BOCA RATON, Fla. — In a groundbreaking appearance at the Cosmetic, Toiletry and Fragrance Association’s annual meeting last Friday, Leonard Lauder laid down a challenge to the beauty industry — innovate or else.

Lauder’s comments came at a time when leading executives were wrestling with the thorny problem of how to revive a flagging fragrance industry, which has just weathered one of the worst Christmas selling seasons in a decade. The four-day meeting ended Saturday evening.

The speech by Lauder, chairman of the Estee Lauder Cos., marked the first time in memory that the industry organization had featured a prominent cosmetics executive to speak candidly about the state of the actual beauty business. Past CTFA speakers traditionally have been well-known figures from politics, journalism, and economic and management affairs, in addition to speakers focusing on product legislation and regulatory matters.

“One of the things that worries me is the loss of reputation of U.S.-made goods,” said Lauder, pointing to the image of American beauty products and packaging across the globe. “The [global business community] thinks that we’re great marketers, but not necessarily delivering great quality. If we’re trying to preach American quality, that starts in this room. If we’re going to be together in this room again, prosperous and well, we need to focus on how we can have a quality reputation unrivaled around the world.” Two factors working against American quality, he said, are lower prices of American goods at retail — “That means there’s pressure to make the cost lower” — and the rush of talent to “industries other than manufacturing.”

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As well, retailers need to shape up, he said. For instance, Lauder said, American department stores are, per square foot, generally less productive than their European counterparts. “People ask, ‘Are we overstored?’ We are underproductive,” he said. For instance, he pointed out, Lauder’s freestanding Aveda, MAC and Origins stores are four to five times more productive than the company’s department store counters, and their comp-store numbers are better than those of department stores. “Part of that is because we are paying rent on these spaces,” he said, noting that after World War II, many department stores were given what he called “sweetheart deals” to anchor shopping malls — deals that still exist to this day and that, in his opinion, don’t motivate stores to perform efficiently.

The retail landscape is bound to change, he said. “We are currently overstored in many airports; we will see mergers in travel retail,” he said. “We will also see continued mergers of smaller perfumeries. Will LVMH sell Sephora? Good question. Will Dillard’s be sold? I think Dillard’s will remain independent, despite the fact that Wall Street is trying to pump up the idea of a merger. Both the Federated Group and May Co. will see pressure to go national. Consolidation is an ongoing process, and I don’t see that changing.” He cautioned, though, against short-term thinking: “During this tough period of business, department stores have cut inventory and service,” he said. “I worry that they’ve put themselves at risk with their short-term thinking. Will they be ready when the economy swings around again?”

Lauder challenged the industry to innovate. “That’s the key word going forward,” he said. “And it will have impact on every area of our industry, from retail formats to fragrance to packaging.” For instance, he’d advise the ailing Kmart to find a niche — as its competitors Target and Wal-Mart have done. “If you’re caught in the middle, you’re nowhere,” he said.

Lauder also gave a belated Valentine to the numerous magazine publishers listening to his speech, as he said that he believed that, going forward, magazines would capture a greater share of consumers’ attention in the promotion of new products, as compared to TV. “Magazines are where it’s at,” he said, adding that there is plenty of room for growth. In the U.S., most older women get product endorsements from word of mouth, but consumers aged 28 to 39 rely on magazines for new product information. He also predicted that the Internet will return to influence within a number of years, noting that “24 percent of women used the Internet to buy something last year.”

Industry consultant David Horner echoed the call for innovation: “The fragrance industry needs to find new ways to sell its products,” he said. “Sephora taking fragrance out from behind glass and alphabetizing it was the sole innovation in the last few years.” Another aspect of the industry sorely in need of overhauling is the sampling segment, Horner said. “Scented strips were the last innovation in that area,” he said. “We need to find a better way to sample the consumer.”

