Last week, I walked into Selfridges, the large department store on Oxford St in London. While I was after the Food Hall on the ground floor (conveniently, it has a kosher food stand) and the Starbucks on the 4th (whose WiFi did not work), in order to get through to them I needed to walk the primary sales area by the main entrance: cosmetics.
Stores are very very careful in allocating floor space. They consider both how much floor space to assign to each item, and where to place those items. Desirous products are always in front, to pull shoppers in; discounted items are advertised but usually towards the back, requiring customers to walk past other, more profitable, items to get to them, and thus encouraging their purchase.
So when Selfridges devotes almost 50% of its most expensive floor’s space, at a very expensive real estate location, in the most valuable placement on that floor, to cosmetics, they must be very profitable for them. They must sell a lot (revenue), and they must make a lot of profit per sale.
Although I do not know much about cosmetics other than a short-lived business relationship with an investor in one company, I can see that Amazon sells a Revlon lipstick for $6.99 for… 0.15 oz. That comes out to about $47 per ounce. By comparison, as of this writing, the precious metal silver is selling for $19.52 per ounce. Lipstick is nearly 2.5 times as valuable as silver!
Once you get under the covers and realize that most cosmetics are created using garden-variety printing materials, not that different than what goes into your local inkjet printer, you see how high the gross margins are… and why they command such prominent placement in stores. Indeed, Revlon’s latest 10K reports a gross profit of ~64%! Most companies would do almost anything for those kinds of margins.
Why does a cosmetics company manage to hold onto such margins in a competitive environment? What is it that allows them to sell lipstick for an insane $47 per ounce?
There are several key factors, including limited competition, and the creation of demand via marketing. But one element is that it is not easy to make make-up. To do so, you actually need two key ingredients:
- Raw materials
- Mixing ability
Both used to be difficult to acquire. Raw materials were specialized and not mass produced, and mixing ability required highly skilled scientists and machines or, at a later stage, precise computers and mixers.
Over time, of course, as office and home printing became commonplace and the production of printing materials became large-scale and commoditized, cosmetics manufacturers wisely latched onto the market, driving their variable costs down and their gross margins up. But they could always take comfort in the fact that only they had the know-how and capital to properly measure and mix the raw ingredients.
Inevitably, that could not last. Your home laptop has more computing power (and memory) than, likely, the space shuttle; precise mixing is done by laser jet and inkjet printers billions of times every single day across the globe.
Enter Grace Choi and her startup, Mink. Mink uses your home computer’s power to determine exactly which ingredients to mix at which ratios and in which order, along with a specialized printer using commodity inkjet ink, to custom-print… make-up. Since almost everyone in developed countries has some form of computer, and most have printers, it is not a far leap to move to a home custom make-up printer.
To her credit, Choi not only found an industry with margins begging to be challenged, but also one whose business model is unable to respond to these disruptions. Everything about the cosmetics industry is unsuited to home or near-home printed make-up. They have teams of scientists; a global supply chain; direct relationships with large retailers; CFOs with margin requirements; significant capital invested in plants and machines. In short, they will be extremely pressed to respond. Their very structure and business model make it very difficult to do so.
This is a much better usage of Clayton Christensen’s (much-abused) term, “disruption”. You are not just offering better, cheaper and faster. You are offering a competitor that the incumbents’ business model fundamentally hamstrings them from responding.
Will Mink succeed? That depends on several factors. No one will argue about getting lower prices and greater convenience. In exchange for these prices, however, women must give up on 2 things:
- Emotion: There is an emotional process involved in going to the store, being treated by “experts”, seeing other women look beautiful selling you beauty (not for naught are the cosmetics sellers normally young and pretty). I cannot relate to the experience, other than perhaps walking through a Ferrari dealership, but I understand that it is there.
- Capital: Consumers won’t call it capital expenditure, but that is what it is: lay out $200 to buy a printer, so you can spend a fraction of the cost on an ongoing basis.
The key to both of these is the level of savings and convenience. If a woman can print lipstick for $10 per ounce instead of $46 per ounce, very few will pay 4x for the satisfaction of a visit; if it is $33 per ounce, far fewer will make the switch and investment. Similarly, if a woman prints makeup once per week, they are far more likely to buy such a printer, than if she does so once every three to six months.
Some other challenges exist:
- Raw material costs: Mink will need to get the raw material costs down. While Revlon may have gross margins of 64%, meaning that it could not be paying more than $17 per ounce (36% variable costs) for the raw materials of that lipstick – and probably much less, once packaging and sales costs are taken into account, as well as the retailer’s margins – consumer pricing for inkjet ink is actually more expensive than cosmetics! An HP 933XL yellow ink cartridge cost $18 on Amazon. HP does not publish its ink cartridge volumes (nor does anyone else; topic for another day), but it has been estimated at 8.5ml or 0.29 oz, which comes out to $62 per ounce! Granted, a large amount of that is HP’s markup, and refills can cost half of that, or $31 per ounce, but that is still insufficiently cheaper to make it worth buying a home make-up printer.
- Supply lockup: It is unclear if the cosmetics companies have any kind of lockup on raw materials manufacturers. Since a significant reduction in costs of compatible raw materials would also lead to reduced margins, or at least pressure on margins, of OEM ink manufacturers, I could easily see HP/Epson/Brother joining forces with Revlon/L’Oreal/Lancome to monopolize raw material manufacturing. Mink needs to quietly lock in its supply chain and create alternative sources. They may not realize that they are overturning not just the cosmetics manufacturers but possibly the ink manufacturers as well.
- Regulatory approval: As of this writing, the FDA does not regulate or approve cosmetics in the US, nor does the MHRA in the UK or parallel agencies in most countries. However, the incumbents do have good relationships with the agencies as well as large lobbying staffs. Inevitably, someone somewhere will decide to use the power of regulation to try and shut down competitors. Airbnb has been fighting this battle against the “hospitality” industry; Uber against the Taxi Commissions; 23andMe against medical testing companies; etc.
What alternative business model would I consider? Overall, I commend Choi and think she is going down the right path. She has an industry with absurd margins and a rigid business model begging to be overthrown. I am not 100% convinced that every household will buy such a printer, even though nearly every household has a woman who buys makeup. That may change if the capital cost drops significantly; there is a big difference between spending $200 on a printer and $100.
I think the “neighbourhood printer” business may be the best alternative. Teenagers or college students, or stay-at-home or part-time mothers, would have a printer serving their local 10 to 20 block radius. They would happily invest in a $200 printer (or even twice that, if it worked more quickly), and then sell custom cosmetics on a one-hour order basis. The effective cost of makeup could easily increase from $10 to $15 per ounce (using my “made up” figures from earlier), leaving sufficient profit for the local neighbourhood “makeup woman” to cover the printer capital cost and make a nice small home business.
To do so, Mink would need to modify its marketing, sales model, support model, and just about everything it does.
Should it do it? That is a key strategic decision that only Choi (and her Board) can make.
Either way, I am impressed by the entrepreneurship and wish Choi luck.