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With decreasing governmental regulations and an increasing middle-class demographic—a population equivalent to that of the entire U.S.— India is quickly becoming beauty’s most important developing market.

At the L’Oréal India headquarters in central Mumbai, Didier Villanueva, the company’s managing director, keeps a small but significant box of beauty goods in his office. Inside are many of the traditional products that have been used by women here for generations—and, in many rural areas, still are: a bindi (dot) for the forehead; kajal, the black liner used to rim the eyes; talcum powder for the face and body; sindoor, a red powder worn on the hair part as a sign of marriage; a basic whitening cream, and coconut oil, to keep hair shiny and conditioned.

The wide assortment of products is a fascinating reminder of India’s enduring interest in beauty. “Beauty and personal grooming are not new to Indian women,” Villanueva says. “It’s just the products that are starting to change.”

Indeed they are—and such change is leading industry insiders to view India as second in importance only to China in terms of developing markets. The country’s beauty and cosmetics market is now estimated at about $1 billion, with an annual growth rate of 15 to 20 percent, according to the Confederation of Indian Industry. The longtime leaders in the market, which include L’Oréal India, Revlon and the Unilever-owned Lakmé, India’s largest local cosmetics brand, have recently been joined by a new wave of beauty offerings, including Chanel, MAC and Max Factor, which will enter the market this month with 10 counters and grow to 20 by yearend.

Add to the equation India’s mushrooming middle class, which is currently estimated at some 300 million people—equivalent to the entire population of the United States—each earning on average between $2,000 to $4,000 a year. The country’s huge trend-following, product-curious youth demographic—about half of its 1.1 billion population is under age 30, according to estimates—also serves as a mind-boggling barometer of just how big an industry like beauty can become here.

Government restrictions on foreign investment, especially foreign retailers, have also recently loosened, increasing opportunities for companies looking to India. For the most part, beauty companies haven’t been directly affected—the main legislative changes made earlier this year have been solely focused on single-brand retailing—but additional developments currently being considered could open the door for foreign-owned megaretailers such as Wal-Mart, which has been actively lobbying the Indian government for new regulations that would allow them in.

It also doesn’t hurt that duties on imported goods have been dropping steadily in recent years. The current standard duties are now at 12.5 percent, although imported beauty products still face an additional countervailing duty of 16 percent. While companies would like to see the duties lowered even more, most say they’re now able to keep pricing on par with nearby markets like Dubai and Singapore, where Indian customers have often traveled to shop.

Such changes are adding more momentum to the market’s already rapid pace. “There’s a growing thirst for beauty products and fashion and makeup,” says Peter Lichtenthal, global general manager of MAC, which opened its first store in June in Mumbai (the city formerly known as Bombay) and plans to add a second Mumbai store and a New Delhi outpost before the end of the year. Those two main hubs have been the primary entry points for most brands, but MAC is also now considering opening in Bangalore, which, along with cities like Chennai, Kolkata and Hyderabad, are quickly being identified as the next retail frontier.

The burgeoning demand is a relatively new phenomenon. Until recently, modern beauty products were often shunned by Indian consumers. “Even just 10 years ago, a woman wouldn’t have regularly worn a lipstick because she would be worried that people would think she was ‘fast,'” says Anil Chopra, vice president of Lakmé Lever, a division of Unilever’s direct India subsidiary, Hindustan Lever. Lakmé’s biggest-selling product for years was nail polish—”because you don’t wear it on your face,” Chopra explains—which was only surpassed in sales two years ago by lipstick, now the category leader for Lakmé.

Chopra understands the significance of these changes better than anyone. He’s been with Lakmé, which was started in India by the Tata Group in 1952 and sold to Unilever in 1998, for more than 30 years, working his way up from an assistant manager position to head of the mass market brand. The role finds him at the helm of the largest cosmetics company in India: Lakmé currently holds about a 48 percent share of the $90 million color cosmetics market and an 8 percent share of the $360 million skin care market, according to industry reports.

But over the past 15 years, Lakmé has been joined by a host of rivals. To stay competitive with the growing number of foreign brands, Lakmé has focused part of its long-term strategy on maintaining a fashion-forward image, in hopes of sustaining its appeal to trendy, young customers. One major component is the brand’s sponsorship of Lakmé Fashion Week, a showcase of the country’s top fashion designers, which the company helped launch six years ago.

“[Sponsoring a fashion week] gives us a great platform, because fashion is all about being young and contemporary,” Chopra says. “It’s important for us to demonstrate that Lakmé is a modern brand, because that’s what customers respond to.”

Respond they do—and not only for Lakmé. The ongoing growth in beauty in India demonstrates that consumer attitudes about makeup are changing rapidly. “The Indian consumer is evolving to a large extent,” L’Oréal’s Villaneuva says. “Her growing exposure to international media and travel has made her much more experimental with beauty products.”