Lauder’s points also seemed to be well taken by Daniel Rachmanis, chairman of Techpack America. “Leonard spoke of the basis of success for everyone in the industry — …quality, innovation and speed to market. He also mentioned that there were some industries, specifically plastics, that were vulnerable [to foreign competition]. I agree, and to address the need for lower costs, we have been in a very strong acquisition trend in low-cost countries. Last year, we bought Anchor Brush, a large Mexican producer which gave us a low-cost base south of the border. At the same time, our 100 percent acquisition of Cosmetech Mably International gives us direct access to the most competitive sources of compacts and other injection-molded products in Indonesia and Asia in general. We believe, however, that in order for those low-cost bases to be effective in the U.S. market, a local presence for product development, sales and customer service is absolutely necessary.”

To address the innovation issue, Rachmanis said, Techpack has just launched an innovation center in its Paris headquarters. “We are building a facility to host our designers, marketers and makeup creators, and also will have four makeup molding machines,” he said.

Ed Kavanaugh, CTFA president, noted that the organization had begun scheduling industry speakers simply because, “this is what people want to hear now. Years ago, people wanted to hear from congressmen and Tom Brokaw.” Kavanaugh added, “We want to do more of this.” As for future meetings, he said that if there are four or five speaking slots, two or three should be filled with cosmetics industry executives.

A strong push for more relevant speakers reportedly came from Andrea Jung, Avon Products’ chairman and chief executive officer, who made that a goal when she accepted the chairmanship of CTFA last year.

But even though Lauder’s appearance broke new ground for CTFA, attendance at the meeting appeared to be suffering from fallout of Sept. 11 and the persistent drag of recession. Attendance has been slipping in recent years, and the trend continued this year. Without the benefit of seeing a final tally, Kavanaugh estimated the meeting attendance at 725 to 730 people, compared with 900 last year and just under 1,000 in 1999. “We did better than we thought we would,” he said, referring to the recession’s impact. In fact, he insisted that the mood in the industry has rebounded. “There is more optimism this year than in the last two years,” he said.

In any event, Lauder’s speech marked a turning point for CTFA, putting it in step with a direction the industry has been taking. Lauder began his speech by alluding to his speech at WWD’s first ceo summit in 1997.

Despite this year’s recession-depressed attendance figure, CTFA attendees had praise for this year’s meeting — including Jean-Paul Agon, president and ceo of L’Oreal USA, a first-time attendee. “It’s a very interesting meeting,” he said. “I am impressed by the professionalism of the CTFA staff, particularly Ed Kavanaugh and his team, and by the depth of their experience and their willingness to support the industry.”

And while executives acknowledged the numbing challenges on the fragrance business, all tried to put a positive spin on the numbers. “While we all realize that we’re going through a rough season, we all think we can pull out of it,” said Patrick Bousquet-Chavanne, group president for the Estee Lauder Cos. Acknowledging the industry’s heavy fall fragrance launch schedule, he noted: “Spring is shaping up as a warmup for fall; fall should drive the business.”

“We’re not ignoring the challenges that currently exist in the fragrance industry, but we are looking to address them with continued newness,” said Hilary Dart, president of Calvin Klein Cosmetics. And newness doesn’t necessarily mean a whole new fragrance brand, either: “We’ve addressed the consumer’s desire for newness with freshened advertising campaigns, including our new Eternity campaign, and built on classic juices by offering items like Eternity Rose Blush, a limited-edition version of Eternity; Sheer Obsession, a limited-edition version of Obsession, and Truth Calvin Klein Lush, a new addition to the Truth franchise.” As well, Calvin Klein is releasing two new men’s fragrances this year, she said. “We don’t want to be reactive to challenges,” she said. “We want to be proactive.”

Strategy number one: Learn to promote daily use of fragrance. “The fragrance business has evolved too much into a gift-giving business,” said Dan Brestle, group president for the Estee Lauder Cos. “People aren’t using fragrance on an everyday basis, and that needs to change if the fragrance business is to improve.”

Several executives said their fragrance business was “as strong as ever.”

