Fortune Cover Story
Dec 12, 2005
Battle for the Face of China

L'Oréal, Shiseido, Estée Lauder—the world's leading cosmetics companies are vying for a piece of a booming market.

By Sheridan Prasso

At the Pacific department store in Shanghai , lanky 24-year-old makeup stylist Jin Jia is all hustle and flow. Dressed in black, safety pins stuck through his shirt, he saunters suggestively around the MAC cosmetics counter with mascara wand and powder brush to the hip-hop thump of Eminem's "Lose Yourself." The music is loud, simultaneously luring and intimidating, and the young women in the store are intrigued. They want this experience of glam, in-your-face modernity. They may not know that MAC is owned by Estée Lauder , but they know it is ku, or cool. And most of the women who sit for Jin's makeovers buy something—smoky eyeshadow for $17.50, foundation cream for $40. No, not cheap. Chic. This is the Shanghai of the roaring 2000s, three generations after it was the fashion capital of the Orient, the Paris of the East. There aren't many Shanghainese around anymore who remember those precommunist days, when women slit their qipao dresses up their thighs and painted their lips lantern red. Their great-grandchildren are starting from scratch.

Across the aisle a clinician at Shiseido's Aupres counter is demonstrating a herb-infused face cream developed especially for Chinese skin at Shiseido's R&D center in Beijing . Dressed in medical white, she rubs Eternal Total Recharge's creamy silk onto the back of a customer's hand and tries to explain, over the music, its effectiveness in creating skin that is "dewy soft." (The literature says something about fibroblasts and collagen and resilience from an emulsion of Chinese asparagus-tuber extract.) The appeal works for the women who have bypassed the MAC counter. Here they can take refuge in a more familiar tradition, rooted in centuries of Chinese aesthetics that equate beauty with ivory skin.

Modernity and tradition—it is a raging battle among global beauty giants vying to win the face of Chinese women. There's French giant L'Oréal pitted against Japan 's Shiseido, both of which are being challenged by U.S. leader Estée Lauder and a handful of Chinese companies that draw upon the desire for traditional skin beautifiers by putting herbs and animal proteins into their products. Their ads line every block of Shanghai 's Nanjing Road , and almost every weekend brings a promotion for a new makeup line, with dancing girls and free makeovers, outside Shanghai department stores. Dior is in the race too. And the American companies Amway and Avon , which got hammered by a 1998 government edict prohibiting door-to-door sales that is supposed to be lifted, albeit with restrictions, by the end of the year. Sephora, the cosmetics arm of LVMH, opened its first store in Shanghai in April and plans 100 in China by 2010.

And those are just the Davids. The Goliath is Procter & Gamble , which has long held the leadership position in the broadly defined cosmetics and toiletries industry because its Olay whitening skin creams outsell every other brand, and its shampoos (Rejoice, Head & Shoulders, and Pantene) hold the top three hair-care positions in China . In March, P&G plunged into the cosmetics competition, too, launching Cover Girl and Max Factor to compete with L'Oréal's Maybelline. Along with its high-end SK-II skin-care line and its other household and food brands, P&G hauls in more than $2 billion in annual sales in China—roughly 70% of that from hair and skin products, compared with a fifty-fifty split in other countries. "We are the beauty company of the P&G company," says Daniela Riccardi, P&G's president for Greater China. "Nowhere else is beauty such an important part of the business."

All that may sound surprising, because China is a country where barely any women used cosmetics a decade ago. When the authorities stopped discouraging lipstick and other bourgeois displays of beauty in the early 1990s, Chinese women were eager to embrace the aesthetics of the modern world. As a result, the beauty industry has been growing at breathtaking speed—doubling since 1998 into a $7.9 billion market that is expected to climb to $9.6 billion by 2009, according to market research firm Access Asia. Some 90 million urban women in China spend 10% or more of their income on face cream, lipstick, mascara, and the like, particularly in fashionable Shanghai , where women spend 50 times more per capita on cosmetics than women nationwide. The makeup component of the beauty market in China is forecast to have sales of $524 million this year, rising to $705 million by 2009, Access Asia predicts. And early entrants who have had time to build market share have seen results: L'Oréal's 2004 sales of $350 million (including makeup and other beauty products), were up 58% over the previous year; Shiseido's China sales last year were $204 million, up 27%.

The beauty business is considered a bellwether of the overall consumer products market, reflecting desire and discretionary income rather than essential day-to-day living. And it's one of China 's most dynamic markets, spurred by rising incomes and increasing spending power. "It's the only big market growing this fast in China ," says Jacques Penhirin, a McKinsey partner who tracks retailing. "This is a market that was almost nonexistent 15 years ago, and about 70% of it remains to be developed."

