Meyer & Associates - State Of The Convenience Store Industry

CIGARETTES CATEGORY MANAGEMENT RESEARCH
Implications of Exclusivity Programs
by Meyer & Associates

PREFACE

My company has been monitoring retailer feedback on cigarettes category management (CM) programs for over three years (A Profile of Cigarettes Importance - CSP 11/96; State of Tobacco Category - CSP 4/97). We've attempted to remain on the leading edge in analyzing dynamics that could adversely impact c-store profits, such as cigarette/tobacco stores, the ripple effect of legislation (price hikes) and non-legislation (Native American issues), and the application of CM principles to the # 1 inside sales category, cigarettes.

Recently, I was invited by the Editor of one of the major trade publications to author an article on the implications of cigarette "exclusivity" programs. Their motivation for having me develop this thesis were twofold: (1) despite the mega trade articles analyzing the injunction against one tobacco manufacturer, several retailers remain confused, and a few remain intimidated in this arena; and (2) they've received multiple inquiries asking about the potential long term impact of exclusivity programs on customer traffic.

While I initially agreed to accept this challenge, upon further examination the Editor and I agreed to not go forward with the article. In brief, we found the number of companies on exclusivity programs was too small a fraction of NACS members, hence we felt our article would be like preaching to the choir. Regardless, because much of this research was completed before our decision and it may have value to some companies, it's become part of this web-site and…with all postings hereto…feedback is welcome.

IT'S ABOUT TRAFFIC

I am prejudice against tobacco manufacturer exclusivity programs primarily because I believe they threaten our industry's ongoing challenge to retain and increase consumer traffic. In 1998, the NACS State of the Industry reported a 4% decline in average customer counts vs prior year; the first reported decline in the industry's history.

About six years ago our industry aggressively embraced quick serve restaurants (QSRs) and proprietary foodservice programs to induce more traffic to their higher cost corners. About that same time, chains began adding pay-at-pump and ATMs at record levels to offer "expected" services for their first priority/fuel customers. They also added "speed-pass" concepts, etc. to earn the loyalty and respect of the gas consumer, with hopes they'd not be lured away by mass marketers adding fuel installations with low-ball prices.

The contradiction that I cannot reconcile is that while most marketers invest in programs to retain and/or grow customer traffic outside the store, some gamble on programs that frustrate enhancing traffic into their locations. Our research concludes that they're subjecting themselves to "cherry pickers"; i.e. customers who may buy their gas at one location, then drive to another to buy their cigarettes and/or milk and beer. If that's an acceptable risk and philosophy of such retailers, maybe they'd find longer term profitability by reducing their c-store "box" and expanding to unattended fueling sites.

This author is a CPA by background so my tendency is to look for trends and numbers for answers. However, having espoused in previous research my resentment for manipulated data (which I've termed CACA in past articles - Convenient (or creative) Accounting Consistently Applied, a technique too often employed by what I term category manipulators, not category advisors), I strain to find definition in history and present "best practices", the latter of which often go undetected. I've summarized below the most relevant examples that prejudice my conclusions why exclusivity can prove hazardous to a c-store's profitability:

Restaurant industry experience - In 1972 - 1975, I was an officer/part owner of 7 high quality, limited menu restaurants. As did the signature chains of that time (e.g. Steak & Ale, Victoria Station), we took advantage of this "concept" craze and offered less than a dozen entrees in top-shelf facilities. We sold the public on the idea that fewer menu items meant higher quality and more affordable meals. Footnote: the public accepted the limited menu concept for about two years, then demanded more selections. Restaurant owners who didn't change found their traffic decline.

Fountain programs - While McDonald's is 100% Coca Cola in their worldwide restaurants, and Subway about 90% Pepsi, in the convenience store industry there are just not a lot of examples where chains have gone "exclusive" with one fountain company or another. In almost every instance where I know that such a decision was made, in my opinion it was motivated by some short term funding motivation. Footnote: most retailers evolved from 6-head (limited selection) fountain programs to 12 or more heads, with 30 - 50% increases in sales. Bottom line, the consumer wanted more choices.

Beer category management - I never heard one c-store operator espouse promoting exclusively Budweiser or Miller or Coors for the year. Is it because the c-store operator perceives beer-drinking "Bubba" to be more potentially vocal if his brand is not promoted? As the beer category gains its deserved (enhanced) focus from c-store operators, which I predict will happen in Year 2000, I doubt we'll hear about beer "exclusivity" programs. In short, the consumer just won't accept it!

Why did CTS outlets evolve? - From virtual non-existence six years ago, this "niche" currently represents about 13% share of total cigarettes industry volume. This segment SOM from markets where retailers were offering consumers too few choices and asking for too high margins. Smokers went elsewhere. Note, too, that one of the CTS publications reported that the average cartons sold per week for "exclusive" CTS outlets are significantly lower than those that are non-exclusive.

