The Estée Lauder Companies Inc. (ELC) posted net sales of $3.56 billion to close off the third quarter of 2020. Despite COVID-19 related retail store closures and a decrease in makeup sales as most people opted to stay at home, this is a mere 9% decline from the previous year’s earnings.
In this article, we’ll dissect how ELC’s prophetic acquisition and incubation of several modern, direct-to-consumer brands hedged them against the accelerating decline of malls and department stores. First, we’ll define the difference between classic and modern brands and then, discuss why classic retailers who have hundreds of millions—or billions of dollars in sales—should pay attention to up-and-coming brands.
Defining classic & modern brands
As a seller enablement platform, we classify retailers based on the ecommerce system they have in place. Most of a classic retailer’s seller-facing technology are simply portals to their backend. Because of this, the seller experience tends to be manual and cumbersome to use.
Under our paradigm, classic brands or retailers’ systems tend to work with electronic data interchange (EDI). They usually have an enterprise resource planning (ERP) or product information management (PIM) system that manages product inventory, purchase orders, and invoicing. Most classic retailers have achieved nationwide or international recognition, such as Walmart, Target, and Best Buy.
Modern brands, on the other hand, prefer to trade using API-based integrations. This is due to the fact that most modern retailers tend to be digitally-native, vertical brands (DNVB) that are built on cloud-based ecommerce platforms such as Shopify Plus and Salesforce Commerce Cloud. They’re comfortable selling direct to consumer (DTC), but struggle to scale and make the leap to wholesale.
By virtue of their digital business model, modern brands like Bonobos, Away, and Tortuga serve a global but niche market.
In ELC’s case, they call classic retailers—like Estée Lauder and Clinique—“heritage brands”. Their “makeup artist brands” like Smashbox and Glamglow tend to fall under the modern brands category.
What is brand incubation & why retailers should do it
As ecommerce investor, analyst, and operator Web Smith says, “The viable companies of tomorrow are the niche brands of today.”
Classic retailers rely on foot traffic—customers who browse in store to discover new products—for sales. Modern sellers, on the other hand, are often more salient at offering relevant products for younger consumer segments because they, like their customers, grew up on the internet and are more adept at social media marketing.
This key difference—a brand’s capacity for ecommerce—opens up the chasm that classic retailers must cross if they want to stay relevant and competitive in the next 3-5 years. And brand incubation is the best way to do that.
Racked defines brand incubators as “support to help a brand get off the ground, hav[ing] more of a marathon mentality, often starting earlier in the development stage.” Incubator partnerships aim to help a modern brand move from a DTC dropship model to a full-fledged, wholesale model. Regardless of which one a retailer chooses to do, sourcing and working with up-and-coming brands is a must if they want to stay relevant and ahead of the curve.
In an interview with Racked, Zoe Leavitt, retail analyst at CB Insights, said, “Historically, big companies were often content to sit back and wait for new brands to reach a certain level of growth before they'd jump in to acquire them. Today, as the startup space gets more active, corporates are facing more and more competition, and startups with long growth records are earning higher and higher price tags. From the corporation's perspective, it might be easier to build relationships more cheaply with a range of early-stage startups through an incubator, and then know that relationship will be maintained as the startups grow.”
Companies competing in the beauty industry have already made headway, demonstrated by brand incubation programs like P&G’s Connect + Develop Program and L’Oréal’s Founders Factory. At other times, “brand incubation” is an early acquisition, evidenced by Unilever’s acquisition of DTC razor company Dollar Shave Club and ELC’s 2017 acquisitions of BECCA Cosmetics and Too Faced.
But why are multinational retailers even bothering to do this?
Undiluted customer access
Merchandising teams in most big retailers are focused on driving margin and onboarding brands relevant to target demographics. Specifically, retailers partner with modern brands in a way that gives them access to new demographics and psychographics, without diluting the core brand.
ELC doesn’t have to water down Estée Lauder’s prestigious brand and price point in order to cater to cash-strapped millennials. To reach the mass market, ELC chose to acquire brands that solved problems experienced by people in front of cameras, whether they were models or avid self-takers. Because who isn’t in front of a camera these days?
