The Booming Cosmetics Market in China

Transcription

1 INDUSTRY SERIES: COSMETICS July 2005 Issue 1 IN THIS ISSUE : I. Cosmetics market definition 1 II. Huge market potential 1 III. A Brand new era 2 IV. Principal market drivers 4 V. The emerging markets 6 VI. Supply of cosmetics 7 VII. Market entry considerations and expansion strategies 8 VIII. Market players 12 IX. Distribution channels 16 X. Performance by product sector Hair care Skin care Color cosmetics 23 XI. Future outlook 26 The Booming Cosmetics Market in China Backed by the robust economic growth, China s cosmetics sector is turning to a huge money-maker evidenced by the rapid development in recent decades. The China Association of Fragrance Flavor and Cosmetic Industries ( ) estimated China s total sales of cosmetics 1 to be nearly 85 billion yuan in 2004, up by 13% from 75 billion yuan in the previous year, ranking number two in Asia after Japan and number eight in the world in terms of sales value. This paper presents the general background of the booming cosmetics market in China, addressing the following aspects: the market size and structure, market entry considerations and the existing market players. Finally, a market analysis by product sector will be provided to give more specific information. I. Cosmetics market definition For the purposes of the study, cosmetics market in the following analysis is confined to the most prominent sectors, namely, hair care, skin care and color cosmetics, excluding the oral hygiene, deodorant, fragrance, sun care and depilatory sectors. II. Huge market potential China is currently the second largest cosmetics market in Asia, with market size estimated to be more than 85 billion yuan in Mainland people s average annual spending on cosmetics, in the early 1980s, was just about 1 yuan (12 US cents); the figure rose to 5 yuan (60 US cents) in the early 1990s, and jumped to 25 yuan (US$3) at the end of In big cities like Beijing and Shanghai, the annual average spending on cosmetics has reached yuan (US$ ). Cosmetics has now become the fifth-largest consumption hotspots on the Mainland only after real estate, automobile, telecommunication products, and education and tourism. The market is expected to expand at an annual rate of about 13% with sales reaching 100 billion yuan by This figure excludes the cosmetics sales in beauty salons. Statistics Department, Room 2440, Building 2, No. 25, North Yuetan Street, Beijing, China. Postcode: Tel & Fax: (8610) , (8610) nmb2000@263.net Contact person: Ms Mu Xuan & Ms Liang Chi Xin 13/F, LiFung Centre, 2 On Ping Street, Shatin, Hong Kong. Tel: (852) Fax: (852) lfdc@lf1937.com Contact person: Ms Freda Tong & Ms JennyAnn Chan 1

2 INDUSTRY SERIES July 2005 Issue 1 Despite the huge advances witnessed over the past two decades, China s cosmetics market is still at a very low level of development and is far from saturation. First of all, with a population of 1.3 billion, China has the largest number of potential cosmetics consumers in the world. Besides, the current per capita annual spending on cosmetics is well below the average of developed countries (US$35-70). The potential of China s cosmetics market is yet to be fully unleashed. Along the rapid economic growth, living conditions will continue to improve and spending on cosmetics is likely to increase exponentially. There is plenty of room for future development and the sector as a whole shows enormous business opportunities. III. A Brand new era After decades of robust economic development and market opening, cosmetics market in China has undergone tremendous changes. It has evolved from an underdeveloped market to a market in which consumers have strong brand preference. 1. The pre-reform era - an underdeveloped cosmetics market In the pre-reform era before 1978, cosmetic products were scarce on the Mainland. The living standard of the Mainland people was low and they paid little attention to appearances and styles. On the other hand, cosmetics available in the country were poor in quality, of limited choice and loosely packaged, owing to the underdeveloped domestic cosmetics production and the lack of imported goods. 2. Early stage of economic reform a booming cosmetics market with surging disposable income and the entry of foreign enterprises In the early stage of economic reform, rapid economic growth was registered. The rising disposable income of Mainland people had led to the upgrading of consumption structure. People demanded higher quality and wider choice of cosmetic products. Meanwhile, multinational cosmetics enterprises offering quality cosmetics, such as L Oréal, Olay, Johnson & Johnson and Shiseido, gradually entered the market and served as an important external stimulus triggering Mainland consumers demand for better cosmetics. The entry of foreign cosmetics enterprises also helped boost the market development. Facing the intense competition with the foreign players, domestic cosmetics enterprises began to upgrade their production technology, management skills, product quality, and to expand their scale of production. 3. The present situation - increasing brand awareness Nowadays, decades after the reform program was first implemented, Mainland consumers, with increasing product knowledge and surging purchasing power, are more sophisticated and value-oriented. Instead of looking solely for low prices, they place strong emphasis on product quality, functions and branding. Branded products, having an up-market image in terms of style, product quality and safety, have become priority choices for consumers. Statistics of IMI Consumer Behaviors & Life Style Yearbook , a market research surveying over 34,000 Mainland consumers, provide good illustrations of this trend. From Exhibit 1-3, it can be seen that, apart from prices, branding and product functions have become key factors affecting consumers choice of cosmetics. 2

