Survey Report |Ecological Analysis of Cosmetics Stores/Distributors in Shandong During Fierce Competition

On September 23, 2020, with the theme of “Breakthrough • Transformation”, the "China Cosmetics Retail Channel Conference • Shandong Summit" organized by the CBO and co-organized by Shandong Cosmetics Industry Association kicked off in Jinan, Shandong. Zhang Huiyuan, Chief Reporter of the CBO, presented a report on "Ecological Analysis of Cosmetics Stores/Distributors in Shandong During Fierce Competition", sharing how the beauty industry will transform in such a conservative market in Shandong.

In August 2020, 5 reporters from the CBO visited 60 cosmetic stores, distributors, brands and other enterprises in Shandong over 31 days. We were surprised by the stability of Shandong’s market, seen both in the store owner’s way of thinking and the purchase choices of local consumers. New trends will will lag behind other provinces other provinces for several years.

The ossified cosmetics environment in Shandong Province seems to have built a besieged fortress, which can not only block external stimuli, such as the impact of the Covid-19 pandemic, but also impede the courage of Shandong’s beauty industry to expand outward and the determination to step out of comfort zones.

As the competition in the industry becomes fiercer day by day, the era where the owner of franchise stores must know how to find proper channels, arrange attractive product portfolio, and get to grips with what consumers want is coming.

01

Demographic dividend stays, conservativeness and stability prevail

Shandong Province, as the second most populous province in China, boasts of well-developed agriculture, industry and commerce and is blessed with a large population in towns and counties. At the same time, as the hometown of Confucius and Mencius, Shandong is home to people who are plain and open, gentle and conservative, and who attach great importance to people-to-people bonds. Due to its economical population structure and characteristics, Shandong’s market has displayed strong resistance to "black swan" incidents like the pandemic.

Among the 32 Shandong cosmetics franchise stores interviewed, 24% of them witnessed performance decline in the first half of the year. In July, 53% of the stores recovered to the level of the same period of previous year with some stores even increasing by 30%， and 12.5% of the stores performing better than previous year. However, another 12.5%of the stores showed worse performance. 94% of the stores believed that the number of consumers recovered to the level of the same period of last year.

Shandong’s store structure presents the following characteristics:

1. Stores well developed in towns and counties

Of the 32 sample stores, 22 chains developed from scratch in towns and counties. Among the 951 stores, 37% of them are in counties, and 24% are in towns (most of them are franchise stores).

From the perspective of store types, those in streets, schools, and shopping centers in ShanDong experienced slump in performance during the pandemic. On the contrary, those in communities, counties and towns showed great resilience. Therefore, Stores in ShanDong towns and counties have steered clear of the impact of the pandemic.

2. No continuous emergence of large cross-regional chains

Most stores are satisfied with their development within the town or county. Among the 32 stores, only 6 stores achieved cross-regional development. 2 stores which launched large scale expansion programs in 2017 experienced the worst decline in performance according to data.

3. Old stores dominate the market, while new comers are scarce

Among the 32 statistical samples, the average age is 19 years, which is much higher than the national average. For example, Rosenel and Chunfeng Yiman were the pioneers to open stores in 1994.

4. Large and comprehensive service and product categories, with cleaning and daily necessities having a bigger proportion

According to statistics, the service and product categories in the 32 samples are: skin care 46%, cosmetics 14%, daily necessities 32%, and facial mask 8%. In 2018, according to statistics from 626 chains across the country, skin care accounts for 45.8%, cosmetics 18.5%, and facial masks 12.6%. daily necessities accounts for only about 20%.

Make-up was not necessary and could be abandoned during the pandemic, but daily necessities were must-haves. This characteristic has greatly buffered the impact of the epidemic.

02

"False brawn" store structure in Shandong Province:

Lack of leading chains, plenty of not so strong chains in the middle, single stores struggling at the tail end

The franchise store channel market in Shandong is immense due to its great population advantage. However, the cosmetics market fails to fully tap the potential.

