The Secret Sauce For Success In The Aggressive Beauty Business

Global consumer products powerhouse Procter & Gamble (NYSE: PG) is contemplating the sale or IPO of some of its beauty brands, according to recent reports. Procter & Gamble’s Beauty division had revenues of $19.5 billion in fiscal 2014, which accounted for 24% of the company’s total revenues. Its beauty business includes marquee billion dollar brands like Olay, SKII, and Covergirl, among others. Despite the presence of such globally renowned brands, revenues from the Beauty division suffered a contraction of 2% in fiscal 2013 as well as 2014. According to our estimates, it achieved an EBITDA margin of 20.4% in 2014, which was the lowest among all divisions of P&G. The Beauty division is P&G’s third largest division, so revenue deceleration and low margins in this division has a notable impact on the performance of the entire company. The extent of poor performance of the beauty business is such that P&G’s CEO A.G. Lafley himself called the beauty industry as “the great industry of promises made and never kept”. ^[1]

But what does it really take to flourish in today’s dynamic and continually evolving global beauty industry? In this article we explore some of the secrets behind the success of the two behemoths in the beauty business, L’Oreal (OTC:LRLCY) and Estee Lauder (NYSE:EL).

How Do L’Oreal And Estee Lauder Rule The Beauty Industry?

Picking Up The Market Cues

Both L’Oreal and Estee Lauder have been responsive to the market signals and have been instrumental in creating products specific to different customer segments.

Over 40% of Estee Lauder’s revenues comes from the skincare segment. In Q1 2015 (ended September 2014), the company witnessed a decline in skincare growth in its most important region, the U.S. (U.S. contributed to 42% of Estee Lauder’s net sales in fiscal 2014.)  A major reason for this was that the US consumers expect innovative products, across newer skincare categories. Estee Lauder realized that innovation must be extended beyond the  traditional skincare formulations like moisturizers and serums to newer concoctions such as masks and oils. ^[2] The company’s recent acquisitions in the beautifying mask (GLAMGLOW) and oil based treatment (RODIN olio lusso) categories are expected to provide the perfect solutions that the U.S. consumers were looking for.

L’Oreal faced pressure from domestic players within the mass-market cosmetics space and has bowed out of the Chinese hair care market by shutting down its Garnier brand. Instead, to retain its market share, L’Oreal accepted an ‘acquire to grow’ strategy and acquired Magic Holdings in China, its  largest acquisition in the Chinese market. Magic Holdings is the leader in the Chinese facial care market, with annual revenues that grew 14% on a constant currency basis to reach $220 million in 2013.

Differentiating Products Based On The Customer Segments

Beauty brands are expected to target different groups of customers with customized product options. For example, L’Oreal’s Urban Decay or Estee Lauder’s Mac are very popular among the younger consumers. L’Oreal’s Age Perfect and Estee Lauder’s Revitalizing Supreme lotions resonate well with its mature clientele. Additionally, these global leaders keep acquiring relevant brands if they perceive a demand and supply gap. (Read more about L’Oreal and Estee Lauder’s Strategic Acquisitions in 2014 here and here).

In comparison, all P&G did was add Fresh Effects line to sell its existing Olay brand (initially targeted for mature women) to the younger clientele. ^[3] In the early 2000’s, Olay underwent a complete transformation from its 1990s avatar, complete with a price hike from $3.99 to $18.99. Consequently, the product, positioned in the masstige category, was a hit with both the prestige buyer and the mass shopper. In the early 2000, Olay was a phenomenal success raking double digit sales and profit growth for almost a decade. However, P&G did not evolve with the changing times, as compared to the core beauty players, and hence got left behind. ^[4]

Importance Of Research And Development

L’Oréal has the largest Research and Innovation team in the cosmetics industry with 3,782 researchers and a budget representing 3.4% of its sales. The R&D budget was over $1 billion in 2014, up by 1.6% as compared to the previous year.

In December 2014, L’Oreal announced the acquisition of Israel-based hair research start-up, Coloright. According to L’Oreal’s estimates, the top two contributors for the global beauty market are skin care (34%) and hair care (24%). L’Oreal has always been a pioneer in hair research, and this acquisition will further aid the company in being one of the forerunners in hair care related innovations.

Estee Lauder’s research and development costs totaled $157.9 million in fiscal 2014 (ended in June 2014), which reflected a 7.5% year-on-year growth.  Estee Lauder employed around 700 employees for research and development activities during the same period. ^[5]

P&G on the other hand, needs to distribute its R&D resources across its diverse product portfolio comprising of consumer goods, beauty, household goods and so on. Hence, unlike L’Oreal and Estee Lauder, beauty product innovations are not the topmost priority for the company.

Wider Distribution Channels

In April 2014, L’Oreal completed the acquisition of Decléor and Carita from the Japanese group Shiseido. Decléor and Carita hold a second position worldwide, in the global Professional Spa and Beauty Institute market. ^[6] The acquisition would ensure L’Oreal’s entry into new distribution channels in the professional beauty segment, such as day spas, resorts, and destination spas which specialize in skin care. ^[7]

L’Oreal had been on the lookout for more robust distribution channels in the African region. Distribution remains unstructured and hence cumbersome in Africa. In a move to further expand its African presence, French cosmetics giant, L’Oreal signed an agreement with CFAO, the specialized distributor from Cote D’Ivoire, to cover the production and distribution of cosmetics in the Ivory Coast. The partnership will bolster L’Oreal’s distribution network as CFAO will be the sole distributor for L’Oreal products in French speaking West Africa.

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1. P&G Learns That Beauty Is Ugly, Bloomberg View, March 16, 2015 [↩]
2. Estee Lauder’s Q1 2015 Earnings Transcript, Seeking Alpha, November 2014 [↩]
3. P&G’s Possible Beauty-Unit Split Shows Industry’s Challenges, Bloomberg, March 17, 2015 [↩]
4. P&G Learns That Beauty Is Ugly, Bloomberg, March 16, 2015 [↩]
5. Estee Lauder Form 10K, for the fiscal year ended June 30, 2014 [↩]
6. Draft agreement between L’Oréal and Shiseido for the acquisition of Decléor and Carita, L’Oréal Finance, October 2014 [↩]
7. L’Oréal Finalizes the Acquisition of DECLÉOR and CARITA, Day Spa Magazine [↩]