS decided to stop mainly because “…the presence of the category is a strike against its credibility as a health provider” – according to its CEO Larry Merlo. Once this happen, others might follow.
In C-Stores chains, the tobacco business was always relevant, not only because of the Sales revenue but also because of the amount of money paid by the Industry in contracts related to share of space and positioning of products in planogram, sales performance or where still is possible, preference in visibility or promotional activities.
It is known that the Gross Margin of Tobacco is the lowest from all categories sold in the store (aprox. 10% weighted average including OTP – other tobacco products). Industry tends to defend this situation with the arguments of the amount of Traffic driven to the store and the fact that in high proportion of sales tickets, cigarettes are sold together with other more profitable products. So they try to move the focus from percentages towards Net Margins in US$.
Tobacco should then be considered a Cash Generation category and retailers should be happy with this. So why are we hearing that many complaints of retailers considering even to stop selling Tobacco?
According to them, most of the tobacco Sales revenue is gone with the bank rates charged for the use of debit or credit cards, which is becoming the most popular payment alternative nowadays in countries like Brazil where coins are turning into a rare and inconvenient element in everyday store operation.
Some others are going beyond the Bank rates and include in their direct product profitability analysis, the operational costs of running a C-Store business distributed across categories. At the end, working 24 hr per day means more electricity, more employees, more costs!
According to a recent study conducted by TMC Consultores Comerciales in 10 stores in different states of Brazil, cost of employees is the most representative expense followed by space rental and energy costs. Despite these costs are not exclusively related to the sale of Tobacco, all of them are necessary to keep the store open and therefore it is fair to assign at least a proportional part of the total costs to Tobacco.
Following this logic, next question is how much of these costs should be assigned to Tobacco? Well, let’s go one by one.
Cost of Staff: without the staff it is impossible to run the store. It represents typically between 15% to 20% of total Sales Turnover. In average a C-Store with Food Service has 4 employees and 1 Manager by period. Normally 2 employees are dedicated to the Food Service operation and the remaining 2 are focused on general operation of the store, from cleaning up to reposition of products on shelves and cashier, where tobacco is sold. Based on this, 50% of cost of staff should be assigned directly to Food Service and the other half should be distributed based on sales participation of Self Service categories.
% Tobacco staff = Cost of Staff x % of employees @ Self Service x % Tobacco sales share
Space Rental: cost of space could be shared among all categories available at store based on its space allocation. To avoid frequent problems between floor and wall displays, it is recommended to use Volume metrics rather than Floor Area metrics. Tobacco is one of the categories with the best rate of Sales / m3 of store because of the high demand and low space required to manage the category.
Total Store Volume: base x high
Tobacco Space: volume occupied by the cigarette dispenser
% Tobacco space = Cost of Rent x Tobacco volume ÷Total Store volume
Electricity: despite there is no need to keep inventory refrigerated, cigarette are sold in a highly illuminated store, which means that is fair to consider to share the cost of electricity consumed by general illumination, computers, security systems and air conditioning. Generally speaking, it is possible to split the energy consumption in 3 groups:
- Beverage Coolers: close to 100% of beverages are sold cold in C-Stores and it is known the energy consumption of these units.
- Food Service: grill, oven, mixers, hot dispensers and food freezers. Also it is easy to calculate consumption in kWh.
- General: air conditioning, store illumination, computers, Internet, etc.
Self-service categories not using freezers should share the cost of the third group – General according to its participation of total sales.
All other administrative costs should be distributed by category as well by the share of total sales, because it involves generic expenses related to the commercial operation of the store: administrative system, uniforms, phone, internet, water service, maintenance and repairs, insurance and accounting among others.
Illustrative Example of a C-Store 2015 Brazil
In this case, a regular store of 60m2 selling R$170.000 per month with 32,4% of Tobacco is not making money with the category considering its corresponding operational costs. It is good to remark that final number is already negative even without considering yet any % of product loss or the % cost of credit/debit cards.
