Estée Lauder vs. L’Oréal: Who’s Winning Beauty’s Arms Race?

Beauty giants are investing in indie beauty brands
By Chantal Fernandez. Source: Business of Fashion.

NEW YORK, United States — Why have there have been so many beauty acquisitions in the last three years? The answer begins on YouTube, where thousands of makeup tutorials are posted each day, including one by a vlogger named Amy Nicola back in June 2015. She reviewed a rosy highlighter developed by Becca Cosmetics in collaboration with one of YouTube’s biggest beauty stars, Jaclyn Hill.

“When I first saw it on Snapchat, not even in person, I was like, I need it,” said Amy, holding the compact up to the camera and describing her skin tone for viewers as a reference. “I consider myself medium tan to medium deep,” she said. “I’m like an NC40 in MAC foundations, which I haven’t used in forever.”

Three days later, Becca sold 25,000 Champagne Pop highlighters in 20 minutes when the product launched exclusively at Sephora. It sold out in four hours. Fifteen months (and three Jaclyn Hill launches) later, MAC’s 70-year-old American parent company, Estée Lauder, bought the buzzy makeup brand for $200 million. It was the prestige beauty conglomerate’s first makeup acquisition since it bought Smashbox in 2010.

The move came just three months after 107-year-old L’Oréal paid $1.2 billion for another successful prestige makeup brand, IT Cosmetics. While only 50 percent of L’Oréal’s $27 billion French business (the “Luxe” division) competes with Estée Lauder’s $11 billion prestige one, the two rivals have been locked in a race over the last three years to acquire brands, boost revenue and maintain relevance.

“Brands that were once considered indie and niche are no longer and consumers are very receptive to these brands and they are really driving the market,” said Karen Grant, a global beauty industry analyst at NPD Group, explaining the moves.

The beauty market — worth $62 billion in the US alone — is growing fast, with prestige beauty outperforming mass, increasing 7 percent in 2015 to $16 billion. As such, L’Oréal Luxe is the company’s fastest growing division, expanding 5.6 percent in the first half of 2016, while Estée Lauder’s adjusted sales grew 9 percent in the year ending June 30. “We remain committed to our goal of exceeding the growth of global prestige beauty by at least one percentage point annually,” said Estée Lauder chief financial officer Tracey Thomas Travis during the most recent earnings call in July 2016.

But there’s little doubt that a crop of younger, independent brands, such as Anastasia and Tarte, are eating into L’Oréal and Estée Lauder’s share of the market. L’Oréal chief executive Jean-Paul Agon addressed the problem at a conference in February 2016. “Who gained shares? None of our big competitors,” he said. “We lost to the local players.”

In recent years, barriers to entry have lowered, thanks to the rise of social media and the growth of specialty sales channels like Sephora and Ulta. “It makes it easier to launch a brand, just look at the Kylie [Jenner] brand,” said Stifel analyst Mark Astrachan. He said both companies have been more willing to do deals in recent years because they see how consumer trends, particularly in makeup, are changing. “You think about the brands L’Oréal and Estée Lauder owned historically, the Cliniques and Lancômes — they are one-stop brands. Consumers want to be more specialised,” he said.

Estée Lauder’s acquisition of Too Faced is a signal that the company recognised how important it is for them to diversify their distribution.

Acquiring a brand is a safer bet than launching one. “They want someone else to take the high risk piece out of it for them, which is why they’re happy to pay a lot of money,” said Tevya Finger, chief executive of beauty incubator Luxury Brand Partners. The company bought Becca in 2012 when it was struggling on the shelves of Duane Reade.

“It was the most depressing thing I had ever seen,” said Finger. Becca was earning $3 million in sales and losing $3.5 million in revenue, but the brand was unusual because it catered to a wide range of complexions. “We had to retool the whole thing. Interestingly, at that time, Sephora saw the fact that we had the colour range.” The retailer picked it up and, with new leadership and a $7.5 million investment from Luxury Brand Partners in place, Becca’s sales exploded. “Becca could be a $500 million company, it could be a $1 billion company,” said Finger. “I don’t see a lot of competition for them.”

L’Oréal might say the same about its most recent makeup acquisition, IT Cosmetics. The brand made $8.8 billion in revenue in 2014, according to ABC, selling on the QVC television channel. It uniquely combines coverage with skincare, a category that has stagnated since beauty shoppers began worrying less about wrinkles and more about their next selfie.“The skincare market, for ten years, was being fueled by anti-aging,” said Grant, adding that the category has since become a problem for Estée Lauder, which is heavily exposed.

While Estée Lauder’s acquisition of Becca and Too Faced may not be a direct response to L’Oréal’s purchase of IT Cosmetics, it is easier to see a correlation between L’Oréal’s acquisition of its first niche prestige fragrance Atelier Cologne, for about $16 million in June 2016, and Estée Lauder’s acquisitions of Le Labo, Frederic Malle and By Killian between 2014 and 2016. Both companies are reacting to changing consumer preferences for unique scents over big brands and celebrity-endorsed perfumes.

