Dark days for the US cigar industry

The recent tax increases combined with the effect of public smoking bans have provoked unprecedented gloom in the world’s biggest cigar market.

A number of comments from the US cigar industry confirm its vulnerability to the spate of public smoking bans and the recent hammering in the tax hikes following the passing of the SCHIP Bill.

According to Norman Sharp, president of the Cigar Association of America (as quoted in USA Today, July 30th) “I can’t even use the words ‘cautiously optimistic’, these are dark, dark days”.

Dan Carr, chief operating officer of General Cigar, supported this pessimistic view with numbers. He stated that cigar sales overall had “dropped between 10% and 15% in the past year”.

The general tobacco products industry context for these remarks is a relentless fall in volume each year – around 3-4% per annum in the US cigarette industry (though moist snuff consumption has been increasing by up to 7% per annum).

There had been a view that cigars might prove more robust than cigarettes, firstly as the primary luxury segment of the tobacco products industry with large and premium cigars, and secondly, through the appeal of cigarillos as a cigar-like cigarette with a tax advantage. But this does not seem to be proving to be the case.

Lack of competitive advantage

Cigarettes, as an industry, have fallen back on pricing strength (ie the ability to raise prices) as a way of keeping profits rising when volumes are falling but the cigar business lacks the competitive advantage and dominant market positioning to do the same. Innovations such as ‘eco-cigarillos’ (basically cigarettes taxed as cigars) in Germany enjoyed success for a time but only with the tax advantage in place – once it disappeared so did they.

Another problem for the industry is that cigars are, if anything, more vulnerable to public smoking bans than cigarettes, particularly when these bans extend to restaurants and bars. This is because most cigars are made to be enjoyed in a more relaxed way and over a longer duration than cigarettes.

Quick blast inimical to cigar style

The cigarillo can be used like a cigarette for a swift nicotine hit outside the bar or restaurant (or public building, or entertainment venue, etc) but most of the cigar market, in value terms, is not cigarillos: the main value of the cigar market in most countries, (even including the US, where according to Euromonitor International over 5 billion cigarillos were smoked in 2008), is in cigars which are longer and fatter than cigarettes and which take longer to smoke.

US cigars market by sector 2008
value US$

Source: Euromonitor International.

There is also something inimical to the style of the product in the ‘quick blast’ mentality: the smoker of a hand-rolled luxury product like a Cohiba or Macenudo is not usually to be seen standing alongside the line of smokers on a downtown street.

Double whammy

In the US it has been estimated by the American Non-Smokers’ Rights Foundation that 17,000 cities have now banned smoking in public buildings, workplaces, restaurants and bars. As part of the double whammy hitting the cigar smoker in the pocket as well as the location, tobacco tax increases are imminent in 34 states.

For many years cigars have escaped ‘under the radar’ in terms of tax increases because of an unstated and scientifically unsupported conviction that they are less unhealthy than cigarettes, mainly for the reason that one does not inhale directly when smoking a cigar as when a cigarette is smoked. However, in the US and Germany, the two largest cigar markets in the world, the playing field is being levelled.

Tax hits cigars harder

In the US, the recent round of Federal tax increases hit cigars harder than cigarettes to make up for the soft treatment in the past: the tax on large cigars rocketed up from 5 cents to 40 cents on April 1st 2009, while small cigars were clubbed by a tax increase of US$1 per pack. According to reports, Flor de Gonzalez Cigars stated that its tax bill per shipment rose from about US$5,000 per 100,000 cigars to more than US$40,000 and the effect on the industry is already evident.

The most important casualty to date has been the Hav-a-Tampa plant in Tampa, which is to close and has already begun laying off its workforce of 500 employees. Rumours abound that other companies may also be forced to make cutbacks.

Gloomy outlook

And the gloomy outlook for the operating environment of the US cigar industry is not improving: according to reports, about 100 bills have been filed to date in 2009 in some 34 state capitals seeking to further increase tobacco taxes. According to the National Conference of State Legislatures, at least 12 states have already passed tobacco tax increases in addition to the federal tax, and 25 more states are considering them.

According to General Cigar, which claims a 30% share of the US cigar market (excluding cigarillos), the company’s industry-wide analysis shows that cigar smokers are either buying fewer cigars or quitting the habit.

The biggest impact of the federal tax hikes in the US was on small cigars – the US$1-per-pack tax increase was proportionately a far bigger hit than that on premium cigars: an increase from 5 cents to 40 cents on products selling for US$20-30 is not as bad and it is likely that socioeconomic group that smoke these products will be less sensitive to the rise. However this means that the main impact is on the mass market end of cigars, and the last thing the industry wants is to be pushed from mass to niche market.

Good but no cigar

The hand-rolled cigar is perhaps the most iconic of all tobacco products, with associations in the consumer mind evoking wealth, luxury, worldly success, celebration and numberless luminaries from Winston Churchill to Groucho Marx.

This is not likely to change. However, the danger is that the combined effects of public smoking bans, tax equalisation with cigarettes, and fall-out from the explosive, health-driven attacks on the tobacco industry by the tobacco control lobby, could drive the industry from mass market to niche market. And, as everyone knows, in global FMCGs (and cigars are more a regional than a global market, being concentrated in North America and Western Europe) it is a short step from niche to tomb.