Another major force driving change has been India’s homegrown movie industry, Bollywood, which generates more than 1,000 movies and $1.2 billion in ticket sales per year. Bollywood stars, whose onscreen and offscreen lives—not to mention makeup, fashion and hairstyles—are relentlessly tracked by the local press, have served as prominent trendsetters for the market. Consequently, the country’s most popular actors have been signed to shill for everything from soft drinks to shampoo. L’Oréal Paris is credited with scoring a major coup when it signed megastar Aishwarya Rai as a global ambassador for the brand in 2003.

“Celebrity endorsements do increase sales of beauty in India, as long as the brand fit is good,” says Rahul Malhotra, the head of marketing for Procter & Gamble India, which uses leading Bollywood star Preity Zinta for its Head & Shoulders campaign and actress Lara Dutta, a former Miss Universe, for Pantene. Not to be left out, MAC will be the official makeup sponsor of the International Indian Film Academy Awards, taking place in Dubai, next month.

Of course, even with the proper pitchwoman, increasing product awareness and market share can be difficult in a vast and constantly developing country like India. Most of the larger companies—such as L’Oréal, Unilever and Revlon—operate their India businesses through direct, wholly owned subsidiaries or joint venture partnerships. Some brands, such as Clarins and Dior, work with a local distributor to make their move into the market.

Others, such as Procter & Gamble, take a multifaceted approach. The company’s shampoo offerings—Head & Shoulders, Pantene and Asia leader Rejoice—are managed by its direct subsidiary, Procter & Gamble India. However, P&G’s prestige products—including fragrances from Escada, Valentino and Lacoste, and, as of this month, Max Factor—are managed by Baccarose, a Mumbai-based distributor that also handles Clarins, Shiseido and Elizabeth Arden.

“[A distributor] partnership provides the necessary expertise to learn and understand the market,” says Karlheinz Cless, vice president of distributor markets for P&G Beauty.

Adds Anthony Rodriguez, director of India operations for Euro Traditions, a Mumbai-based beauty distributor that handles Dior, Versace and La Prairie: “India is a very complicated market for many companies, whether you’re dealing with distribution networks, import duties or other areas. The benefit of a distributor is that we know and understand the market very well and can provide that local expertise for the brands we work with.”

But some industry watchers aren’t convinced that working with a distributor is the best approach, especially now that the competition is rapidly increasing. “Using a distributor is the single biggest mistake that companies are making in the India market,” says Rahul Bhalchandra, the head of wellness for Pantaloon Retail (India) Ltd., one of the country’s largest retail groups. The company owns a variety of different retail outlets, including large-format department stores like Pantaloons (which currently has 20 outlets nationwide, with plans to nearly double that by yearend) and Central (with three doors and plans for 10 more by the end of 2007). The company is also developing a new beauty retailing concept, a health mall that would combine spa, salon and fitness services along with retail outlets in one location. The first health mall is set to open in the western city of Ahmedabad in the next three months.

“If you’re looking to really build your brand in the market, using a distributor is not a good approach,” Bhalchandra says. “They operate as more of a trader than a brand builder. Any company that has set up in India on its own and worked on the market directly will, in the next five years, be at least three or four times ahead of a company using a distributor.”

Bhalchandra points to L’Oréal India as a perfect example of the best way to approach the market. L’Oréal entered India in 1991 with Garnier, and has slowly been building its presence, which now also includes L’Oréal Paris makeup, skin care, hair care and color and men’s products; Maybelline New York; Vichy derma-cosmetics; Garnier skin care, hair care and hair color, and a professional products division, which has formed collaborations with a growing number of local salons.

However, a high level of brand recognition also brings plenty of new problems, especially in the area of illegal parallel imports, commonly known as the gray market. For years—particularly because the beauty selection in legitimate Indian stores has been very limited—local merchants have sold a wide range of illegally imported beauty products, from brands that have been here for years to ones not yet available in the country (such as The Body Shop).

“Where the gray market has worked best is with brands that are already in the country but products which are not,” says Bhalchandra of Pantaloon. “People have always traditionally shopped for their products from local gray market stores, and it is still very strong. At this point, [modern retail formats] like supermarkets and department stores have only touched a very small percentage of Indian consumers.”

Dealing with the gray market has become a rite of passage for any brand entering the Indian market. Take MAC, which became the first brand from the Estée Lauder Cos. to enter India when it opened a shop in the Juhu area of Mumbai in June. MAC products have long been available through illegal imports in local stores across the country and, until more stores can be added and more consumers reached, the brand is realistic about its chances of competing with the vast gray market.

“The reality is that many cities in India are very large in size, and in order to reach a wide number of customers, it’s necessary to open in several locations in one city,” says Alexis Szabo, the India brand manager for MAC. “Until more good retail locations are available, the gray market is going to continue to be a factor for any company.”

