n Wholesalers and independent retailers are damned if they raise cigarette prices and damned if they don't, as Ed Bedington reports Most wholesalers and smaller retailers are as reliant upon tobacco as a heavy smoker. Cigarette sales form a large part of their sales ­ up to 25% for some independents ­ yet they both share a measly 8% profit on the price of a pack. But even though none of them are making any money out of tobacco, there is very little that can be done. The reason is simple. As every trader knows, almost 80% of the cost of a packet of cigarettes is tax, so the lion's share of the profit in this business flows to the government. But the government is not alone in making money. As a consequence of the high price of cigarettes and rolling tobacco, smuggling is a flourishing and highly profitable business. At the same time, the legitimate trade is faced with ever higher rates of duty ­ which in turn feeds demand for contraband ­ while the abolition of forestalling ­ stocking up on cigarettes before a budget and selling them at the higher post-budget price ­ has effectively destroyed margins in the wholesale sector. Indeed, cash and carry operators are now making little, if any, profit on the tobacco they now sell. But few are prepared to put up prices, fearing such a move would drive retailers into the arms of rivals. Booker md Gerry Johnson recently confirmed that despite the fact the country's top C&C group does £1.2bn of its business in tobacco a year, it makes nothing in return. He said it was as lot of effort for little return and promised to talk to suppliers in a bid to find a solution. Booker is now keeping quiet about those talks but, whatever the result, there are obstacles that must be overcome for any improvement in the situation. One of Johnson's contempories, David Gyles, md of specialist tobacco wholesaler DG Wholesale, says he makes about 6p on every outer of 200 cigarettes sold for about £35. "For wholesalers to get back to the position they were in when forestalling existed, they would have to add 12p onto every outer. To make only a few pence on a £35 sale is ridiculous. But putting prices up means you are also squeezing the margins of the retailers." There are also the hidden costs of security and insurance, because cigarettes are targets for thieves. Gyles adds: "An insurer isn't interested in how many tins of beans you may have, all they want to know is how many cigarettes you stock." Despite these obvious drawbacks, wholesalers and retailers have no choice but to stock tobacco. It all boils down to demand. In recent trading figures, Booker attributed its like-for-like sales growth of 2.7% to strong tobacco sales, underlining the important role tobacco plays in its business. "It's a vital part of any cash and carry operation," agrees Gyles. "If we didn't do cigarettes, then retailers would not buy other products from us, they would just go somewhere else. You can make money, but you have to be careful. You have to be very tight on stock control and eliminate shrinkage. A wholesaler who doesn't sell cigarettes would not be in business for very long." And the same is true for retailers. Cigarettes are seen as the key footfall driver ­ they bring smokers into the shop who then buy other products as well. Southampton retailer and spokesman for the Tobacco Alliance, Paul Mason, says: "They're essential to my business, I'd be a fool to say I could stop selling them. If I haven't got them in, then Mrs Smith is more likely to go somewhere to buy her cigarettes, newspaper and pint of milk. We have to bite the bullet and take the lesser margin." Mason believes the only way retailers can make more out of tobacco is by selling in greater volumes. But stocking larger amounts increases the initial outlay as well as costs and makes them a more attractive target for thieves. Jerry Marwood, MD of the Newshops chain, is philosophical about the problems. He says: "Cigarettes put us in the market for smokers, who are a large part of the population. But there are a number of products that we sell for low margins, and cigarettes are just another part of the mix. "By far and away the biggest issue we face is smuggling. In our sector, when smuggled cigarettes are available locally, our sales drop off considerably. Smuggling is seen as a clever crime, a bit like fiddling your tax returns. But local retailers bear the brunt." Buying smuggled cigarettes is not a harmless activity, as Imperial Tobacco's sales director Geoffrey Couchman points out. "Serious organised crime is behind cigarette smuggling. There's a well organised chain and often the product goes through several ports to hide the trail. And if you're caught, it's a lot less risky than bringing in drugs, it's almost just a slap on the wrist in comparison." Smuggling affects the whole industry ­ about one in three cigarettes smoked in the UK are smuggled, resulting in a loss of nearly £3bn in duty to the government. It has finally responded by granting £209m extra funding to Customs and Excise to fight the bootleggers, although no targets have been set (see over for more details). Customs also introduced duty marking on tobacco products this year. Unfortunately that has a limited effect on the smuggling problem. Sure retailers are less likely to try to sell contraband. And while the initiative created massive headaches for the independent trade, it has done nothing to deter the smugglers from selling their wares down the pub. And the Tobacco Alliance's Mason believes the extra investment in customs does nothing to solve the problem for retailers either because the demand for cheap cigarettes remains. "We are unpaid tax collectors for the government. We sell them at very little profit to get people into the shop, or they can go and buy them down the road, half price from a smuggler. The only people making money out of tobacco are the government and the bootleggers. We're not making anything out of it by selling them legitimately." Thanks to duty marking, any retailer tempted to sell non-kosher cigarettes faces a £5,000 fine, and would also lose another footfall driver in the form of their lottery terminal because Camelot also takes a hard line. The situation looks bleak for those involved in the tobacco trade, so is there anything that can be done to restore some kind of profitability to the industry? In short, no. As far as the government is concerned, it has ruled out any reduction in duty to achieve that. A spokesman for the Treasury says: "The government will not let criminals dictate health and fiscal policy. Cutting duty rates would be contrary to the government's health objectives." Yet despite these health objectives, manufacturers claim cigarette consumption is on the increase ­ but on the illegitimate side. Imperial Tobacco's Couchman says: "The legitimate consumption of cigarettes has gone down, but the absolute consumption has gone up. The government aims to reduce smoking by taxation for health reasons, but it's actually increased it, making it counter productive." While the government remains hard line, manufacturers, wholesalers and retailers are left between a rock and a hard place ­ and some businesses are responding by putting up their prices. DG Wholesale's Gyles says cash and carries are merely passing the problem along to the retailers by raising prices. "Wholesalers need to get their margins up, but then we are squeezing the retailers' margins, and where do they go?" Nobody likes to talk about it, but retailers do benefit from extra sales of tobacco accessories such as the rolling papers bought by those who smoke contraband tobacco. But this does not offset the lost business. So premium pricing of tobacco and cigarettes is something that is becoming more and more common according to Imperial Tobacco's Couchman, with retailers adding anything from a couple of pence to 20p onto a pack. But he says this is far from ideal. "We estimate around 20% of retailers do this, but you're then dealing with the laws of diminishing returns as customers might pay the price once, but won't come back." And by raising the price you're playing into the hands of the smugglers. So the entire tobacco industry is in a Catch-22 situation. As Couchman says: "There's no quick fix for retailers to make more money." {{COVER FEATURE }}