Fabrizio Freda Discusses China, U.S. Department Stores and U.S. Makeup’s Slowdown

Beauty is booming in Asia.
The region, which has always been known for its skin-care savvy consumers, is becoming a crucial growth driver for the large beauty conglomerates, especially as sales have softened in North America and Western Europe.
On Wednesday, the Estée Lauder Cos. Inc. touted a 24 percent jump in net sales in the Asia-Pacific region, driven by double-digit growth in most of those markets, especially China, where the company has posted six consecutive quarters of double-digit increases. Earlier in the week, L'Oréal posted a 25.8 percent gain for the Asia-Pacific region.
For Lauder, expansion in Asia was coupled with gains in travel retail, online sales and the turnaround of its U.S. segment, which all contributed to an 8 percent sales gain for the fiscal first quarter. The beauty firm posted $3.27 billion in net sales. Net earnings were up 17 percent to $500 million, and diluted net earnings per share gained 17 percent to $1.34. In mid-day trading, the company's stock was up more than 5 percent, to $138.53.
By category, skin-care's gains were the most significant — up 17 percent to $1.49 billion thanks to La Mer and Estée Lauder. Makeup sales moderated, up 2 percent for the quarter to $1.41 billion, bolstered in part by MAC's international growth but dragged down by lower sales from Clinique and Smashbox. Fragrance sales — a new phenomenon in China — were down 1 percent to $472 million because of the company's adoption of new accounting standards, and hair was up 5 percent to $143 million, driven by gains in two Aveda product lines.
By the numbers, the Asia-Pacific region is Lauder's smallest geography, with $855 million in sales for the quarter — but it's also the firm's fastest growing. Here, in an exclusive interview with WWD, chief executive officer Fabrizio Freda walks through selling in China, the turnaround of the U.S. market and trends in global makeup consumption.
WWD: China has been hot for a while now. How much opportunity do you see there, and what is driving the market in terms of product and retailing? 
Fabrizio Freda: In China, I believe the opportunity continues to be big and for the long term. The key thing is that the consumers are really passionate about beauty and they're passionate about high-quality products, so the phenomenon is there is a lot of trading up of the consumer to higher quality. 
The other phenomenon is that the younger consumers in China have access to bigger purchasing power than the previous generation, so the consumers that access luxury tend to be younger on average than in many other countries of the world. You can have these consumers for longer and you can grow with them, over time, with the right brand.
consumers have always been very focused on skin care — they are among the most sophisticated consumers in skin care in the world. The good news is they are buying more and more makeup, particularly the younger generation, and fragrances, which has been for years a very low priority for those consumers. High-end fragrances and high-quality fragrances and the artisanal part of our portfolio is very much loved by Chinese consumers.
They are in need of big customization. There are a lot of products that are very specifically preferred. In foundation, the cushion compact in China is now 40 percent of the total foundation market. In other markets in the world, it's less than 5 percent. They have this big preference for products that are uniquely suited to their lifestyle. The cushion compacts is used as a touch up — something you can have with you in your bag and in the course of a day, touch up.
We've learned to tailor our innovation to those specific needs more and more. Another example is specific ingredients. For example, Estée Lauder's Nutritious franchise, which is based on pomegranate…is very successful in China.
E-commerce is extraordinarily important in China, particularly Tmall in our case. In China today, there is demand from consumers living in about 600 cities, they're big cities, each one could have millions and millions of inhabitants. We have distribution of physical doors today in China in our most penetrated brand, which is Estée Lauder, in 118 cities, so there are hundreds of cities where the consumer can only access the brands online or frankly, traveling — travel retail.
There is also an enormous amount of demand because what is happening is that social media is national. In the past, traditional advertising was done even by city in the case of China, but definitely by province. Today, when you do something on social media, like a big social media campaign, it is instantly national, creating more demand in cities where distribution in physical doors is not yet advised. That's what is boosting the demand online and when these consumers travel. For many consumers in China, is the only option available.
WWD: Are the physical doors generating a high volume of sales, or are they more of a marketing tool? 
F.F.: The productivity per door in China is very high, it's much higher than the U.S. because there are less doors and those doors are bigger. There are not as many places where you can have luxury doors of the right quality, so our brands are obviously very selective on where they open stores. Also in terms of growth the majority of our growth in China is same door — it's not distribution.
WWD: Things in the U.S. market are finally turning around — what was it that worked? 
F.F.: We have been improving our sales with our department store partners, and we continue to collaborate with them to increase traffic to their brick and mortar stores. And some of the department stores are getting some significant improvements in their business, and our business with them is also starting to improve.
The second key point is the fact that we are doing, with all our department store partners, a very good job online, so their retail dot-com's continue to be stronger and stronger. The combination of improvements in the brick-and-mortar and retail dot-com, excluding the Bon-Ton closures, which for us had a big impact… our department store business positive again.
We also continue to grow very well in specialty multi with good progress in Ulta Beauty, Sephora, Bluemercury. We're seeing improvements in many of our freestanding stores.
WWD: Smashbox struggled this quarter. What is happening there? 
F.F.: Smashbox had a soft quarter because of a competitive situation, versus their innovation — they had a very high base period because in the first quarter of last year, they had a very big launch that this year was not replicated. It's a temporary situation and we're going to do our best to go back to the right level of innovation and traction.
WWD: What do you think of the concept of beauty burnout? There are some YouTube videos of people decluttering their makeup collections — are consumers sick of makeup? 
F.F.: The makeup market has slowed down in the U.S., but that's not the case in many of the other markets in the world. The makeup market is accelerating in China — 70, 80 percent growth — and the same is happening in many emerging markets. In the U.S., makeup is slowing down as a market and skin care is accelerating. What we're seeing is more of a normalization of trends in makeup.
The word "burnout" is too much because it's growing but it's not growing at the same level it used to. The level of consumption in makeup is actually at a very high point in the U.S., so it will be difficult to grow very strongly from level of consumption. What we're seeing is more of a normalization of trends in makeup.
On the other side we're seeing an acceleration of trends in skin care, also in hair care — this is linked by simply the consumer interest. Consumers are discovering how…a good skin-care practice is essential for makeup as well, because if you put on makeup without the right canvas under the right makeup, you don't get the same quality results. What is helping that is the fact that social media YouTube influencers — all of this was very focused on makeup. Now it's getting stronger in skin care and also in hair care — you see consumer education in these two categories is increasing accordingly.
WWD: Lauder posted a 2 percent gain in makeup this quarter — is that driven by launches or repurchase?
F.F.: For foundation or face in general, it's very driven by repurchase. Women don't change their foundation easily, particularly when they've found the right shade for them. If you're speaking about lipstick…they're curious to try new ones, and the same happens for eye shadows.
Our face business is absolutely driven by loyalty repurchase rates, and then our color business is a bit more driven by launches and trial.
WWD: In the U.S., masstige, value-priced products are taking off, and that's a segment Deciem fits into. What do you think about that segment, and would Lauder ever play there?
F.F.: I don't think masstige is a very attractive proposition for the long-term. We are not doing frankly anything in masstige. Even your mention of Deciem, I don't see Deciem, our minority investment, as a minority investment into a masstige concept. It's an ingredient-centric line and you need to buy four Deciem products to get the formulation we have in other products, just you do it ingredient by ingredient. It's a different philosophy, but in the end, the cost per benefit for the consumer is very similar, and it's done in freestanding stores with high-quality service, with great creativity, good products, etc. It's a proposition which is a prestige proposition.
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