FADING LIKE SMOKE

R. MICHELLE BREYER

The tobacco wars continue to take their toll on supermarket retailers, who find it hard to sell cigarettes and related products in a charged environment of heavy taxation and government regulation.

Six months ago, Mad Butcher senior vice president Roger Burks called a meeting of his store managers to report that, nearly overnight, sales of an entire department had gone up in smoke. Rising prices, coupled with increased state and federal regulations, caused cigarette sales at the chain's eight stores to fall to a third of what they had been five years before.

While revenues from cigarettes once accounted for 4% of the chain's total sales, today that figure is closer to 1%, Burks said. In one week, lost cigarette revenues -- about $40,000 -- equaled the sales volume of one store. Cigarette profits dropped $100,000 last year.

"It's gone and it's going to get worse," Burks said. "We're looking at a category that may not even be around in five years," he said.

Burks' dire predictions notwithstanding, expenditures for tobacco products were $50.4 billion in 1997, up from $47.2 billion the previous year, according to the United States Department of Commerce Bureau of Economic Analysis, Washington.

But some supermarket retailers are feeling the pinch of the tobacco crackdown. In some states, including Arkansas and Texas, self-service cigarette counters are outlawed. Customers often must go to special service counters to purchase their cigarettes.

"These regulations have slowed down category sales by making it less convenient for the customer to purchase cigarettes," said Andy Carrano, spokesman for A&P, Montvale, N.J., where cigarettes account for 1% to 2% of total grocery sales.

At the same time, increased taxes have made cigarettes less affordable -- a trend that is expected to reduce consumption. Tobacco settlements in 46 states, which will cost tobacco companies about $246 billion over the next 25 years, created a price increase of about $6 per carton. In Virginia, the price of a carton of cigarettes jumped from $15 to $22 a carton. In Maryland, where cigarette taxes are higher, the price jumped from $20 to $27 a carton.

"There's no question that the percentage of the grocery basket going to cigarette sales has been reduced," said Brian Suher, managing director of Piper Jaffray, which follows such chains as Safeway, Albertson's and Vons.

President Clinton is seeking an additional 55-cent-a-pack cigarette tax. In January, Clinton also threatened a lawsuit against cigarette makers and an increased tobacco tax, which is meant to recover the tax dollars spent treating sick smokers who are medical beneficiaries under federal programs.

It is expected to be months before a suit is filed, but such an action could result in even higher cigarette prices.

In addition to higher prices, cigarettes have become more inconvenient to purchase, and this situation could worsen in the future.

Citing an alarming increase in teenage smoking, the Food and Drug Administration in 1997 began requiring clerks to verify the age of any buyer of cigarettes or smokeless tobacco who looks 27 or younger, to ensure that no one under 18 buys these products. The new regulations were meant to be the first phase of a three-part national crackdown on teenage smoking -- a plan that included the elimination of all retail self-service counters.

But last August, the majority of a three-judge panel of the U.S. Court of Appeals for the Fourth Circuit in Richmond, Va., ruled that the FDA has no jurisdiction to regulate tobacco products, reversing a prior decision of another district court.

The government is seeking review of the new decision by the full Fourth Circuit. In the meantime, until the court has the opportunity to rule on the rehearing request, the first phase of the FDA tobacco program remains in force. Thus, the FDA continues to enforce the age and picture ID provisions that went into effect in February 1997.

While there is currently no federal law, some states and cities have passed their own laws prohibiting self-service tobacco counters. In these states, all cigarettes and chewing tobacco must be merchandised and stored behind or underneath the sales counters and must be sold by a clerk.

"[In many states], it's up to each company or store to decide how they want to display cigarettes and smokeless tobacco products," said Ty Kelley, director of government affairs for the Food Marketing Institute, Washington. "Some may wish to restrict access, or they may want [the products] out so the consumer can see the different brands and styles that are available.

"We do know there will be a considerable amount of legislative activity affecting tobacco at the state level," Kelley said.

In addition to local rulings, the Clinton administration hopes to persuade Congress and the U.S. Supreme Court to give the FDA the power to regulate tobacco.

"They may rule in favor of the tobacco companies, or they may say that the FDA does indeed have authority over tobacco," he said. "If that happens, we're back to square one."