To counter the gray market’s extensive reach, brands like MAC have focused on promoting a service-oriented approach and wide product range that isn’t generally found in gray market stores, which are often small mom-and-pop shops in local neighborhoods.

“Service is a big priority for MAC, and consumers here are responding to that because it’s not something they’ve really had before,” says Mickey Contractor, a well-known Bollywood makeup artist who serves as a consultant to MAC in India. “We really try to encourage people to sit and have a consultation at the store. We’ve seen that in this type of environment, when our makeup consultant suggests something, the customer really responds.”

But historically, such Western-style retail environments have had a minimal presence in India. Most beauty products have long been purchased at neighborhood chemists or local gray market shops, which have a poor atmosphere but a broad customer reach. “The number of large-format retailers is growing and our sales in these formats are also growing faster than the average, but as a percentage of business, it still remains very low,” says Malhotra of P&G India. “Modern retailers as defined in Western markets account for less than 10 percent of our business.”

Lakmé’s Chopra credits the company’s massive cosmetics market share to the fact that the brand has a widespread local distribution network in “fancy stores,” a traditional type of women’s-focused neighborhood shop, where the brand is sold alongside jewelry, fabric and other beauty products.

“Many beauty companies in India have been focused on finding the ‘right’ retail environment, but that means they’ve been unwilling to consider [distributing to] the local stores,” Chopra says. “For Lakmé, these shops contribute 40 to 50 percent of our sales, and I think that will remain strong for at least the next five years.”

The good news is that as India develops—and it is, by all accounts, developing very quickly— the retail environment is also rapidly changing. In the past five years, large-format department stores like Pantaloons and Shoppers’ Stop have sprung up in major metropolitan areas, offering a more modern experience for customers. With an estimated 500 malls currently in construction across India, the number of modern retail formats is expected to skyrocket soon. A removal of government restrictions on foreign-owned multibrand stores like Wal-Mart could provide plenty of other options as well.

“One of the biggest changes happening in the industry is in distribution options,” says Varsha Dalal, executive director of beauty distributor Baccarose. “The retail environment is becoming much more like what you’d find internationally. We’re now starting to be able to present the products the same way they are presented around the world, and that’s very important for any brand in this market.”

In addition, there’s been a small but significant increase in other retail options, including drugstore-style stores like Health & Glow, a joint venture between Dairy Farm International, which also operates the drugstore chain Guardian in Asia, and a local partner. Another contender for a share in beauty sales is La Galleria, an upscale fragrance and beauty emporium that is reminiscent of Sephora. La Galleria is offering a brand-new type of beauty shopping experience in India with its first flagship, which opened in north Mumbai in December and stocks more than 80 fragrances and beauty brands, including Dior, Chanel and Versace. A second New Delhi flagship is scheduled to open by the end of the year.

“It’s a completely new type of shopping option in the country,” says Santosh Savant, the distribution manager of Designer Brands Retail Network, which operates La Galleria. “But now that more customers are exposed to retail environments abroad, a pleasant shopping experience is something they’re starting to look for and willing to travel [across the city] to find.”

Still, while retail options may be improving, a visit to most beauty counters in India shows there’s still a long way to go. Even in many modern department stores, sales counters are dirty and dingy, sample products are messy and unappealing and the sales staff aggressively pounce on anyone who passes by.

Nowhere is this discrepancy more obvious than at the Juhu-area Shoppers’ Stop department store in Mumbai, home to the in-store MAC boutique as well as a separate area with counters for brands like Clarins, Dior and L’Oréal Paris. The regular beauty section is cramped with counters, and even a quick browse is constantly interrupted by the aggressive tactics of the sales assistants, who are provided by brands to staff the counters. In huge contrast, the MAC section is a pristine boutique staffed by quiet but helpful professional makeup consultants, exactly like any other MAC store in the world. The enormous disparity doesn’t go unrecognized by customers, either: On a recent Saturday night, MAC thrummed with shoppers and activity, while the other beauty counters nearby were comparatively empty.

“For years, the focus on beauty retail in India has been the hard sell,” says Bhalchandra of Pantaloon. “Now that approach is putting the consumer off. There needs to be more of a move to an ‘advice when called for’ approach. It’s one of the things that we must correct, especially if we want the beauty department to move forward.”

Another significant component in developing the market could be the effort put into brand promotions in stores and other public areas. “Brands aren’t making enough promotional efforts,” Bhalchandra says. “No matter if you look at fragrances or cosmetics or any other product, beauty is a category that is heavily driven by promotions and marketing activities. However, that’s barely happening in India. If you go to any other country, you will find a brand like Chanel doing regular promotions. But in India, brands aren’t using that approach. That essentially means the category has not developed at all.”

