FUND NEWS
Money, Millennials and the Future of Beauty
GCI Magazine - May 16, 2016 – Recently, Fashion Group International (FGI) hosted a breakfast panel of beauty leaders from the worlds of media, private equity, retail and brands to discuss shifts in consumer mindsets, brand opportunities, investments and M&A, and more.
The Niche Explosion
The beauty industry has undergone parallel explosions in the amount and variety of niche brands and voices, which have provided unprecedented choices and democratization of information and perspectives for consumers. As a result, products such as face oils have become their own discrete category, while vloggers have harnessed immense power sought after by even the largest multinational beauty houses.
Elle beauty director Emily Dougherty noted that there are now more than 10,000 people on LinkedIn listing themselves as beauty editors. This spike in the number of voices has been enabled by a concurrent diversification in communication channels. Yet standard bearers such as Elle continue to cast a large shadow as influencers.
The rarest type of innovation, the lightning bolt, involves a completely new concept or product category and is most likely to excite a beauty editor.
Inside the Mind of a Beauty Editor
What does an Elle editor look for? Dougherty explained that, when surveying products for editorial coverage she asks: does it work, is it better than products already on the market, is it a breakthrough technology or format, and is it inspirational?
Inspirational products are fun, but maybe not always more efficacious than their predecessors, Dougherty said. In some cases, inspirational products may represent a breakthrough in rethinking a specific category or consumer need and, while not perfect, represent further innovations to come. In short, these products can act as a bellwether of where beauty is going.
Dougherty discussed the various types of innovation beauty editors look at, including so-called pivot products—repurposing existing tech for a new application—and refinement products, which are all changing the experience or point of view of a product or category or boosting relevance.
The rarest type of innovation, the lightning bolt, involves a completely new concept or product category and is most likely to excite a beauty editor. Dougherty detailed one recent lightning bolt, BitterLaceBeauty's prism cheek highlighter, which comprises a pan (44 mm) of multicolored pigments that can be swiped by finger onto one's cheek for a prism effect.
A brush can be used for a more blended look. Sold by the small brand on Etsy, the product unexpectedly took off on social media, creating immediate sellouts and long delays for replenishment orders.
Because millennials are led by what their hearts are attracted to,
connection can trump performance.
The Etsy Effect and Its Limitations
Lightning bolts are particularly potent for millennials, Dougherty said, because those consumers are often less focused on efficacy than products' "vibes." Describing this phenomenon as "the Etsy effect," she noted that often small niche brands can get away with efficacy lapses because of their emotional connection with consumers.* Because millennials are led by what their hearts are attracted to, connection can trump performance.
The same cannot be said for multinationals. Top brands, said Dougherty, have to be perfect. Alicia Valencia, senior vice president of beauty for HSN, agreed, noting that if brands don't have efficacy, they don't really have a brand at all. As a result, clinicals and other backing evidence on claims is crucial.
Quality will trump anything else in the long run, added Peter Jueptner, senior vice president, strategy and new business development at The Estée Lauder Companies. Brigitte King, deputy general manager of Kiehl's USA, echoed those sentiments, adding that efficacy matters.
Products have to have a payoff, which is why some of Kiehl's legacy products remain among its top sellers. Elana Drell-Szyfer, CEO of Laura Geller Beauty also noted that some of her brands' decade-old products remain some of its top sellers because their quality is their legacy. The brand continues to focus on its core ingredient and process story to bring women to the brand. She concluded, that it "100% has to work."
The End of Influencers?
Brands seeking to speak to millennials' hearts—and, ultimately, their wallets—are eager for access. Yet television viewership continues to decline for Americans age 18-24, according to Nielsen, while ad blocking has decimated many online campaigns even as digital marketing spends continue to rise. That's why, according to Schlesinger Associates, 84% of marketing groups surveyed would introduce at least one influencer marketing program.
Paying trendsetters and thought leaders to advocate for brands is big business, and is already creating its own celebrities, like YouTube personality Michelle Phan. Last year, GCI reported that The&Collective launched an influencer marketing agency to connect brands with social influencers who have gained significant traction on digital platforms. But does it work?
According to Dougherty, yes and no. While influencers on Instagram, YouTube and Snapchat can indeed positively impact brands, scale matters. As digital celebrities begin to amass hundreds of thousands or even millions of followers, their potency to influence declines.
As a result, Dougherty noted that consumers are beginning to embrace micro influencers, those personalities with large followings below the 100,000 threshold. Because engagement diminishes with the larger audiences, smaller-scale influencers truly have a new opportunity to boost brands.
Stuck in the Middle
While the niche and top multinational and heritage brands are succeeding in the digital space and connecting with millennials in their own distinct ways, there is a challenge in middle. Mid-tier brands—like mid-tier influencers with neither massive nor targeted audiences—have difficulty generating excitement. Dougherty suggested that mid-tier brands need to rediscover their stories and tell it consistently.
Private equity money and attention can shore up these challenges, making the brands highly attractive acquisitions for top beauty multinationals.
The Beauty of Private Equity Investment
Private equity has become more specialized in recent years, said Rich Gersten of Tengram Capital Partners, leading to a decline in generalist investing. Gersten's firm targets the consumer product space, with five of its 11 brands—including thisworks, Laura Geller Beauty, Deva Curl, Nest Fragrances and Cos Bar—falling in the beauty space.
So why is more private equity and investment banking turning to beauty? For one, said Gersten, beauty is a large and growing industry that is highly fragmented, with niche and indie brands offering unique investment opportunities.
Many of these businesses are passionate, uniquely positioned and founder-owned. These businesses sit in a high-margin space and offer private equity investors "attractive" exit opportunities.
