A more open environment for direct selling is nourishing China's cosmetics market

----By Lindsay Frangs

The cosmetics industry in China stands alone in its ability to fulfil the needs of three key stakeholders: businesses, the customer and the government. An ever-expanding customer base is the vision of any company; a growing product range available at a respectable price is any customer's dream; and increasing foreign investment is the government's greatest desire.

The Chinese cosmetics industry is valued at around RMB85 billion annually, with industry experts predicting growth rates of between 25 and 50 percent in the next 10 years. With the growing spending power of Chinese consumers, new research and development centres opening up and relaxing legislation, it is a wonderful world of colour, especially for the cosmetic direct-selling market.

Recently, the Chinese government dropped prohibitive laws against direct sales companies. US-based Avon was the first company to receive a licence in February 2006. The Ministry of Commerce (MOFCOM) approved Avon's application for direct selling, allowing the company to hire independent promoters to sell products directly to consumers. Avon, Amway, Nu Skin and Mary Kay were the major contenders pushing the cause during the past few years and consequently the doors have finally been eased open.

New models

Following a 1998 ban on direct selling due to lack of control over pyramid schemes, companies have been operating under restrictions for the past seven years. Foreign-invested direct-sales companies were allowed to continue selling door-to-door through an independent sales force, however, they had to open shops and sign labour contracts with all their salespeople, whose income would be based solely on their own sales rather than those of the people they recruited.

The past 12 months have seen progressive steps by the Chinese government to get direct selling back into the retail game. In April 2005, a trial permit was issued to Avon allowing "official" operation in Tianjin, Beijing and Guangdong province. This was followed by the release of a new direct selling legislation effective as of December 1st of last year, with the final step being the awarding of the first direct selling licence in February 2006.

"The benefits of the granting of licences are threefold," explains Paul Haacke, Vice President of Marketing, Nu Skin China. "Firstly, the obvious advantage is that it will allow the selling of products away from fixed retail stores. But more importantly, the licence allows Chinese nationals to participate in part-time work. To date, nationals have only been allowed one job, and therefore it was a considerable risk to quit their job to follow a career path in cosmetics. Now they can test the water part-time." Haacke concludes, "The third benefit is that we now have the government stamp of approval on this business model."

The new law focuses on three requirements for direct-selling companies in China. First of all, foreign-funded direct-selling companies are required to invest a minimum of RMB80 million and exist as a business outside of China for at least three years. Domestic companies must have cumulative sales of RMB500 million for three years before they can apply to enter the direct-selling business. Secondly, every direct selling company must put down a deposit starting at RMB20 million. The deposit is set aside for handling consumers' complaints, fines and compensation. The size of the deposit prevents smaller, weaker companies from entering the market. Lastly, there is a limit on the levels of trainee numbers. Training courses held at a company's headquarters can include no more than 600 people. At provincial-level branch companies, the limit on trainees is 400; in-store training has a limit of 200; and in smaller places, 50 is the cap.

The industry's global players have few or no issues with these increased regulations, but they are concerned about a fourth condition relating to compensation. Angela Keung, president of the Hong Kong Direct Selling Association and general manager of Amway Hong Kong, says, "The direct-sales laws are designed to force direct selling into a single-level marketing-type (SLM) structure with commission-based compensation capped at 30 percent of personal sales. The Chinese regulations tie the percentage to an individual salesperson's sales. In nearly all traditional direct-sales organizations, salespersons are allowed to be compensated on sales-support services." This aside, the new regulations favour foreign companies due to the stringent capital and sales requirements that domestic companies may find hard to fulfil.

Foreign companies that have been struggling to restructure their direct selling business models in line with the Chinese legislation welcome a positive outlook. Almost all the big names saw a decline in sales over the past years, in contrast to the increases seen across the board for retail cosmetic companies. "We have made a lot of effort to restructure our business model, but it needs some slight changes," said Gan Chee Eng, vice-president of Amway China.

"Sales in this fiscal year (from September 2005 to August 2006), may be lower than in the previous year, but any business decline will be within our expectations," Gan said. Amway has not yet applied for a direct selling licence and under the ruling can operate as is until December 1st, 2006.

Pretty good

Direct selling does have distinct advantages, and China stands to benefit greatly from this retail method. Customers get personal, comprehensive information on the product and have it delivered to their door. It is a cost-effective, efficient marketing channel for small businesses and new products. Direct sales can offer new employment opportunities for individuals, particularly in poorer rural areas. The skills learned through direct selling are transferable and can be used by individuals to build new business ventures. While the industry respects and supports efforts to protect the public from fraud, this need not limit the growth of legitimate direct-selling firms.