After comparison and analysis of the performance of these stores in 2019, we figured out the most glaring characteristic: lack of leading chains, plenty of not so strong chains in the middle, single stores struggling at the tail end.

Let’s look at the leading chains first.

In 2019, the total sales of the top ten cosmetics stores in Shandong Province reached 515 million yuan, which shrank by 110 million yuan compared with 625 million yuan in 2017.  It is also much lower than Sichuan’s 1.472 billion, Guangdong’s 1.313 billion, Zhejiang’s 1.145 billion, Jiangsu’s 885 million, Guangxi’s 786 million and Anhui’s 766 million.

In 2019, the entry threshold for the top 10 club in Shandong Province was close to 40 million, which was the same as in 2017. This is lower than Jiangsu (65 million), Zhejiang (60 million) and Henan (45 million).

No store in Shandong exceeded 100 million yuan in cosmetics according to the data of store sales in 2019. At the same time, there was no well-known and dominated store emerging in Shandong which covers the whole province or the whole country. In addition, there are only 4 stores with cosmetics sales of more than 50 million in 2019 (excluding dehydration data from independent beauty salon systems, stores of daily necessities, etc.).

Secondly, there are many chains in the middle that are not strong and in unrefined operation.

26 of the 32 samples reported the store sales of 20-50 million yuan.

Generally, these stores are famed chains in a county, whose sales totaled 670 million yuan. There are a total of 137 counties in ShanDong. If we include the dominant stores that were not interviewed in other counties, all these county level stores in the middle of the market together exceed leading chains.

Finally, it comes to stores in the tail end.

These stores are generally small in size. Due to the aging of the store structure and lack of systematic management, they performed dolefully in the face of risks. The reporter observed in Northwest Shandong that many street-side stores that are not chain stores remained closed.

03

Unrefined operation:

Low yield, area efficiency, and per customer transaction

According to statistics, the average yield of a store in Shandong Province in 2019 was 1.07 million yuan, the lowest across the country. Many of the store chains with total sales of 20-30 million yuan have 20-30 franchised stores.

During our survey for the CBO in Guangdong Province in June 2020, we learned that 80% of the local stores are low-efficiency, poorly-managed stores run by couples, with a monthly yield of only 30,000 to 50,000 yuan. The overall average annual yield of these stores is about 1.2 million.

It seems that the stores in Shandong ignore area efficiency and human efficiency due to Shandong’s huge land area and population. The area efficiency is about 20,000 yuan.

The per customer transaction in the cosmetics store is about 90 yuan which is a bit on the lower side because there an abundance of daily necessities. Repeat purchases and associated purchases are more important. Many store owners revealed that after the pandemic, consumers are generally more cautious in spending money. They believe that the per customer transaction continues to fall in 2020 in terms of product sales.

04

Huge advantages:

Low labor costs and rental costs, while net profit continuing to fall

In 2019, the average labor cost of the 32 sample stores accounts for 12% of the total, the rental cost 11%, the gross profit 35%, and the net profit 12%. In 2017 the average labor

 cost of Shandong’s franchise stores only accounts for 11% of the total, and the rental cost 10%, the gross profit around 40%, and the average net profit 17%.

The profit margin has continued to decline in the past three years.All store owners believed that profit margin will be further compressed in the second half of 2020. The reasons are as follow:

1. The endless online price decline has forced offline stores to cut prices, leading to the decrease in gross profit.

2. Labor and rental costs continue to rise;

3. Inventory loss;

4. Huge cost in back-office.

We have made a report on franchise stores in 24 provinces in 2018. The per capita consumption of CS channel cosmetics in each province can be obtained through dividing total sales of the top ten stores in the province by its population.

In 2018 the per capita consumption in Sichuan, Zhejiang, Inner Mongolia, Ningxia, and Qinghai topped the rank. As for Shandong, it was only 6.28 yuan, ranking only second to the last in the country.

