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State of the Industry: Eco-values Escalate

Briony Davies
Back to the June Issue

The latest research from Euromonitor International shows that, in 2006, the cosmetics and toiletries industry posted a growth rate of more than 5% over 2005, its overall highest since 2001. The industry continues to benefit from a combination of strong macroeconomic trends (including a worldwide rise in consumer spending power); key demographic factors such as aging populations and higher life expectancies; an increased interest in appearance and personal care as a means of preventive healthcare; and lifestyle and climatic changes that are creating opportunities for new product niches. Legislative restrictions, too, are having a positive impact by improving consumer confidence and facilitating international trade, and technological advances are improving product efficacy and providing manufacturers with new marketing tools and advertising opportunities.

Emerging Markets Show Strongest Growth

With growth rates of 13%, Eastern Europe and Latin America were the fastest movers from a regional perspective, alongside key markets in Asia-Pacific, with expansion linked to large populations, rising disposable incomes, modernizing retail and distribution networks, and increased consumer awareness. With regard to the mature markets of Western Europe and North America, fortunes appear to be on the up after a lackluster 2005, due, in part, to the continuation of economic recovery in the large markets of the U.S., Germany and France. Western Europe takes the lion’s share of global C&T sales, although its importance has contracted over the years. The region now accounts for just less than 30% of the world market, with sales up 3% on the previous year. North America’s performance is closely linked to that of the U.S., where 2006 sales were in excess of $50 billion—a first.

Eastern Europe to Become a Two-tier Market

Russia was the largest cosmetics and toiletries market in Eastern Europe in 2006, with sales of $8.5 billion, representing approximately 42% of regional value. The trend toward more premium products is a particular feature of the Russian market. As growth threatened to slow across most cosmetics and toiletries products, the premium segment offered the greatest opportunities. Growth of 13% in Romania is also notable, and came about largely as a consequence of the country’s improved economic fortunes, resulting from regulatory reforms necessary for its accession to the European Union (EU). Heavy brand advertising by multinationals also drove up sales, although discounting in the core hygiene sectors, such as bath and shower products and oral hygiene, proved a drag on growth.

Eastern Europe is expected, in the long term, to become a two-tier market, a division forming between the EU accession nations and Commonwealth of Independent States (CIS) countries. EU members will experience rapid development, with the trends evident in Western Europe spreading eastward. Demand for premium products and value-added brands may even exceed economic growth in these markets as consumers look to leave the hardships of the recent past behind and embrace Western lifestyles. It is largely the younger demographics that are driving value growth, as these consumers are more willing to sacrifice thriftiness for fashion.

The CIS countries (an alliance of former Soviet Republics), excluding Russia, are set to see less dramatic rises in economic fortunes, and remain more insulated from international fashion and beauty trends. The opportunities are strong in Eastern Europe, but there are some threats and challenges that manufacturers need to be aware of—including the abundance of counterfeit and copycat brands, and economic and political instability. Growing energy prices, too, could undermine the cost advantages of local production, as could rises in living standards, which would inevitably increase labor costs.

Brazilian Boom Continues

Brazil continued to drive growth in Latin America in 2006 with sales of $18.2 billion, an increase of 13% on the previous year. The good performance is due, in part, to prices remaining stable, rising below inflation rates. An appreciated real compared to the U.S. dollar kept the cost of imported raw materials in check and brought stability to prices of premium imported products, underpinning a price-led increase in demand. The ever-growing youth segment, the increasing number of women in the labor force and an increased life expectancy for Brazilians provided the foundation of the vibrant Brazilian cosmetics and toiletries industry on the demand side. On the supply side, dynamic product segmentation allied with extremely efficient direct sales distribution (with the direct sales channel accounting for 30% of market value) contributed to growth.

Latin America, as a whole, is expected to experience rapid development over the forecast period, with new products expected to emerge that satisfy diverse demands such as convenience and efficacy. Latin American consumers have a different concept of beauty from that held in Western Europe and North America. While Asia-Pacific and Eastern Europe are, to varying extents, influenced by Western fashion and beauty trends, Latin American consumers have their own ideals. For this reason, it is a prime target for ethnic cosmetics and toiletries, with repackaged international brands being less likely to appeal to consumers in this region. Price is a major determinant of success in Latin America, where, for many consumers, the purchase of hygiene essentials is a financial stretch. The split between premium and mass products is remarkable, with 99% of products across all sectors categorized as mass.