3 The Booming Cosmetics Market in China Exhibit 1: Factors affecting consumers choice of shampoos, 2004 (% of respondents that regard the factor as important) Others Sample Product Buying recommen- City size Prices Brands functions convenience Advertising dations Packaging Others Beijing 5, Shanghai 6, Guangzhou 2, Shenzhen 3, Chengdu 1, Chongqing 2, Wuhan 2, Xi an 1, Shenyang 2, Nanjing 2, Total 33, Source: IMI Consumer Behaviors & Life Styles Yearbook Exhibit 2: Factors affecting consumers choice of face moisturizers, 2004 (% of respondents that regard the factor as important) Others Sample Product Buying recommen- City size Prices Brands functions convenience Advertising dations Packaging Others Beijing 3, Shanghai 4, Guangzhou Shenzhen 1, Chengdu Chongqing Wuhan 1, Xi an 1, Shenyang 1, Nanjing 1, Total 17, Source: IMI Consumer Behaviors & Life Styles Yearbook

4 INDUSTRY SERIES July 2005 Issue 1 Exhibit 3: Factors affecting consumers choice of lipsticks, 2004 (% of respondents that regard the factor as important) Others Sample Product Buying recommen- City size Prices Brands functions convenience Advertising dations Packaging Others Beijing 1, Shanghai 1, Guangzhou Shenzhen Chengdu Chongqing Wuhan Xi an Shenyang Nanjing Total 6, Source: IMI Consumer Behaviors & Life Styles Yearbook In a competitive market like China, where a vast variety of products catering to different consumers needs are available, there is a pressing need for enterprises to put more efforts in brand building so as to distinguish their products from the others. Cosmetics enterprises now devote a lot of resources in advertising and research and development to shape their brand images and to provide customized products for their target consumers. A survey released by CTR Market Research shows that cosmetics and toiletries sector ranked first in advertising spending in China in 2004 with US$4.8 billion plunked down, an increase of 34%. Olay, a famous brand of Procter & Gamble (P & G), spent US$565.8 million on advertising, a 160% increase over The promotion and advertising activities for cosmetics take various forms, such as placing advertisements in press, Internet, high-traffic roads, buildings, metro stations and buses; organizing onsite displays and demonstration shows; and employing celebrities as spokesmen to increase brand reputation. Enterprises are also actively utilizing the comprehensive coverage of CCTV to improve their reach across the country, especially in second- and third-tier cities and the rural area. In November 2004, CCTV auctioned its prime time advertisement slots for a record sum of 5.3 billion yuan (US$634 million). P & G became the new bid champion spending more than 385 million yuan (US$46.5 million) on the auction. IV. Principal market drivers 1. Strong economic growth and growing awareness of personal well-being The strong growth of the cosmetics market has been underpinned by the vigorous economic growth of China and the increasing disposable income of Mainland residents (see Exhibit 4). In 2004, China s GDP hit 13,651.5 billion yuan (US$1,648.7 billion), rising 9.5% year-on-year (y-o-y) compared with the previous year. 4

5 The Booming Cosmetics Market in China Exhibit 4: GDP, urban and rural income and total retail sales (both absolute amounts and annual growth rates), Total amount (yuan) Average annual growth rate (%) GDP (billion yuan) , , , , , , Per capita annual disposable income of urban households (yuan) , , , , ,472 9, Per capita annual net income of rural households (yuan) , , , , Total retail sales of consumer goods (billion yuan) , , , , , Source: National Bureau of Statistics of PRC (NBS) Mainland people are now better-educated, better-paid and they attach more attention to fashion and their personal image. They not only focus on improving basic living conditions, but are also keen to enhance their overall quality of life. Their increasing awareness of health, hygiene and appearance has made cosmetics one of the consumption hotspots. In fact, the pursuit of beauty and health is no longer confined to young women only. Cosmetic products are gaining popularity among men, children and the elder people. The cosmetics market is getting bigger and bigger embracing consumers from all ages and from all walks of life. 2. The fast expanding rural market Currently, rural income remains low and the cosmetics market growth is mainly led by urban consumption. With 62% of the national population, the rural residents made up only 34.1% of the total retail sales of consumer goods in Boosting rural economic development and consumption have always been the Central government s main concerns. To raise farmers income and to accelerate agricultural development, several measures and polices, such as reducing or abolishing agricultural tax and granting more subsidies to farmers for crop production, have been implemented in recent years. To improve the efficiency of rural distribution network, in February 2005, the PRC government announced its plan to build a national rural retail network covering 70% of all villages within three years, by developing chained retail stores such as supermarkets and convenience stores 2 in counties and major towns. It is expected that, in the coming future, significant improvements will be made in respect of farmers income and distribution efficiency, which will encourage rural consumption and unleash the huge potential of the vast rural market. 2 The operation modes of these stores may be different from those in the urban areas to cater to the specific needs of rural residents. 5

