Shiseido Company, Limited (4911) Earnings Call Transcript & Summary

Well, good afternoon, everybody, and thank you very much for joining this session. I'm delighted to welcome to the conference Mr. Kentaro Fujiwara, President and Chief Operating Officer of Shiseido; and also Ms. Ayako Hirofuji, the Deputy Chief Financial Officer, and she will take over as Group CFO on July 1. Mr. Fujiwara-san, Ms. Hirofuji-san, thank you very much for joining us again this year. Perhaps before we look back over what has happened over the last year and to the strategy going forward, perhaps you'd like to say a few words, perhaps for the introduction outlining Shiseido's position and philosophy in the world of beauty.

Yes. Thank you very much for the introduction, and good afternoon, everyone. So I just introduced for the company briefly is that Shiseido was founded for over 150 years ago in 1872 and as a Western type of the pharmacy in Ginza, Tokyo. And now Shiseido operate in 120 countries with 36,000 of employees and 100 different type of nationalities. So since 1991, I joined Shiseido, and I have mainly involved of the overseas markets like EMEA, Travel Retail, Korea, China. So when I joined the overseas business -- when I joined Shiseido, overseas business is less than 10%. But now it's approximately for the 70% business is coming from the overseas. So currently, Asia accounts for the big part of our business. But given the increasingly volatility of the Chinese market, we are putting a lot focus on the rebalancing our global footprint, namely the growth accelerations in the EMEA, Americas and APAC.

So last year, you launched SHIFT 2025 and Beyond, which targeted a 6% margin in 2023, a 12% margin in 2025 and a 15% margin later in 2027. Market conditions weren't as favorable, and you recorded a 4% margin last year, and you recently updated the market with new targets which included a 9% margin for 2025 and a 15% margin -- core margin later on. What were the most significant market impacts that led you to change the targets of the company?

So 2 major environment changes affected our operation last year. So the volatility surrounding the China market was the signaling factors. As you know that for the boycott due to the release of the treated waters and as well as the destocking in the travel retail due to the Daigou crackdown. So however, we are committed to learn this crisis to opportunities in order to make our company better. So I believe that environmental changes is always a good opportunity to the company to evolve. So as you can see the slides, there is a 2 phase after the COVID-19. 2020 to 2022, this is a period of our brand portfolio transformations. COVID has a significant and prolonged impact to our business. So we have to make a very tough decision to ensure our company survival. So the one core area we defined as Skin Beauty and the brand portfolio was restructured. So this was indeed very painful but necessary transformations. So resulting in the major reduction in the fixed costs with the sort of the effort, we start to recover. So then now we are in the second phase of the transactions, business transformation to achieve the sustainable growth, improving the profitabilities. The aim here is to reshape our cost structure. So I believe that the growth is the most important for our business. So we will be well positioned for the longer-term profitable growth. So of course, but short-term profit deliver is not one that matters. We are now working on the transformation on how we operate and the overall productivity by driving the efficiency in the whole area of the company.

And so it would be good to explore the update to SHIFT 2025 that you've announced. And within that, you announced the business transformation measures. Perhaps if we could start looking at the JPY 40 billion cost reduction program, which is equivalent to a little over 4% of sales and equivalent to the 2023 operating profit. Is -- perhaps why is such a fundamental program needed? And what are the major areas of focus, please?

Yes, so...

Just to clarify, the JPY 40 billion from my side to clear out the numbers here. This is across 2-years time horizon as we go through the global footprint reorganization as well as achieving a sustainable profitable growth model mentioned by Fujiwara-san just now. The major bulk of the execution will be happening this year and with full year benefit happening in the next year and across these 2 years, which is shown in this chart is building blocks of JPY 15 billion this year, JPY 25 billion in the second year. Out of which Japan, of course, is the biggest chunk of that, biggest contributor of JPY 25 billion, followed by JPY 8 billion in China and others. We have even further granular building blocks, in fact, from here, which we are monitoring and tracking through a global transformation committee, which is a global committee that secures whether we are on track and whether if there's any deviation from there to come up with some other means to recover such deviation. So that's how we are monitoring the cost reduction piece of JPY 40 billion.

Okay, thank you.

I think the last point to Hirofuji-san said that for the global transformation committee initiative, GTC initiatives is very important. So this is not just for the cost reductions. So more importantly, this is the transformation of how we operate. So I would like to achieve the 2 goal by that. So one is that business transformation. It is to transform our business structure to have, let's say, agility to respond to the market changes. And the second is to pursue to the operational excellence. So it is maximized for the profitable growth. So regarding the OP excellence, so set up the initiative for the productivity improvements at the global level and work on that company-wide. So particularly attention and efforts are focused on gross profit. So strategic pricing, brand mix, SKU mix, channel mix and the COG reductions and et cetera. And we aim to create a structure where growth contribute more to the OP margin. So regarding the business transformation, as Hirofuji-san said, is that Japan is very, very crucial. So because of the topline was impacted by the heavy fixed costs have been issue for Japan. The significant decline of the inbound sales and the severe impact of the COVID-19 in Japan, so it's also impacted. But more serious is that the structure was not able to generate the profit in changing such market situation. So high fixed cost was a real challenge for Japan.

