Consumer Staples, Consumer Discretionary Author: Manqing Fang, Linyan Feng Editor: Luke Sheehan Jul 30, 2020 12:50 PM (GMT+8)

Since Perfect Diary was established, Jinfeng Huang has established his ambition within the company – in essence, building the Chinese L 'Oréal.

Eye shadow. Image Credit: Joanna Kosinska/Unsplash

Perfect Diary was founded in 2016 by Jinfeng Huang, the former COO of UNIFON (300740:SZ). By launching middle-level KOLs on Xiaohongshu and building up a targeted traffic pool on the Wechat operation platform, Perfect Diary has managed to create bestsellers and substantial sales growth – and has become the rising superstar among cosmetics startups. On 2019 Tmall 618 Night, Perfect Diary became the best seller in the beauty categories –  its sales growth reached as high as 1193%.

Chinese Beauty Market Overview

Since 2018, there has been a trend to opt for Chinese domestic beauty products in China. All of a sudden, multiple brands launched and spread quickly, including the most famous ones like Perfect Diary, Florasis, and Judy Doll.

According to the 2019 Chinese Domestic Cosmetics Insight Report, over 42% of consumers are more willing to choose Chinese domestic cosmetics products. More than 60% were eager to purchase the products again after trying Chinese cosmetics brands for the first time. However, even as the Chinese beauty market grows at a rapid rate, the penetration rate is still low – the primary customers are from first-and-second-tier cities. The average consumption of cosmetics only reaches ⅙ of that of the US, Japan, and Korea.

Besides, Chinese beauty brands still take on a low-price strategy and find it hard to establish a presence in the high-end market.

Perfect Diary's Potential IPO in Hong Kong

According to insiders, Yatsen, PD's parent company, has already chosen Goldman Sachs and Morgan Stanley to prepare for its first IPO, planning to go public at the end of this year or early 2021. It has considered Hong Kong as a potential listing place but has not yet made the decision. Perfect Diary has not confirmed the story and is not willing to reveal related information regarding the rumor.

So far this year, Perfect Diary has been taking frequent actions in the capital market. In April this year, it finished a new USD 100 million financing. This round was led by Tiger Global Management, followed by Hopu Fund and Boyu Capital.

The rise of the ‘Internet L’Oréal' in China

Since Perfect Diary was established, Jinfeng Huang has established his ambition within the company ­– in essence, building the Chinese L 'Oréal. Perfect Diary is, for sure, a superstar in the current Chinese beauty market – with more than 20 million followers online, it has succeeded in becoming the cosmetics brand with the most followers. Behind the brilliance, the success of Perfect Diary is suggestive of a canny ability to seize fast-moving opportunities.

Responsive and Creative Digital Marketing – It is not dramatic to say that marketing created today's Perfect Diary. However, we want to discuss two unique marketing strategies brought out by Perfect Diary. Here are two approaches that truly changed its game:

1) Development of private traffic. Private traffic means developing a sticky customer base through a public platform. Private traffic is unique to Chinese brands. Chinese customers are less likely to visit brands' official sites or use emails besides their work, which is dramatically different from US customers who routinely visit favorite brands to check for discounts or check for promotions in their email boxes.

Perfect Diary has a beauty IP called Xiaowanzi that adds customers who scan the QR code while purchasing their products. In this way, the IP will build up WeChat Groups and recommend products specific to customers’ needs. By using this active account and building up WeChat communities, Perfect Diary can make sure customers are more likely to repurchase products or even try new products under Perfect Diary.

2) Aiming for lower-to-mid level KOLs for promotions. From the topmost level of popularity to the lowest, their endorsements are proportional to 1:1:3:46:100:150. Such strategies help Perfect Diary's advertisements to be more convincing and more natural to build up a community around a young population. Customers spread their opinions about Perfect Diary's products in their shared online community with detailed notes and high speed of response, which is another innovative marketing approach from Perfect Diary.

However, it is still important to acknowledge that advertising strategies are easy to copy. Some large international brands have started using similar procedures and launched make-up notes on Xiaohongshu as PD does. Besides, the timing of finding the next trending platform is crucial as well. Perfect Diary missed the early stage of using short videos like TikTok for advertisement.

Segmenting brands for different ages is also a key strategy – L'Oréal (LRLCY: OTCMKTS) is known for its broad spectrum of brands under its big umbrella, either through acquisition or internal incubation. Perfect Diary follows the same track. It acquired LittleOndine, which targets students and newcomers to the workplace, and launched a new brand, Abb's Choice, which focuses more on skincare and people aged up to 28. With such integrations in the area, Perfect Diary will provide more SKUs in its offline stores, offer better experiences to customers, and extend consumers' brand life cycles.

Expanding to offline stores from online success is another coda worth adding – Perfect Diary's success often reminds investors of another similar case, Three Squirrels, which also got famous with its online sales but moved offline by opening up stores at a fast rate. The logic is that, although online shelves can display enough products, users are more likely to focus only on the best sellers. The profits of bestsellers are usually lower. The marginal cost of online traffic for advertisers like PD is rising due to: 1. oligopolies such as BAT (Baidu, Alibaba and Tencent) and Sina are dominant in the market leaving almost no space for competition. 2. saturated online penetration means higher cost acquisition cost for ad publishers.  Opening up offline stores means breaking into a place with higher competition, as famous international giant brands like YSL and Dior are everywhere in China nowadays. The substantial increase in cost is another concern for Perfect Diary's offline expansion.

Will it be the next L' Oréal?

Even though it has a high growth rate, Perfect Diary's story is still far away from being the next L'Oréal. The first reason is its pricing strategy. Cosmetics products are known for their high margin, justifying their massive investment in branding. Although low prices have helped PD to break into the Chinese cosmetics market, they have also made its margin suffer. The average margin of large international brands reaches 70%, while Perfect Diary's marketing fees already take over 40%~50% of its revenue, according to insiders.

We have seen Perfect Diary's effort in terms of better brand logo design and more expensive decoration fees invested in its offline stores, but whether that will boost Perfect Diary's margin is still questionable. Furthermore, in big sales events like Tmall 618 Sales, the price of Perfect Diary's products is extremely low, which makes consumers doubt product quality and real production cost.

Currently, Perfect Diary's number of fans across the network has reached 20 million people. Its online marketing has almost reached the ceiling. Going abroad to a blue ocean market such as Southeast Asia is a choice to grab a bigger local share – but it still needs long-term layouts and field trips, which are challenging. With increasing competition within online marketing channels, the price for the services is very likely to increase. With massive investment in marketing but little in R&D, the operation is not strong or resilient enough to stand out from its peers. According to customers' surveys in 2019, Perfect Diary is in the sixth place of best-known Chinese cosmetics brands, but its reputation does not bring it into the top 20.

Moreover, L'Oréal has acquired ModiFace, a tech company aiming to provide a simple app for skin diagnosis and skincare planning harnessing AI. It allows L’Oréal to integrate technology and green, renewable elements in their services and products. In this aspect, PD is still far from L’Oréal.

Besides aggressively expanding and trying to catch up with L’Oréal, focusing on the product's quality, improving reputation among users and increasing user loyalty all seem to be more critical. It should be careful not to follow UNIFON's path, which would see inventory turnover days increase to more than two times that of international brands. Instead of only growing production, using the money strategically and investing in vertices like beauty-tech or making efficient acquisitions like what L’Oréal does may be more sustainable and prevent a potential waste of capital.