Haacke of Nu Skin says, "When we started business in China in 2003 we focused on the provinces in eastern China due to the obvious reasons of higher income of the population in those areas and better infrastructure for advertising and retail store set up." He explains, "Now we have stores in every province in China and employ 3,600 active sales representatives and approximately 1,500 support staff."

Mary Kay employs 340,000 sales staff, Avon has 74 branches employing nearly 2,000 associates and Amway has 140 stores located in every province with a sales force of 120,000 sales representatives, as well as a team of 80,000 authorized agents. With this significant employment volume having been created in an industry under apparent restrictions, experts are positive about the future.

Global cosmetic manufacturers are also increasing their dedication to China through acquisitions of local brands, relocation of their regional headquarters to China, introduction of research centres and development of Chinese-centric cosmetic brands. Nu Skin has two of its three major research and development centres located in China with the third in Utah at the global headquarters. "Nu Skin has an analytical laboratory in Shanghai with 30 staff and a second lab in Beijing employing 20 staff," Haacke says. We also have the Nu Skin manufacturing plant in Shanghai. All products sold in China are manufactured in Shanghai and about 5 percent is for export."

This follows the trends of non-direct selling global cosmetics manufacturers. L'Or¨Ĥal opened a research facility in Pudong (Shanghai) in September 2005. Shiseido, Japan's biggest cosmetics maker, unveiled a new and expanded research facility in Beijing in November 2005, a week after the launch of Est¨Ĥe Lauder's new facility in Shanghai, all signs of an expanding makeup market. Put the two sectors' sales figures together and you could be looking at a beautiful new business opportunity.

Regulatory makeover

The Cosmetics Working Group outlined specific changes it wished to see in how its industry is overseen in the EU Chamber's 2005 Position Paper. The Working Group now has an opportunity to see its recommendations acted upon, as new regulations for the sector's main regulatory bodies, the Administration for Quality Supervision, Inspection and Quarantine (AQSIQ) and the Ministry of Health (MOH), are in the process of drafting new rules. Among the key recommendations from the Position Paper were: - Unify the double certification system currently in force for imported cosmetics and ensure equal treatment of imported and domestic non-functional cosmetics.

- Reconsider AQSIQ and MOH's requirements of certificates for Bovine Spongiform Encephalopathy (also known as BSE, or Mad Cow Disease) for any single import.

- Unify AQSIQ and MOH's conflicting compulsory standards for cosmetics.

- Standardise the Chinese translation of INCI names.

- Reduce consumption tax rates for make-up products to match the 8 percent rate for skin and hair care products.

- Revise the current State Administration for Industry and Commerce (SAIC) regulations on advertising that are not in conformity with the provisions of the 1995 Advertising Law and international practices.

Seeking harmony

Cosmetics may be a flourishing business in China, but foreign companies continue to face difficulties arising from an antiquated, inefficient regulatory regime that tends to cause more confusion about the rules than clarity. "The authorities still have an old approach to cosmetics," says Christian Chatelard, Chairman of the European Chamber's Cosmetics Working Group. "Transparency is not their main characteristic."

The problem is that two separate government bodies supervise the industry - the Administration of Quality Supervision, Inspection and Quarantine (AQSIQ) and the Ministry of Health (MOH) - and they frequently get their wires crossed. In some instances they impose overlapping, redundant rules, Chatelard says. For example, AQSIQ and MOH each require separate but practically identical import certificates for cosmetics, an extra step that can delay imported goods' arrival in the Chinese market by up to six months.

In other cases, Chatelard says, "What is regulated on one side is the opposite of what is regulated on the other." Indeed, both AQSIQ and MOH have their own conflicting sets of hygiene standards for cosmetics (AQSIQ's are nearly two decades old), making it possible for some products to receive MOH's approval but not AQSIQ's. Chatelard says this double regulating stems from the fact that Chinese authorities have been attempting to "make a melting pot of regulations", picking and choosing standards from the US, Europe and Japan. "Sometimes it's not very harmonious," he says.

Both MOH and AQSIQ are currently in the process of drafting new regulations, which Chatelard hopes the Chamber can help influence. His wish? "We would like to be under the supervision of only one organisation. That would be clearer for us." While he sees that outcome as unlikely, it is no reason to stop trying. "The authorities have been receptive, yes, but we still need to push further for more harmonised regulations."