The contract business for cosmetics is rapidly developing in Russia. This line of work is giving domestic cosmetics companies a chance to take over new market niches and compete with imports.

Lilia Moskalenko

Today, nearly a third of Russian cosmetics companies are developing recipes and cosmetic bases for contract clients. Contract production is the fastest growing segment on the Russian perfume and cosmetics market with growth rates of almost 80-90% a year. Analysts believe that Russia could soon become Europe’s biggest cosmetics producer by contract.

Division of labor

Where did this huge demand for Russian contract production come from? To answer this question, it is important to understand what role contract production plays in the world cosmetics industry today. In the 1980s, Western cosmetics markets became fully saturated. To survive the intense competition, cosmetics manufacturers were forced to put out new products as frequently as possible, as much as two or three dozen new products a month. This required a huge R&D base. It soon became clear that it was not possible to manage production facilities, labs, and marketing divisions all at the same time, as in the end companies were not able to respond rapidly to changes on the fickle cosmetics market. Contractors were hired to generate new ideas and technologies and mass produce them. Today, hundreds of contractors operate around the world, and two or three dozen work for premium brands. Some contractors merely carry out the client’s precise instructions at their plants, while others offer a whole range of ready-made solutions, such as formula development, base creation, and product packaging and certification.

Two or three years ago, contract production began to develop in Russia. The demand for contractors came predominantly from foreign cosmetics companies and today their share of orders runs as high as 60%. These are transnational corporations like Schwarzkopf, Unilever, Procter & Gamble, and other, lesser-known companies from Poland, Bulgaria, Spain, and other countries. Outsourcing has become a requisite part of foreign companies’ business strategies, as they traditionally operate in the budget and mid-priced segments of the cosmetics market. Outsourcing also allows them to cut costs by 25-30%. “Foreign companies, especially traditional ones, need to beat out Russian manufacturers in terms of price, as their products fall into the same price range,” says Yelena Sagal, Vice-President at Arnest, “and every season they put out the lowest priced product possible.”

Recently, Russian companies concerned with keeping costs low have also begun to use contractors. Among them are market leaders such as Kalina Concern, Nevskaya Kosmetika, and wholesalers like Mak Dak and Cosmetic Market. However, the majority of Russian clients—around 80%—are small regional cosmetics companies. To the extent that transnational corporations take over the mass market for cosmetics, Russian companies are in essence left with only one way to grow: targeting niche markets. In the last year or two, Russian cosmetics companies have been striving to find unique products that will create a niche free of competition. However, many do not have the proper manufacturing, technological, and most importantly R&D resources to accomplish this. This is why they are turning more and more to contractors.

Down in the lab

In Russia today, around a hundred contractors are currently in operation. In general they make skin care products such as moisturizers, shampoos, shower gels, and masks, the kind of products that were traditionally manufactured in larger amounts than perfumes or makeup in Russia.

Russian contractors can be divided into two categories: scientific laboratories specializing in contract production and cosmetics companies that not only fill orders but also have their own brands. Scientific research labs such as Nizar, Mesoplast, and other veterans of the Soviet pharmaceuticals industry were the first to offer contract services. Then new labs hit the market, like Tvins TEK, Akvalan, and Astera. These companies focused on tailoring services to those Russian companies looking for unique products. For example, Nizar developed the well-know Silver Dew (Serebryanaya rosa) skin care line for Mak Dak based on “silver” water. The Princess line of cosmetics for young girls was also developed under contract at the request of wholesaler Cosmetic Market.

According to contractors, Russian customers often order market research in addition to new formulas and products. Russian companies also demand innovations that could turn into unique products. However, coming up with something truly innovative—a completely new type of formula—requires basic scientific research and that means major resources, the kind of money that only premium cosmetics companies such as Estee Lauder and Christian Dior have nowadays. For this reason, Russian labs can only make innovative combinations of well-known components, such as vitamins and other active ingredients.

However, obviously even this kind of work requires specialists well-versed in medicine and cosmetology, as well as fairly complicated production technology. Of course, not all labs can offer this. Yet the Russian cosmetics market is growing so fast that it compensates for any risk associated with market misses. “The cosmetics market is currently on its way up, especially in Russia’s regions where most of our orders come from. And practically any new moisturizer or shampoo can be sold for about six months. A lab would have to produce huge quantities of a truly bad product to wind up in the red,” noted one contractor, Mr. Solonnikov.

Meeting their standards

Recently, makers of brand-name cosmetics have also started to offer contract services, for example Rokolor, Arnest, and Svoboda. This is unprecedented in the history of the world market, as brand-name cosmetics companies are trying, on the contrary, to get rid of production facilities.

Why would companies with strong brand names start contracting?

More likely than not, outsourcing has become a real way to reduce the risks of their core business. “Though contract production is a lot less profitable than managing our own brands, we plan to devote more than 50% of our production capacity to contracting,” explains Andrei Mamykin, Vice-President at Rokolor. “Contract production is a stable business and will help us protect ourselves from seasonal fluctuations and other brand-related risks.” Moreover, the majority of Russian producers have excess production capacity. Unable to compete with imports, some Russian companies were forced to cut production of their brands. In addition, Russian contractors are performing relatively well, and their profitability is at least 15%.

Contracting has also become a crucial part of solving another problem that has plagued Russian cosmetics companies, namely improving the quality of their products. Outsourcing by foreign clients allows Russian producers to bring their production culture up to world standards by implementing up-to-date production technologies and logistics and maintaining strict standards for inputs and components. Meeting clients’ technological standards has proven to be the most difficult aspect of the business for Russian contractors. Many of them use production lines built 20-30 years ago. “We were not able to pass the technological audit at first, though we had always been considered one of the most advanced cosmetics companies in Russia,” recounts Sagal at Arnest. “When people came from Schwarzkopf and spent some time at our factory, they wrote up a huge list of remarks. It took $25 million and an entire year to meet all their requirements. When Schwarzkopf asked us to produce Fa deodorant, we had to build an entire separate line and couldn’t use our existing ones, the way many Russian producers do. Now we are used to the fact that every new product requires new equipment.”

It is also far from easy for Russian contractors to meet standards for inputs and components, despite the fact that components are usually imported. “At present, there are no specialists even at major dealers that know a lot about input quality and the peculiarities of selling inputs. They are just as weak in service and logistics,” explains Solonnikov.

Whether they like it or not, contract production is forcing Russian cosmetics companies to become more sophisticated in their operations. They believe that working together with Western companies forces them to improve production technology and thus increase the quality of their own brands.

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