Six Thoughts: Altria’s Premium Cigar Exemption Stance

On Tuesday, Cigar Aficionado published an article that made the final 24 hours of my vacation a lot less enjoyable. It also made the lives of every single employee of Nat Sherman’s cigar division a lot less fun.

That article is one regarding Altria—the second-largest tobacco company in the world with brands such as Marlboro, Virginia Slims, Copenhagen, Skoal and more recently, Nat Sherman.

The article, accurately, pointed out that as part of the U.S. Food & Drug Administration’s (FDA) recent Advanced Notice of Proposed Rulemaking (ANPRM), Altria—like many others—had submitted comments regarding whether the agency should reevaluate the regulation of premium cigars.

If it’s not clear by the headline—America’s Largest Cigarette Company Comes Out Against FDA Exemption For Handmade Cigars—Altria’s letter, written by Jose Luis Murillo, is not in favor of FDA granting an exemption for premium cigars.

That article—perhaps more than any other in recent memory—has generated a lot of commentaries. Many of them, if not most of them, have been people—ranging from manufacturers to retailers to consumers—expressing their displeasure with Altria and oftentimes to not purchase Nat Sherman products ever again.

I certainly understand people’s outrage if they only read Cigar Aficionado’s article or someone’s comments about said article on social media. However, that outrage—particularly towards Nat Sherman’s cigar division—seems generally misguided if you are able to factor in a few key facts.

For a controversy that probably didn’t need to be one, this subject has been talked about enough. As such I have some reservations on both commenting on editorial decisions by Cigar Aficionado and furthering a conversation that I don’t think needed to happen. However, much of that conversation has been missing essential context, some of it very elementary facts, other educated speculation.

So here they are, my thoughts on this mess, which ruined an otherwise calm Tuesday of vacation:

1. ALTRIA BEING OPPOSED TO PREMIUM CIGAR EXEMPTION IS NEITHER NEW NOR NEWS

When I first saw the Cigar Aficionado post my reaction was “meh, that’s not news.”

As we noted in 2016, Altria submitted a letter as part of the 2014 deeming regulations process that argued against an exemption for premium cigars. The concept that Altria is against premium cigar exemption is by the very definition, not news.

2. ALTRIA’S 2018 POSITION IS BETTER THAN ITS 2014 POSITION (AND THAT MIGHT BE NEWS)

What might be news is the story beyond the headline.

Altria’s stance in 2014 was that FDA should not exempt premium cigars. The position in 2018 is that FDA should not exempt premium cigars, but it should regulate them differently. The nine-page document from this comment period is far friendlier to the premium cigar industry than the original 2014 document, which made no mention of supporting differential—and easier—treatment.

Perhaps most problematic to Cigar Aficionado‘s article—and much of the commentary since, including Michael Herklots’ statement—is that there is been essentially zero mention of Altria’s original 2014 letter, let alone the differences between the two.

While the main takeaway probably should be Altria has softened its position on premium cigars, it’s also worth spending time looking at the individual proposals for what Altria thinks a different type of regulatory system should be. I would be hard-pressed to believe that if you told people in the cigar industry this is what FDA is going to do with cigars next that most people would not consider it a big win.

3. A REASON ALTRIA IS OPPOSED TO EXEMPTION

Despite the article and the commentary that it’s generated, there’s been essentially zero discussion of why Altria takes this stance. It’s not mentioned in the original Cigar Aficionado article, or here, here, here or here, The closest I can find was Kaplowitz who wrote, “they put their best interests ahead of their industry’s.”

Kaplowitz argues that Altria can afford regulation, while others cannot and that would put competitors out of business. None of that is false: Altria can afford the costs of regulation, some companies will not be able to afford it. However, I don’t think that’s why it took the position it did. (This would also be an example of where reading Altria’s actual letter would be helpful, as Altria argues for the softening of many of the most burdensome restrictions, but I digress.)