Local players—including Natura Cosmeticos, the only regional player in the top five companies in Latin America—provide high-quality products at competitive prices, so trading up is not a strong trend in this region. However, there is some movement to go upmarket with premium or value-added brands. The expected growth in private label cosmetics and toiletries, the result of a more developed distribution network and price consciousness in consumers, is a threat to future dynamism. There also remains a continuing risk of economic and political instability in many of the region’s major markets, most notably Colombia and Venezuela.

China Continues to Climb

Although some of the hype about China, in general, is being transferred to India, Euromonitor International believes that China still holds the key to cosmetics and toiletries growth in Asia-Pacific, at least in the medium term. China is set to become the world’s third largest economy before the end of the decade, overtaking Germany to sit behind only the U.S. and Japan. India, by contrast, still won’t be in the top 10 by that time. This, along with increasing urbanization and improvements in the retailing infrastructure combine to make China an attractive prospect for cosmetics and toiletries manufacturers.

Growing at an average of 11% per year for the past five years to reach 2006 sales of $11.7 billion, China has retained its place in the world’s largest and most dynamic markets. Rising disposable incomes continue to be the basic sales driver—average disposable income has grown almost 60% since 2002—allowing consumers to spend an increasing amount on cosmetics and toiletries. Extra cash has also facilitated trading up to more expensive products/brands. This is most pronounced in premium products such as fragrances, skin care and color cosmetics. In addition, growing product awareness and a stronger retail presence have fueled consumers’ interest in cosmetics and toiletries, and constant product innovation and media advertisements have been instrumental in further boosting the penetration of more established brands, such as Olay and Artistry.

Looking forward, the key to unlocking potential in this emerging market lies in tapping into the rural consumer base, which direct sellers such as Avon and Oriflame, having licenses to operate in China, are well placed to do. Multinational manufacturers also need to be aware of local consumer preferences and tailor product portfolios accordingly.

Skin Care: Large and Growing Fast

Skin care, with sales of $60.1 billion in 2006, is the largest of all cosmetics and toiletries sectors; it is also the fastest growing both historically and by forecast. Consumers’ desire to reverse, halt and prevent the signs of aging is fueling sales—particularly in the antiaging and anticellulite subsectors, which grew at 10.3% and 9.3%, respectively, to exceed the overall category increase of 7%.
Innovation is a major feature of the skin care sector, largely because brand loyalty is low, particularly in the dynamic antiaging sector, prompting companies to try to lure consumers with eye-catching new developments. Segmentation is sophisticated, and its latest permutation includes encouraging younger women to trade up to higher value products and appealing to consumers over 55 with, for example, whitening and brightening creams, as opposed to traditional antiagers.

Products that mimic the results or experience of beauty salons and spas are also an important trend in skin care, and natural and organic ingredients continue to be a major growth driver. Recent trends include a crossover from food products and source-specific ingredients. The small players that dominate this market niche are becoming acquisition targets as this trend continues to gain momentum, as exemplified by L’Oréal’s recent acquisition of Sanoflore.

Fragrances Fight Back in 2006

Fragrances stood out with particularly strong growth in 2006 compared to the other sectors. Coming in third after sun and baby care sales, fragrance posted an increase of 7% to reach $30.7 billion. In 2005, fragrances had only been the sixth most dynamic sector, beaten out by emerging categories, such as men’s grooming products and skin care, where value-adding had been aggressive. This upturn in fortunes is due largely to the success of the masstige segment, dominated by celebrity-branded scents, in the major Western European markets. Fragrances rose by over 2% in 2006, up from less than 1% the year before. While emerging regions, such as Latin America and Eastern Europe, continue to contribute the most in terms of absolute growth, increases in Western Europe contributed an extra $260 million to 2006’s global total.

Shift in Retail Landscape

In retail, convenience is a key driver of change. Supermarkets/hypermarkets are, by far, the leading channel for cosmetics and toiletries purchases in Western Europe, Australasia, Latin America, Africa and the Middle East, and a close second after direct sales in Eastern Europe. Low prices and one-stop shopping convenience are a powerful combination in today’s fast-paced society, and supermarkets/hypermarkets attract a share from almost all other channels. Only in North America are supermarkets/hypermarkets lower down the rankings, holding fourth place with a 15% retail value share—this due primarily to the success of discounters, namely Wal-Mart.

However, other retail formats—specialists, pharmacies/drugstores and department stores—are fighting back against the dominance of supermarkets/hypermarkets. These channels, however, have come to a key realization—that they have more power to engage consumers shopping for cosmetics than do supermarkets/hypermarkets. The range of initiatives taken by specialists and department stores has been broad. German cosmetics retailer Douglas has added hair salons to its stores and offered points for Lufthansa’s Miles & More bonus program. At Selfridges in London, Lancôme opened a beauty therapy suite where customers can receive treatments.

