2 Core Strengths Powering the Growth at Estée Lauder

We dive deeper into Estée Lauder (EL -1.61%) by looking at the core strengths that have provided a foundation for the company's recent success. From its multi-faceted approach to sales channels and a penchant for opportunistic acquisition, learn about these distinct competitive advantages in the Industry Focus video below!

A full transcript follows the video.

This video was recorded on April 10, 2018.

Vincent Shen: Something else that I think is really important for this business in terms of how they sell through their products is their sales channels, so distribution model, because they have a variety of different storefronts, their online business. What's the story there, Asit?

Asit Sharma: The company has a really interesting division of channels. The first is primarily department stores. There are specialty retailers as well. This is a straight quote from the company, "Upscale perfumeries and pharmacies and prestige salons and spas." So again, look at that gamut of high-end luxury, premium, all the things that you mentioned, Vince, which in my mind always pop, translate into margin, profit margin.

Shen: Yeah, exactly.

Sharma: They're also in freestanding stores. They own about 1,400 freestanding stores, and about 500 additional stores are operated by third parties. They operate those under four labels: MAC, this is a Canadian company which the company acquired in the 1990s; Jo Malone London; Bobbi Brown, which many listeners will be familiar with; and Aveda, also a very common name. This distribution channel, as you said, Vince, it's heavy into brick and mortar.

But, the company is also really into online sales. It's got a burgeoning e-commerce channel. It has about 1,400 different e-commerce and mobile sites. One thing that I'm really interested in is, we talked about Hudson Retail a few weeks ago, Vince, and that it leases retail space in airports. This is something that has been a boon to the company in terms of what it calls travel retail. So, those folks in China who are driving up sales in that market are also great travelers, and they spend money in the places they visit. There are a few companies of Estée Lauder's size that are quite as good at pulling dollars -- or pulling yuan, rather -- out of customers as they work their way through airports and then travel in the countries that their final destination is. This is just an overview of how widespread and how many distribution channels this company has.

Shen: I think the story that management really paints regarding its recent growth and strength, it's all about taking a very holistic approach to how they leverage their very broad product and brand portfolio, and then how they push into these different channels and geographic markets, online, their online channels, and then also traditional outlets like department stores, specialty retailers.

Something else I wanted to cover, too, that I think has shaped a little bit of their recent strategy. About two years ago, the company implemented a bit of a restructuring effort that they called Leading Beauty Forward. With that, they're taking efforts to change their marketing and adapt them to a more digital focus, given how important it is, obviously, that comes up all the time on the show. Ultimately, they want to better connect with their customers. A big part of that, for example, is social media and how social media influencers can be a key part of how they connect with younger consumers, since that demographic tends to find the social media medium to be the most compelling.

Then, beyond that, the company has also worked toward a nimbler supply chain, for example. Something that was very pronounced in terms of the effect with this restructuring is the time to market for products. Historically, it took the company about 18 months to bring an idea to market. Now, it's just 12 months for bigger ideas, while small changes can happen as quickly as just five or six months. Then, the restructuring has also helped, for example, lower their inventory levels, align some of the functions at the company so they can support all those different sales channels that we've mentioned. Overall, in terms of quantitative value, management estimates an annual benefit of about $200-300 million from Leading Beauty Forward. So, pretty powerful.

Last thing here, before we get to the next part of our discussion, that I think is very important in terms of the context of how this business works and how it's grown over the years, is in terms of M&A activity for the company. The company is a pretty regular buyer. They are often looking for brands that they can roll into the portfolio, fill in certain niches that they maybe feel are under-covered and offer a good return on investment. I think, in the past few years, they've acquired something like six or seven smaller brands. What are some of the details there, Asit?

Sharma: Just a reminder, the company went public in 1995. That was also the year that it made its first acquisition. Up until that time, for over 50 years, Estée Lauder had developed brands in-house. There was an individual cosmetician who was like a cult figure in New York City in the mid-90s. Her products were sold in Neiman Marcus. That was none other than Bobbi Brown, who I just mentioned a few minutes ago. That was the company's first acquisition, in '95. That brand is now sold in 60 countries. So, the model is, acquire these brands and then, obviously, expand them.

I went back and looked at the history. Since then, the company has had a pretty regular cadence of acquiring a major brand every two years. But in recent years, that has really ticked up. Just to review a few, Estée Lauder bought Hollywood skin care brand GLAMGLOW in January of 2015; fragrance house KILIAN in February of 2016; BECCA, which is a makeup brand, November 2016; and Too Faced in December of 2016. Now, the company has a June 30th year-end, so those last two acquisitions actually came in the most previous fiscal year. That speaks to what Vince was saying, that the company ramped up its acquisitions in the past few years.

But I think that this emphasis Estée Lauder has on technology, innovation, as you mentioned, Vince, research and development spends about $120 million a year in research and development -- I think that lends itself to buying these brands, wrapping them in, and then doing brand extensions, making new products, testing them out, offering new SKUs in these varieties of markets. And oftentimes, they will take a brand from the U.S. and transplant it, the lift and shift model, into Asia with a few modifications. And that's been very successful for them.