My guess is there are many reasons why Altria—and other mass market companies—are opposed to exemption, but the easiest one to point to is user fees.

As part of the Tobacco Control Act, Congress established the FDA’s Center for Tobacco Products (CTP), a division responsible for regulating tobacco. That division is funded by user fees, which are paid by six different types of tobacco products: cigarettes, cigars, snuff, pipe tobacco, chewing tobacco and roll-your-own tobacco.

Products under those six categories are subject to user fees, which are calculated by taking a total amount of money allocated for CTP, a number that is set by Congress, and dividing it based on the amount of federal excises taxes, sometimes known for cigar as SCHIP, a company pays compared to the rest of the products in those six categories.

For FY2018 the total amount allocated for CTP is $672 million, of which cigars—both premium and otherwise—are responsible for just under 10 percent, or $66.4 million.

Mass market cigars, which account for over 95 percent of all cigars sold in America, include brands from Altria (Black & Mild), Swisher International, Imperial Brands, plc (Phillies/Dutch Masters/Backwoods), Swedish Match (White Owl) and others. All of those named companies have premium cigar interests except Swedish Match, which previously was an owner of General Cigar Co. and Cigars International, but has since divested.

While mass market cigars might be 97 or 98 percent of the volume of cigars sold, they don’t account for 97 percent of the user fees paid to FDA. Because of how cigars are taxed at the federal level—52.75 percent of the wholesale price, capped at 40.26 cents per cigar—premium cigars pay a much higher percentage of the total dollar amount of taxes than the volume or even sales would indicate. My guess is that premium cigars pay at least 10 percent of excise taxes and thereby extension user fees, but it’s probably closer to 20 percent and maybe as high as 25 percent.

If cigars were to be exempted, the total amount of user fees the cigar category paid would not change, that number would still be $66.4 million. However, premium cigar companies wouldn’t be liable for paying any part of the $66.4 million, rather, the mass market cigar companies would be forced to make up the difference. This would likely go on for at least one fiscal year, potentially as many as two years, but eventually would be adjusted.

Now, Altria generated $25.57 billion dollars in revenue last year. So a fraction of $66.4 million is inconsequential, but so is Nat Sherman’s profit on premium cigars. It’s very likely that in same period of time Altria would stand to lose more money in the adjusted user fees than it would make on Nat Sherman premium cigars. Furthermore, there’s no evidence that would suggest that exempting premium cigars would increase sales of Nat Sherman cigars.

So yes, Altria is putting its interests ahead of the industry. That’s no different than what many companies have done, including all those that support a definition of a “premium cigar” that excludes flavored cigars like ACID, Java and others. In the midst of all of the FDA fight, there are very few companies that have taken stances that are harmful to their own bottom line in favor of their competitors in the collective industry.

4. I’M NOT SURE ALTRIA IS WRONG

I went to school on a campus built on the R.J. Reynolds estate. While there, I took classes that looked at the impacts the company had on the city of Winston-Salem and its people. Some of that focused on the regulations—specifically the 1964 Surgeon General’s Report and the Master Settlement Agreement—and how it not only affected RJR, but Winston-Salem as a whole.

What I learned pretty early on is that the company—and the other major cigarette companies—learned from the mistakes of the mid-20th century. For a couple decades they tried fighting the government at every turn: Congress, the courts, the court of public opinion, etc. That changed dramatically when Congress banned cigarette advertising in the early 1970s.

Eventually, the cigarette companies learned that they couldn’t win individual fights with the government.

Simply put, the board was stacked against them. From a regulatory perspective, the cigarette companies had everything to lose, the government had everything to gain; the government was also the ones who got to pick the rules themselves; and public opinion had shifted enough that everyday Americans weren’t going to stand up for the right of Joe Camel to be on television.

Instead, they learned that while they couldn’t win every individual fight, they could control what the battle was over, how it was fought and oftentimes where and when it was going to be fought. They made a decision that in exchange for softening stances and giving up some rights, they wouldn’t be blindsided and they would protect what was essential to their businesses. At times, the government and industry wouldn’t agree, and so the cigarette industry would file as many lawsuits as it could. Sometimes it won, sometimes it didn’t.