Manufacturers Become Retailers

Consolidation among retailers has prompted similar action from suppliers, in an effort to gain negotiating power with retailers. However, some manufacturers are tackling the problem head-on, creating opportunities for their own brands by buying a slice of the retail industry. Stand-alones are the primary route into retailing for multinationals; Nivea Haus provides one example. Based in Germany, Nivea Haus is a multilevel retail outlet that offers spa treatments, as well as a range of 500 Nivea products. L’Oréal expanded its involvement in retailing through its 2006 acquisitions of The Body Shop and U.S. distributorship Beauty Alliance International.

The Estée Lauder Companies was perhaps hardest hit by the merger of department stores May and Federated (owners of Macy’s and Bloomingdale’s). As Federated’s largest customer, 16% of Estée Lauder’s total business in 2005 was controlled by Macy’s alone. Aware of the need to broaden out from the department store channel, The Estée Lauder Companies has been working to create a global network of retail stores for its own labels, including Bobbi Brown and MAC. This approach has proven particularly successful in emerging markets, and is likely to be echoed by other manufacturers.

Natural Cosmetics to Stay in 2007

The year 2007 is about building on existing trends, and extending beyond current parameters. However, it will not just be more of the same. The year will continue to bring innovations that pull together trends to satisfy a broader range of demands. Some will look beyond the beauty industry for inspiration. Natural and organic ingredients were big news in 2006, and their presence is expanding to the mainstream in 2007. The increasing focus on health and well-being, the rising incidence of allergies and concern about the safety of everyday chemicals are driving the trend. Government initiatives have also helped raise awareness. In the EU, for example, new legislation was passed in December 2006, set for a July 2007 implementation, to outlaw potentially harmful chemicals used in cosmetics and toiletries and require that others be safety tested.

The spread of retail concepts such as Whole Foods (which is now expanding beyond its home market in the U.S.), The Organic Pharmacy and Wal-Mart’s Natural and Organic Bodycare Oasis have also helped lift the profile of natural and organic products. Looking beyond 2007, Euromonitor International expects global regulatory bodies to converge and establish a single organic certification standard and establish a definition of what constitutes a “natural” ingredient.

Ethical consumerism is a newer trend, borne, in part, from the demand for natural and organic ingredients. As the realities of global warming and the exploitation of developing labor markets gain increasing media attention, consumers have grown sensitive to these concerns and want products that fit their growing eco-values—those with a minimal environmental impact and that give something back to the communities in which they operate. Once a niche position espoused by specialty brands such as Green People, “going green” has now become such a potent selling point that even the world’s largest cosmetics and toiletries multinationals are becoming eco-friendly. Fair trade, a concept already well entrenched in food (chocolate and coffee particularly) and more recently being adopted by the clothing industry, has yet to appear on cosmetics and toiletries labels, but could be a new development to watch out for in 2007.

Consumers Rule Retail in the Youniverse

A new development running contrary to the current celebrity trend puts the spotlight on consumers, making them the stars. It is a way of building loyalty, of making consumers feel as if their favorite products are working for them and listening to them as if they have a stake in the brand. The result is customizable products, such as Prescriptives’ Colorprint service that helps identify the foundation and colors ideal for a consumer’s skin type.

In retail, it has also meant an increase in customer service. Christmas 2006 saw an array of new initiatives designed to make gift shopping faster and less stressful. Macy’s, for example, tried to alleviate long checkout queues with mobile point-of-sale scanners and express checkout carts on wheels. This is also a reaction to a new age of democracy where power is in the hands of all; the Internet is becoming a tool for bringing together the small contributions of people and making them matter. The youniverse gained global recognition in December 2006 when Time Magazine announced its “Person of the Year,” you. Developing and capitalizing on this trend is one way manufacturers can carve out a niche for themselves.

Future Outlook

Euromonitor International forecasts average annual growth of 3% to reach global sales of more than $313 billion by 2011. Skin care and sun care are expected to lead growth, with the importance of the emerging markets of Russia, China, Brazil and India increasing dramatically. As these areas grow, it is likely that local leaders such as Natura, Kalina and Faberlic will become increasingly important on a global scale and that multinationals will work harder to understand ethnic consumers and adapt strategies on a market-by-market basis. Whatever the future holds, innovation will be key to securing success, and manufacturers and retailers alike will have to rapidly adapt to the changing circumstances to exploit potential growth.

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