05

Upending of the structure of brands/services and products

Reshaping of the relationship among brands, distributors and stores

The above mentioned figure proves that Shandong’s CS channel has huge potential yet to be tapped. Given its strong foundation but unrefined operation, I define its CS channel development status as "false brawn". Therefore, can those stores in Shandong achieve further development and turn "false brawn” to “strong”?

The stores in Shandong were not badly hit by the pandemic in the first half of this year according to data. However, Covid-19 has pushed the beauty market into uncertainty from prior stability. The industry insiders must move forward from their comfort zone to keep up with the new market, consumers and future.

From the perspective of external environment, the biggest impact of the epidemic on Shandong's CS channels is the upending of the structure of brands/services and products and the reshaping of the relationship among brands, distributors and stores. The specific changes are as follow:

1. The traditional dominant domestic products are upended, and the proportion of private brand products/directly supplied products increases

The online and offline prices of some brands were out of proportion and control during the pandemic. The disorder in prices in brand live streaming elicited the conflict with the offline stores. As a consequence in Shandong’s market, the original price order wasinterrupted and the profit margin of stores which sell brand products slumped.

30 of the 32 interviewed stores have marked products products down by 20% since the pandemic. Currently the discount is offered everyday, instead of several times of year as in the past. All of this has destroyed the price system. In this way, these brand products are basically sold at a 30-50% discount, narrowing the profit margin to only about 10%-20% for big name domestic products, which can not bear labor and rental costs.

Almost all store owners believed that one of the transformation ways is to increase the proportion of private brand products and directly supplied brand products among the 32 stores interviewed. The traditional domestic mainstream brand products will still be on the shelves in stores, but now will act as attraction rather than the main products and profit hunters.

Currently all of the 32 interviewed stores have introduced their own brand products and directly supplied brand products with regional protection. These products account for 10%-70% of the total products in different stores. The owners generally believed that 40%-50% is a favorable proportion to keep the balance between profit and consumer demand.

2. Receipts from distributors drop sharply and the "brand-distributor-store" relationship is being damaged

Unlike stores which can choose what brands to work with amid price turbulence, sales distributors/distributors who are bound with brands experience more hardship.

In Guangdong, where we carried out a survey in June, the receipts of interviewed distributors dropped from 50-70% in the Q1 of 2020 due to the inventory consumption. Very few sales distributors entered the new retail market earlier, through online business, or benefitted from the purchase mania of disinfection and cleaning products, and performed better in return of payment in the first quarter compared with the prior year.

In Shandong, large distributors, which have strong stronger risk resilience, witnessed a decline of 20%-40%.  Small sales distributors, which mainly work with just two or three brands, saw a decrease of 50%-70%. All distributors are pessimistic about this year’s performance.

Many business managers switched to another job after the epidemic. Many companies closed for holiday. This is the reason why there were no salesmen going into the market and managing the brands after the epidemic, according to many stores in ShanDong.

3. Cosmetics and imported products have great potential to be tapped in Shandong

Cosmetics are not the dominant products in Shandong’s market. The year of 2017 witnessed the popularity of cosmetics and imported products. Cosmetics accounted for 19% of the total in Shandong according to the report on franchise stores in 24 provinces in 2018.

Cosmetics accounted for an average of 14% of the total among the 32 stores interviewed this time. Their cosmetics sales fell by 48% in the first half of 2020. Many stores were not able to make money on cosmetics and stopped the delivery of account statements.

It is worth noting that many store owners believe that cosmetics still has a bright future. The store needs to meet the requirements of channels and provide cost-effective age appropriate cosmetics that are conducive to area efficiency and inventory. In the future, the counters dedicated to traditional cosmetics brands will be phased out while self-serve cosmetics counters will be the replacement, with cost effective small cosmetic products as the mainstream cosmetics. In addition, the most important thing is to keep the price stable.

As for imported products, 2 of the 32 stores which pay more attention to experience refuse imported products. The proportion of imported products is only less than 10% on average.