The overall strategy seems to have worked.

While cigarette consumption is less than half of where it was at its peak, the drop-off is far less compared to other tobacco products like cigars and pipes. Despite the restrictions on advertising, cigarette companies still spend more than $1 million per hour on marketing and promotion in the U.S. And remember, Altria—just one of those companies—generated $25 billion in revenue last year.

I imagine that if you asked Murillo—or his contemporaries and predecessors at Reynolds, British American Tobacco and others—to give unbiased advice, even if it hurt the companies they represent, for the premium cigar industry, the advice would be rather similar to what’s in the letter. It would also probably include this key argument: you want to be regulated now, not later.

The argument is that at the moment we have an anti-regulation executive branch, but that won’t last forever. At some point, a more intense anti-tobacco administration will come into play and when they do, you want to be at the bottom of the pile of priorities. Being an unregulated tobacco product would move you towards the top.

From the perspective of big tobacco, it would be far more advantageous for the cigar industry to negotiate with a friendlier FDA now, establish rules that you can live with and be able to stay as far off the future administration’s radar as possible.

Instead, the cigar industry oftentimes seems to be fighting with an NRA mindset, i.e., give up nothing. That works for the NRA because of the incredible political clout the group has and the existing laws it’s established that make it very challenging for any gun regulation to go anywhere. But outside of the banks, NRA and organized religion, most industries don’t have enough political clout to fight at every single turn.

As such, the recommendation from the big tobacco model would be to negotiate before it gets worse.

I’ve advocated something similar since 2014 and it generally fell on deaf ears until August 2016, when the industry was suddenly regulated. The conversations I would have many people changed from we will not be regulated to we just need sensible regulations. Many of those people, seemingly at the invitation of FDA’s ANPRM, have moved back into the exemption is a must stance.

I understand it—shoot for the moon—but there is one downside: time.

If FDA was to exempt premium cigars now and a Democrat was to win the White House in 2020 or even in 2024, it would likely leave the cigar industry very vulnerable to future regulations. Yes, it would mean some period of time with no regulation which would help a lot of companies, it would serve as a delay in any rules—which would help everyone—but it also would mean that the blindside scenario comes back into play unless you are willing to get the exemption and then go negotiate, a strategy that the cigar industry doesn’t  seem to want to embrace.

The government holds nearly all the power. The only thing restricting a government agency are the court, another branch of the government. As such, it’s oftentimes not about leverage, as much as it is finding someone you can work together with.

5. THE LARGER PROBLEM(S)

First, if you really do believe Altria holds as much power over the FDA as some commenters have alleged—stating that Altria wrote the tobacco control act—then why poke the bear? There’s no question that Altria, like others, will be consulted before the FDA acts on anything regarding cigars—premium or otherwise—but the premium cigar industry shouldn’t try to go to war against Altria. One, Altria is worth more than the entire premium segment, by a lot; secondly, Altria’s bottom line will not be affected by the premium cigar industry, third it will only make everyone’s lives more challenging in the real battle: FDA.

As we will inevitably write more about in the future, the cigar industry’s legal fight is not cheap and it’s going to cost millions of dollars more. There’s already a large disagreement about how to pay for a part of the legal work that’s been done. Furthermore, there are only a couple dozen companies that are actually paying for the lawsuit at the moment. Altria could be a help to solving some of those issues or it could decide it’s been attacked enough and opt to not contribute to a legal fight that will have zero meaningful impact on its bottom line.

It would be hard to fault the company if it opted to do the latter, particularly after the last few days.

Even beyond the legal bills, it’s challenging to see how a conversation between industry and FDA would go at the moment. The collective cigar industry has had issues in the past with coming to agreements about SCHIP, flavored cigars and even a definition of premium cigars. None of what’s taken place over the last 48 hours is going to bring even the premium cigar industry any closer on solving any of the very real problems that exist in its strategy.