Skin care has seen strong M&A activity, said Gersten, including Nestlé purchasing Proactiv, Unilever purchasing Dermalogica, and Estée Lauder's stake
in Dr. Jart+ and GlamGlow.
Often, these business are succeeding despite themselves, Gersten said, with fantastic products and highly engaged consumers overcoming deficits in human resources, infrastructure and business strategy. Private equity money and attention can shore up these challenges, making the brands highly attractive acquisitions for top beauty multinationals.
In acquiring "upgraded" brands from private equity, purchasers are typically seeking new territory or segments, or even expertise in elements such as social media, said Gersten.
Where the Action Is
Color cosmetics have driven a fair amount of private equity activity, Gersten explained. Prestige beauty, no surprise, is expanding "incredibly." Brands such as L'Oréal have acquired brands such as Urban Decay and NYX from private equity. Meanwhile, other brands such Laura Geller have taken on new private equity investments or are actively seeking them.
Skin care has seen strong M&A activity, said Gersten, including Nestlé purchasing Proactiv, Unilever purchasing Dermalogica, and Estée Lauder's stake in Dr. Jart+ and GlamGlow. A number of brands are currently held by private equity, including Sundial Brands and Perricone MD.
Working within a small business means that executives have to process great volumes of information and quickly prioritize and make determinations.
Hair care has seen less activity in private equity, perhaps due to less clear growth and a smaller prestige hair market, Gersten explained. That said, there has been some M&A activity in recent years, including Church & Dwight's purchase of Toppik and Henkel's acquisition of SexyHair.
Growth in fragrance investment has shifted to artisanal brands, Gersten continued. Recent activity has included Estée Lauder's acquisitions of By Kilian and Le Labo. On the retail side, Macy's has acquired Bluemercury, while Target has purchased DermStore.
Anatomy of an Acquisition
As Gersten noted, private equity may often seek out founder-owned companies that are seeing success despite structural or resource challenges, whether it be a lack of capital, direction or talent.
Founder-owners must trust the private equity partners they select because they are not just selling their company—they're selling their name. Gersten added that keeping founders engaged requires giving them a continued ownership interest in the company and providing them, through investment, with the money to grow to the next level.
From Gersten's perspective, ROI on a private equity deal should come in at roughly three times the money invested. Typically, a private equity firm holds onto and builds its acquisitions for four to five years prior to sale.
If a company has been sitting in a private equity portfolio for a longer period, it's typically "because it's not working," Gersten added. But when do you know when to sell? Gersten's answer was simple: when you begin receiving a slew of unsolicited interest from potential buyers.
In the case of Laura Geller Beauty, Tengram Capital Partners brought in an experienced beauty executive, Drell-Szyfer, as CEO. Drell-Szyfer said she was interested in the opportunities afforded by a private equity environment and felt her skill set—speed and agility, among others—fit the company's needs.
Drell-Szyfer previously held roles with companies such as L'Oréal, The Estée Lauder Companies and Avon Products and compared those experiences with working in a private equity environment. Aside from the rapid pace, she explained that one typically has the same goals and expectations as in any other top beauty company, but with fewer resources and capital and less time.
Large brands must never lose sight of the unique stories
behind their smaller acquisitions.
This has taught her how to analyze and process situations and make decisions quickly and firmly, she said. Working within a small business means that executives have to process great volumes of information and quickly prioritize and make determinations. Time and financial management skills are an absolute must, she concluded.
Aside from her duties with the Laura Geller Beauty Brand, Drell-Szyfer has helped scout itworks—Tengram Capital Partners' only non-US brand—while on a trip to the United Kingdom. Her initial discovery and the firm's investment occurred within a year, according to Gersten, showing the pace of deals in the private equity space. Drell-Szyfer has also become involved in finding new talent for the firm's other portfolio companies.
In the end, she said, her role is to add value to the brands and make them a resource that other companies would want to acquire. Drell-Szyfer added that it is critical to talk openly with staff regarding the goal: to build the brand in order for it to be sold.
Don't Love It? Don't Buy It.
Top brands have become aware that competition can come from anywhere, said King. As a result, they are engaging in M&A at the smaller niche level. Jueptner noted that beauty brands are looking at smaller assets that can "refresh" their portfolios. These acquisitions create greater diversification and can be built up to handle today's fragmented consumer base
Jueptner said that fragrance is an arena with great potential, particularly in high-end artisanal luxury products. He added, however, that passion comes first: "If we can't fall in love with brand, we won't buy it."
Valencia cautioned that success, particularly on her platform, requires a great product, great story and great storyteller. Failure on any one pillar could hinder success. As a result, she said, large brands must never lose sight of the unique stories behind their smaller acquisitions. In this way, HSN can act as a partner in helping build brands.
It is important to keep acquired brands' headquarters where they are rather than consolidating them within the beauty centers of New York or Paris.
King noted that, in addition to fixing supply chain issues, her job has focused on preserving brand DNA. She noted one incident in which, while mapping out the brand, the Kiehl's founders demanded the resulting document be printed on parchment.
This small detail signaled to King so much about what the brand must continue to be. To this day, while Kiehl's evolution is ongoing, she said that L'Oréal is focused on enhancing the brand's roots while keeping it competitive and agile by, among other strategies, scaling up and leveraging digital channels.
Jueptner concurred with King, saying it is crucial to ensure that entrepreneurs don't get lost in the large acquirer company and lose their unique voices. For one thing, he said it is important to keep acquired brands' headquarters where they are rather than consolidating them within the beauty centers of New York or Paris.
This retains brand authenticity and discrete identity. Because, unlike the tree- to four-year timespan of private equity, brands like Estée Lauder are focused on building brands over 10- and 50-year periods. Building them to last.
*That said, Dougherty explained that millennials do like products that come from specialists and experts—people seen as authentically knowledgeable.