6 INDUSTRY SERIES July 2005 Issue 1 3. The rise of the middle-class Sandwiched between China s most affluent people and the hundreds of millions of farmers and factory workers, a rapidly growing middle class has emerged. According to the National Bureau of Statistics of PRC (NBS), middle class refers to those with annual household income of 60,000 yuan (US$7,230) to 500,000 yuan (US$60,240). This group of people has stable income, can afford private-owned houses and cars, and have extra money to spend on beauty goods, holiday and education. They have higher expectations than other consumer groups and pursue a life with style and taste. Generally speaking, they demand a better shopping environment and higher product quality. They are also brand-conscious and less price-sensitive. Many of them are employees of multinational firms. The NBS predicted that by 2020, middle class would increase from the current 5% of total households to 45%. They will expand exponentially in major cities such as Beijing, Shanghai, Guangzhou and Shenzhen, and will become an influential group in the society. This rising middle class is becoming one of the most active consumer groups for cosmetics in the next years. 4. Women fueling the market growth Mainland women, especially those office ladies, are now increasingly appearance- and image-conscious. The proportion of cosmetics spending in their total expenditure has been increasing. The growing number of young females in whitecollar jobs will further drive the cosmetics sales. Being more financially independent, their demand for cosmetics will be greater than ever. V. The emerging markets 1. Babies and children The market for babies and children offers huge business opportunities with market potential exceeding 400 million yuan, according to official statistics. Every year, around 20 million babies are born on the Mainland. The total number of children aged between 0 and 14 is estimated to be 300 million. Under the one child policy, Chinese parents are willing to spend as much as they can on baby and children care products. Currently, only few brand owners offer such products, with some famous ones being Johnson & Johnson, Yu Mei Jin and Frogprince. The lucrative market potential is likely to attract more brands to enter and bring in new technology. Thus, a rapid sector growth is anticipated. 2. Men Men s cosmetics market is growing in China with market growth rate forecasted to surge to around 6% or much higher by To get a share of this newly emerging market, many cosmetics enterprises have been introducing men s product lines, such as JC of Aupres, Glf of Shanghai Jahwa, Nivea men, Biore Men, etc. Men s cosmetic products are, presently, far more diversified and are no longer limited to shaving tools. Other products including cleansing products, moisturizers, essences, hair treatment products and fragrance etc. are now available. However, compared with the market for women, men s market is relatively small and the growth rate is much slower. Currently, men s cosmetics are only popular among the more affluent and fashion-conscious young men in big cities, while most of the men on the Mainland are still reluctant and do not feel the need to use cosmetics. More time and product education are needed for the perception to change and for the market to grow. 6

7 The Booming Cosmetics Market in China VI. Supply of cosmetics 1. Production In the early 80s, there were less than 200 cosmetics manufacturers on the Mainland. However, this number has been increasing dramatically since the 90s. The cosmetics industry grew exponentially with annual growth rate outpacing that of the whole light industry. Official statistics reveal that around 3,200 cosmetics manufacturers are operating on the Mainland at present. This figure is calculated based on the number of renewal production licenses granted in However, the actual number of manufacturers should be far more than 3,200, given the fact that numerous small cosmetics factories are in operation without formally applying production license. Of the 3,200 factories, some are set up by brand owners to produce their own products, while some others are Original Equipment Manufacture (OEM) factories performing processing functions only. The huge potential of the Mainland market has been attracting many multinational cosmetics manufactures to invest in China and to exploit this new source of profits. However, before joining the World Trade Organization (WTO), China imposed high tariff rate on imported cosmetics. Foreign exchange control, product standard and quality control requirements are also barriers to export to the Mainland. As a result, many foreign brands, in cooperation with their domestic counterparts, set up their manufacturing base on the Mainland to take advantage of the low production costs and to be free from the trade barriers. Currently, there are around foreign-invested cosmetics manufacturers in China, with total investment exceeding US$1.5 billion. Examples of these enterprises include P & G, Johnson & Johnson, Avon, Revlon and Amway from the U.S.; Unilever from the U.K.; Henkel and Weina from Germany, L Oréal from France; and Shiseido and Kao from Japan. While the foreign-invested manufacturing enterprises account for the lion s shares of the premium market, several domestic manufacturers maintain strong positions in certain products. Numerous small domestic manufacturers produce regional or generic brands and distribute their products within their own province or neighboring provinces, but their share of the overall market is very limited. Nearly 90% of the domestic manufacturers are small in scale having annual sales less than 50 million yuan. Besides, they focus on the lower market segment and offer cosmetics at extremely low prices. As at 2003 year-end, only around 50 domestic manufacturers realized annual sales of over 100 million yuan. Of which, only Shanghai Jahwa, Beijing San Lu, Raystar Cosmetics (Shenzhen), C-bons Group, Arche Group and a few could achieve annual sales exceeding 500 million yuan. 2. Imports of cosmetic products Though China s cosmetics imports surged by 39.2% to US$100 million in 2003, imported cosmetics still constitute a limited share in its cosmetics consumption. Perfume, body spray and eye care were the major items of imports. Due to mad cow disease, imports of cosmetic products from certain countries were regulated in 2003, which dampened the year s import. From 2005 onwards, the tariffs are reduced to around 10% on average, which creates a more favorable environment for foreign enterprises wishing to export to the Mainland. The tariff reduction will push down the retail price of cosmetics but the impact is not likely to be as significant as expected, given the fact that many foreign brand owners have already set up manufacturing base in China and imported cosmetic goods only accounted for 1% of the total cosmetics sales in China. 7