Major oil coincidence? - Few c-store executives would question Big Oil's prowess in building "pumpers" and attracting fuel customers. I find it particularly compelling, then, that to the best of my knowledge no major oil company has a cigarette "exclusivity" program. This is a curious and new revelation and requires further inspection. My goal is to determine if any of these companies have definitive research that further supports the opinions in this thesis.

History of converts - About 2-3 years ago, Arco and SuperAmerica terminated their exclusivity cigarette contracts and opted for deals with multiple tobacco companies. While I'm not privy to the exact reasons for their decision, my (then) contacts at these companies implied that they did significant research on SOM trends and related traffic issues affecting their core (loyal credit card) customers, in order to validate the bases for this major merchandising change.

Exceptions - I recognize that certain chains continue to have exclusive programs. To potentially understand more about their, perhaps unique, circumstances and results from "exclusivity", I recently modified my Company's web-site (www.dickmeyer.com) to include the following invitation:

"Are there any retailers with an exclusive cigarette program who can validate that they INCREASED their chain's gross profit DOLLARS (from all non-gas products) without adversely impacting total customer counts?"

I certainly will analyze any responses that are received.

DATA GOLD MINES

Each chain can make an informed and documented decision on what cigarette category programs make the most sense for their situation. With the virtual data-mines available from each tobacco manufacturer, inclusive of information on their competitors' brands and share of market (SOM), retailers don't have to chance forfeiting traffic. Nor, do they have to chance reducing overall gross profit dollars.

This section summarizes the major data sources related to the cigarette category:

Wholesaler connection - A good many retailers are unaware that, typically, they have signed a release that allows their wholesaler to provide each tobacco manufacturer with details of the retailer's weekly purchases, by-store and by-brand. The good news from this data conveyance program is that each major tobacco company should be using the same by-store, by-company and by-trade area data. See next item.

Manufacturer databases - Some of the tobacco manufacturers have made significant investments to develop virtual reservoirs from the data they receive from the wholesalers. Their databases are usually the source of suggestions to category managers from the tobacco company's representatives.

Using these data resources, including the mega by-store/by-company reports that manufacturers can generate, is helping many chains report double-digit growth in units this past year. They're not doing it by lowering their margins; they're doing it by analyzing under-performing brands and employing promotions to sell at least their proportionate share of each brand in each of their markets. This is one retail category where the "80/20" rule definitely does not apply. Out of stock means out of business!

REPORT EXAMPLE & DISCUSSION

COLUMN 1 2 3 4 5

SHARE OF MARKET (SOM) EST'd LOST CARTONS

PERCENTAGE PER WEEK

TRADE XYZ PER PER

LINE BRAND AREA CO VAR STORE COMPANY

1 ABC 10.65 4.00 -6.65 -10.0 -499

2 DEF 6.74 1.00 -5.74 -8.6 -431

3 GHI 6.68 4.00 -2.68 -4.0 -201

4 JKL 3.17 1.00 -2.17 -3.3 -163

5 MNO 4.00 2.00 -2.00 -3.0 -150

6 PQR 2.45 1.25 -1.20 -1.8 -90

7 STU 2.54 1.80 -0.74 -1.1 -56

8 VWX 1.63 1.50 -0.13 -0.2 -10

9 Totals - 8 Brands 37.86 16.55 -21.31 -32.0 4,863

10 Estimated # of carton customers forfeited (note 5) 4.8 331

11 Estimated # of pack customers forfeited (note 5) 74.6 5,146

12 Estimated total # of customers forfeited (line 10 + line 11) - note 6 79.4 5,477

13 Average sale per cigarette customer per referenced research $4.39 $4.39

14 Calculated per week sales forfeited from customers of above 8 brands $348 $24,045

15 Annualized potentially forfeited sales (notes 7) $18,121 $1,250,336

Note: this sample assumes a 50 stores chain with 150 average cartons per week.

Reminders for using this tool:

Change Cols 1 and 2 to chain's actual trade area data

Change 150 in Col 4 formula to actual average cartons for the area or company

Adjust assumed carton/pack % relationship used in Col 4 formulae (lines 10 & 11) to Chain's relationship

ASSUMPTIONS

Column 1 and 2 data can be obtained from manufacturer's databases.
Column 3 = difference between the company's share (Col 2) and the trade market area (Col 1)
Column 4 = a per store extension utilizing the average cartons sold in this area, factored against the variance in Column 3.
Column 5 = an extension of Col 4 times the number of stores in this example; i.e. 50 stores
For lines 10 & 11, this example assumes a carton/pack sale relationship in the company of 30/70%. The resulting calculation on line 10 was then factored by 50%, to be extra conservative in lost total carton customers. To continue a conservative approach, the resulting pack volume on line 11 is divided by 3 packs per customer instead of expected volume of 2 packs per customer.
For the reasons in note 5, Line 12 represents a conservative estimate of total forfeited customers.
In general, this manufacturer's model concludes that a chain who becomes competitive relative to the top eight brands above could increase their PER STORE WEEKLY customer counts by the amounts on line 12 and their PER-STORE WEEKLY sales by the amounts on line 15 (columns 4 and 5).
Line 13 from Convenience Store Shopping Market Analysis
Line 14 = Line 12 x Line 13
Line 15 = Line 14 X 52 weeks

Last year, in an effort to exploit the potential with the new NACS Category Management Guidebook, I collaborated with one of the tobacco manufacturers to understand some of the reporting "tools" available to their customers. The accompanying worksheet, which I modified with their permission, will apply to any retailer. If chains follow the suggested steps and utilize their own data (from the manufacturers' databases), they can determine their potential enhanced revenue from under-promoted brands.

