Why Are Cosmetics Players Exiting China?

by Trefis Team
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Recently, mass-market cosmetics manufacturer, Revlon (NYSE:REV), announced its plans to exit the Chinese market. [1] Revlon derives approximately 2% of its revenues from China. Revlon’s direct-selling competitor, Avon Products (NYSE:AVP), is facing similar weakness in sales in the Chinese mainland region. In recent times, many international retailers have considered closing shop in China to reduce costs and improve operational efficiencies. The latest announcement comes from cosmetics giant L’Oréal (OTC:LRLCY), which highlighted plans to end Garnier product sales within the Chinese market, citing a slowdown in the Chinese economy. [2]

In this note, we analyse the current market conditions and trends shaping business performance for cosmetics companies in China. We have price estimates of $24 for Revlon and $33 for L’Oréal, against their current market prices of $25 and $34 respectively.

See Our Complete Coverage For Revlon | L’Oréal

Cosmetics Retail Sales Fall In China As Economy Slows Down

Retail sales for cosmetics in China for the year 2012 were estimated to be close to $22 billion (~RMB 134 billion), impacted by a slowdown in the country’s economy and lower discretionary spending. [3]  In comparison, cosmetics’ sales in 2010 stood at approximately $24 billion, with skin care product sales accounting for more than 60% of total retail cosmetics sales. [4]

This represents an 8.3% erosion in value over a span of two years. Combined with the fact that Chinese retail cosmetics sales witnessed explosive growth and tripled in value during the 2000-2010 period, the retail cosmetics market in China could begin to see a steady decline in product sales in the coming years. Reasons supporting this view on the market include:

  • Consumer Buying Migrates To E-commerce:
    • Chinese consumers have shown great adoption to online shopping and e-commerce over the past two years. Chinese e-commerce sales topped RMB 1.3 trillion (~$214 billion) and are expected to surpass U.S. e-commerce sales in 2013.
    • According to consulting firm Bain & Company, the Chinese e-commerce market is on a 32% growth trajectory, with total sales doubling to reach RMB 3.3 trillion (~$545 billion) by 2015. [5]
    • Digital penetration, which represents online sales as percentage of total sales, has reached 9% in Tier 1/Tier 2 cities in China and stands at 6% across all cities in China. For cosmetics product sales specifically, this penetration rate is 3-4 times higher in the Chinese market [5], indicating the shift in the customer buying pattern from traditional brick-and-mortar retail outlets to the seller’s online platform.
    • These trends highlight the shift in the consumer purchasing proposition model, with more customers preferring online shopping. Going forward, we expect an increasing decline in comparable store sales growth from brick-and-mortar outlets of cosmetics companies as digital penetration continues to expand in China.
  • Premiumisation of Products Pressures Participants:
    • Prestige beauty product sales within the Chinese market have been increasing in recent times, with global players such as Lancôme, Kiehl’s (operated by L’Oréal) and Estée Lauder quickly gaining market share. In the skin care segment, L’Oréal has a market share of 17% and is the largest player in China. [6]
    • L’Oréal has the highest market share in color cosmetics in China, supported by a wide product portfolio of mass-market, mid-range and premium make-up products targeting various customer groups. Maybelline from L’Oréal targets customers in the mass-market color cosmetics market, while L’Oréal Paris and Lancôme target customers preferring mid-range and premium color cosmetics’ products. [7] This diverse set of products has helped the company gain market share quickly in China.
    • Other prestige cosmetics players like Estée Lauder and Japan-based Shiseido also have seen strong offtake of their products, stipulating an increase in luxury product sales in China. Going forward, we expect luxury product sales to continue increasing rapidly as discretionary income ontinues to expand in China.The infographic shown below indicates how cosmetics product sales are expected to trend in the future.

EMI_premiumBPCdynamics-v1.0

(Source: Euromonitor International, May 2013)

  • L’Oréal Concedes Defeat To P&G By Shutting Down Garnier:
    • The exit of Garnier from China indicates L’Oréal’s weak footing in the Chinese hair care market. According to Euromonitor, P&G (NYSE:PG) holds the top spot in the Chinese hair care market with revenue between $3.5-$4 billion [8], and a 37% market share in the country. [9] Rejoice from P&G leads the Chinese hair care market, closely followed by Head & Shoulders and Pantene.
    • Unilever and L’Oréal generated revenues of $1.75-$2 billion and $2 billion respectively. [10] Despite similar revenue numbers, Unilever’s early entry into the Chinese hair care market resulted in a higher market share for the company. With such intense competition from global personal care players in the Chinese mass-market hair care product segment, we believe L’Oréal had limited room in gaining market share in the segment.
    • Additionally, products in the Garnier brand are priced higher despite being mass-market products. [9] This higher price point, in comparison to its peers for a mass-market brand, should have led to a reduction in market share, and subsequently, in revenues for the company.

Going forward, we believe the ongoing shift of purchasing cosmetics online will intensify as digital penetration within mainland China increases. Furthermore, we expect existing mass-market cosmetics retailers such as Avon Products to continue facing downward pressure on sales with greater offtake of prestige and masstige products.

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Notes:
  1. SEC Filing, Revlon IR, December 2013 []
  2. L’Oreal ends Garnier sales in China amid slowdown, Reuters, January 2014 []
  3. China Cosmetics Industry Report, 2013-2016, China Market Research Reports, September 2013 []
  4. Holding a mirror to China’s economy through cosmetics, China Daily USA, October 2013 []
  5. China e-commerce spending poised to bypass U.S. in 2013; on course to more than double by 2015, Bain Press Release, September 2013 [] []
  6. Skin Care in China, Euromonitor, April 2013 []
  7. Colour Cosmetics in China, Euromonitor, April 2013 []
  8. Early Foothold in China Pays Off, Advertising Age, October 2012 []
  9. Hair Care in China, Euromonitor, April 2013 [] []
  10. L’Oréal pulls back from China market, Financial Times, January 2014 []
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