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Avon Faces an Uncertain Future

The company’s search for a chief executive officer has stirred speculation about the path best suited for the direct seller.

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Anew Platinum skin care.

Courtesy Photo

Outspoken Intense by Fergie.

Outspoken Intense by Fergie.

Courtesy Photo

Andrea Jung

Andrea Jung

Melanie Dunea

Avon Products Inc. is at a critical crossroads.

The company’s search for a chief executive officer — as its chairman and current chief Andrea Jung still occupies the corner office — has stirred speculation about the path best suited for the direct seller. Should it continue as a public company or be scooped up by another firm? Could a group of investors take the company private and shut its boardroom doors to fix Avon’s troubles away from the glare of Wall Street?

And who will lead the transformation?

RELATED STORY: Avon Needs Operational Skills, Vision >>

The industry’s unofficial list of candidates to replace Jung continues to grow. Among those mentioned are HSN’s Mindy Grossman, Bare Escentuals’ Leslie Blodgett, the Estée Lauder Cos. Inc.’s John Demsey and former Procter & Gamble Co. veterans Ed Shirley and Susan Arnold.

In recent years, Wall Street analysts have grown increasingly uneasy with Jung’s handle on the company’s operations in the wake of underperforming results; executional hiccups, particularly in Brazil; an ongoing investigation by the U.S. Securities and Exchange Commission tied to the company’s dealings with analysts, and allegations that Avon executives bribed officials in China and perhaps in other countries.

Late last summer, one analyst called Avon a “rudderless ship,” while another said it has been underperforming for years.

The company’s stock price fell precipitously in the latter half of this year, hitting a near five-year low of $16.14 on Dec. 13, the day that the board said it would split the roles of chairman and ceo. Avon’s shares closed Thursday at $17.44.

Plans call for Jung to step aside as ceo in 2012, once a new chief has been installed, and to take on the role of executive chairman for a minimum of two years.

That is raising some eyebrows, however, since the new ceo will report to the board that Jung will head. The management team will report to the ceo, said an Avon spokeswoman. Describing Jung’s duties as executive chairman, the spokeswoman said, “She will work closely with the board and with the ceo to continue to define and drive the company’s strategic direction and brand positioning.”

Financial observers questioned how long Jung will stay on, however. As one analyst put it, if a number of potential ceo candidates say they need more autonomy to accept the post, the board may rethink its current agreement with Jung, which includes an annual base salary of $1 million, a discretionary cash bonus of $1 million and long-term incentives equal to 400 percent, or $4 million, of the base salary.

The package already has been criticized by former ceo’s of Avon, according to a report in The Wall Street Journal. Referring to SEC investigations, one source said, “She should stay only to clean up, then she should go.”

There is a collective cry from Wall Street analysts for a ceo who sees Avon for what they say the business really is: a direct-selling operation, not a consumer products company. To her credit, since taking over the helm in 1999, Jung has grown Avon to a nearly $11 billion business from $5 billion.

“This is a direct-selling company. It is not Clorox, and that should be taken into account,” said ConsumerEdge Research analyst Javier Escalante. “Avon needs to restore the morale of the representatives.”

In his view, Avon needs a charismatic, media-savvy “motivator in chief” who understands direct selling is a push business. He suggested Avon fortify that role with a strong chief financial officer and chief operating officer who have a solid command of direct-selling logistics and representative compensation structure.

“It’s very unlikely that the person who can step onstage and motivate the reps could also be this McKinsey & Co. type of person who can also figure out the complex logistics behind the millions of tiny transactions Avon executes,” said Escalante, who suggested Blodgett as a potential candidate for the ceo post, given her ability to win over women and inspire excitement about products. “Avon is a momentum and a beauty business; therefore, creating imagery is key. Avon needs a team led by a rather charismatic ceo, who brings experience in building and rebuilding brands. Then you can surround that person with a very strong strategy and logistics team.” He added, “Direct-selling companies cannot grow if they cannot attract and retain salespeople. They need a motivator or a coach.”

Connie Maneaty, an analyst at BMO Capital Markets, also sees the role as “too big for one person.” But she questioned the need for a figurehead at Avon. “If the reps make money, the leader who helps them do that is aspirational,” she said. “A figurehead can only take you so far.”

She added, “Avon needs a strategic-thinking ceo and chief operating officer who is a real expert in execution. The chief operating officer role is really critical to implement what’s already under way and to train the next generation of managers.”

Sanford C. Bernstein & Co. analyst Ali Dibadj said, “The new ceo has to work with the cfo to get a handle on the financials of the company, then reset the bar on what earnings need to be and lay out a financial plan. It needs to get its strategy clear by region, and make some tough decisions about people.” Dibadj said the role of Jung as a figurehead is palatable as long as the ceo has stewardship of the brands. “There needs to be a renewal of management,” he said.

Caris & Co. analyst Linda Bolton Weiser sees the split role differently, noting the idea that Jung’s presence will prevent constructive change at Avon is exactly the concern that investors had with the Estée Lauder Cos. when Fabrizio Freda was brought in to succeed William Lauder as ceo; Lauder then assumed the role of executive chairman. “It didn’t help that the company said at that time that Fabrizio and William would ‘work together in partnership.’ Investors thought Fabrizio might not be able to do things, like head-count reduction or shutting down brands that Lauder family members had started. He has accomplished both,” she stated.

She, along with several others, suggested Susan Arnold, P&G’s former president of global business units, as a “dream” candidate, emphasizing how Arnold rose to a high level at P&G, where she helped to oversee Olay’s early, rapid growth, and her global experience. Others dismissed Arnold on the grounds that her somewhat intimidating personality would fail to win over representatives.