In ShanDong the reason for difficulties in selling imported products are as follow:

1. Popular well-known imported products can only serve as attractions because there is no price advantage compared with online channels;

2. It is difficult to attract consumers with imported products that are not famous;

3. Since Shandong is near the sea, there are hordes of personal shoppers to Japan and Korea in many places in Shandong in who sell imported products;

4. Insufficient profit margin, especially after the epidemic when all want to “survive”;

5. Conservative consumption habits of Shandong consumers.

06

Intensive and delicate operation is the key

Shandong stores need to improve their operations

Most beauty industry players in Shandong regard the epidemic as the unprecedented crisis for CS channels across the province. In the past, the majority of them were content with the environment where they could benefit from brands. They seldom tried to think about the future of market environment and consumers’ demand.

First, they must change their way of thinking and use an open mind to review the new market environment. They should give up on the illusion of the high margin from the past, the dependence on brands, and negative people relationships.

Second, they should fully release the potential of consumers, giving full play to their member value. The meticulous management of members will be the top priority of Shandong’s stores. Building a digital background system for all members is necessary. Holding regular gatherings and member activities will bring consumers the sense of value of the membership vs only point collection.

Third, it is necessary to enhance digital sensitivity and strengthen background management capabilities. Many large stores are run without a background system so far. It is like the engine on a speedboat. When business environment was great in the past, stores could sail along the water without an engine. Now the situation is difficult, they are sailing against the current. Without this engine, they are bound to fail.

Fourth, they must shift from a price war to a value war. Offline stores can not win a price war against online channels. The most important task for offline stores is to bring value to customers, let customers feel offline stores bring more to them compared to online stores. ShanDong stores are enhancing in store customer experiences and services.Many of them start to provide more services such as cosmetic medicine, tattooing, and skin improvement services.

Fifth, the industry should optimize store types, focusing on community, town and village to strengthen experience and services. This epidemic showed that the stores in community, town and village enjoy immense development potential in Shandong, a densely populated province. Many of them witnessed rapid growth in sales, even better than last year after the epidemic. The stores in community is blessed with high customer retention, which makes repurchase and high per customer transaction more frequent. These light stores, with only about 1000 SKUs, have low costs in inventory, human resources and rent. These type of stores are very suitable to sell products at the front and provide customer services at the back. At the same time, they can be the paragon for experience and service.

Conclusion:

As the competition in the industry becomes fiercer day by day, the era where the owner of franchise stores must know how to find proper channels, arrange attractive product portfolio, and get to grips with what consumers want is coming.

In the meantime, the ShanDong industry professionals must be aware that new changes and opportunities are around corner in the coming years. First of all, Shandong is home to raw material leading enterprises such as Freda, Bloomage Biotech and BMSG, thus gaining a monopolistic advantage in hyaluronic acid, sodium alginate and other raw materials. Second, new brands such as RELLET, Dr. Alva, BIOHYALUX, MEDREPAIR, Natural Melody and LITTLE DREAM GARDEN, are emerging on the domestic market with their own features in recent years. Third, R&D institutions such as Shandong University and Qilu University of Technology have started to be engaged in the cosmetic area R&D. Finally, the rapid rise of Linyi as the city of wholesale and e-commerce is also highly anticipated.

Shandong will be the next powerhouse of cosmetics with a complete industrial chain in the near future. By then, the channels of cosmetics franchise stores will benefit from the industrial cluster.

Du Fu, the poet sage, visited Shandong for the first time and was stunned by the spectacular scenes of Mount Tai more than a thousand years ago. He left the famous verse to describe the mountain, which cover the whole province with green trees. ``O Peak of peaks, how high it stands. One boundless green o’erspreads two states.” Now in 2020, the vitality of the cosmetic market in ShanDong will be as immense as Mount Tai.

We wish ShanDong industry professionals one day step out of their of comfortable and stable conservative operational approach, as Du Fu said in his poem “try to ascend the mountain’s crest; it dwarfs all peaks under our foot”.