The beauty industry landscape evolved over the last few years as COVID-19, inflation, and recession fears weighed on the economy.

That ability to adapt to ever-changing consumer demand is now being buoyed by an appetite for luxury spending and an uptick in M&A deals.

"People are spending a lot more, and they're excited because they're also feeling seen again," Pauline Brown, former chairman of LVMH North America, told Yahoo Finance. "Whenever people feel visible, they invest in their appearance."

Prior to COVID-19, the global beauty industry was a $532 billion business, with the US being its largest market, according to the Brazilian industry organization ABIHPEC. Driven by skin care, the US prestige beauty industry amassed a total of $18.8 billion in sales throughout 2019.

Today, revenue for the beauty and personal care market amounts to $579 billion and is expected to grow by 3.53% annually, according to Statista estimates.

"There's a lot more experimentation," Brown added. "It used to be that you'd have a few products sold for newness. And I think especially with Gen Z, there's a lot more search for newness, and trial and experimentation. The trends cycled through much quicker than they used to."

'The big gorilla': L’Oréal

The leaders of the US beauty space include Unilever (UL), Estée Lauder (EL), Procter & Gamble (PG), Shiseido (SSDOY), LVMH (LVMUY), Beiersdorf (BDRFY), Chanel, Natura & Co, and Coty (COTY).

And then there is L’Oréal (LRLCY), which is the largest cosmetics and beauty company in the world.

Like many companies, the French conglomerate took a revenue hit in 2020 as COVID-19 and supply chain disruptions weighed on sales. Yet it remained the leader and gained market share as Unilever and Estée Lauder battled for the No. 2 spot. In 2021, L’Oréal's sales rebounded to 32.29 billion euros.

"In 2020, the COVID-19 pandemic ... triggered a crisis of supply due to the widespread closure of points of sale which led to an unprecedented, if temporary, decline of the beauty market," L’Oréal chairman Jean Paul Agon said following the company's Q4 2020 results. "L’Oréal has traversed this crisis in the best possible condition and has even grown stronger."

One reason for L’Oréal's dominance has been its edge in the hair care category: It's "the big gorilla in hair" compared to rivals, Brown told Yahoo Finance.

Estée Lauder, meanwhile, has lost market share in the US to L’Oréal. In the company’s recent earnings call, Estée Lauder president Fabrizio Freda said, “We generated $3 billion in cash from operations, a 16% decrease from the $3.6 billion in the prior-year period.”

Despite losses, Estée Lauder is looking to reaccelerate growth across the globe. The cosmetics giant is looking to innovate across its skin care category, enter new markets, and sell inventory to licensees.

However, smaller brands are now starting to enter the fray.

"The brands that are innovating and marketing effectively behind that innovation will succeed at it," Raymond James senior analyst Olivia Tong told Yahoo Finance. "And that's the [more] important point rather than the size of the company."

Beauty trends driving the industry

A few emerging trends in the beauty industry accelerated during the pandemic.

When the demand for cosmetics changed suddenly, brands were forced to adapt and many started offering new products.

Entrepreneurs Kylie Jenner, Kim Kardashian, and Khloe Kardashian took advantage of the shift in consumer demand and used their influence to manufacture and distribute hand sanitizers through Kylie Cosmetics and face masks through SKIMS and Good American brands. (Coty acquired a 51% stake in Kylie Cosmetics for $600 million in 2020.)

Then, throughout the pandemic, millions of consumers took to online shopping.

Consequently, e-commerce has become a major factor for the beauty industry, nearly quadrupling between 2015 and 2022, a McKinsey report found, with its share accounting for more than 20%.

According to projections, e-commerce will grow at 12% per year between 2022 and 2027, making it the fastest-growing sales channel for the beauty industry.

Another element that gained traction is social media, which played a major role in the pivot to e-commerce.

"I think social media has been a big game changer for beauty in general," Canaccord Genuity managing director Susan Anderson told Yahoo Finance Live in May. "I think it's really gotten the consumer engaged in the category."

Although beauty sales are dominated by a handful of players, including prestige and private label collections from retailers such as Sephora and Ulta (ULTA), smaller brands such as ColourPop and e.l.f. Beauty (ELF) have been able to remain competitive and amass their own loyal followings, in part due to product innovation and social media.

"What I would say about brands like e.l.f., [and] to a lesser extent ColourPop, is what they’ve really, really done well, is they've taken the innovation and the kind of fashion-forward appeal of Sephora brands and they made it very, very affordable," Brown said. "So they move quickly. They're basically fast fashion for beauty."

Others point out that e.l.f. has created value for consumers beyond its price point by offering quality and convenience.

"They are not relying just on being the most inexpensive," Tong explained. "They are spending money behind it. … They care about product quality, advertising, partnering with the retailer, all the things that a lot of companies do, and building an audience for that."

That innovation has been an engine for the industry by leading to incremental sales.

"When it comes to cosmetics, it's a lot harder to saturate," she said. "Because I may have 10 lipsticks, but if I love the new formulation or I love the new packaging, I can always find space for 11."

'Lipstick effect' props up beauty

While the US has so far been able to stave off a recession coming out of the pandemic, industry execs have been eyeing consumer spending closely for any signs of weakening.

"I think the word of the last 18 months has been resilient to describe the consumer," Avondale Asset Management founder Scott Krisiloff told Yahoo Finance in July. "But still the consumer is very resilient, continues to spend, continues to want to have the experiences that the consumer wants to have."

That has especially been the case in the beauty industry, which historically holds up better than other industries during economic downturns due to what experts call "the lipstick effect."

According to Sucharita Kodali, retail analyst at Forrester Research, the lipstick effect occurs when consumers continue to spend on small luxuries, even as they pull back on spending in other areas.

Lipstick represents "an affordable luxury for consumers that may not be experiencing gains in other places," Kodali said. "It's a way to indulge yourself in an affordable way, and it's something that we see happen in almost any type of economic hardship."

The relative strength of consumers has given companies the confidence to make major M&A deals even in an uncertain economic environment, a positive sign for the industry overall. "The growth in beauty has been built on effective or strategic acquisitions," Brown said.

In recent decades, M&A has become a core part of L’Oréal’s growth strategy.

In April, L’Oréal acquired Australian skin care brand Aesop in a deal that valued Aesop at $2.5 billion. It marked L’Oréal's largest acquisition to date aimed at helping the beauty giant expand its presence in the luxury market and in China, the second-largest beauty market behind the US.

In addition to M&A, more beauty brands have looked to expand through brand partnerships with major retailers.

In the second quarter, Target (TGT) executives highlighted double-digit growth in the beauty category, driven by in-store Ulta locations, known as shop-in-shops. Department stores such as Macy’s (M) continued to see outperformance from prestige beauty brands such as Estée Lauder. And Sephora locations in Kohl's (KSS) stores offered a bright spot for the retailer.

"Sephora at Kohl's continues to exceed our expectations, driving a total beauty sales increase of nearly 90% year over year," Kohl's CEO Thomas Kingsbury said in the company's second quarter earnings call. "We opened nearly 200 Sephora shops in the quarter, and momentum in our existing Sephora shops continues to accelerate with greater than 20% comparable beauty sales growth in the Sephora shops opened in 2021 and 2022."

While some retailers warned that consumers may be growing more cautious, shoppers are still invested in spending across beauty, hair, and skin care.

"There isn’t really a slowdown in sight," Brown said. "I don't see the appetite for beauty products changing."

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