By  on December 19, 2008

Holiday shoppers are viewing beauty purchases through a new lens: deal or no deal.

Industry experts report this season shoppers have put blinders on, blocking out nearly all non-sale merchandise from sight as they happily stumble upon ample discounts in stores and online. Their bargain-hunter mentality has forced department stores to succumb to markdowns in what was once considered the last discount-free stronghold: prestige beauty products.

To get in shoppers’ line of vision and move merchandise, U.S. department and specialty stores have resorted to aggressive new tactics, including discounts, coupons and freebies.

In the U.S., the heightened promotional environment on the beauty floor — whether seasonal or longer term — ends the industry’s decades-old taboo against discounts.

“Discounting is the promotional message of the season, regardless of the category,” said Wendy Liebmann, founder of WSL Strategic Retail. At a recent presentation, Liebmann declared that sale signs, hanging from store ceilings and plastered across windows, are the de rigueur holiday decoration this season. “Retailers are discounting everything to get people into their stores.”

From a survey of beauty retailers, the discounts are plentiful: Both The Body Shop and Bath & Body Works posted signs trumpeting 50 percent off select merchandise outside their doors; at Lord & Taylor, a Lancôme 17-piece cosmetics set valued at $339 was available for $49.50 with any $36 purchase or more; Sephora marked down Stila’s color-cosmetics-and-handbag set to $50 from $115, and at Victoria’s Secret Beauty, the price of the Ultimate Very Sexy Makeup case, containing 19 makeup items, was slashed to $90 from a $150 value price.

In Europe, holiday price warfare of seasons past was replaced by more subtle promotions. For instance, at the Sephora flagship in Paris, on the Avenue des Champs-Elysées, no major visible discounting was found. However, when asked whether discounts were available at Sephora, a saleswoman said adjustments could be made if someone were to show that a competitor has the same product at a lower price. She added that in some other Sephora locations, such as in the Paris suburb of Bagnolet, more widespread discounts on beauty items were being conducted. In London, while many of the prestige department stores, such as Harrods, Harvey Nichols and Selfridges, had little promotional activity beyond traditional gift set displays, some players on Oxford Street, one of the city’s main shopping thoroughfares, were offering steep discounts. On Tuesday, health-and-beauty chain Boots, for instance, proposed a 10 percent markdown on all fragrance gift sets, and in-store promotional material advertised savings of up to 50 percent on selected fine fragrances.

Industry executives are anxiously waiting to see if aggressive pricing this Yule will boost sales. If fragrance is any indication, the prospects look grim. In the prestige channel, the fragrance category has seen a drop-off in both dollar sales and units, which are down 3 and 6 percent, respectively, for the year to date period through October, according to The NPD Group.

Regardless of the damage to margins, the thinking is the merchandise has got to move. “As a manufacturer, we really don’t care or control retail prices,” said Dan Brestle, vice chairman and president of the Estée Lauder Cos. Inc. North America. “Once they buy the goods, our retail partners can do what they like with them.”

Brestle added one-time discounts don’t have to affect fragrance’s luxury positioning. “If this discounting becomes a way of business, yes, it will have a negative affect on the business,” he said. “But if it is a one-time thing these holidays, no. I think everyone realizes that this year is an aberration.”

But what happens after Christmas trees are dragged to the curb and the last Hanukkah candle is lit?

Liebmann said the barrage of sale signs may prompt shoppers to reevaluate the actual value of products they once bought at luxury prices, and to ask, “Are those prices justified?”

She added, “It’s going to be a major challenge for high-end retailers to re-create the mystic of luxury.”

Industry observer Allan Mottus suggested the discounts are the result of years of skyrocketing prices in the beauty category. “As much as discounting seems distasteful, it’s a necessary price correction,” he said, later adding, “Discounts are a smart thing as long as they are not abused.” Mottus said he anticipates six to nine months of “pain in the industry” as the price correction takes place.