8 INDUSTRY SERIES July 2005 Issue 1 VII. Market entry considerations and expansion strategies 1. A fragmented market characterized by rural-urban and regional income disparity As players prepare to enter the Mainland market, it is important to keep in mind that China is not a single unified market; instead, it is composed of many fragmented and localized market characterized by its two-tier market structure (urban and rural) and regional diversity. Dualism in consumption patterns: The two-tier consumer market One should note that there exists a wide income gap between the urban and rural households. In 2004, of the 1.3 billion people in China, 543 million were urban residents while 757 million were resided in rural areas. Income growth in the rural areas has been lagging behind that in the urban areas, as shown by the rising urban-rural income ratio from 2.5 in 1980 to 3.21 in With 41% of the country s population, the urban residents made up 65.9% of the national retail sales in Restrained by low income, rural residents tend to opt for cheaper anonymous branded products and some even regarded cosmetics as luxuries that they cannot afford. By contrast, cosmetics are widely used in urban areas, particularly in large coastal cities. The urban residents are much more affluent and they demand more sophisticated products. The market segments The Mainland consumers can be broadly divided into four segments the high-, mid- and low-income groups and the rural residents. The upper income group consumers mainly concentrate in the first-tier cities, where purchasing power is relatively strong. They demand high quality cosmetic products and prefer premium-imported cosmetics from the U.S., Europe and Japan, such as Estée Lauder, Christian Dior, Chanel, Clinique, SK II, Lancôme and Shiseido. Purchasers of cosmetics in this segment are mainly affluent and appearance-conscious young and middle-aged females with monthly salary exceeding 3,000 yuan. Consumers in the middle-income group are usually mid-income city dwellers and residents in second- and third-tier cities. They tend to purchase well-known domestic brands or high-end mass products, for example Olay, Aupres, L Oréal, Relvon, Maybelline and Herborist. For the less affluent city dwellers or the more affluent rural residents, products with prices ranging from 10 to 300 yuan are their priority choices. These include brands such as Biore, Clean & Clear, Dabao, Maxam, Yu Mei Jing, Mininurse, Longliqi and TJOY. For the vast majority of the Mainland people, premium products remain far beyond reach. Rural residents, who account for 59% of the total population, spend far less on cosmetics and they tend to opt for low-end anonymous branded products. Regional Performance sales concentrate in the East Regional income disparities in China provide significant implications for enterprises wishing to enter the market. Important differences in development level and living standards are evident among regions. 8

9 The Booming Cosmetics Market in China The eastern coastal regions are the wealthiest part of China. People there are comparatively well off and are more exposed to the outside world. They are more likely and better able to afford cosmetic products to improve personal hygiene and image. In 2003, the retail sales of cosmetics of enterprises above designated size 3 in the eastern region amounted to 14.3 billion yuan, making up 69.1% of the national total (see Exhibit 5). Shanghai and Beijing ranked first and second in cosmetics retail sales respectively for 5 consecutive years. Their per capita retail sales of cosmetics in were far higher than that of the other cities (see Exhibit 6). However, after the rapid growth in the early years, their sales growth rates have been slowing down in recent years (see Exhibit 7). On the other hand, other eastern cities are gathering pace and have experienced strong growth in cosmetics sales. In 2003, Fujian, Zhejing, Guangdong and Shangdong recorded y-o-y cosmetics sales growth of 42.6%, 41.2%, 33.3% and 24.2% respectively, much higher than the national average of 17.9%. By comparison, cosmetics sales in the less developed region of the central and western part of China are relatively low. The central and western regions constituted only 18.7% and 12.2% of the national retail sales of cosmetics of enterprises above designated size in 2003, respectively (see Exhibit 5). Per capita annual retail sales of cosmetics in certain cities, such as Jiangxi, Guizhou, Tibet and Gansu, were as low as 2-4 yuan in 2003 (see Exhibit 6). The main factors hindering their development include low disposable income, limited product awareness and less established distribution network. However, accompanying the acceleration of the Go West policy and the Central government s policies of boosting the economic development of the central region, cosmetics markets in these regions are taking off and some cities have recorded significant growth in cosmetics sales (see Exhibit 7). Exhibit 5: Cosmetics retail sales of enterprises above designated size by region, 2003 Source: National Bureau of Statistics of PRC 3 Above designated size: with annual sales of over 5 million yuan and an employment of or over 60 at year-end. 4 Due to the constraint of data availability, retail sales of enterprises above designated size has been used as a proxy to calculate the per capita retail sales of cosmetics. 9

