Cosmetics groups move deeper into China

Mrs Chen, who only gives her surname, is delighted that she can buy her favourite cosmetics in her provincial town of Zhenjiang, some 250km inland from Shanghai and close to the Yangtze River.

A beautician massages her face with serum at L’Oréal’s Lancôme counter in the gleaming Yaohan department store, as she explains: “I first heard of Lancôme through a friend and last year I saw this counter and tried products here. They make my skin feel softer.”

Zhenjiang is one of China’s smaller and less affluent “tier-3” cities, urban centres that consumer goods multinationals are targeting because of their potential for faster growth than the more saturated first-tier cities, such as Beijing or Shanghai, or even second-tier provincial capitals such as Nanjing.

China is the world’s second-largest market for luxury cosmetics, after the US, and where L’Oréal and Estée Lauder, the two biggest luxury cosmetics companies by sales, are fighting for market leadership.

The drive into new cities is key for that battle.

Though L’Oréal started selling luxury cosmetics in China a decade before Estée Lauder, the two have a similar market share for this category. Both have increased their shares rapidly over the past decade, according to Euromonitor – mainly at the expense of Amway Corp, a direct-sales operator selling a broad range of cosmetics.

“More of Estée Lauder’s growth is expected to come from expansion and awareness-building in tier 2 and 3 cities as tier-1 cities begin to mature,” the US group said. Expansion in new cities helped propel retail sales growth of 28 per cent in Estée Lauder’s second quarter to the end of December 2012.

The 40-something-year-old Mrs Chen is one of millions of potential consumers among the expanding middle class in the provincial cities. The 261 tier-3 cities are prefectural centres, with a combined population of more than 207m, while the lesser tier 4 and 5 cities have a combined population of more than 300m.

“Three-quarters of China’s urban population live outside tier 1 and 2 cities and they account for two-thirds of retail sales,” said Stéphane Rinderknech, China general manager of Paris-based L’Oréal’s luxury cosmetics division in Zhenjiang this month. “There will be 260m more middle class people in China over the next 10 years.”

Mr Rinderknech said Zhenjiang, and other urban centres like it, are particularly attractive to consumer companies because disposable income per head is on average higher than in the largest cities – the lower cost of living more than compensates for the more modest salaries, he said.

Their inhabitants have taken to travel – 45 per cent of mainland Chinese visitors to Hong Kong are now from lower-tier cities, throwing up a new potential supply of airport shoppers for cosmetics companies.

“It’s important to touch them where they live, so that when they travel they already know us,” said Mr Rinderknech. “Also digital penetration is very high, at 80 per cent, which throws up lots of opportunities for us.”

The women here might not be dressed perfectly, or in a sophisticated way. But they are rich. They want to have good treatments for their skin [even if] the price is not so cheap

Most of L’Oréal’s sales in China are of mass-market cosmetics, including L’Oréal Paris and Maybelline mascara. But their sales growth has slowed to 5-6 per cent a year and, with a presence in 700 cities, they are already widely distributed. Luxury cosmetic sales are growing more rapidly – up 22 per cent last year, compared to the previous year – mainly because of the expansion into new urban markets.

Of the 70 cities in which Lancôme – its flagship luxury brand – has been launched over the past two years, 33 were in tier 3.

Luxury cosmetics, such as L’Oréal’s Kiehl’s, Biosonic, Clarisonic and Giorgio Armani, have to be sold in shops that look upmarket and to people who can afford to buy them.

Launching too quickly into cities that do not have exclusive districts and shops, risks damaging the image of the brand, which is not the case for mass-market cosmetics.

Jean Paul Agon, L’Oréal chairman and chief executive, said: “In China, penetration is going further for mass than luxury.” This was because there were still relatively few tier-3 cities that could accommodate a luxury department store, he said.

But Zhenjiang is one of the cities that has built luxury malls and Lancôme opened its counter in the seven-storey Yaohan 18 months ago. The modern retail emporium containing upmarket names, including Estée Lauder, Dunhill and Cartier, would not look out of place in any large international city.

But outside, rows of motorbikes are parked in the dusty street and, unlike Shanghai, there is virtually no English on street signs, highways and shops.

“The women here might not be dressed perfectly, or in a sophisticated way,” acknowledged Laurence Ma, Lancôme’s general manager for China. “But they are rich. They want to have good treatments for their skin [even if] the price is not so cheap.”

Most of the Zhenjiang clientele are the wives of wealthy private businessmen in the city’s thriving textiles, paper and chemical industries, said Ms Ma. They spend on average Rmb2,000 for 2.5 products per visit to the Lancôme counter. The average disposable income in Zhenjiang is Rmb22,000 a year.

Economic growth is slowing in China but that will not make a difference to the demand for luxury cosmetics, according to a bullish Mr Agon: “I’m not concerned about the economic slowdown in China – it’s very limited. We believe the future of China is bright and that it will become our number-one market in the world,” he said.

A government clampdown on extravagant gift-giving that has hit sales of watches and other luxury products has not affected cosmetics, said Nicolas Hieronimus, head of L’Oréal’s luxury business.

“We’re not in the super-premium luxury world. We are not selling €10,000 watches, but €300 creams at best,” he said.

Back in Zhenjiang, Mrs Chen is relieved she no longer has to make an hour-long trip for her creams: “I used to have to go to Nanjing to buy my cosmetics so I am glad this centre has opened up here.”