Chinese tradition means that just about every woman there equates beauty with fine skin. Poems from the Tang dynasty and even a millennium earlier describe beautiful women as "jade white" and "creamy tinted." China 's ancient tales have mothers giving their daughters pots of face cream to take on long journeys. Today even urban grandmothers still drink a concoction of ground pearls mixed in water in the belief that it keeps the skin white. "Chinese people ask for even whiter tone than what is selling well in Japan ," says Tadakatsu Saito, chairman of China operations for Shiseido, which has the most experience of all the multinationals with whitening because of the huge market in Japan . "When we try to sell them their exact color, they say, 'Too dark. Do you have anything lighter, brighter?' "

The modern desire for whitening is sometimes mistaken as a desire to take on the trappings of Western beauty aesthetics in a country where popular surgeries for eye widening, breast implants, and a more prominent nose bridge are exactly that. Commercials advertising such cosmetic procedures are ubiquitous on Chinese TV, and it's the rare Shanghai taxi without an ad for them over the seat back. But the value of clear white skin is deeply rooted: Herbal recipes for keeping courtesans' faces translucent can be found in ancient imperial records. Women in China who can afford it think little of spending at least as much money on facial moisturizer as on clothes. That would be unusual in the U.S. , where 87% of women spend less than $20 when they buy skin cream.

But at Plaza 66, an upscale mall in Shanghai , fashionable Shanghainese women toting designer purses and Starbucks coffee cups pause all day long to buy expensive moisturizer at the counter of La Mer, another Estée Lauder brand. One of them, Qiao Hong, 42, is picking out a jar of face cream ($287.50) and eye-lifting serum ($418.75) that she plans to send her husband back to purchase later in the day. She's a university professor. Her husband owns a garment factory. While they are well off, $700 is still a lot of money to spend on potions, but the counter girls report that Qiao isn't unusual: A typical day finds 20 to 25 women doing the same. "It's necessary for a woman to treat herself well, and my husband also agrees that it's important for a lady to look good," Qiao says. "It's really worth the money. With money, you can just make more of it, but your skin—if you lose your beauty and youth, you cannot get it back." La Mer's counter has 32 other women on a waiting list to purchase a 500-milliliter jar of face cream. Cost: $1,750. Shiseido finds similar demand for its Clé de Peau line, which, at $500 for 30 grams, is more expensive than gold. On any given Saturday afternoon, the comfy chairs at the Clé de Peau sections of department stores are filled with buyers and with women waiting to take their places.

L'Oréal's new laboratory in Pudong is a 32,000-square-foot facility stocked with pigments, waxes, and oils. Didier Saint-Leger, a biochemist, oversees the microscopes and chromometers that measure the effectiveness of skin-whitening creams, the ovens that heat emulsions to test stability, and the two-way mirrors that enable him to observe the way Chinese women apply face creams and makeup. The center opened in September with 43 Chinese researchers, most of them chemists. Next year, when L'Oréal completes construction of Phase II, currently an empty field at the back of the lab, there will be 75. Chinese herbs, roots, and flowers will be tested there, distilled and researched for their impact on skin and hair. Hua jiao, the flower of the prickly ash tree that adds tongue-scorching spice to Sichuan cuisine, is reputed to clear up acne and will be among them, as will traditional whitening agents such as ginkgo leaf, ginseng, and mulberry.

"We cannot separate the beauty and the culture," Saint-Leger says. "I am trying not to think like a Caucasian. Basically, human beings, 95% of the world, have dark hair and eyes. Caucasians could be considered mutants." (Saint-Leger also hopes to unlock such secrets as why Chinese women's skin wrinkles, on average, at a rate ten years behind that of French women.)

The R&D center is part of L'Oréal's transition from the image it currently projects in China—its Chinese name, Oulaiya , means "elegance coming from Europe," and its ads feature pinkish colors on white faces—to something more recognizably Chinese. Its recent acquisitions of Yue Sai, for a decade the most popular cosmetics brand in China, and the low-end skin-care line Mininurse are steps in that direction. But Shiseido is already ahead in the traditional-formulations game, with its "Chinese national brand" Aupres and its recently expanded three-year-old Beijing R&D center. It has already launched its first product (Eternal Total Recharge) and has more on the way.

Not to be left out, Estée Lauder opened its own 15-scientist Innovation Institute in Pudong in November, stacked with pigments with names such as "gleamer flake" and "magic mauve." As a latecomer, Estée Lauder's strategy has been to build a finally-this-glamorous-American-brand-is-available-in-China buzz for its prestige lines long before they go on sale. It also gives away cosmetics to China 's leading makeup artists to encourage them to experiment on models for shows and movies. "We have been watching and feeling the pulse of the China market for a long time," says Carol Shen, Lauder's Taiwan-born general manager and the only ethnic-Chinese woman heading a major beauty company in China . "The market just wasn't that ready before."

Now, clearly, it is. " China changes so fast," Shen says, looking out her Shanghai office window high above the haze covered city. "You blink, and the market is there." Shen used the same strategy to launch the Clinique and Estée Lauder lines, advertising in the Chinese edition of Elle years before they were for sale in China . She was based in Hong Kong at the time and understood the importance of China 's jet-setting sophisticates, who read fashion magazines and make shopping trips to Hong Kong , Europe , and the U.S. , then set trends when they get home. Being Chinese, she says, gives her an advantage over Europeans and Japanese. "They also have a deep understanding of the markets," says Shen. "But for me, it's faster."