10 INDUSTRY SERIES July 2005 Issue 1 Exhibit 6: Per capita annual retail sales of cosmetics by region, 2003 Source: National Bureau of Statistics of PRC Exhibit 7: Growth rates of cosmetics retail sales of enterprises above designated size, Provinces/ Municipalities y-o-y growth rate Eastern region Fujian -7.1% 37.0% 20.5% 42.6% Zhejiang 30.2% 6.9% 19.0% 41.2% Guangdong 14.5% 19.2% 22.5% 33.3% Shandong 17.8% 12.2% 19.5% 24.2% Jiangsu 5.0% 10.6% 18.2% 19.4% Liaoning 19.1% 33.7% 19.4% 18.0% Hebei 2.2% 7.9% 21.6% 11.6% Beijing 15.9% 32.7% 2.3% 9.0% Tianjin 63.9% 17.9% -6.4% 7.8% Shanghai 42.0% 27.3% 10.2% -0.2% Central region Hubei 60.2% -3.8% 2.5% 38.0% Jiangxi 11.1% -10.9% 0.2% 35.1% Henan 5.1% 3.3% 20.0% 30.6% Jilin 30.3% 32.0% 21.3% 16.6% Heilongjiang -0.6% 8.7% 15.4% 13.1% Hunan 12.4% 8.9% 37.7% 12.6% Inner Mongolia 1.0% 29.2% 10.5% 11.2% Hainan -7.4% 68.4% 40.2% 10.3% Anhui 4.2% 16.2% 27.6% 9.1% Shanxi 41.3% -13.6% 21.6% 7.8% 10

11 The Booming Cosmetics Market in China Provinces/ Municipalities y-o-y growth rate Western region Yunnan -4.7% -6.6% -7.4% 77.2% Tibet -4.8% 58.8% 28.4% Chongqing 1.3% 24.5% 32.7% 25.2% Sichuan 30.1% 12.5% 14.8% 24.0% Xinjiang 5.9% 14.4% 10.9% 23.0% Ningxia 6.6% 10.3% 17.4% 21.9% Shaanxi 7.6% 27.0% 30.6% 11.9% Qinghai -5.8% 14.5% 40.1% 6.6% Guizhou 28.9% 24.3% 12.5% 2.7% Gansu 35.3% -13.2% 8.6% -5.8% Guangxi 10.2% 0.7% 37.0% -12.1% National average 20.8% 16.5% 14.1% 17.9% Source: National Bureau of Statistics of PRC 2. Acquiring domestic brands as a way to penetrate into the second- and third-tier cities and the mass market Experts predicted that China would become the world s second largest market for luxury goods in ten years time and its demand for luxury and premium goods would surge exponentially once its per capita disposable income reached US$2,500. Albeit the huge potential that the premium market shows, it takes time for the market to grow. Given that 60% of the Chinese population are living in rural areas and have low disposable incomes at present, the Chinese market is actually geared towards low-priced mass products. On the other hand, the developed cities along the coastal areas are currently packed with both multinational and domestic players and show signs of growing market saturation. The second- and third-tier cities, and the inland cities, by comparison, are relatively untapped and show great development potential. Therefore, some foreign players, apart from consolidating their position in the high-end segments, are striving to extend their reach to the mid- and low-end segments and to the less developed cities. However, the complexity of China s distribution system, the relatively high-pricing of foreign products, and the lack of local knowledge and network all make it hard for foreign players to penetrate into the mass market. In this respect, acquiring well-known domestic brands with heritage to take over their existing distribution network, established reputation and local network is regarded as a fast and effective way for multinational players to break into the mass market. Some multinational players have already put forward their acquisition plan. One recent case in place is the acquisition of Mininurse and Yue-Sai, two well-known mass brands in China, by L Oréal in the late 2003 and the early 2004 respectively. Both Mininurse and Yue-Sai possessed extensive sales network: Yue-Sai has 800 cosmetics counters in 250 cities; Mininurse has over 280,000 sales points across the country. So far, L Oréal has built up its sales networks in most large Mainland cities, but not in the less developed ones. This strategic move enables L Oréal to extend its reach to many second- and third-tier cities and penetrate deeper into China s vast southern and central market in addition to the highly competitive eastern coastal areas. It will also provide a far wider and deeper distribution coverage for all product lines of L Oréal. 11