Wachovia Capital Markets LLC analyst Jason Gere does not expect beauty firms to lower prices going forward, but he anticipates both vendors and retailers to fund more promotions to clear out merchandise. “The holiday season is as advertised. It’s very sluggish and likely worse than people anticipated,” said Gere. “[Discounting] is a way that everyone is sharing the pain to move inventory.”

While it is the retailer’s responsibility to absorb the point of sale reduction, there have been telltale indications of stores seeking markdown money, like in ready-to-wear.

Aggressive promotions have begun to show a slight shift in the average price of beauty products, said Karen Grant, NPD’s global beauty industry analyst. She noted that in the year to date period the average price rose 4 percent, but price growth shrank to 3 percent in October and 2 percent in November. As a point of comparison, in the prior-year period, prices grew 5 percent, with growth shrinking to 4 percent in October and 3 percent in November. Grant noted the pattern is the same, but price growth has slowed this year.

Referring to a spate of promotions in prestige, Grant said, “Retailers are at least trying to get as much volume as they can,” despite the margin erosion. “The challenge the beauty industry is seeing is the same challenge that the rest of the industries are seeing. The whole [retail] environment is offering deals,” she said, mentioning the Florida car dealership that offered the buy-one-car, get-one-free deal. “If you’re not part of it, consumers may bypass you.”

Grant also observed there’s been a change in the nature of the promotions. Referencing Estée Lauder’s online promotion over the Thanksgiving weekend that offered a $25 reward (redeemable in January) on purchases of $100 or more, Grant said, “It used to be gift-with-purchase or a free product. Now it’s cash.”

Perhaps Connie Ruscio, vice president and general manager of Fragrances Elite International LLC, which distributes Versace fragrances, summed up best the urgency and gravity of the moment.

“I’m taking advantage of traffic in the store to move merchandise. We are doing it in selective items, not across the board.”

A number of fragrance industry executives shied away from speaking for attribution. But other industry figures spoke freely not for attribution. Some appeared uneasy about using this markdown tactic to soften the blows of a dreadful season, amid reports of December fragrance sales running 20 to 30 percent down. Accordingly, the sell-through rate of some of the gift sets this season were lagging behind last year’s pace when retailers proposed the markdowns.

“There was no traffic in the stores,” said one executive. “Or the traffic that was in the stores was racing past the fragrance department to get to the 70 percent markdowns [in r-t-w].”

Another senior industry executive echoed the sentiment that steep discounts in other areas of the store forced deals on the beauty floor.

“Why you’re seeing more dramatic cuts is that the discounts in r-t-w have been so dramatic that they’ve made fragrance less important valuewise,” said the executive. “When you see $200 cashmere sweaters discounted to $75, you know you’re in trouble, because beauty has historically owned the price points between $45 and $75. When r-t-w gets marked down to our level, many of our customers buy that instead of a gift set.”

While beauty inventory levels were kept near normal levels through the holidays, the executive expects that there will be inventory cuts after the first of the year. “I am anticipating that stores will be destocking in the spring, but not aggressively. If it’s too aggressive, it will be self-fulfilling that sales will be down. However, we will ship every week if we have to.”

Many executives made it clear that they marked down the sets that were not moving, not all of them across the board, and early indications of the effectiveness of the gift set markdowns were decidedly mixed. One manufacturer saw some sales movement this week, while another claimed the needle did not move at all.

In the short run, these tactics may bring some relief, but the precedent worries some.

“We have established a protocol that will be very difficult to be up against next year,” said one manufacturer. “We are going to have to reevaluate the number of sets we put in the stores,” the executive said, noting that “the stores have come to rely on that business.” Some brands reportedly do as much as 50 to 60 percent of their annual department store business in sets, while others try to hold it down below 30 percent.

The sell-through is usually high, apparently because consumers see the sets as a bargain. The typical cost of goods on a gift or value set can hit 50 to 55 percent of the retail price, compared with 15 to 30 percent for a regular-priced item. Now, there is a 20 percent discount on top of that. For instance, MAC Cosmetics offered its holiday kits for 25 percent off.