Since some retailers have 5 and others have 50 or 500 stores, the relevance of this example should be viewed by Column 4, the "per store" data. When this chain examined their SOM for the top 8 nationally promoted brands they found themselves seriously lagging their trade area competitors. Lines 10 and 11 show them forfeiting about 5 carton and 75 pack customers per week, respectively. Notice how quickly these 80 new transactions adds to almost $21,750/year in sales per-store. Multiply that times the 50 stores in the example and its $1.5 million annual sales!

Using this example, what's the pre-tax profit of not carrying /promoting the top 8 brands? Considering the market-basket approach to estimating total sales impact, I used 30% overall gross margin for c-stores, about what NACS reported for 1998. Factored against $21,750 per-store lost sales, the pre-tax profit impact is about $6,500 per store (For 1998, the average pre-tax profit per-store was $35,600 according to NACS).

Other primary reports that I observed are outlined below. The report names may vary a bit between manufacturers or they may have more/less information and retailer value

Volume trending report - Absolutely required consumption for decision making. On one page the retailer views average weekly carton volume for the 12 most recent months and 12 months average, in a variety of compilations: by store, by company, by manufacturer, by full price or branded savings or private label, etc. It's a lot of information but it's presentation makes it easy to view opportunities.
Customer Satisfaction Level Impact - Calculates the total cost associated with losing a cigarette customer. The retailer can input their own assumptions, in terms of incremental sales and pack/carton ratio and number of stores. The model computes calculates estimated sales related thereto. Note: this was the model utilized for the modified illustration discussed above.
Charts - Look for average per store charts showing the trend of full price and branded savings. When the branded savings trend dramatically decreases as a result of an exclusivity program, regardless that full price increases, I recommend the retailer look closely at all their critical barometers including: total customer counts; total gross profit dollars from cigarettes; and total cartons. Category management is not about increasing one supplier's SOM, it's about improving the Company's bottom line!

Retailers are encouraged to be aggressive in seeking out all of the reporting capabilities available from each manufacturer. For those chains using the tobacco category as an introduction to more sophisticated category management techniques, as proposed by NACS' initial guidebook published in 1998, their investment in understanding smokers will reap multiple paybacks when studying subsequent merchandise categories.

SMOKER'S BUYING SIGNALS

The smoker is our industry's MVP (Most Valuable Patron). At minimum, therefore, these drivers are worthy of recall to marketers considering their tobacco CM options:

Convenience Store News Out of Stock Study 2/98:
1. Out of stock - 50% of smokers who face an out-of-stock will not substitute their desired brand
2. Value of forfeited customer - Consumers left after an average of 2.4 out-of-stock experiences. Unfortunately, these store switchers are valuable customers -they visit convenience stores an average of 5.6 times a week and spend approximately $5.12 per visit
Decisions and Actions in Cigarette Retailing - McLane 4/98:
1. Buying power - Cigarette purchasers also purchase other products 62% of the time. Additional purchases increase the average transaction by more than 70% above the cost of the cigarettes.
2. Destination prejudice - Cigarettes are a planned purchase 85% of the time.
3. SKU maximization - Stores lost volume if there was inadequate selection. The range of 200 - 250 SKUs appeared to be the point at which high volume stores differentiated themselves from average and low volume stores.
4. Won't come back - The cigarette consumer will switch stores before they switch brands.
Solution Selling - Philip Morris 6/97:
1. About traffic - The key to keeping these productive customers coming back is to make stores their destination for cigarette purchases, using a discipline approach to the five P's: Product, Presence, Position, Price and Promotions
2. About product positioning - Highly visible fixtures give smokers confidence a store has their preferred brand.
3. About smoker - Among items bought most frequently with cigarettes: soft drinks 35.5% of trips, dairy 16.3%, beer/ale 16.3%, candy and gum 14.7%, snacks 8.5% (PM sources this to ACNielsen Shopping Basket Study 9/95).

CLOSING COMMENT

Meyer & Associates is encouraged that retailers are aggressively embracing category management principles to become better merchants; this is great for the health of our industry. Our motivation for this report is our concern that, as we improve our offerings to the public that we: (a) keep our eye on the consumer - he/she "rules"; (b) that we not mortgage our futures for the sake of some short-term allowances; and, most importantly, (c) that we do our homework and make informed CM decisions that attract the maximum number of profitable customers to our convenient locations.