12 INDUSTRY SERIES July 2005 Issue 1 3. Increasing investment in research and development (R & D) In response to the increasing sophistication of Mainland consumers and the stiffer market competition, new product development plays a major role in attracting consumers. In this regard, investment in research and development (R & D) is crucial, especially to foreign players who are not familiar with the local preferences. The existing foreign players on the Mainland have been putting much effort in R & D work so as to localize their product offerings to meet the demands of Mainland consumers. Many of them are planning to enlarge the scale in the near future, for example, by setting up new research centres in collaboration with local academic institutions or conducting large-scaled market research. Domestic players, who placed less emphasis on R & D in the past, have now changed their mindsets and have been allocating more resources to R & D in recent years. Enterprises such as L Oréal China, P & G (Guangzhou), Shiseidso, Dabao, Yu Mei Jing and Unilever China have already set up their own R & D centres to enhance their design capabilities. 4. Localization strategies There exists significant cultural, language and institutional differences between foreign countries and China. For foreign cosmetics enterprises to win market share in China, localization is a must. Actually, many foreign cosmetics players have been making increasing efforts to localize their products and operations. As mentioned previously, R & D centres and comprehensive marketing teams have been set up by foreign enterprises to develop products that cater to Mainland consumers skin types, preferences and living habits. It is reported that, to deepen its understanding of Mainland consumers, P & G made contact with more than 3 million local consumers every year for up-to-date market information and feedback. Localization of employees is another major steps taken by many foreign cosmetics enterprises. For example, Unilever recruited and trained over 90% of its managers locally and is working to minimize the number of expatriates in the company; P & G has been recruiting from campus in China for 16 years and more Chinese managers have taken up important positions replacing expatriates. Apart from that, many foreign players have localized their raw material sourcing and manufacturing to reduce production costs and time. Many of them have set up factories in China and they procure a significant amount of raw materials locally. For instance, for its domestically sold products, Unilever sources 90% of the raw materials used from the Mainland. Another example is P & G (China), which purchases 80% of the raw materials from the local market every year. Other localization strategies are also widely adopted by the foreign cosmetics enterprises, such as localizing marketing mix, developing relationship with local government, actively participating in local charity work and customizing the operation system. VIII. Market players 1. Foreign players Multinational enterprise cashing in and dominating premium market The lucrative cosmetics market in China has been attracting many multinational enterprises. At present, most major multinational brands are available in major cities. These enterprises mainly target at the most developed cities and have been dominating the premium market. Owing to the relatively high pricing, higher operation costs, and lack of local knowledge of the highly fragmented Mainland market, foreign players have yet established significant presence in the mass market and in second- and third-tier cities. 12

13 The Booming Cosmetics Market in China Sources of products Foreign cosmetic products sold on the Mainland can be basically classified into three types: imported, self-manufactured by foreign brand owners and produced by local OEM factories. The imported goods are mostly premium products of famous international brand owners. They are usually sold at much higher prices. The production and the formula of such products are strictly controlled and protected by the brand owners. On the other hand, many big cosmetics enterprises that wish to have long-term businesses in China, have established production base on the Mainland to supply part of their domestically sold products. While a significant amount of raw materials used are sourced locally to reduce production cost, the most important and special ones remain imported from overseas. A number of foreign cosmetics enterprises choose to outsource the production process to the local OEM factories. Some big enterprises let theses factories produce some of their mass or more developed product lines, so that they can concentrate their efforts in developing and producing new or higher-valued items. The smaller foreign brand owners, who do not have production base on the Mainland, are also actively cooperating with these factories. Strengths of multinational players Multinational cosmetics enterprises have considerable advantages over their local counterparts in the aspects of scale of operation, financial strength, technological level, management know-how and experiences in brand building. Consistent product quality, together with substantial advertising and promotion, helps them establish impressive brand images. Most of the foreign players adopt localization strategies to win market share in China. They employ many local staff, and are trying to replace the expatriate staff with local Chinese people. Some of the big ones even set up R & D centres and comprehensive market research teams in China to get instant market data and to develop products that are tailored for Mainland consumers. Exhibit 8: Major foreign players Cosmetics company & its major brands in China Procter & Gamble (Guangzhou) Ltd Olay SK-II Max Factor Covergirl Rejoice Pantee Pro-V Head & Shoulders Vidal Sassoon Clairol Herbal Essences Ascend Wella Crest Zest Development in China Established subsidiaries and factories in Guangzhou, Beijing, Chengdu and Tianjin with a total investment in excess of US$1 billion since entering the country in 1988 Vast product variety comprising skin care, hair care, bath and shower products, color cosmetics, women s health products, oral hygiene, baby products, food and drinks, catering for all sorts of people: both young and old, and low and high income consumers Employing over 4,000 people Having 5 distribution centres in Beijing, Shanghai, Xi an, Chengdu and Guangzhou Taken back the remaining 20% shares from its joint venture partner, Hutchison Whampoa in 2004 Going to introduce the color cosmetics brands to China in May 2005 The first manufacturing enterprise to set up an Efficient Consumer Response (ECR) system in China Set up R & D centre in collaboration with Tsing Hua University in Beijing in 1998 with total investment reaching US$27.5 million by the end of 2003 Yearly spending on R & D accounted for 3.8% of the annual sales 13

