Robust profit margins in the e-cigarette segment face pressure from federal regulators in addition to being squeezed by recent U.S. tariffs against China.
By Anne Baye Ericksen, Contributing Editor
At midnight on Aug. 23, the second tranche of President Trump’s tariffs officially took effect, levying a 25% tax on 279 products from China, including electronic nicotine delivery systems (ENDS).
While politicians, pundits and economists argue about the diplomatic and trade value of such actions, convenience store and vape shop owners and operators brace for the probable financial fallout.
“It definitely will have an effect on profit margins, but to what extent I’m not sure yet,” said Tim Greene, category director of tobacco and general manager for the Cigarette Store Corp., dba Smoker Friendly. Based in Boulder, Colo., the business owns more than 100 retail sites, including Gasamat convenience stores.
“It’s nerve-wracking because we don’t know what’s going to happen with vaping and e-cigarettes,” added Anna Bettencourt, senior category manager for VERC Enterprises, which operates 26 convenience stores in Massachusetts and New Hampshire.
As a double whammy, the U.S. Food & Drug Administration (FDA) Commissioner Scott Gottlieb on Sept. 12 mandated the manufacturer of JUUL, British American Tobacco’s Vuse, Altria’s MarkTen XL, Imperial Brands’ blu and Japan Tobacco’s Logic submit details on how each will confront and prohibit youth access to and use of their products. The companies have 60 days from the original announcement date to comply or face the possibility of the FDA removing their items from store shelves.
According to the FDA press release, “This could mean requiring these brands to remove some or all of their flavored products that may be contributing to the rise in youth use from the market until they receive premarket authorization and otherwise meet all of their obligations under the law.”
Concerned entities have argued that fruit, dessert, tropical and candy e-liquid and nicotine salt flavors encourage underage vaping. Consequently, numerous cities and states have proposed and/or passed bans on flavored tobacco products, San Francisco being the most recent.
“We’re also fully committed to the concept that products that deliver nicotine exist on a continuum of risk, with combustible products representing the highest risk, and electronic nicotine delivery systems perhaps presenting an alternative for adult smokers who still seek access to satisfying levels of nicotine, but without all of the harmful effects that come from combustion,” said Gottlieb. “But in enabling a path for e-cigarettes to offer a potentially lower-risk alternative for adult smokers, we won’t allow the current trends in youth access and use to continue, even if it means putting limits in place that reduce adult uptake of these products.”
A company spokesperson for JUUL, which was mentioned specifically by Gottlieb, issued the following statement soon after:
“JUUL Labs will work proactively with FDA in response to its request. We are committed to preventing underage use of our product, and we want to be part of the solution in keeping e-cigarettes out of the hands of young people.”
“Our mission is to improve the lives of adult smokers by providing them with a true alternative to combustible cigarettes. Appropriate flavors play an important role in helping adult smokers switch,” the spokesperson added. “By working together, we believe we can help adult smokers while preventing access to minors, and we will continue to engage with the FDA to fulfill our mission.”
TARIFFS TIMES THREE
What’s more, the president has proposed a third round of tariffs for later this fall.
“The third tranche originally had a 10% tariff on e-cigs, but the Trump administration recently signaled it could increase it to 25%,” said Gregory Conley, president of the American Vaping Association.
So how did e-cigarettes get caught up in an international trade war? The U.S. government classified ENDS as “other machinery” for the second tranche. The reason why the convenience store industry is concerned about this designation is that an overwhelming majority of e-cigarettes are manufactured in and imported from China. The U.S. General
Accountability Office states 91% of the $342.3 million customs value of e-cigarettes in 2016 came from China. U.S. News & World Report referenced a claim by Shenzhen officials that more than 100 companies in the southeastern region of China manufacture 90% of all e-cigarettes sold around the world.
Under the tariff mandate, e-cigarette devices brought into the country will be taxed 25% by U.S. Customs and Border Patrol. That added cost almost certainly will be passed on to distributors, who then will increase charges on retailers. As of late summer, price hikes had not yet been realized, however, c-store owners and operators expect them soon.
“Retailers are getting notices that wholesale will increase 20-25% because distributors are not importing a year’s worth of product at a time. They bring in enough product to keep customers satisfied for a month before importing more,” said Conley.
“If the trade war is prolonged, we could see some stores shut down. Already we have states where retailers feel the effects of increased taxation,” he added. “For example, if you add a 25% tariff on top of the 40% wholesale tax in Pennsylvania, you’ll see more consumers go online in hopes of saving a few bucks. That’s bad for growth.”
It’s also a challenge to profit margins.
“The margins are good, but not good enough to absorb price increases,” said Bettencourt.
Therefore, consumers ultimately could end up bearing the overall cost. Last month, the Annals of Internal Medicine published a study indicating nearly one out of 20 adults in the U.S. use e-cigarettes.
A prolonged period of sales growth starting in late 2017 could temporarily buffer losses caused by tariffs. The e-cigarette category has been performing so strongly that Wells Fargo Securities bumped up its annual projection to an estimated $2.33 billion based on statistics pulled from Nielsen-tracked channels—a spike of $1 billion more than last year.
For the four weeks ending Aug. 11, JUUL maintained its lead with more than 837% growth in unit sales, according to Wells Fargo Securities. MarkTen claimed second place with an increase of more than 686%. Its companion MarkTen XL Bold gained 128% and even NJoy grew unit sales by 53%. The only major brand to report a loss in unit sales was Vuse.
“Pod systems have revolutionized the category,” said Greene. “There’s been a shift from open systems to pod systems. Users are getting their nicotine delivery out of a more simple and smaller device and it’s had a great influence.”
E-cigarette manufacturers are banking on this trend to stick around. Several Big Tobacco players have released new designs and updated models. Earlier this year, Imperial Tobacco introduced myblu. Both Greene and Bettencourt added it to their inventories, but agree it’s too soon to effectively gauge whether it presents a competitive challenge.
“They did a promotion with a starter kit for $1, so it’s too early to say how well It’s really doing,” said VERC’s Bettencourt.
“It’s been marketed hard throughout the summer, so I don’t know how good the customer response really is,” added Greene.
Also, R.J. Reynolds Vapor released Vuse Alto in August with plans for nationwide distribution in November.
“It’s a bigger pod and the nicotine level is there. The price point is good and the margins are there for retailers. I think Reynolds will market the hell out of it,” said Greene.
Various groups and policymakers have voiced concerns over e-cigarettes used by middle and high school-aged youth.
Also, more and more lawmakers are pushing to raise the minimum purchasing age.
According to the National Association of Convenience Stores, approximately 350 cities, towns and counties have enacted 21 as the minimum age. In July, Massachusetts became the sixth state to pass 21, taking effect in January 2019.
“But there’s a grandfather clause for those who turn 18 before Dec. 31 unless the town is already 21. It’ll be interesting because we might see some local activity before January to change the age to 21 where it has not already been done,” said Bettencourt.
But even with all that, what keeps Bettencourt up at night is making sure her stores have adequate space allotments for the popular category.
“There’s a buzz of what’s coming down the road. I’m trying to figure out where to put new products and how to reallocate space,” Bettencourt said. “It may make sense to take space from other categories.”