Like Arnold’s, Ed Shirley’s departure from P&G as vice chairman of Beauty & Grooming was seen as abrupt, as he also was considered a rising star within the company. Many speculated Shirley left in search of the c-suite and that spearheading a turnaround at Avon could suit his competitive nature. Shirley, as would many of the others named, would likely have non-compete contracts to contend with, though.

Observers also pointed to Mindy Grossman, the seemingly tireless ceo of HSN, as a strong candidate. Grossman’s command of marketing and ability to transform HSN’s image from a distant number-two player in the home shopping channel to a multichannel, celebrity-studded retailing force could put her on Avon’s short list.

Beyond the chairman and ceo roles, Avon’s executive ranks need fortifying, both in the U.S. and globally, said analysts.

During the latter half of Jung’s tenure, analysts have frequently pointed to what they see as Avon’s lack of a succession plan. Citi analyst Wendy Nicholson wrote in a research note on Dec. 13, “Jung has been ceo of Avon since 1999, and during her 12-year tenure, perhaps the biggest criticism we could make of her is her poor leadership in so far as she has failed to put into place any type of internal succession plan, not just for her job but also for other senior positions at the company.” She called the number of senior managers who have come and gone during Jung’s tenure “stunning.” As part of a restructuring program begun in 2005, Avon cut the number of its management layers in half and reduced the size of the overall management team by 30 percent, and in March it reorganized the management structure, collapsing its six commercial business units into two major business groups: the Developed Market Group and the Developing Market Group.

One source said of the upcoming management changes, “Andrea likely has a tremendous amount of power with the board. How else do you explain that there was no natural number two to succeed her?”

In recent months, Avon filled both the post of cfo and president of Latin America with two executives from outside the company, namely, Kimberly Ross, previously from Royal Ahold, and Fernando Acosta, who joined from Unilever. Nicholson noted, “It took Avon roughly 10 months to put a new cfo and a new head of Latin America in place, so we suspect the naming of a new ceo will take considerable time as well.”

Most industry watchers deem Avon’s challenges “fixable,” but caution that learning the peculiarities of the direct-selling model will take time for a ceo plucked from a consumer products company.

Stifel Nicolaus & Co. analyst Mark Astrachan, along with several of his peers, called for Avon to move to a more multilevel structure for sales representatives to increase their earnings potential. He also noted that Avon’s value price points make it more labor-intensive for sales representatives to earn a living than at its direct-selling competitor Nu Skin, where the price on skin care can climb north of $100.

“You want Avon to be a business where you can earn a living, not supplement a living,” said Astrachan. “It takes an awful lot of lipstick [sales] to equal a $200 skin cream.”

It’s a common argument.

“There’s not enough octane in the company,” said one source. “You have to work too hard to make a living. The model is wrong, and Avon’s price points make it a one-two punch.”

The source continued, “Avon’s model is flawed. It’s disadvantaged in the U.S. because it’s single-level and the price points are too low.”

Mass-priced products cannot sustain a direct-selling company because it doesn’t yield enough compensation for sales representatives, said Escalante of ConsumerEdge Research. He also noted that in markets like Brazil, representatives have opened shops where they sell products from three competitors, namely Avon, Natura and Jequiti, creating a disincentive for new representatives to join Avon.

In his view, the enterprise shows the maturity of emerging markets and is an indication Avon needs to look elsewhere — including Indonesia and India — for growth. International markets account for roughly 80 percent of Avon’s revenue.

He wrote in a research note earlier this month, “If Avon sees itself as a direct seller, it needs to overhaul, as opposed to keep tweaking, its compensation or earnings opportunity so that Avon can recruit, retain reps and grow its sales force — the core of any direct seller growth model. The stumbling block is that the Avon brand does not have the authority to price, and the tiny transactions from retailing things like 99 cent deodorants cannot fund the compensation of a multilevel marketing network. If instead Avon sees itself as a beauty company, it will be strategically sound to diversify away from direct selling through M&A, with the level of risk increasing with the size of the target. After all, Amway has been testing retail brands, as the acquisition of Laura Mercier indicates.”

Industry observers suggested the incoming ceo should have the courage to look at retail channels beyond the catalogue, a move that the company always resisted. Avon has “phenomenal manufacturing and research and development,” said one source, who suggested John Demsey, a powerful Lauder group president, for the top job. Another name that surfaced was Patrick Bousquet-Chavanne, former group president at Estée Lauder Cos.

But the retail venture would have to be under a different name to avoid alienating the network of representatives.

There’s also the possibility of being swallowed by a direct competitor, like Amway, which is private. Or, with the appreciation of the yen, Shiseido or Pola could strike. Then there’s L’Oréal, which has in the past denied the possibility, but that still has not quelled the rumor of a possible takeover, given Avon’s strong presence in the emerging markets that L’Oréal craves.

“There aren’t many companies with factories in Brazil and China,” one executive noted, adding that the company could be taken private only to go public again.

Yet another observer maintained that these scenarios are too narrow in scope. If Avon is in the direct-selling business, why not fuse with a more relevant consumer products company like Amazon or Apple? He also refused to rule out a takeover by P&G or Johnson & Johnson, both of which could tap Avon’s vast rep network to distribute razor blades or baby lotion.

“Its distribution system doesn’t work anymore.” The door-to-door approach broke down decades ago when American women started going to work, leaving no one at home. In the emerging markets, Avon can’t match the retail experiences being offered up by newly entrenched competitors like Lauder, L’Oréal and P&G.

Industry consultant Allan Mottus said, “Avon will have to transition to a whole world to find regional pockets where they can do well, and not run as this large conglomerate that it has turned into.”

 

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