Neil Katz, president of Liz Claiborne Cosmetics, said his fragrance business had seen an 11 percent increase overall last year. “We attribute that success to several factors,” he said. “First of all, we’ve always got some promotion going; it’s the only way to compete. If 80 percent of what consumers are buying is on sale, we have to compete with that. Also, we’re constantly introducing new brands and new concepts.” The firm’s last fragrance, the Latin-influenced Mambo, is one example, he said: “It’s something completely different,” he said. “And consumers are responding to that; over Valentine’s Day, it was in the top 10 in 1,500 of the 2,200 doors we’re in.” However, he predicted that the softness in the economy would continue through the summer, “at least.”

Jean Hoehn Zimmerman, executive vice president of sales and marketing for Chanel’s beauty business, also professed to be “very happy” with her overall fragrance numbers: “We’ve just come off of a 15 percent increase in fragrance in January,” she said. “We’ve held our share, increased it in some places. People aren’t buying big-ticket items, but they’re buying the small luxuries. It’s not about gift-with-purchase or purchase-with-purchase; it’s about giving them a product they want.” Zimmerman will continue to build business this year with several initiatives, including a major women’s fragrance launch in the second half.

“When you have a weak economy, it highlights the challenges in the industry — …but we have incredible excitement going forward with Arden,” said E. Scott Beattie, chairman and ceo of Elizabeth Arden. “Our fragrance business is growing by double digits, and we have plans to develop other areas of the business, including color. We are launching a new color line in Europe, which is our strongest color market, that will come to the U.S. next year. We’re also planning to offer color stockkeeping units — …nails and lips — for our Elizabeth Taylor business. We’re also reinvesting in our doors and looking to build our foundation and skin care businesses — particularly Ceramides.” Addressing Arden’s consumer perception as a “more mature” brand, Beattie pointed out that the recent signing of actress Catherine Zeta-Jones as the brand’s new spokeswoman was the first step in addressing a broader audience for the brand. As reported, Zeta-Jones’ first major campaign will be for a new fragrance the company will launch later this year.

Oil houses say they aren’t seeing a slowdown in new projects, although some say finished projects are sitting on the shelves a bit longer. “We’re seeing just as many projects and taking them up to finalization, although, with some, the final buttons aren’t being pushed quite yet,” said Charles Drayson, president, fine fragrance center for Firmenich. “But things are looking up. By the end of spring, things should be picking up.”

Patrick Firmenich, corporate vice president for Firmenich SA, said that although there were fewer fragrances launching this spring, opportunities still exist for growth. “The percentage of consumers using fragrance is smaller here in the U.S. than, say, in Europe,” he said. “There are a lot of untapped opportunities.” Those opportunities, added Drayson, include, as an industry, promoting the use of fragrance at key times — “not brand-related, just promoting the use of fragrance overall,” he said — and targeting additional consumer groups. Firmenich’s Michel Bongi, currently vice president, corporate development of perfumery, who will succeed outgoing corporate vice president, perfumery Jean-Pierre Linder in June, noted that men — …particularly those of high-school age and those who are African-American or Hispanic — …are a particular opportunity, as they are underrepresented in the current fragrance market.

“It’s been a tumultuous year, but we’re seeing a sense of optimism,” said Errol Stafford, president of fragrances worldwide for Givaudan.

“There are a lot of things out of inventory,” said Demi Thoman, president of fragrances, North America for Quest International. “Our business in January was up double digits. I think we’ll see an uptick in the fragrance business.”

Still, there’s plenty of effort to be made, said Michel Mane, president of Mane USA. “We have to develop initiatives to deal with market pressure,” he said. “There’s a real need for meaningful innovation.”

“I’m extraordinarily pleased with the progress the company has made over the last year,” said Richard Goldstein, chairman and ceo of International Flavors & Fragrances (IFF). “Notwithstanding the global recession, we have achieved the synergies that we set out to achieve. We’re in our fifth straight quarter of meeting expectations. And with fine fragrances, Nicolas [Mirzayantz, vice president of global business development] and his group have done an outstanding job, bringing New York and Paris into one cohesive team. We’re looking forward to a great year.” Goldstein also spoke of the importance of continued innovation to drive the fragrance industry. “For instance, our perfumers have profited immensely from interaction with our flavors people,” he said. “They bring a new, fresh perspective to the process.”