Bhalchandra, who until six months ago was the head of the Health & Glow beauty store chain, points to Vichy as the perfect example of the power of promotion. “They’ve been driving the brand through a lot of promotions, including samples and other educational efforts,” he says. “As a result, the amount of sales they do for the space they occupy has been very significant. A Health & Glow store in Bombay, for example, now sells 400 to 450 units a month from a 3-foot counter. And this is a brand whose average price is [about $22], so it doesn’t come cheap to many consumers.”

For now, most brands rely on TV campaigns and local magazine advertising to get the word out about their products. A host of widely distributed local magazines—including Femina, Cosmopolitan, Elle and Marie Claire, which will launch at the end of this month with a June issue—have boosted brand recognition and cosmetics awareness.

“Even in the past two years, there’s been a huge increase in knowledge about brands, and it’s mostly because of the media,” says Nisheeta Mehta, a corporate communications representative for Designer Brands, La Galleria’s parent.

A 22-year-old Mumbai native, Mehta typifies the target customer for many beauty companies: a young urban professional with a wide exposure to international products and a growing amount of money to spend on them.

But even though Mehta is a fan of products like Olay (which she’s bought on trips abroad) and eyeliner (a staple of any Indian woman, no matter her age), her regular beauty routine proves there are still some hurdles to getting customers in India to fully embrace new products.

“I’ll try something new but only if I feel comfortable about it,” Mehta says. “I still swear by my grandmother’s skin care recipe—a little milk cream, a pinch of turmeric, a half-teaspoon of honey and two drops of lemon juice. It’s what she used for years, and I still think it’s the best thing for my skin.”

Such strong traditions have kept some product categories from developing in India. Hair conditioner, for example, is almost nonexistent in the market because many Indian women continue to use hair oil instead. But India’s long beauty heritage has also bolstered some categories like skin-whitening products, which has become a market leader. “Skin whitening has always been very important to Indian women, and most will use some type of whitening product regularly,” Mehta says.

Mehta also represents the middle- to upper-middle-class demographic that many brands have identified as the consumer group with the most spending potential. “We see two types of beauty consumers in India,” says Dalal of Baccarose. “There are the very wealthy, high-society consumers, but they never shop in India. So we target the second level of consumers—they’re making money, but they don’t travel as much and they want to learn about new products.”

A typical professional in this category could earn anywhere from $250 to $1,000 per month, which—particularly for younger consumers, who often live with their parents until marriage—translates into quite a lot of buying power in India. “Younger people are able to spend more money than someone who’s in her 30s,” Mehta points out. “They don’t have a family to take care of or other responsibilities. There’s no one to spend on but themselves, so they do.”

They’re also very aspirational, which has helped make masstige products like Revlon and L’Oréal Paris among the strongest in the market, says Bhal-chandra. “Consumers are looking for something a little better than the mass products, and that’s why the masstige category is doing really well,” he says.

It’s also a strong indication of the market potential for prestige brands. Currently, industry watchers estimate that fragrances make up about 60 percent of prestige sales but retailers say they expect a shift toward makeup (currently 25 percent of prestige sales) and skin care (15 percent), particularly as more brands enter the market. For now, the few prestige brands in the market—like Clarins, which has 19 counters across seven main cities, or Shiseido, which has 13—are limited in size and scope, but more are on their way: On a visit to India in November, Estée Lauder chief executive officer William Lauder announced he hoped to bring the flagship Lauder brand to the country by the end of this year, and L’Oréal India has reportedly set up a prestige products division to explore the market as well.

“Beauty products make luxury more accessible, and we definitely can see that in India,” says Marielou Phillips of Chanel’s India operations, which maintains two beauty counters, one at the sole India Chanel store in New Delhi and another at the Mumbai La Galleria flagship. “Even if someone can’t afford a Chanel bag, they can probably afford a lip gloss. And in fact, lip gloss has become one of our most popular beauty products.”

Positioning a brand in the masstige category by simply raising its price has almost universally backfired, though. “Some companies have tried to reposition their products to a prestige level in the India market, but customers know if a product is more expensive here than it is abroad,” Bhalchandra says. “There has been a lot of international exposure and travel for Indians, particularly those in the main cities. Secondly, there is the gray market. When customers see a lower price of the exact same product in a gray market store, they realize that if someone can illegally import the product, not pay duties, make a huge profit and still sell at half the price being charged in the country, then there is obviously something very wrong.”

If one thing is clear about India’s beauty market, it’s that the increasing competition means there’s less room for brands to make such mistakes. “Between retail development and consumer evolution, the next three years are going to bring major changes,” predicts Savant. “But if brands don’t come here now and establish themselves, they’re going to lose out. To be successful requires a long-term approach.”

This article appeared in WWD BeautyBiz a special publication to WWD available to subscribers.