But not all retailers are feeling the effect of increased tobacco regulation. In some states, especially those that still allow retailers to offer self-service cigarette counters, little has changed.

"We haven't seen any change in our business whatsoever," said Steve Smith, store manager of Woodman's Food Market in Janesville, Wis.

When a Woodman's store in Madison moved cigarettes from its grocery department to the liquor department as a test to see how cigarette sales would fare if the government eliminated self-service, sales plummeted 30%. Not surprisingly, store officials decided they wouldn't expand the new merchandising program to other stores unless it became necessary. Since last year's court ruling put the brakes on the FDA plan, moving cigarettes is currently not an issue for the chain.

But many supermarket chains have developed different strategies to deal with declining cigarette sales and the potential for further regulation.

A handful of retailers have experimented with segregating tobacco products in separate areas or even creating separate stores to restrict access to those of legal age. These "tobacco shops" may offer a wide selection of other products in addition to cigarettes, from candy and mixers to magazines and premium cigars.

"It's an opportunity for a grocer to [put a] problem area into a controlled environment," Piper Jaffray's Suher said.

One of the most successful applications of this strategy is The Great Alaska Tobacco Co., a concept launched two and a half years ago in Anchorage, Alaska, by Carr Gottstein Foods.

Even before November 1998, when Alaska became one of the states disallowing self-service, Carr Gottstein decided to move most of its cigarettes out of its supermarkets and into a 24-hour, controlled environment, said Richard Watts, general manager of Great Alaska Tobacco. All patrons must be at least 19 years old. In addition to restricting access to minors, these stores have the secondary effect of reducing theft of cigarettes -- the category with the highest shrink rate in many supermarkets.

"When the law changed, we were ready," Watts said. "We became the place to buy tobacco for people of legal age. Sales have been awesome."

Since the addition of the stores, Carr Gottstein has seen its total cigarette sales volume double in Alaska. Sales increases at Great Alaska Tobacco stores have been in the triple digits since the units opened.

Initially, there were two Great Alaska Tobacco stores. Today there are seven, with another three on the drawing board. Most of the stores, ranging from 400 to 1,200 square feet, are next to or in the same shopping center as Carr Gottstein stores. The one freestanding location, in Sodotna, Alaska, has the second-highest volume of all stores in the chain.

Most carry more than 300 cigarette brands, including a large selection of imported brands. The stores also sell 300 different types of premium cigars, including 40 imported brands. Two of the stores have walk-in humidors. The units also stock gum, candy, soft drinks, cigar accessories, cigar apparel, humidors and high-end lighters and have recently expanded into sports apparel.

Watts believes stores like Great Alaska Tobacco are better positioned to compete with the growing number of discount cigarette stores and specialty smoke shops -- stores with names like Butt Hut, Cigarettes Cheaper and Pappy's Tobacco Road. Many supermarkets have lost cigarette sales to these smoke shops. Nationwide, there are an estimated 4,000 smoke shops, which offer a friendly atmosphere and competitive prices to a smoker who has found both these attributes in short supply at traditional retailers.

"When the tobacco user came into our store, it was the first time [he or she] was treated like a normal citizen without being discriminated against," Watts said.

Great Alaska Tobacco also boasts the lowest cigarette prices in town. But future expansion of these tobacco shops is dependent on what happens after the merger with Safeway is completed.

In some cases, retailers are looking for non-tobacco forms of revenue to make up for lower cigarette sales.

It has been a challenge for Mad Butcher, Pine Bluff, Ark., which saw sales drop $3,200 a week at one of its stores. Considering the small-town store did a total of $60,000 a week, that kind of revenue is difficult to make up.

The chain considered putting tobacco products in a separate room, but with stores ranging from 18,000 square feet to 26,000 square feet, there wasn't any space to work with.

"Instead, we looked at where we had weaknesses," Burks said.

The chain has since added pizza shops to some of the stores. Another location got a bakery and an expanded deli. The entire chain has put a greater emphasis on perishables, candy, chips and soft drinks. The stores also have entered new categories, by selling watches, calculators and organizers.

While these efforts have helped, they haven't made up for the losses incurred by falling cigarette sales, Burks said.

"We didn't realize how good the cigarettes really were," Burks said. "We're talking about a department with higher sales than produce. They didn't take up much room and they generated so many dollar sales. Maybe we just took them for granted."