One immediate concern is that the intrinsic value of fragrance will be lost in the melee as retailers cut r-t-w pricing to the bone in a desperate attempt to clean out inventories. Another worry is that fragrances will be turned into a discount category. “It is a real danger,” said another executive. “After the past decade of stagnation, we’ve held the best real estate in the store while maintaining full price. If we become a sale item, we will not maintain the space.”

The executive said the only hope is that a 20 percent markdown will not quicken the consumer’s pulse and this season’s gift set markdowns will fail. “If it is perceived by the retailers that ‘We tried this and it didn’t work,’ then it will be the last time we’ll see it. It didn’t appear to help last week.”

He concluded, “I hope it is a short-term situation. But I’m not optimistic.”

Panic may be forcing retailers to pull more promotional levers.

Dennis Keogh, senior vice president of marketing for Coty Prestige, said, “The [fragrance] category is down and the [emphasis is] to move through inventory — people don’t want to take those returns, and Christmas sets are able to be returned.” He continued, “We’re seeing a lot of price slashing that none of us have ever seen before from the high-end like Neiman Marcus and Saks Fifth Avenue and department stores,” he added. “Yes, it is affecting the fragrance category dramatically — we’ve never seen anything like this.

“If the normal discount was 20 percent and then dropped another 20 percent,” said Keogh, “[retailers] are saying to customers ‘40 percent off.’ These are very aggressive statements.”

Discounting has also prompted shuffling of fragrance ranking — like some scents that were ranked in the high teens moving to a low-teens position or even a number-12 ranking.

While a number of vendors have agreed to take major markdowns in sets, many at 25 percent, according to Keogh, he said that Coty is not. In a sign of Coty’s leveraging power with so many scents on the market, “Some stores are taking the markdowns on their own [reflecting a difference between the manufacturer’s suggested price and the in-store price], but not charging us back for it because we have not agreed to take the markdown expense.”

He said Coty Prestige is tracking at an 85 percent sell-through rate and could hit 90 percent. “We’re where we want to be.

“The battle is to not allow a slowdown in turns and to manage slow sell-through, which [the industry is trying to avoid].”

Some of Coty Prestige’s best performers include Harajuku Lovers — “That’s been far more successful than we’d hoped,” — said Keogh, as well as the Marc Jacobs, Calvin Klein and Kenneth Cole brands. “We’re feeling pretty good in view of the environment.”

Gary Borofsky, senior vice president of cosmetics and fragrances for Macy’s Central, suggested the industry ought to tout the value of its offerings, rather than discount gift sets further.

“I believe the industry as a whole needs to do a better job of calling out the values we offer to the customer now and throughout the year,” said Borofsky. “In many cases, the value set price is already 20 to 50 percent off what the customer would pay if the items were purchased individually — however [retailers and manufacturers] don’t scream that value savings.”

He continued, “Offering customers great values and then discounting on top of that does nothing but confuse the customer. We are not getting price resistance on high-demand giftable scents, such as the Dolce & Gabbana, Juicy Couture, Estée Lauder Sensuous, Ed Hardy, Harajuku, Chanel and Dior. So if the product is right and the customer sees the price-value relationship, discounting gift sets even further should never be an issue.”

He added, “We did not follow the move some retailers took to discount cosmetics and fragrances this month. But “what we have done is reprice some slower-selling product where we have seen consumer price resistance.” However, he added, this is a strategy the retailer has taken in years past, and would do so any time of the year moving forward, holidays or not.

Another beauty executive predicted that the beauty business will end the holidays flat to minus one. “I’ve seen discounting sporadically, but nothing to the depth it is today,” said the executive. “The economic meltdown happened so quickly, and we’re all trying to deal with it. If these economic conditions had happened in May, we would have lowered the prices and no one would know that we’d done it. But that didn’t happen, and we’ve repriced — kicking and screaming.”

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