14 INDUSTRY SERIES July 2005 Issue 1 Cosmetics company & its major brands in China Unilever China Ltd Hazeline Pond s Vaseline Pears Zhong Hua Signal Lux Dove L Oréal China L Oréal Lancôme Biotherm Vichy Shu uemura Maybelline Matrix Helena Rubinstein La Roche-Posay Kerastase Elsève Garnier Yue-Sai Mininurse Development in China Joint venture of Unilever set up in Shanghai in 1986 Product range comprising skin care, hair care, deodorant, detergent, soap, toothpaste and fragrance Suffered setbacks in mid 80s and 90s with many of its joint ventures failing to earn profits, and thus entered into large scale consolidation and integrated its various units under one holding company Actively acquiring local brands, most notably, Zhong Hua Massive spending in advertising, for example, spent 100 million yuan on promoting the brand, Pond s Established R & D centre in Shanghai in 2001 with initial investment amounted to US$166 million Working on building a low cost and competitive production base by relocating and consolidating its production and logistics facilities, and R & D capabilities to Hefei in Anhui in an attempt to lower the overall production costs and the product prices Entered China in 1997 Retail sales in China doubled to almost 3 billion yuan (US$361 million) in 2004 Opened over 400 cosmetics counters in nearly 100 cities across the country Employing over 7,000 people in China Having 3 plants on the Mainland, 1 in Shanghai and the others in Jiangsu and Hubei, exporting goods to Japan, South Korea, Southeast Asia and Taiwan. Offering products ranging from hair care, color cosmetics, skin care, fragrances Acquired two famous local brands, Yue-Sai and Mininurse in 2003 and 2004 respectively as a step to tap the mass market Placing strong emphasis on R & D with yearly spending taking up over 3% of the annual sales; setting to open its fourth R & D centre in Shanghai in June 2005, following Paris, New York and Tokyo; publishing a report on the skin types of Mainland women in 2002 by surveying 2,000 women aged between 25 and 60 in 6 years time Moving its Asian training centre to China from Singapore in April 2005 Source: respective companies homepage, media and research agencies 2. Domestic players Domestic players playing major roles in mass market and gathering pace to develop brands As the income level of the majority of Mainland consumers are still quite low, domestic products which are relatively cheap are highly welcome in the mass market, especially in second- and third-tier cities. The majority of the domestic cosmetics enterprises are small in scale and are not as well-operated as their foreign counterparts. Compared with foreign cosmetics rivals, the domestic players lack competitive advantages and are markedly overshadowed in such aspects as scale, management, talent, technology and brands. A report released recently by Sinomonitor International reveals that Chinese brands are losing ground to foreign rivals in the domestic cosmetics 14

15 The Booming Cosmetics Market in China market. The report ranked the top competitive brands in 27 consumer product sectors for the year Comparing the ranking lists for 2003 and 2004, the report for 2004 saw several domestic brands on the outs. This report reveals two prominent features: foreign products enjoy much greater brand loyalty than their domestic rivals; and consumption patterns are moving upscale. Though domestic players show strength in local knowledge and network, lower labor and management costs, and higher flexibility, they are losing competitive edge amid the severe competition with the foreign counterparts. Therefore, in recent years, domestic cosmetics enterprises have been striving to improve their production efficiencies and product standard by developing technology, streamlining the supply chain and intensifying their efforts in brand building as well as in research and development. Some new domestic brands are now prevalent in the market, including Dabao, Yu Mei Jing, Chinfié, Skek, Arche etc. Exhibit 9: Major domestic players Cosmetics company & its major brands in China Beijing San Lu Factory Dabao Shanghai Jahwa Co Ltd Maxam Chinfié Herborist Soft Sense Gf (for men) Cocool Liushen C-Bons Group Slek S-Dew Maestro Development in China A state-owned enterprise set up in 1985 King of mass products and famous for good quality but fair price Launching the well-known Dabao herbal series of cosmetics offering more than 100 products including skin care, hair care, color cosmetics, perfume and clinical products Possessing extensive sales network with 157 counters in major department stores in 27 provinces and municipalities Exporting to about 30 countries or regions, including Japan, the U.S. and other European countries, with export volume increasing consistently at a rate of 40% annually Selling in some specialty stores in Switzerland, Sweden, Greece, Tunisia and Cyprus Built the largest cosmetics factory in Bangladesh in 1992 Established in 1992 Offering skin care, hair care, baby care, bath and shower, and household cleaning products Total sales in China reaching 2.2 billion yuan in 2004, with 1/6 of the sales coming from premium products Launched a popular premium traditional Chinese herb-based skin care product line called Herborist in 1998 emphasizing on Chinese Concept Actively setting up joint ventures with multinationals as an important strategy to upgrade management know-how and production capabilities Set up joint venture with Sephora from France recently, planning to open cosmetics professional stores for Herborist Orlane approaching Jahwa to seek cooperation opportunity Investing 3% of its annual turnover in R & D Starting operation in Wuhan in the late 1980s Focusing on hair care products and targeting at low-income earners Brand owner of the most popular domestic hair care brand, Slek Enjoying a broad distribution network penetrating into both urban and rural areas Source: respective companies homepage, media and research agencies 15

