Discount basic cigarette

Conventional wisdom dictates that a 1 percent hike in the price of cigarettes will generally lead to a decrease of about one-quarter of 1 percent in cigarette consumption, according to management consultants. So at a time when sin taxes have pushed cigarette prices to over $5 a pack, and the category itself is all but flat overall, how can sales in the drug channel be trending up at almost 13 percent, and flirting with the $2 billion mark, according to AC Nielsen? (For more see chart.) It would just seem to defy conventional wisdom.

Unless, of course, you take in to account the dynamics of the drug store cigarette shopper--then a few clues come to the surface. While it may be too early to tell what the real effects of higher cigarette taxes may be on consumption, there are certain factors that have contributed to the recent advances by the drug channel.

First, the cigarette shopper in drug is predominantly a per pack customer. Relatively speaking, drug stores never sold a lot of cartons. And that has made a big difference.

According to numbers provided by RJ Reynolds, in 1998 drug stores sold about 83 cartons of cigarettes per week as compared with a little more than 200 cartons a week in the food channel, and more than 275 in discount. That year, carton sales outpaced per pack sales by more than 2-to-1 in mass. In the food channel carton sales represented about 70 percent of all cigarette sales, in direct contrast to drug, where the ratio was more or less reversed--70 to 30, packs to cartons.

In addition, the carton piece of the cigarette business has come under attack by a relatively new, and steadily emerging class of trade, the cigarette/tobacco store outlets. By summer, discount cigarette store outlets numbered about 6,500 locations throughout Arizona, California, Idaho, Illinois, New Mexico, Nevada, Oregon, Texas, Washington and Wisconsin, according to figures compiled by Tobacco Outlet Business. Further, the lower prices offered by such stores have been known to bring smokers--particularly carton purchasers--across state lines to stock up. The numbers bear this out. These stores can average sales of more than 820 cartons per week.

There aren't any new channels of distribution competing for the per pack cigarette customer. That business belongs to drug, small food stores and convenience stores.

But moreover, there are a couple of other factors that favor the per pack business. First, per pack customers tend to be the most loyal--both to their brand as well as the store that always, has it in stock--purchasing about four to six times a week. It is a SKU-intensive business, requiring roughly 250 to 300 different SKUs to satisfy about 95 percent of all customers. But it is a customer worth keeping. About 64 percent of pack purchasers usually buy something else, according to market basket analysis.

And beyond the basic attributes, of the per pack purchaser, there seem to be more of them than ever before, according to Yale professor Klaus Wertenbroch, Ph.D., of the university's school of management.

In a study, entitled "Consumption Self-Control by Rationing Purchase Quantities of Virtue and Vice," Wertenbroch concluded that sophisticated strategies employed by consumers to cut back on certain items they deem bad for themselves--such as cigarettes and fatty foods--have led to higher profits for big tobacco and other industries. For example, many smokers attempt to cut down by buying cigarettes by the pack instead of the carton, much the same way a dieter might try to buy smaller servings of "forbidden" foods.

Certainly, this kind of unconventional thinking on the part of the consumer has helped to defy conventional wisdom on sin taxes and consumption as it relates to the cigarette business in drug stores. Current factors favor the per pack business, and that is where the drug store traditionally competes.