If your belief is that there is a legitimate chance that FDA will exempt premium cigars, some of these issues are worth risking in the face of exemption, but when I talk to executives at companies there are very few people who think that FDA granting an exemption is on the table.

6. SOME FINAL THOUGHTS

Here are some random other thoughts in no particular order:

Yes, Altria Has Used Regulation to Get Rid of Competition — Many of the cigarette regulations made it challenging for anything but the industry’s largest players to compete. Altria certainly played a role in that and it helped in making the company what it is today

Do I think that’s what happening here? No.

If you think that Altria—who will have generated about $475,000 in revenue in the time that it has taken you to read this much of the article—cares about putting anyone from RoMa Craft to Rocky Patel out of business, you are out of your mind. The amount of money this company makes is staggering; staggering compared to Nat Sherman, staggering compared to the entire cigar industry.

To give you some idea, Altria’s side hustle netted the company $5.3 billion in cash and nearly 10 percent of the world’s largest brewery.

Nat Sherman was bought so Altria could go after the American Spirit business. If Altria really wanted to be a player in the premium cigar space, it would be acquiring and consolidating in a manner that looked like a three-year-old buying Hot Wheels’ cars.

Altria Isn’t Alone In This Position — Altria’s stance is probably no different than many other companies that have both premium and mass market cigar interests. Swisher International, which owns Drew Estate, does not appear to have submitted a standalone comment, it was part of the Cigar Association of America comment which advocated for exemption. Tabacalera USA—which is the Imperial division that includes Altadis U.S.A. and JR Cigar—submitted a comment in favor of the exemption. ITG Brands, Imperial’s mass market subsidiary, did not appear to submit a comment. Regardless, the position isn’t that uncommon.

Altria Is Not Going to Support Exemption of Any Tobacco Product — Due to its corporate structure and other policies, there’s just zero chance of that happening. At best, Altria would have no comment.

Nat Sherman Cigars Are Already Regulated More Than Others — Because Altria is a signee to the Master Settlement Agreement (MSA), there’s a variety of restrictions placed on Nat Sherman that don’t apply for other companies. For example, there’s no official Nat Sherman social media accounts, Nat Sherman employees are restricted about what they themselves can do on the internet, the brand’s promotional materials—including those that are just shown to cigar retailers—are forced to have additional warning labels, etc.

Do I think that’s why Altria wants regulation? No. Because requiring cigar companies to be regulated will have zero effect on whether the @Nat42nd Instagram account can return.

The People at Nat Sherman Didn’t Ask for Any of This — You want to know who gets hurt by a boycott of Nat Sherman? It’s not Altria. Let’s say this results in a loss of $1 million in sales of Nat Sherman cigars. For Altria, it would be the equivalent of the net worth of the average American declining by $2.75, i.e. irrelevant.

The Nat Sherman sales representatives don’t work on straight commission, but this does not make their lives easier and better, something that’s particularly frustrating once you realize they had nothing to do with this.

Exemption via FDA Seems Very Unlikely — I would be extremely surprised if FDA were to exempt premium cigars. Even if the agency wanted to, it would cause legal issues with an existing lawsuit in Maryland filed by pediatricians who allege FDA has already failed to meet its requirements under the deeming rule. It would also—and more problematically—almost certainly hurt the agency’s efforts to defend its rules regarding e-cigarettes and vapor products, a segment that FDA has both Congressional and public support to regulate.

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I suspect that much like the outcry when Drew Estate was bought by Swisher, this will blow over for most. There are very few retailers that are willing to make a stand over making a dollar, and despite the comments about boycotting Drew Estate, the company seems to be doing just fine. For Nat Sherman the story will be similar: as long as a cigar sells, much will be forgiven and more will be forgotten.

Nat Sherman advertises on this website; if you think that that has anything to do with what is written above, I suggest you take a look at this.