Selling to the masses in China is something else entirely. Rural China is still largely unpenetrated by beauty products, and with retailing and distribution still badly managed in China 's hinterlands, the companies that have the best strategies for reaching the women there, rather than the minority who shop for imports at department-store counters, ultimately will win the largest market share. "There is a huge opportunity to make the whole cake bigger," says Austin Lally, P&G's vice president in China . "In hair care there's potential to quintuple the size of the category." That means getting rural women who wash their hair once a week to wash daily. For those who use only shampoo, the next step is to get them to buy conditioner and ultimately coloring, gel, and mousse. For women who use only cleanser and skin moisturizer, there are toners, exfoliants, and facial masks. "Women in Japan and Korea use seven or eight steps for skin care," says Haw Diann Wai, Estée Lauder's Malaysian-Chinese product-development manager. "We're not that sophisticated yet."

Paolo Gasparrini, president of L'Oréal China , is leaning over a coffee table drawing a pyramid. He is explaining how he is trying to reach the consumers at the bottom, where household incomes average $37 to $50 a month. The small-store distribution channels he acquired with Mininurse—which has been reformulated and priced at less than $2—allows L'Oréal to reach into 280,000 stores nationwide, giving the company the potential to launch shampoos through those channels as well. The number of Chinese households with incomes above $625 a month is expected to reach 22.4 million by 2008, so there's lots of potential to expand L'Oréal's mid-range lines through China 's mushrooming network of hypermarkets.

L'Oréal may also begin introducing products differentiated by region—heavier creams for China's cold northern climes and lighter ones for the tropical south—as well as by skin tone. "Segmentation is something that's becoming more and more important," says Gasparrini. "There's still huge space in the market to take." L'Oréal, like all beauty companies in China , finds there also is space to educate Chinese consumers, who know little about applying cosmetics or why they need exfoliants. "In other countries women learn how to use cosmetics from the mom," says Gasparrini. "That's not the case in China . We have to substitute the mom."

It may be Shiseido, however, that has the most thorough and comprehensive outreach strategy with its local brands—endeavoring to reach Chinese women in the thousands of smaller cities who have not had access to cosmetics for decades, if ever. Shiseido has built a chain of 25,000 stores in Japan , a country one-25th China 's size. Last year it started doing the same thing in China . Apart from the 400 Chinese department stores selling Shiseido brands in major cities, the company is rolling out what it calls "voluntary chain stores" across China 's hinterlands to reach out to lower-end consumers. It finds mom-and-pop retailers willing to allow Shiseido to install a counter, put up a Shiseido sign, and hire full-time staff. Shiseido takes care of training and checks on the store's progress weekly. The company is selling hundreds of products it has developed and manufactured through two joint ventures in China , under brands with names such as Za, Uno, and Fitit. After making many of the products available in 4,172 small retail outlets in China , Shiseido opened 700 freestanding stores in the past year and plans 5,000 by 2008.

"We are the best at this system," Shiseido's president and CEO Shinzo Maeda boasts from a comfortable, cream leather chair at Shiseido headquarters in the Ginza section of Tokyo. Ultimately, Maeda says, Shiseido expects to double its annual China sales, on operating margins of more than 20%, and make China contribute one-fourth of Shiseido's overall global revenue. "Ten years ago we thought that 1% of Chinese women would be Shiseido customers," says Masaru Miyagawa, president and CEO of Shiseido China . "Now we think that 10% of Chinese women will be Shiseido customers."

There are Chinese companies in the beauty game as well, and being Chinese, they are best poised to play the tradition card. One of those is Shanghai Herborist Cosmetics, a division of state-owned Jahwa. "We're the Body Shop of China," says Herborist's fashionable brand manager, Lily Xu. Herborist makes 130 products for use from head to toe; one of its most popular is a "whitening revitalizing mask," which uses seven herbs that claim to lighten skin tone in 15 minutes, producing faces "as white as a lotus seed." Herborist now has 180 freestanding boutiques in 40 cities in China and plans 100 more by next year. Xu is excited about a recent agreement with Sephora to sell Herborist products in its China stores and ongoing discussions with the company to sell Herborist abroad. "Back to nature is the cosmetics and skin-care trend in fashion now," says Xu. "Once Origins or L'Occitane come to China , then we'll have real competition. But we'll still be able to distinguish ourselves as coming from Chinese tradition and Chinese medicine."

It's all about mixing tradition and modernity to reach Chinese consumers, says Yue Sai Kan, a TV celebrity in China who founded the cosmetics line acquired by L'Oréal. Sitting on a plush sofa in her New York City townhouse, where she spends her time when not working on a new show in Shanghai , she opens a book of paintings from the Tang dynasty, when China was ruled by an empress, Wu Zetian. She points out the red lips and painted brows in the depictions of women who lived more than 1,000 years ago. "See, Chinese women have always used cosmetics," she says. "In the Tang dynasty they used as many steps of makeup as we do today. Chinese women had been discouraged from using cosmetics for 35 years. It was a world of darkness, of no color. Now it is changing. What you have to do is give them international, yes, but Chinese have a lot of pride in themselves and their traditions. The best thing you can give them is a belief in themselves."

And 37 shades of red to choose from.