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Lauder Seeks New Sales Outlets Without Alienating Traditional Partners

Sales through traditional channels are slowing, so the cosmetics giant is looking at other options, including the Internet and its own stores.

The new

Sephora

cosmetics emporium at New York's Rockefeller Center would seem to have everything to cleanse, exfoliate, moisturize and tint -- except for

Estee Lauder's

(EL) - Get Estee Lauder Companies Inc. Class A Report

popular

Clinique

skin care and color cosmetics line.

It's not for lack of room -- the latest Sephora measures a booming 21,000 square feet. No, Clinique's absence comes down to location. While Sephora's other New York outlets are in department-store-free zones like SoHo and the World Trade Center, the midtown location is just a pumice stone's throw from

Saks Fifth Avenue

(SKS)

, coincidentally the first department store account landed by Estee Lauder herself back in 1948.

This highlights the delicate balancing act Lauder must perform as it seeks to expand beyond its slow-growing traditional sales channel into new ventures like Sephora, a unit of French luxury goods giant

LVMH Moet Hennessy Louis Vuitton

(LVMHY)

, as well as its own independent retail outlets and e-commerce. That's a crucial push, because prestige sales of cosmetics, skin care and fragrance (the pricier, more exclusive brands sold in department and specialty stores instead of drugstores) rose just 3% last year to $6.2 billion, according to

NPD BeautyTrends

, which tracks retail sales.

"The department store is losing its hold, and Lauder wants to maintain its share," says Allan Mottus, editor and publisher of cosmetics industry newsletter

The Informationist

. It's a hefty share, too: Lauder accounts for about 50% of overall prestige cosmetics sales.

Alone but Not Lonely

By no means is Lauder blowing off department stores. It can't, since they still generate the vast majority of sales and will for the foreseeable future. But the company is also doing more than just dipping a carefully polished toenail into new waters: Its stand-alone retail stores should generate about $350 million in sales in four years, representing about 35% of the growth in total domestic sales,

Merrill Lynch

analysts Heather Hay and Scott Johnson wrote in a recent research report (their firm has done underwriting for Lauder, and rate the shares a buy).

That's still a relatively small piece of Lauder's annual sales, which rose 9% to almost $4 billion in the year ended June 30. But if analysts are counting on Lauder to grow, and department store sales are sagging, success in other channels is key to meeting investor expectations. With its shares trading at 37 times fiscal 2000 earnings, consistently hitting its numbers, to quote the recently IPO'd

Martha Stewart

(MSO)

, is a good thing.

Lauder's biggest immediate potential, say analysts, is its stand-alone retail stores, which sell its tree-hugging

Origins

and

TheStreet Recommends

Aveda

lines, and its

MAC

makeup line. These stores produce higher margins than counter sales at department stores (no pesky royalties) and may attract younger shoppers who wouldn't be caught dead in

Lord & Taylor

but would consider popping into an Origins store after hitting the

Gap

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.

"Their freestanding stores are profitable in one year, while it typically takes retailers two to three years," says Cynthia Hope Hatstadt, an analyst with

Robertson Stephens

who rates the shares a buy. (Her firm hasn't done underwriting for Lauder).

The company now operates about 100 stand-alone stores, mostly Origins and MAC. But in the next five years, that number could increase to between 400 and 500, say the Merrill Lynch analysts. They say that so far, sales gains have been generally incremental, so the new outlets aren't cannibalizing sales that would have occurred anyway.

Love at First Blush

Another incremental sales opportunity lies in

e-commerce. Lauder now sells Clinique and Origins products directly to consumers and has a partnership with retailer

Neiman Marcus

(NMG.A)

to sell

Bobbi Brown

makeup and skincare products (Neiman does the fulfillment at the Bobbi Brown site and gets credit for the sale).

Angela Kapp, vice president and general manager of Lauder's online division, says that 54% of people buying from the Bobbi Brown site were buying at least one item for the first time, while 37% were completely new to the brand.

"If we can start to convert these people to customers, then they can shop in all channels," she says. "What we've tried to communicate to retailers is that we are not interested in robbing Peter to pay Paul. The vast majority of our business continues to be done in the real world."

Kapp, emphasizing that the sites are more a branding exercise than a revenue generator at this point, wouldn't comment on sales thus far. (Merrill Lynch estimates Clinique's online sales have totaled $5 million since last November's launch.) Nor would she comment on whether all the Lauder brands would make the jump to online sales.

Analysts predict they will, and that brands will likely be rolled out in the order of their appeal to Internet-savvy consumers (so expect the flagship Estee Lauder brand to go up last). And more direct sales, rather than partnerships, are likely, they say. "I was surprised to see them working with Neiman," says Michael May, analyst with

Jupiter Communications

. "If their objective is to own the customer relationship, using a partnership doesn't meet that objective." Estee Lauder isn't a current Jupiter client.

Merrill Lynch also names a handful of other growth channels that will likely add to sales, including spas, hair salons and drugstores, the latter two accessed through the acquisitions of Aveda and

jane

(an inexpensive, teeny-bopper cosmetics line), respectively. "One of the things that makes them so intelligent is that as they acquire businesses, they can use brands to break into new channels," says Robertson Stephens' Hatstadt.

And then there's Sephora, which prides itself on the soft sell, eschewing the army of spritzer-shooters that stalk the cosmetics floors of department stores. Steve Bock, executive vice president for marketing and merchandising at Sephora North America, Latin America and the Far East, says the chain also offers incremental sales opportunities for Lauder. "I think what they recognize is that we have a very, very different customer than the department stores do," Bock says. "We do business very, very differently."

Maybe so, but apparently not differently enough to get the nod to sell Clinique just paces away from Saks. "There's no way they'd jeopardize the relationships they've had for an eternity," says Hatstadt. Whatever steps Lauder takes toward new channels may be important, but for now, they'll have to be taken lightly.