“There are some of those tit-for-tat acquisitions occurring, but I think it’s actually more to balance out a competitive portfolio,” said Maureen Mullen, co-founder of research firm L2. Prestige fragrance outperformed skincare sales in the US for the first time in 2015, according to NPD. While Estée Lauder does not break out individual numbers for brands, its fragrance division grew 10 percent to $1.5 billion in fiscal 2016, led by Jo Malone, a 1999 acquisition, which grew by double digits.

The purchases are also about adding sales channels. “Lauder’s acquisition of Too Faced is a signal that the company recognised how important it is for them to diversify their distribution,” said Mullen. Macy’s is Estée Lauder’s biggest client, accounting for 9 percent of total sales and nearly 40 percent of US sales, and is aggressively closing stores. “We are really focused in working together [on] how to increase traffic in store,” said chief executive Fabrizio Freda in the most recent earnings call. “It’s a suicide pact,” said Mullen. “Those channels are obviously not growing.”

Too Faced, meanwhile, accounts for 5 percent of searched colour cosmetics brands on both Sephora and Ulta, while IT Cosmetics has 3.5 times the visibility of an average beauty brand on e-tail sites, including Amazon, according to L2.

Mullen said Estée Lauder has had a “love-hate” relationship with Sephora over the last 15 years, which is why its brands are less visible there. (Of Sephora’s top 10 searched brands, four are owned by LVMH, which also owns the retailer.) “When Sephora entered the US in 1998, Lauder held back,” she said. MAC is not carried there. “Their core franchises, like Clinique and Estée Lauder, were very late to the Sephora game and as a result it’s been difficult for them to get some of the prime placement.”

We don’t like even the idea of niche, because for us, a nice niche brand is a brand that becomes big one day.

Estée Lauder depends on its own stores for one third of its total growth, and opened over 170 of its own retail stores, mostly MAC, in fiscal 2016. But despite its store network, MAC is still concentrated in department stores and tourist zones. As a result, its US makeup sales declined in the three months ending September 30, 2016.

Estée Lauder, the brand, and Clinique are also struggling to attract millennials. The former saw sales decline in fiscal 2015 but then flatten in 2016, thanks to the launch of Estée Edit, a youth-focused product line featuring Kendall Jenner as chief ambassador. Both brands’ skincare lines are struggling — indeed, Clinique’s 3-Step Program is no longer a rite of passage for young American women.

Meanwhile, one of L’Oréal’s best bets from the last three years was actually a mass makeup brand with professional clout: NYX, founded in 1999 by Toni Ko, was acquired in 2014 for a reported $500 million. Sales grew 70 percent in 2015, double the expected level. In 2016, L’Oréal took it global and opened dedicated stores in the US. Agon said: “[NYX] could become maybe the number one worldwide for makeup. But it’s okay, the first two today are Maybelline and L’Oréal, two in our portfolio, so if we have the top three we will be happy.”

L’Oréal’s size has historically allowed it to pay higher multiples for brands than Estée Lauder, but not every buy is a sure thing: the company had to write down two recent acquisitions in 2016 after poorer than expected performance. The first was Clarisonic, a luxury beauty device maker it bought in 2011 for an undisclosed amount and recorded a goodwill impairment of €234 million in June. It announced in September that it will outsource production, previously based in Washington, and lay off over 100 people. The second was mass Chinese skin care mask company Magic Holdings, which it acquired for €600 million in 2014 and for which it recorded a €213 million impairment. It has suffered from the onset of new competitors, too. Both brands represent new categories for L’Oréal, which have proven to be a challenge.

Conquering every category at every price point is L’Oréal’s goal, and every acquisition is pushed for maximum growth. “We don’t like even the idea of niche, because for us… a nice niche brand is a brand that becomes big one day,” said Agon on an earnings call in July.

While the strategy allows the company to capitalise on an emerging brand’s momentum, it underestimates how much consumers care about specialisation, specialty retailers and founder-led companies — especially in prestige. Product quality is still essential, of course. But IT Cosmetics is successful, for example, because founder Jamie Kern Lima speaks to QVC viewers directly about her own skin conditions.

So which company is making smarter buys? Right now, both are playing catch up, doubling down on the booming makeup category, and under pressure to maintain dominance. But in this accelerated beauty market, the comparative value of one acquisition over another has less to do with the forces that fuelled its success initially and more to do with how Estée Lauder and L’Oréal will preserve its vision as it grows.

Estée Lauder — which prides itself on being the absolute winner of luxury beauty — does not have L’Oréal’s mass business, and deep pockets, to fall back on when the market changes. But it does have patience and a greater willingness to work with founders that sets it apart. The company that looks at acquisitions as case studies, not bandaids, will avoid turning today’s best bets into tomorrow’s fading stars.

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