Strategic Audit of The Estee Lauder Companies

Strategic Analysis The Estée Lauder Companies

Joshua Dopkowski EMBA Cohort 5

October 23, 2014

STRATEGIC ANALYSIS: THE ESTÉE LAUDER COMPANIES

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Objective and Summary The following analysis provides an overview of The Estée Lauder Companies,

examines the overall operations and state of the business, identifies opportunities and

threats, and provides a strategic recommendation based on research and analysis. All

financial information regarding The Estée Lauder Companies was obtained from The

Estée Lauder Companies SEC filings, and all competitive, industry, market and salary

information was gathered from several sources including Forbes, Yahoo! Finance,

Bloomberg and Hoovers.

Report Structure

1. History

2. Corporate Snapshot

3. Marketing

4. Supply Chain

5. Industry and Competitive Analysis

6. Financial Analysis

7. PESTLER Analysis

8. SWOT Analysis

9. Strategic Recommendation

History The Estée Lauder Companies is named after its founder, Josephine Esther

Mentzer, who was born in 1906 in Queens, NY. Josephine’s nickname was “Esty,” and

as a result of her father’s Hungarian accent, her name was pronounced to sound like

“Estée.” The nickname stuck for life, and would ultimately be the first half of a globally

recognized brand name, and business pioneer. Estée began working for her uncle Dr.

John Schotz, a chemist that also lived in Queens and ran his own business, New Way

Laboratories. New Way produced and sold beauty products including creams, lotions,

rouges and fragrances. Estée’s approach to selling was to enter hair salons and apply

samples of the product to women who were waiting or were having their hair dried. One


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such salon, the House of Ash Blondes, was impressed by Estée’s effectiveness, and so

owner Florence Morris hired Estée to sell her products.

In 1930, Estée married the man that would become her life long partner in life

and business, Joseph Lauter. The couple soon thereafter revised their last name to

“Lauder,” as Estée felt that it had a better ring to it. The name change actually caused a

family rift that was never truly resolved. Estée and Joseph began making their own

products in 1940, and in 1946, they officially launched the Estée Lauder Company. In

1948 Estée Lauder pioneered the gift-with-purchase promotion, and in 1953, Estée

Lauder launched what is now considered its flagship product, Youth Dew perfume and

bath oil. Youth Dew was a sensational success and was followed by a series of major

successes over the next several decades, which include:

• 1960 Estée Lauder goes international and begins selling in London.

• 1968 Estée Lauder launches Clinique, and the famous Clinique Counter.

• 1974 Estée Lauder hires Irving Penn to shoot Clinique Ads.

• 1990 Estée Lauder launches Origins.

• 1992 Estée Lauder creates the Pink Ribbon for Breast Cancer Awareness.

• 1993 Company begins licensing fragrances.

• 1994 Company begins practice of acquisitions.

• Next two decades see multiple acquisitions, bringing the total brand

portfolio to 28 cosmetic and beauty brands.

Corporate Snapshot The Estée Lauder Companies is a multi-national corporation with operations in over 16

different countries, and a market presence in every major market in North America,

South America, Asia, Europe and Australia.

• Corporate HQ located in Midtown Manhattan, New York, NY.

• The Market Cap is $23.34B USD. • Company directly employs approximately 42,500 globally.

• Nine executive officers all of who have base salaries of $1 million. Executive

officer total annual compensation ranges from $3 million to $31.5 million.

• Board of directors consists of 15 multi-ethnic male and female professionals.


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SELECTED FINANCIAL DATA 2014 2013 2012

Sales 10,968.8 10,181.7 9,713.6

Cost of goods sold 2,158.2 2,025.9 1,995.8

Gross profit 8,810.6 8,155.8 7,717.8

Operating income 1,827.6 1,526.0 1,311.7

Net income 1,209.1 1,019.8 856.9

Dividends 0.78 1.08 0.525

The Estée Lauder Companies 28 brands:

Estée Lauder Aramis Clinique Prescriptives Lab Series Origins Tommy

Hilfiger

MAC Kiton La Mer Bobbi Brown Donna Karen Aveda Jo Malone

Bumble and Bumble

Michael Kors Darphin Flirt! GoodSkin

Labs Tom Ford Coach

Ojon Smashbox Ermenegildo Zegna

Aerin Beauty Osiao Marni Tory Burch


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Marketing and Brand Business Units Marketing is the single greatest expense for the company, with more than $2.6

billion in costs dedicated to Marketing, Advertising and Promotion. Marketing

departments exist as part of the brand business units and report into the brand

presidents, which in turn report into the Group Presidents. Regional marketing groups

exist in the USA for each brand, and report into the brand business unit at corporate

HQ. Regional marketing groups also exist globally with each subsidiary, and report into

the brand business unit at corporate HQ. Each brand has an in house creative and

creative services team that reports into executive leadership of the brand business unit.

All brand business units consist of marketing, sales administration, creative,

finance, accounting and product development. Other brand functions including

packaging, legal, R&D, corporate communications, travel retail, quality, manufacturing

and distribution are managed by corporate divisions that do not report directly into the

brand business units. In this manner The Estée Lauder Companies corporate divisions

function as agencies servicing their clients.

Supply Chain The Estée Lauder Companies corporate structure places all supply chain

activities outside of the brand business units, and therefore all Supply Chain operations

are corporate functions. Multiple production facilities are positioned strategically around

the globe and allow for final product assembly to occur on the same continent as the

target market. Major production operations for the company are in Long Island, NY,

Pennsylvania, Canada, Belgium and Japan.

The largest cost for products is packaging, and the package development

division of the company works with a global network of suppliers, many of whom have

operations in the New York/New Jersey region. Global Package Development is a

corporate division dedicated to the cost effective and quality production of packaging for

all 28 brands. The global Supply Chain faces many challenges from a plethora of

regulations on product and packaging that vary significantly by country.


