The one retailer that Amazon can’t seem to destroy is in cosmetics

Lots of pretty colors.
Lots of pretty colors.
Image: Reuters/Jumana El Heloueh
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Amazon is becoming one of the most important channels in beauty.

In Beauty and Personal Care, each of the top 10 categories on Amazon’s US store are growing by at least 24% year over year, with some categories nearly doubling in size since the first quarter of 2017. Luxury products are particularly strong, growing at 57% in the first quarter of this year versus an increase of 30% for the total beauty segment, according to data source One Click Retail.

One of the biggest trends in beauty is for consumers to buy high-end and prestige products. This trend has driven so much traffic that Amazon has introduced a unique badge for items classed as “professional beauty,” where Amazon has “curated a selection of high-quality products that can be found in professional settings such as salons, spas, and dermatology offices.”

Not stopping there, Amazon has recently announced that it is setting up an “Indie Beauty Shop” within its marketplace, where brands sell directly to consumers. Brands that will qualify to be in the Indie store cannot not be available at major retailers such as Target, Walmart or Ulta Beauty.

Amazon is also winning in product search, with 69% of consumers saying they search for, and purchase beauty and personal products through Amazon, according to a 2016 survey undertaken by A.T. Kearney.

Should this worry investors in the US’s largest beauty retailer, Ulta Beauty? Not so much, according to a recent UBS report on the company.

The (well-groomed) barbarians at the gate

Ulta Beauty is described as “one of the best growth stories in retail” by UBS, which sets the market for beauty products and services at $139 billion in 2017 and growing. It is growing even as Amazon aggressively expands, powered by a combination of new store openings, exclusive product selection, and a successful loyalty program that supports e-commerce and prestige purchasing. The company also just cracked the Fortune 500 list, securing its place amongst the country’s most successful companies. Ulta’s stock price is up 10% since the beginning of the year.

According to UBS data, Ulta has grown from 1% of the beauty industry to 4.2% since 2008. Over the last two years, Ulta has picked up 30% of the industry dollar growth and is forecasted to reach a market share of 6.6% in 2022, through a combination of store and e-commerce growth. Cosmetics make up 51% of Ulta’s sales, which is the category where Amazon sees its lowest relative growth.

Premium beauty products have been driving the overall industry, growing at more than double the rate of mass-market products. Customers become more valuable over time as they migrate to prestige products; 77% of beauty enthusiasts purchase both mass and prestige products with the portion of prestige spend rising to 60% over five years. And most importantly, Ulta’s loyalty program keeps these customers returning, either to the physical store or online, generating 90% of sales through the loyalty program. More than 75% of consumers that made a purchase at Ulta in the first quarter of 2017 made another purchase at the retailer in the 12 months following, according to UBS research.

Brick-and-mortar beauty—especially cosmetics—thrives because buying makeup is a personal and unique experience. It’s only in a store that a consumer can perfectly match a shade or find details of how to use new products. Many consumers also want to use a product immediately, something that can only be done in a physical store.

Ulta, so far, has managed to maintain exclusivity on product selection while being able to compete on price. Ulta’s 25 top-selling makeup items are not available from Amazon directly, according to the UBS research. What products are available through Amazon third-party sellers are, on average, 35-40% higher in price.

The bet that Ulta investors are making is that consumers will keep purchasing beauty products based on the experience that specialist beauty stores provide; real-world tactile choices, face-to-face human curation and personal recommendations, rather than Amazon being successful at beautifying its online store and making consumers feel just as special.

An announcement from Amazon that the company is planning to expand its operations in a new market has usually been enough to spook investors. When Amazon announced plans launch an independent company that will offer healthcare services to the companies’ employees, the market value of 10 listed health insurance and pharmacy stocks dropped by a combined $30 billion in the first two hours of trading.

When Amazon announced plans to roll out lower prices at Whole Foods locations, it sent the supermarket chains into a tailspin, losing close to $12 billion in market capitalization in a single day. So it can be surprising to hear that certain retail is thriving, even as it faces competition from Amazon.

So if Amazon and Ulta—as well as other specialty beauty stores such as Sephora and Sally Beauty—are winning, who is losing?

The answer is department stores and mass-market sellers, which include grocery, warehouse and drug stores like Walgreens. According to UBS, channel sales of beauty products through department stores have dropped from 11% of the channel in 2003 to 9% in 2017, while mass, grocery, warehouse and drug have declined from 58-49% over the same time period.