Focus: The Foxconns of fast beauty propel South Korean cosmetics' success in China

Cosmecca Korea Co

09/07/2018 15:32

(Repeating story to additional subscribers)
    * S.Korean cosmetics contract manufacturers a key to China
success
    * Top contractors all approached by foreign
investors--sources
    * Foreign investors were seeking minority stakes--sources
    * One contractor feared foreign stake would upset other
clients
    * Contractors fast turnaround times attractive to cosmetics
firms

    By Joyce Lee and Hyunjoo Jin
    SEOUL, July 9 (Reuters) - At a factory two hours south of
Seoul, women clad in plastic caps and masks put peach-coloured
eye-shadow into cases, right next to a machine churning out a
skin-colour face powder.
    The difference between the two lines: the first is supplying
one of France’s best-known premium cosmetic brands, while the
second is serving a South Korean budget firm.
    The plant is operated by Cosmecca Korea  241710.KQ , the
country's third-biggest contract cosmetics maker, which produces
a range of products for more than 300 customers, all the way
from high-end brands like Estee Lauder  EL.N  to nimble domestic
firms such as Clio and Dr.Jart.
    It is factories like this that have made South Korea the
epicentre of fast beauty, a world in which the time it takes to
get a product idea onto store shelves has dropped dramatically,
often by years. This is vital as fickle millennial consumers can
easily leave last year's hits as this year's busts.
    Their dominance of the world of contract manufacturing for
cosmetics may have become as important to the industry as Apple
 AAPL.O  iPhone manufacturer Foxconn  2354.TW  has been for
electronics.
    Some of the major Korean brands they work for have been
acquired by global cosmetics companies such as L’Oreal  OREP.PA 
and Unilever  ULVR.L , and according to people with direct
knowledge of the matter, the manufacturers themselves have
received investment offers, some from foreign cosmetics firms.
    South Korea's three largest contract manufacturers - Cosmax
 192820.KS , Korea Kolmar  161890.KS  and Cosmecca - have all
been approached by foreign investors about buying a minority
stake in recent years, three people with direct knowledge of the
situations told Reuters. The sources asked for anonymity and
declined to elaborate further citing confidentiality of the
approaches.    
    One of the sources said one of the manufacturers had
rejected a 2016 offer from an overseas cosmetics company for a
minority stake, partly due to concerns that such an alliance
could upset its broader customer base.
    Representatives for the companies declined to comment.
    
    DEMAND FROM CHINESE BRANDS
    Though largely staying in the background with little public
recognition themselves, contract manufacturers stand to benefit
as Korean brands they work for rapidly grow in China's $53.5
billion cosmetics market. That's thanks to their value for money
image, fast turnaround times for new products, and smart online
marketing. 
    China's own fast-growing cosmetics brands, albeit still
small, are also driving the revenue growth of South Korean
manufacturers, although margins on these contracts can be low,
company officials say.
    The stock market performance of the three has been mixed,
though they have all outperformed the main benchmark in South
Korea.
    Shares of global No.1 Cosmax  192820.KS , has gained 34
percent year to date, far outpacing a 8 percent drop in the
wider South Korean market  .KS11 .
    Cosmecca shares rose 8 percent and second-ranked Korea
Kolmar  161890.KS  fell 3 percent in the same period.
    All three have, though, outperformed the 21 percent decline
in shares of Amorepacific Group  002790.KS , South Korea's
largest cosmetics powerhouse.  
    Amorepacific, which uses both in-house and contract
manufacturing, reported revenue fell 10 percent and operating
profit slumped by nearly 30 percent in the first three months of
2018. Its brands include the top-end Sulwhasoo, mass market
Innisfree, and young makeup offering Etude House.
    Even as all the top three contract firms, which are also
known as original equipment manufacturers (OEMs), posted revenue
growth in the same period.
    "The surge of smaller players gives tough times to beauty
giants like Amorepacific. By contrast, this is a favourable
environment for OEMs," said Park Jong-dae, an analyst at Hana
Investment & Securities.     
    "While brand companies have up and downs, OEMs garner stable
earnings. They are most suited to the industry's structural
changes - Asian growth and diversified distribution channels."  
            
    STRUGGLING TO CATCH-UP
    In particular, they are central to the success in the
high-growth China market of small Korean brands with new ideas
but no production or research capabilities, industry executives
and experts say. 
    When French luxury giant LVMH's  LVMH.PA  private equity arm
was conducting due diligence on Clio before buying a stake in
2016, among its key questions was: "How do you come up with new
products at such a fast speed?," said Lim Mira, a manager at
Clio's strategic planning team.
    Contract manufacturers such as Cosmax deliver on orders much
more quickly, in as fast as three months compared to about a
year overseas contract manufacturers require, Lim said. 
    The firm used to source products from an Italian contract
manufacturer in the past, but has now shifted to Korean
manufacturers, she said.
    "Many global players are struggling to catch up as the
lifecycle of any success has shortened, pushing them to come up
with new innovations at a much faster speed," said Laura Chu, a
China-based account director at researcher Kantar International.
    In China, Unilever's share declined from 3.2 percent in 2014
to 2.8 percent in 2017, while L'Oreal's share fell from 9.4
percent to 8.5 percent during the same period, according to
research firm Euromonitor.
    Seeking to turn the tables, both Unilever and L'Oreal, as
well as other European and American majors, have paid big
premiums in the last two years to scoop up South Korean brands
thriving in China.
    Unilever announced a 2.27 billion euro ($2.67 billion) deal
for Carver Korea in September - maker of the A.H.C. cosmetics
brand, whose China sales rose more than 30 percent in 2017,
according to Kantar International.
    "Geographically it will enable us to strength our position
in two of the top five largest skin care markets - China and
Korea," Lizzy Chen, a U.K.-based executive at Unilever, told
Reuters. 
    South Korea-based Nanda, which was acquired by L'Oreal for
an undisclosed sum in May, saw sales of its flagship cosmetics
brand 3CE double in China last year.  urn:newsml:reuters.com:*:nL8N1S96KQ
    The strong performance was particularly notable given that
last year a major spat between Seoul and Beijing over South
Korea’s installation of a new U.S. missile defense system led to
an unofficial boycott of South Korean brands in China.
    South Korean contract manufacturers have been expanding
China production to meet surging demand.
    Cosmecca's chairman Cho Im-rae said that in recent years it
has been running its factories in China at full throttle. It is
planning to open a third factory there. 
    "China's cosmetics demand is growing enormously," he said in
an interview with Reuters.
    ($1 = 0.8514 euros)

 (Reporting by Joyce Lee and Hyunjoo Jin; Additional reporting
by Dahee Kim
Editing by Soyoung Kim and Martin Howell)
 ((jungyoon.lee@thomsonreuters.com; +82 2 3704 5609; Reuters
Messaging: jungyoon.lee.thomsonreuters.com@reuters.net))