16 INDUSTRY SERIES July 2005 Issue 1 IX. Distribution channels China s retail sector has undergone tremendous changes in the few past years. Different types of modern retail formats flourish in the market. Cosmetic products are now sold in diverse channels, of which department stores and supermarkets are the most popular. 1. Department stores centre of reliable, genuine and safe products Department store, which is generally perceived as the centre of reliable, genuine and safe products by the Mainland consumers, is the main distribution channel for branded cosmetic products. To set up beauty counters, the cosmetics enterprises should have a wide array of products and distinctive brand images. The requirements on capital and brand image are also much higher. Beauty counters of various famous brands have been opened in numerous department stores across the country. For example, Aupres of Shiseido Liyuan Cosmetics Co Ltd has already opened over 230 cosmetics counters since Maybelline of L Oréal China also has over 500 cosmetics counters in the country. In general, department stores in China can be divided into three classes the high-, mid- and low-end based on the products they sold, store environment and management. The top cosmetics brands (such as Estée Lauder, Christian Dior, Clinique, Lancôme, Chanel, Orlane, Shiseido and SK II) are usually distributed in high-end department stores - the popular shopping venue of affluent consumers. It is not easy to set up a beauty counter in these stores as they impose strict entrance requirements in the aspects of market standing and sales record of the brands. Sources reveal that the sales of such beauty counter in the high-end department stores such as Beijing Lufthansa Shopping Centre can exceed 10 million yuan per year. 2. Supermarkets, hypermarkets and grocery stores major distribution channels for mass products Supermarket, hypermarket and grocery store, by contrast, are the major distribution channels for lower-priced mass products the basic cosmetic products such as hair care items, and brands targeting at the mid- to low-end market, such as Pond s, Clean & Clear, Biore, Maxam, TJOY, Mininurse and Caisy. Prices of these products are usually around 5 to 150 yuan. Some international brands, such as Olay, are selling in both department stores, and supermarkets and hypermarkets. They distribute the premium product lines in the former while offering mass product lines in the latter. 3. Pharmacy chains an emerging channel for medicated cosmetics A bright spot in the cosmetics market is the emergence of pharmacy chain as a popular distribution channel for multifunction, medicated and natural cosmetic products. Pharmacy chains, where pharmacists and doctors are usually hired to introduce products and explain product functions to consumers, present a more credible and professional image. These chains, therefore, have attracted many consumers who wish to buy cosmetic products that emphasize specific functions (such as wrinkle-free, whitening, anti-acne and slimming), medical use and natural ingredients. Vichy entered the Mainland market in Only after two years operation, it had already set up beauty counters in more than 200 large pharmacy chain stores. Uriage from France, Cortry and Longliqi from China have also achieved success by selling in this channel. 4. Specialty stores providing professional services and full range of merchandises of a specific brand Specialty store for cosmetics is taking off on the Mainland. The professional services and the full range of goods provided by the stores appeal to many Mainland consumers. 16

17 The Booming Cosmetics Market in China In fact, most of the specialty stores operating on the Mainland are owned by the former direct selling companies. The PRC government banned all direct selling operations in 1998, which forced all the direct selling companies to adjust their business models. These companies, including Avon and Amway, then set to establish their own specialty stores. Avon has achieved great success with over 5,500 specialty stores and 1,000 cosmetics counters in 74 Chinese cities at present. Its total sales reached 2.4 billion yuan in 2003, up by 24% y-o-y. Amway, on the other hand, adopted the salesmen plus stores operation model to fit for the Chinese market in In six years time, Amway has set up over 110 specialty stores on the Mainland employing more than 70,000 salesmen. Its cosmetics sales in China accounted for 1/5 of its global sales, hitting 10 billion yuan in 2003 with 66% y-o-y growth rate. Specialty stores are not only favored by the former direct selling companies, but also by premium brands. For instance, Shiseido opened its first specialty stores in September 2003, offering 233 products from eight Shiseido brands. Sources reveal that Shiseido is going to open 5,000 more by Professional stores dominated by numerous small players but some big ones targeting at mid- to high-end segment emerging Professional store, selling a wide variety of cosmetic products and brands, is particularly popular in small cities, where large department store does not exist and limited distribution channels for cosmetics are available. At present, most of the professional stores on the Mainland are standalone stores and are small in scale. They offer a wide variety of products, from anonymous branded products to some famous foreign brands, at lower prices. Big discount can also be obtained through bargaining. Recently, some chained professional stores positioning themselves at the mid- to high-end segments are emerging in China. They are larger in scale and they put more emphasize in shaping store and brand images. Sa Sa, a Hong Kong cosmetics enterprise operating chained professional stores opened its first store in Shanghai in March 2005 and plans to open 3-5 more in half a year s time with a total investment of around HK$30 million. The new store in Shanghai is Sa Sa s biggest store in Asia, which offers products of over 100 brands - 70% foreign and 30% local brands. Most of the products are house or salon labels like Swiss Program or mass brands like Up2U (by Avon), Neutrogena, Pond s and Color Zone. Sa Sa is still in talks with local agents to get more popular brands to the store. Another company, Shanghai Jahwa, joining hands with Sephora, is also in the process of setting up professional stores under the name of sifulanyijiahua ( ). It targets on high-end products with Chinese characteristics. 6. Direct selling awaiting market liberalization Direct selling is currently prohibited on the Mainland. However, it is reported that the long-awaited Rules of Direct Selling, legalizing direct selling and setting up a comprehensive legal framework for such operation, will be promulgated this year. This rule, lifting the ban on direct selling, will offer an alternative distribution channel to cosmetics enterprises. In preparation for the legislation, in April 2005, the Ministry of Commerce of PRC and the State Administration for Industry and Commerce approved Avon as the first trial direct-selling company in Beijing, Tianjin and Guangdong. 7. Online sales in initial stage of development Online shopping is increasingly popular among young people. Currently, there are many online stores selling different kinds of branded cosmetic products. Premium and imported products are usually sold at lower prices in this channel. However, almost all of them are smuggled or bootleg products. So far, few well-known brands offer online sales services. DHC of Japan has recently entered the Mainland market and uses online and telephone ordering as its main distribution channels. 17