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Industry and Competitive Analysis The personal care industry is estimated to be over $600 billion globally and is

largely consolidated, however many small players exist and future market fragmentation

is a distinct possibility. Cosmetics/beauty is a sub-sector of the personal care industry,

and in the United States cosmetics/beauty is a $57 billion market. The Estée Lauder

Companies dominate the skincare market, which comprises 34% of global

cosmetics/beauty. The largest horizontally integrated global competitor in

cosmetics/beauty is Paris based L’Oreal with €23 billion annual revenue.

The largest competitors of The Estée Lauder Companies are:

• L’Oréal

• Proctor & Gamble

• Unilever

• LVMH

• Coty

• Chanel

• Revlon

• Avon

• Elizabeth Arden

• L Brands Inc.

• Johnson & Johnson


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Financial Analysis An initial review demonstrates that The Estée Lauder Companies are a

financially strong organization with clear growth over the last three years. Actual

revenue, gross margin, net income and diluted EPS increased year-over-year, while

COGS and operating expenses as a percentage of revenue decreased. Current ratio

and ROE are very strong in comparison to industry competitors.


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Despite strong performance and financials, The Estée Lauder Companies has an

unusually high SG&A expense of 63.6% of total revenue. Upon further examination, a

clear picture of the SG&A expense is not available, with $1.4 billion unaccounted for:

PESTLER Analysis The Estée Lauder Companies face many challenges from Environmental law as

it pertains to the waste stream, primarily a result of product packaging and shippers.

Exchange rates pose another challenge as foreign markets become increasing vital.

Currently 26% of all sales occur in international department stores. Income disparity

and rising costs of living compromise the middle class and upper middle class strata

that possess disposable income. Cultural views of cosmetic products and animal

testing continue to have an effect on the company along with the increasingly health

conscious and wellness focused consumers that reject wasteful or “inorganic” products.

As digital marketing continues to replace traditional channels, The Estée Lauder

Companies struggle to adapt. Technology also reshapes the supply chain and allows

for legitimate start-up cosmetic companies to be conceived much easier than in the

past. The legal landscape currently provides a de facto free-for-all in the United States,

however laws around trademark, intellectual property and mergers and acquisitions

provide routine challenges for the company. Extreme disparities between various global

regulations lead to highly complex supply chain strategies on the global scale.


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SWOT Analysis Strengths

The Estée Lauder Companies produce and sell some of the best skin care products

in the world under globally recognized brands such as Clinique and Origins. The

company boasts a global supply chain, global distribution, global market presence,

strong partnerships and customer base, highly valuable brand equity, access to

skilled labor, financial strength and is largely recession proof.

Weaknesses

The Estée Lauder Companies produce exclusively luxury cosmetics/beauty CPG’s.

Gross margin appears to not be holistic, and the hair care abilities of some brands

are not universal or available to all brands. The company has a terribly inflated

SG&A expense, overpaid executives and a culture of nepotism along with a political

corporate culture.

Opportunities

The Estée Lauder Companies can increase share value even further through the

reduction of the SG&A expense and a restructure of the method for accounting of

COGS. The opportunity exists for vertical integration through market penetration into

other luxury sectors. A further opportunity exists to capture health conscious and

wellness market, as well as penetration into the consumer level “masstige” markets

currently dominated by competitors Revlon, L’Oreal, Proctor & Gamble and Coty.

Threats

Industry fragmentation may occur as new entrants are able to take advantage of

new technology in production, marketing and distribution. As digital marketplaces and

ecommerce companies such as Amazon continue to grow, the threat of new entrants

further increases. Digital marketing also poses a threat as The Estée Lauder

Companies currently have a very small presence in that space, and therefore are not

prepared for a significant and sudden shift. The rise of the wellness trend and

companies such as Whole Foods also pose a serious threat. As stated above, rising

income inequality also diminishes the customer base.


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Strategic Recommendations Despite being in a very dominant position, The Estée Lauder Companies faces

a significant threat of becoming irrelevant. Should a significant portion of market share

shift away from the company, the astronomical SG&A expenses would destroy the

financial health of the organization. To avoid this, The Estée Lauder Companies must

become a larger part of their existing customers lifestyles and also enter the lives of

new customers. This should be achieved through a 3-step process:

1. Gross margin performance has a direct impact on operating profit, and therefore

a more accurate GM will help deliver increased profitability. COGS must

therefore include packaging risks, instrument manufacturing, infrastructure costs,

merchandise, a portion of payments to customers, license agreements and

royalties based on net sales. Furthermore, COGS must be audited to identify

structure gaps that may exist in the most recent acquisitions. 2. SG&A must be precise and provide a clear breakdown of all expenses. This

includes routine and methodical analysis to identify value opportunities in SG&A

such as cost reductions, leverage opportunities and synergies. 3. Company must become vertically integrated through the acquisition of new

business units in holistic beauty such as yoga/wellness and products that support

a lifestyle, rather than strictly cosmetic/beauty products. Other possible business

unit acquisitions include luxury furniture, boutique fashion/apparel, wine & spirits

and jewelry.

Potential For Acquisition

This analysis further identifies The Estée Lauder Companies as an excellent

candidate for a merger and acquisition by a larger competitor such as Proctor &

Gamble. As 63.6% of revenue is consumed by SG&A, a large organization with many

of those fixed infrastructure costs already in place would stand to profit immensely from

acquiring The Estée Lauder Companies. Therefore, should The Estée Lauder

Companies reject the notion of vertical integration, this report then recommends active

measures to sell the company.

Strategic Audit of The Estee Lauder Companies

Business

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