Now the question is: Should we stop selling Tobacco? The answer is NO, but you have to reconsider WHERE it should be sold in the store.
Guarantee the traffic of smokers entering to the store is always a positive reason why to keep selling the category, but if you know that you are not making money selling ONLY cigarettes, you have to motivate regular tobacco shoppers to buy a more profitable product in the same visit.
As Tobacco can only be sold in a Point of Payment (Cashier), we recommend moving the Cigarette display towards the Food Service area, to leverage on the product correlation with Coffee and Beverages and the smoking occasion of “Day Break” to try to include some snack in the ticket.
This initiative is being used in few Convenience Stores in Spain, who placed the Tobacco Machine side by side the Food Service area.
The second element to consider when making business with Tobacco is the value of the FEE paid for better conditions (space and planogram position) at product display. Keep in mind that historical values paid by industries are not longer possible, so don’t make your plans too much dependent of this.
It is common in other categories to offer some sort of variable compensation to those retailers who never get out of stock in the strategic products, achieve volume objectives or allow the company to implement a promotional activity in their stores.
As the numeric distribution of cigarettes is still one of the highest among Consumer good products, the Value risk of out of stock for the industry is limited, because shoppers just need to walk few steps towards the next store and probably find their regular product available. So for the industry, pay some extra money to avoid out of stock is not worth it. However, in countries where still the planogram is visible visual dominance is desirable, even though shoppers typically ask for the product without taking a look at what is exposed. In Canada, where there is no visibility of tobacco planogram industries might close agreements to reserve the best planogram positions, so staff and shoppers can always remember where their preferred product is located behind the doors.
Retailers perceived that biggest players in the tobacco industry are not willing to pay the same amount of money for the same category conditions as before during the negotiation process to renew category contracts. Those retailers, who didn’t anticipate this potential move, were counting with the FEE to achieve their business objectives, creating internal stress and friction on both sides.
So what are the alternatives now?
It is necessary to realize that during economic crisis, all industries are reducing exposition to risk and therefore they will be tempted to pursue the change from fixed payments to variable compensation, which is becoming a popular practice in many categories.
For retailers, obviously the fact of loosing a “Secure and Up front income” is negative, affecting mainly the cash flow plan, because if objectives are correctly set, it is possible to receive the same amount of money but at the end of the period, if expected results are delivered.
Understanding the situation, there are 5 ideas that should be considered by both sides in the near future:
- During the negotiation process, define the “Boundaries” for variable compensation that will help to close an acceptable agreement with retailers. Minimum payment must cover at least the commercial negative margin of 4%. From this level on, any agreement will be positive for retailers.
- During the objective definition, consider the category trend in the closest geographic area available because what is happening with the category in the Country is not necessary reflecting the situation in your particular state. See the example of USA or Canada.
- The fact that strategic focus is moved towards Food Service does not imply that Tobacco must be forgotten. It still represents at least 30% of your monthly income! Just think different.
- Seriously consider moving the tobacco display towards the Food Service area. Not necessarily it means moving what exist today. Think about all potential alternatives. The new available area could be transformed in a communication site to be sold to several impulse driven industries. At the end, it is probable that several players would like to use this strategic site to improve its communication with shoppers, creating an additional income source.
- Start developing the backing area as a premium display zone for highly profitable impulse driven products such as TOP Bombonier gifts and Liquors. Why not selling this area to a big Liquor distributor as a premium exhibition site for strategic and new products launches?
In any case, the objective is to guarantee that both parties involved in business will continue to be happy managing the category, otherwise more problems will arise. Convenience Stores will continue to be a strategic channel for the tobacco industry and moreover its relevance will grow in future as other channels might stop selling the category.
Similar analysis should be done for every category in relevant channels or stores. Our objective in TMC Consultores Comerciales is to motivate a serious debate of alternatives to maximize the revenue of every cm3 per store.
“Change is the law of life. And those who look only to the past or present are certain to miss the future” – John F. Kennedy
What do you think?
Writen by Carlos Ignacio Alfonzo Sotillo.