Appearances can be deceiving
China’s booming cosmetic treatment industry belies rail- thin profit margins
China’s cosmetic treatment market has been booming in recent years, thanks to the country’s growing middle class and a generation of young people keen on looking as good as possible. But industry insiders pointed out that the industry’s net profit margins are slim because of rising marketing costs. Still, venture capital firms and large companies in other industries have been more than willing to pour money into the business.
On the streets of Sanlitun in Beijing’s Chaoyang district, it’s not uncommon for pedestrians to catch the odor of hyaluronic acid, a chemical used in skin- care treatments, wafting from dozens of cosmetic treatment clinics that have crowded the area.
The clinics are there because there are clients willing to pay – and keep paying – for their services.
“It’s like a drug addiction,” an executive from a chain of cosmetic treatment clinics told Caixin Weekly on Monday.
“If a woman walks in, there is an 80 percent chance she will try the service. And once women try it, most will become clients for the rest of their lives,” said the executive, who preferred not to be identified.
The cosmetic treatment industry capitalizes off the pursuit of beauty. In China, the industry has burgeoned over the last five years, averaging an annual growth rate of nearly 30 percent. By 2016, the domestic market was worth billions of yuan.
Even though the market has grown rapidly in China, it remains largely untapped, especially when compared with countries with mature cosmetic treatment markets such as South Korea, Japan and the US.
China’s huge population and rapidly growing middle class give the industry tremendous potential, according to the report. The market is also being propelled by the generation born in the 1990s, which has come under the influence of online celebrities augmented by plastic surgery, fashionable clothing and immaculate makeup.
These groups are not only open to cosmetic treatments, but are also willing to borrow money to pay for them, offering the possibility of explosive future growth for the industry, the report said.
Slim net profits
However, the industry remains a sector that sits on inflated gross profit without generating much net profit, industry insiders noted.
For example, the gross profit margin of the cosmetic treatment companies listed on China’s New Third Board averaged above 50 percent. But their net profits are lower than 15 percent, and are in some cases below 7 percent, Caixin reported.
The phenomenon is more evident in the unlisted small and medium- sized cosmetic treatment companies. “Only one- third of the companies are actually making a profit,” an unnamed investor told Caixin.
And the small net profits are being eroded by surging costs in advertising because the industry relies heavily on marketing to win clients, analysts said.
It generally costs about 6,000 yuan ($ 870) for cosmetic treatment institutions to acquire one client, according to a report published by Guosen Group. Expenses for marketing, sales and raw materials make up 50 percent, 20 percent and 10 percent respectively of an institution’s total costs.
The diversification of media platforms has also added to the industry’s financial burdens, the report said.
“We cannot ignore Baidu because it’s a search engine with a monopoly, but new media such as Weibo, WeChat and mobile applications have become important channels for attracting traffic,” Ma Dongsheng, vice general manager of medical beauty company Ever Care, told Caixin over the weekend.
Ma noted that the company also spends a lot on traditional media like TV.
The cosmetic treatment company Arsmo serves as a good example of how these expenses impact the bottom line. In 2015, the company spent 23.17 million yuan on promotions, representing 78 percent of its net profit, the Caixin report said. In 201 2016, promotional costs increased to 111.77 mi million yuan, while its net profit tumbled to o 23 23.67 million yuan.
Investors who are lured in by the gross profit bubble generally propose measures such as cutting expenses to improve the net profit margin, said Sun Changmin, former chief financial officer of cosmetic treatment company Munion.
“But those measures wouldn’t have much impact because it’s nearly impossible to slash promotional spending,” Sun said.
Sun explained that companies compete ferociously for experienced plastic surgeons.
“To retain talent, hospitals offer high salaries or ways to help surgeons avoid paying taxes,” Sun noted. “If investors sought to manage the organization in a regulated way, they would need to be willing to pay more of their unpaid taxes, which sometimes amount to tens of millions of yuan.”
Industry consolidation
Financial institutions remain willing to pump money into the cosmetic treatment industry, despite its slim net profit. Currently, no single player has come to dominate the market. Investors believe that through mergers and acquisitions ( M& As), the industry will consolidate around a few well- established chains with high standards and high- quality services, which will in turn attract more clients, Caixin reported. With this in mind, some leading venture capital and private equity firms such as Sequoia Capital, Matrix Partners China, Fosun Group and IDG Capital have jumped on the bandwagon, investing in cosmetic treatment mobile applications, beauty equipment suppliers and surgery clinics. Industry newcomers also include conglomerates whose main businesses have nothing to do with cosmetic treatment, according to media reports. For example, clothing maker Lancy marched into the market in April 2016 when it acquired a 30 percent stake of South Korean medical beauty group DMG in a deal valued at 25.2 million yuan. Lancy also plans to allocate 700 million yuan to establish three cosmetic treatment hospitals and 30 clinics in the next two years.
In July 2016, the real estate corporation Suning Universal Group announced plans to create China’s largest cosmetic treatment empire. The company has established a 5 billion yuan fund, while also spending 1.4 billion yuan on M& A deals for cosmetic treatment institutions.
Suning Universal is confident in its plans to expand into the cosmetic treatment industry.
“The cosmetic treatment industry remains in an early stage of development, and we believe our company’s accumulated management experience and talent training systems can be transferred [ to the industry],” a Suning Universal spokesperson was quoted as saying in the Caixin report.
But traditional players have a different view.
“Those newcomers have an edge in capital, but what matters more in the industry is an experienced team,” Ma said.
Hu Dazhi, vice- general manager at Mylike’s Internet Department, agreed.
“Managing hospitals is different than managing restaurants and hotels, where investors can quickly copy their experiences,” Hu said.
“If investors sought to manage the organization in a regulated way, they would need to be willing to pay more of their unpaid taxes, which sometimes amount to tens of millions of yuan.” Sun Changmin, former chief financial officer of Munion