For example, in 2010, ELC acquired Smashbox Cosmetics, started by an LA-based photo studio. In an interview with Racked, Smashbox cofounder Dean Factors shared that they created products that ‘photographed well and that models weren't eager to wipe off at the end of a shoot — that they in fact wanted to wear outside the studio.’ This naturally attracted an influential clientele who spent their daily life in the spotlight, putting in motion a natural word-of-mouth and influencer-driven marketing flywheel for Smashbox.
Customer-centric product development
Modern brands tend to be on the ground and close to the customer. They are particularly good at creating products consumers actually want. Thanks to the internet, these emerging companies can access, educate, and acquire customers from any niche or sub-niche within a vertical, even one dominated by bigger players.
Specifically, newer brands are far more likely to take a customer-resonant stance, whether it be on environmental or social justice issues. BECCA Cosmetics, for example, values inclusivity and creates “effortlessly glowing complexion products for every skin type and color.” Thus, onboarding the right DTC brands also allows big retailers to index against abrupt shifts in customer demand.
2PM posits that, “Niche brands are lesser-known but well-loved because they acknowledge a small group and solve a niche problem. [They] grow not by volume but by depth.”
ELC’s 2015 acquisition of Glamglow is a perfect example of this. The brand created skincare products to help actors and models look photoshoot-ready instantly. The ELC acquisition freed Glamglow’s founder to work exclusively on product development, leading to the creation of a ground-breaking matte lip plumper, thus kickstarting a new category of products on Sephora.
Accelerate digital transformation through deep partnerships
In its State of Fashion 2021 industry report, McKinsey found that leaning into digital transformation could spell the difference between industry irrelevance or dominance. The report stated that “fashion players must optimise the online experience and channel mix while finding persuasive ways to integrate the human touch.” It went on to comment on the importance of retailer’s relationships with its partners saying, “To mitigate future ruptures, fashion players should move away from transactional relationships in favour of deeper partnerships that bring greater agility and accountability.”
ELC not only acquired profitable companies. It also picked companies that possessed transformational, transferable knowledge that could benefit all its brands.
For example, ELC acquired Too Faced—a makeup brand with a fun, cheeky, feminine feel—in 2016. In the process, ELC gained possession of Too Face’s Instagram account that had 7.3 million followers, driven by a proven influencer marketing program. As of this writing, Too Faced’s account has almost doubled to 13.2 million followers and works with a global network of influencers and creators, most of whom command audiences of over 200,000 Instagram followers each.
Similarly, when ELS acquired Smashbox in 2010, it was preparing to move away from department stores and enter B2C retail marketplaces like Sephora (also known as “speciality-multi stores” in the beauty industry).
At the time of the acquisition, Smashbox was already a Sephora favourite. The acquisition helped transfer successful strategies on how other ELC brands could partner with a specialty-multi like Sephora, as well. In an interview with Racked Beth Dinardo, global brand president of Smashbox and Glamglow, said, "Each brand is incredibly different and true to its DNA, but at the same time we are one group of people trying to help each other succeed."
Retailers should actively incubate brands before it's too late
Most sourcing teams are run by experienced executives who have been looking at the same industry for 20+ years. Historically, to find brands, most teams look to other marketplaces. However, finding truly unique, emerging brands is challenging because there is no index or aggregator for DTC brands, especially brands who are quietly doing phenomenal numbers for their niche. To find brands creating bankable products, merchandisers constantly have to have their ear to the ground—and oftentimes this means saying yes to a new, unproven brand years before they’ve achieved their billion-dollar potential.
In 2007, ELC acquired Rodin Olio Lusso—a label founded by Linda Rodin, a now 70-year-old model, entrepreneur and fashion icon who inspires women of all ages. In an interview, ELC executive group president John Demsey asked himself, “Why would an $11-billion company bother with a million-dollar business like that?” And continues, “Because we have to. If you only focus on running the legacy business, you might miss tomorrow's big story.”
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