By  on November 16, 2007

NEW YORK — As fragrance marketers gear up for the holiday season — when the industry generates about 60 percent of its sales for the year — months of declining consumer confidence are creating a challenging environment, panelists at a Fragrance Foundation state of the industry luncheon said Wednesday.

Still, there is a bright spot: While consumers' "willingness to spend is somewhat off due to consumer confidence numbers," said panelist Lynn Franco, director of The Conference Board Consumer Research Center, their "ability to spend is still intact" thanks to low unemployment and the addition of jobs since the summer.

The Consumer Confidence Index slipped to 95.6 — the lowest reading since hurricanes Katrina and Rita two years ago — from 99.5 in September. However, employers added 166,000 jobs to payrolls in October, about double economists' expectations, and the unemployment rate last month was unchanged from September at 4.7 percent.

"Personal income growth is the silver lining," said Franco, who was joined on the panel by equity analyst Christopher Ferrara, who is senior director at Merrill Lynch; Gilbert Harrison, chairman and chief executive officer of Financo Inc., and moderator Darby Dunn, who is a reporter with CNBC.

Harrison noted that unseasonably warm weather, which has been seen this fall, "affects results" and "retailers are cutting fourth-quarter forecasts due to the weather."

Macy's Inc., the nation's largest department store chain, said Wednesday its same-store sales for the fourth quarter could range between a 2 percent decline and a 1 percent increase, totaling $8.7 billion to $8.9 billion. For the year, sales are projected to fall by between 0.3 percent and 1.3 percent, or $26.4 billion and $26.6 billion.

Despite the sobering data, Harrison is optimistic. "The National Retail Federation is talking about a 4 percent increase in sales, but I think it will be more," he said. "The consumer is optimistic. They like to spend."

Dunn pointed to a recent poll that said 72 percent of 1,000 consumers surveyed said they would spend the same this year as they did last year, or about $1,100. Furthermore, 42 percent of them said they would spend for a fragrance.Harrison contended that "impulse purchases and hot products are critical to success," adding that although people are looking for a unique product offering, the fragrance industry all too often comes up with the "same old stuff."

In order to spur results, Harrison argued, the fragrance industry should decrease its dependence on department stores, its "lifeblood for many, many years," by expanding across retail channels or by making acquisitions related to other channels.

According to Harrison, 60 percent of consumers plan to shop in the discount store channel, while 26 percent plan to shop in specialty stores and more than 30 percent plan to shop in department stores.

"The department store is not where consumers are spending their money today," said Harrison, who added that "department stores have lost tremendous traction" as specialty stores like Sephora and Ulta have expanded. Also, there has been a "shift toward mass fragrances," as prestige scents have ended up in the mass market.

Beauty sales in the mass market, which were flat in 2004, have seen growth of 4 percent more recently, according to Ferrara. In the prestige market, growth of 4 percent in the 2004 to 2005 period has tempered and is showing a flat to 1 percent growth.

While department stores have held market share in color cosmetics, Ferrara said, market share in fragrance and skin care has declined by 6 percentage points, dollars that have shifted to the mass market.

"Due to the launch of prestige fragrances in mass, women are changing the places they shop," said Ferrara. On the skin care side, he said, mass brands like Procter & Gamble's Olay have taken market share from the prestige market.

Ferrara said prestige players have experienced a "higher cost of doing business" in the past five years, as sales have been flat or slightly up, while spending on advertising has risen 26 percent. He indicated the short-lived nature of celebrity scents hasn't helped.

However, because there are higher gross margins in the beauty industry, Ferrara said, pointing to margins of up to 75 percent at Lauder, beauty firms "tend to weather the storm better."Harrison added that while celebrity scents account for 23 percent of the prestige fragrance business, their longevity is an issue. Designer scents, he said, such as those from Tom Ford and Vera Wang, "seem to have a bigger impact than celebrity."

"The conundrum the [beauty] industry is facing," said Harrison, is that it spends so much money on launching new fragrances. But "if you stop the launches, what happens to the existing [inventory]? The consumer wants something new."

Ferrara contended that investors are comparing household manufacturers with beauty firms as companies like P&G, (which, he said, does about $2.5 billion in sales with its prestige fragrance brands) get deeper into the beauty business.

In the long term, according to Ferrara, investors will demand that such firms balance "process-driven, financial discipline" with the "art" of making aspirational products like prestige fragrances in order to maximize profitability. He indicated that the Estée Lauder Cos. potentially took a step in this direction last week when it announced Fabrizio Freda, a P&G executive, is in line to become Lauder's ceo in two years.

"The greatest risk to the prestige [market], more than product efficacy," said Ferrara, is "a greater emphasis" on cost than on the excitement a product can create. "It's up to the players to find a balance."

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