The business of beauty

This article has been produced on behalf of Walter Scott.

The Walter Scott Global Equity Fund and the Walter Scott Emerging Markets Fund are proudly brought to you by the Macquarie Professional Series.

As part of Walter Scott’s thorough research program, the investment team travels extensively to meet directly with company management, to form a first-hand view of a company’s potential for long-term success.

Walter Scott Investment Manager Paul Loudon recently visited the US north-east - home to some of the largest and most successful personal care companies in the world. Paul discovered how three of the best known are coping with competition, economic uncertainty and rapid changes in the consumer landscape, and shares his insights here.

The global personal care market is worth more than $100 billion annually and it is growing at more than 8% per annum. Emerging market (EM) consumers are becoming wealthier and spending more on health, well-being and beauty. Male grooming has become mainstream, with young men increasingly prepared to pay up to look good. Ageing populations are keener than ever to preserve an element of youthfulness. And, across the board, premiumisation is on the rise.

Such trends should bode well for the leaders in the field. Yet competition is intense. Smaller, nimble companies are snapping at the heels of larger players and growing interest in local, organic and natural products places further pressure on established multinationals.

Over the years, Estée Lauder has shown a consistent knack for identifying and acquiring fast-growing brands in the prestige beauty category. Equally importantly, it has successfully integrated these businesses, enjoying and even accelerating their growth.

I wanted to see how the big players were coping and a trip to the US provided the perfect opportunity. Over several days, I met Estée Lauder and Colgate- Palmolive – and one former holding, Procter & Gamble (P&G).

The meetings were highly informative, providing tangible evidence of the way that each company is striving to retain a competitive edge and drive performance.

I started out at an Estée Lauder investor day in New York. With 30 top brands, including Clinique, MAC Cosmetics, Jo Malone London and La Mer, the group can really put on a show for investors and, sure enough, this was a glitzy occasion.

Beneath the glamour, however, it was absolutely clear that Estée Lauder is a business with a well-defined strategy and the talent to deliver it. We heard from CEO Fabrizio Freda, CFO Tracey Travis and the heads of every major division within the group. I was fortunate enough to sit beside the eponymous founder’s grandson, William Lauder, at lunch. As Executive Chairman, he had plenty to say about the company’s history and future, particularly its focus on premium brands.

Over the years, Estée Lauder has shown a consistent knack for identifying and acquiring fast-growing brands in the prestige beauty category. Equally importantly, it has successfully integrated these businesses, enjoying and even accelerating their growth.

Of course, the company has benefited from a long period of economic expansion, but Lauder and Freda seem confident that they can weather a downturn in GDP growth, and they gave us five clear reasons why.

First, there are sufficient brands in the portfolio to provide genuine product diversity. Second, the business benefits from a diverse distribution base, selling through department stores, specialist beauty retailers, travel outlets and digitally. Third, the company is truly international, with a strong presence in China. Fourth, the cost base is more flexible than it used to be, so the business can take out costs relatively fast if sales growth falters. And finally, Estée Lauder maintains that consumers are very attached to their particular beauty brands, so they would be loath to give them up even if economic conditions falter.

Management optimism is reassuring, but the proof of the pudding will come if and when the climate changes.

Colgate-Palmolive is at a rather different stage. Its long-term track record is extremely good but the business went through a rough patch from 2015 to 2018 and this was a useful chance to understand the company’s current strategy.

The timing of my visit, earlier this year, was particularly opportune, as the company is in the throes of a real transition. Noel Wallace has recently become CEO, replacing Ian Cook, who led the group for 11 years. And there is a renewed emphasis on growth and innovation, with new products, new routes to market, new businesses and enhanced research and development (R&D). Importantly, there is a real focus on driving growth through in-depth research into what consumers want and value.

Total toothpaste is the group’s top product, but it had not been seriously revamped in a long time. Now the company has relaunched it, including popular features, such as odour neutralisation, sensitivity, on-trend flavourings and smarter packaging.

Today, the biggest successes in the toothpaste category are “natural” and sensitive brands. But Colgate is confident that the new, improved Total will find favour with customers. We will see if it is right in the next six to 12 months.

The group is also exploring new routes to market. It clearly has a substantial presence in the general retail space and has been very successful at building relationships with dentists to gain third-party endorsement and drive sales. Now, it is keen to develop a much stronger presence in pharmacies, particularly in Brazil, which is a big market for the company. The strategy makes eminent sense and should make a genuine difference, if executed well.

There has been a renewed focus on marketing, too. Following a period of arguable underinvestment, the company is now redeveloping its advertising strategy, not just by increasing expenditure as a percentage of sales, but also by working more with social media influencers, including highly segmented micro-influencers, to reach as broad a range of customers as possible.

Colgate is, of course, best known for toothpaste, but there is a flourishing pet food division, too, spearheaded by Hill’s Science Diet, a premium brand that alone is responsible for around 8% of group sales. This has benefited from an end-to-end transformation, with improved taste (apparently), texture and packaging, designed to promote higher prices and optimise online sales.

Even as the business drives innovation in its core categories, it is branching out into premium personal care. This is almost certainly a canny move. The sector has been growing at mid to high single digits for several years, compared with low single digits in the oral hygiene space. Against that backdrop, Colgate acquired skincare specialists EltaMD and PCA Skin in December 2017.

Within the industry, global players traditionally take 18 to 36 months to bring new products to market. Having dramatically improved its processes, Colgate can now develop and commercialise a product within six months.

And in July this year, Colgate spent $1.7 billion on the skincare assets of Laboratoires Filorga Cosmétiques. These deals do not just broaden Colgate’s repertoire: they also provide valuable insights into the direct-to-consumer channel. Colgate does not play in these waters yet, but it is certainly under consideration – learning from its own subsidiaries will doubtless prove helpful.

Before meeting the company, I had some questions about the headwinds it faced and whether it could really address them. But I left encouraged by the magnitude of change in the organisation, the dynamism and the energy. Even product development has become much more effective. Within the industry, global players traditionally take 18 to 36 months to bring new products to market. Having dramatically improved its processes, Colgate can now develop and commercialise a product within six months. This could prove to be a game changer for the business.

CEO Noel Wallace’s international experience should work in Colgate’s favour, too, particularly as EM comprise half of Colgate’s business and are responsible for most of its growth.

From Colgate’s Manhattan headquarters, I took a quick trip to Cincinnati, Ohio, to see P&G. It made sense to see how this business, Colgate’s arch-rival, was performing and how it intended to address both the challenges and opportunities in the personal care space.

Under Chairman, President and CEO David Taylor, there has been a genuine determination to empower category leaders, foster entrepreneurship and speed up decision-making. Like Colgate, P&G is well aware that local start-ups can prove highly disruptive, and it is keen to justify its premium pricing through targeted innovation and product superiority.

In the past, the company relied too much on breakthrough innovations from the R&D team. Today, the group has adopted a more holistic approach to drive market share, focusing not just on the product itself, but also on packaging, marketing, distribution and value.

P&G looks to be adopting several similar strategies to Colgate. However, I was also reassured by the extra layer of dynamism at the Manhattan-based business and its move into premium skincare.

Having visited three giants of the personal care sector, I came back feeling that there is genuine momentum within this space.

Consumers seem prepared to pay up for innovative, well-packaged products that will make them feel good, and the winners in the sector will be those companies that grasp this point and run with it. Overall, it was a worthwhile trip.

This article is from Walter Scott’s Research Journal 9 (September 2019).