Adapting to Regulatory Changes: Smoker Friendly’s Strategic Response

With the arrival of a Democratic majority in Congress and a Democratic president, Smoker Friendly and the rest of the tobacco industry expected a much more hostile reception in Washington, DC, but had no notion what the impact of two big changes in 2009 would be. The first was the continuation, after three vetoes from the Bush administration, of the State Children’s Health Insurance Program, or SCHIP. The program was expanded by $40 billion entirely on the back of the tobacco industry, increasing the cost of some categories by as much as 3,000%. This expansion went into effect in April.

The second was the long-expected move to put regulation of the industry under the FDA, which went into effect in June. Industry leaders expect tobacco manufacturers will be hit with nearly $8 billion dollars in fees as a result of this change.

“In late 2008, people knew these changes would likely be coming, but had no idea of the effect, especially with the economy in a free fall,” said Terry Gallagher, president at Smoker Friendly. “Some were predicting a 5% drop in unit sales, but others went as high as 18%.”

Plan of action

Luckily, Terry, his brother and vice president of operations Dan, and their team developed a plan to insulate Smoker Friendly as much as possible. That plan required two major shifts in the company: closing corporate-owned stores and redistributing responsibilities to maintain a high level of service.

The company began monitoring stores closer than ever. Dan said there were none losing money, but ultimately 15 weren’t supported enough to risk over-extending the company in a period of uncertainty. That move brought the company down from 100 to 85 locations across the Mountain and Midwest states.

The next adjustment the teams at Smoker Friendly made were to push middle managers’ administrative duties up to the corporate office, giving them more time to take a greater role in the field and supporting customers.

“We saw what happened at Circuit City: the company went through a massive layoff, eliminating expensive but highly skilled employees, which brought service down and ultimately contributed to its demise,” said Dan. “We made sure to keep those people who had been with us the longest and knew this industry so the service our customers expected wouldn’t change.”

Once the changes at the federal level were filtered down, Smoker Friendly saw its best-guess predictions come true: it suffered about a 7% loss in unit sales. But its steps to prepare allowed it to maintain a relatively strong position through the end of 2010.

Dan added that another key element of the company’s preparation was increased communication with customers at the store level. Smoker Friendly’s new POS, rolled out in 2008, included a small customer-facing display screen that was the perfect tool for encouraging customers to lobby the federal government against the expansion of SCHIP and then educating them about the changes it brought about when it was ultimately passed.

“This helped prevent sticker shock on April 2 when our customers came in and saw their brands increase by eight or nine dollars in some cases,” said Terry. “And many manufacturers have changed their product lines or added new offerings that we were able to tell our customers about.”

Partners through thick and thin

These are just two of the latest ways the tobacco industry has changed in the last decade; Terry and Dan emphasized that a key value at Smoker Friendly is the ability to turn on a dime and adapt quickly. But for them, such a challenge provides many worthwhile opportunities.

“These changes at the federal level have made it more difficult for grocery or drugstore retailers to stay in the sector; many have reduced or cut out their tobacco offerings just to save the headache. But we’re dedicated to this industry and think there are great opportunities to dominate this niche market,” Dan said. He added that, because of the raising costs, many smokers are evaluating their options and branching out from traditional cigarettes into cigars and other smokeless tobacco products manufacturers are currently introducing to the market.

For example, Smoker Friendly’s 20 walk-in humidors and six full smoking lounges are seeing increased traffic these days, and the company plans to add another two or three lounges in 2010 as real estate opens up.

And though the Gallaghers are hopeful concerning organic growth in the next year, they are putting a great emphasis on growing Smoker Friendly’s network of authorized retailers. Currently, 750 independent tobacco retailers carry the company’s private label brand of cigarettes, cigars, and other products, which gives them a powerful point of difference to the value-conscious tobacco consumer. Terry said the company is currently targeting convenience stores outside of its main geographic footprint, and highlighted the 120-store Daily’s chain based out of Tennessee.

He added that much of Smoker Friendly’s success comes from its long and healthy relationship with the manufacturers it works with.

“We pride ourselves on our close partnerships and aim to be a place that welcomes tobacco manufacturers,” he said. “We love serving as a testing ground for new products or services as it helps our partners develop and provides our customers with the latest in the industry.”

Dan added that such relationships are also important to survival during this period of flux. “There is a lot of opportunity, but success requires a willingness to work together to overcome the challenges ahead.”