One of last year’s hottest topics, scents over the Internet, has fizzled, but Clint Brooks, vice president of research and development for IFF, thinks the concept has potential. “In my opinion, they missed one thing,” he said. “They had great marketing, but they lacked the hardware to deliver on their promise. They just didn’t have a machine ready when the money ran out. I do think there’s potential, but the hardware will continue to be the challenge. Still, it’s an exciting frontier, and I think it will be viable in the next two to three years.”

The conference’s mass players also were hanging tough in the face of economic challenges.

“The business is hanging in well,” said John Galantic, the newly named president of Coty U.S. “It was flat at yearend, but that was to be expected, given this past fall’s events. We’re off to a good start this year.” While he acknowledged the fragrance industry’s well-publicized problems, he said that Coty is addressing the issue with innovative concepts like the company’s new Club Med scent. “It’s an example of marrying a great brand name with a terrific scent,” he said. While a beach resort might not be the most obvious branding opportunity, “it gives us the chance to evoke the beach experience with a well-known recreational name,” he said.

“Our beauty businesses are seeing both top-line and bottom-line growth,” said Marc Pritchard, vice president and general manager of Procter & Gamble’s beauty group, which includes Cover Girl, Max Factor, Clairol, Head & Shoulders, Olay, Pantene and Physique. P&G’s fine fragrance unit did see some dropoff post-9/11, but Pritchard said he’s confident that the business will recover. “Post-9/11, consumers are looking for things they can trust;…they’re returning to core values. They trust the P&G beauty brands to deliver for them.”

Going forward, Pritchard said, the company will drive growth with continued innovation and updating, including new foundation sku’s from Cover Girl — including the new Fresh Complexion Oil Control, which bows in July. There will also be continued additions to Max Factor’s Finity franchise, which includes Lipfinity, the long-wearing lip color line, as well as Face Finity, a collection of nonsmudge, long-wearing foundations. Lipfinity, in particular, will likely more than double its shade range from its current 24 to nearly 60, he said.

Of the much-discussed Physique hair- care line, Pritchard said, “It’s a great product, but it’s too complicated to shop. The product will be repackaged.” Will the price — which approaches department store pricing — …drop? “We don’t know yet.”

Michael McNamara, president of Neutrogena, said, “The economy is recovering modestly — we’re seeing an improvement. Our business is strong, and we’re seeing great growth from many of our new products, including additions to our Visibly Firm and Healthy Defense franchises.”

“Our business is very good right now,” said Howard Bernick, president and ceo of Alberto-Culver. “We’re not seeing any sort of a slowdown — -in fact, we think our business will be up at least 10 percent this year, and we think profits will be up at least 15 percent. We’re doing very well in food, drug and mass market venues — …and we’re glad we’re not in the department store business.”

In fact, added Jim Marino, group vice president of hair care for Alberto-Culver, “In some ways, the downturns have played into our good fortune, as we sell such value-priced brands.” Marino added that the company’s ethnic businesses — …particularly Pro-Line — …are doing very well: “They offer a great opportunity, both domestically and internationally,” he said.

“Although conditions could hardly be more difficult, the industry has shown remarkable resiliency,” said Jung, as she addressed the CTFA general session. “We’ve made significant strides, including regulating ourselves and addressing the need for globalization. Harmonization remains our goal, but the European Union is going in a different direction — …so we need to work with our colleagues in the EU.”

Kavanaugh noted that while the cosmetics and toiletries industry did $150 billion globally last year, 75 percent of that figure was done outside the U.S. The European Union accounted for 40 percent of that figure, he said.

Despite the tentative sense of hope for an economic recovery, the mood of the conference was marred by an accident that happened early in the conference during Firmenich’s annual boat cruise. Annette Green, president of the Fragrance Foundation, apparently lost her footing while going down a stairway, suffering a head cut that required stitches and breaking her foot. Injured but unbowed, Green soldiered on through the rest of the conference, rolling into the business meeting in a wheelchair. “The sessions were excellent — …Leonard was especially wonderful,” she said. “He set the tone for a great meeting.”