And if we focus a little bit more deeply on the changes in Japan, this accounts for JPY 25 billion you announced out of the JPY 40 billion. just from your comments, how significant a change is this fundamentally to the operating model of the organization? And what difficulties have you faced in the restructuring the headcount and the modernization of the business given the regulatory and labor market framework within Japan?

Yes. So until 2022, I was in China, and I just returned from China, and I analyzed what is the real challenge for the Japan market. So simply said, it's -- one challenge is to transform to the growth model. And the second is that reform of the organization culture. There is 2 challenges so remained. And in the past, so the Japan growth is not sufficient, leading to the bottom line because of the business model. So growth is too much rely on to the new product-driven sales, and large volume of delivery, and the face-to-face selling model with the beauty consultants at the stores, so which make to a lot of the number of the SKU in the long-tail and too much -- too comprehensive and complicated for the channel policies and organization was so complicated. So those kind of the issue is also created to the high fixed costs, and organization has become the rigid and siloed. So we really reviewed to the all activities from the 3 perspectives. One is that achieve the sustainable growth. Second is that profitable business model. Three is consumer-centric. So as a group, Japan, of course, is a big market for us. So therefore, we expect it to the economic growth, but it is not only for the such role of Japan. So I also expect it to the Japan should also lead to the innovation. So based on that kind of the analysis, we implement to the strategy into Japan. In terms of brand strategy, both selection and the concentration of the brands and SKU. So target is 70% of the sales is coming from the 7 core brands and the hero SKUs. So in order to accelerate that, we make the strategic allocation of the investment toward those core brands. Then so with these efforts, so I'm really proud of my team is to make it for the good achievement and also that achievement encourage us. So Q1 results in the local consumer purchase is high-teen percent, but the core brands has achieved growth at high-20% and the hero products growth of over 30%. So I would like to say strategic strategy are working. Then so in terms of channel strategy, so consumer point of view, channel-based approach does not work anymore in Japan. So we need to focus winning where people gather. So we just check to the consumer research, 70% of the cosmetic consumer use multiple channel, 30% -- more than 30% use of the 4 or more than that. So meaning is that we really accelerate or the shift to the OMO, online merge of the offline and which is initiative is very inevitable. So that's why I said to the EC, e-commerce 30% ratio intentionally. And the last part is the cost reductions. So by changing to the brand strategy or the channel strategy, we lead to the efficiency, productivities and the cost reductions, focus on the brands and the SKU, so improve of the COG ratio and also reductions of the POS material and to be simplified organization and the process give us to the deduction of the fixed cost of the back-office facility like IT or the offices.

And these cost-saving measures create new benchmarks that culturally, companies need to change if these are to be embedded. There does historically seem to be a high level of complexity and layering of costs in the organization. Is that cultural shift of mindset to growth without adding complexity, is that underway within the organization? And do you see any risk of any IT-related disruption or changes to phasing of revenues?

Yes. To be honest, so when I just in charge -- started in charge of the Japan business, I was a little bit surprised because of the organization is lack of the crisis and the lack of the agility. So structural reform and optimize of the productivities is will be completed by the end of this year. But I felt without organizational culture changes, so the reform still have a risk to go backwards. So therefore, organizational culture, change of the organizational culture is very, very essential. So I delivered the message to the old employee to the let make self innovation, meaning that our goal is to each employee to become to the change leader and regain the spirit of challenges. So in order to do it, based on to the current growth strategy, we have reformulated to the necessary skill and necessary capabilities and the way of working for the old position in the future. On the top of that, company is committed to make investment for the re-skilling and training if you want to change. But on the other hand, if you don't want to change, so company also introduced an early retirement program. So as a result, around for the 1,500 employees used early retirement program. But in changed market, it's very important and employees should not be just waiting for the top-down directions. So we need a culture in which the organization is agile and more willing to take on the higher goals. So the reform has just begun, but the first quarter was very good. So you can see the chart is employee also regaining to the confidence that's a good situation. So I will continue to spend a lot of the time on the organizational culture changes. And I will be listening to their concerns, expectations, and feedback from the field with the goal of completing our business transformation in Japan.

It's a very fundamental change in the organization. If I may follow up just on one aspect to the business transformation, the marketing expenses. Many investors get nervous when companies look to cut A&P? And obviously, you do have high gross margins, which support the A&P investment. In what ways are you looking to optimize your A&P costs? And will you be allocating that budget a little bit more differently behind the areas which you think are going to be most productive for you?

So I want to emphasize that we do not intend to cut A&P for the sake of the short-term profit. So our principle is make sure sufficient investment behind our core area while cutting the inefficiency and the complexity. To achieve this, we need to have a clear focus. So we need to focus on the strong global brands to scale them even further. we need to focus on the where people gather. So through this approach, I'm very happy to say that Q1 this year, in China business market, we gained market share even under the challenging situations. And in Japan, so we identified the 7 core brands to heavily invest. So this does not mean we are not just cutting the marketing investments, but we make the allocation of the marketing investments more clearly and the more important of the marketing ROI.

And perhaps finally, looking in Japan, if we look at the distribution channel changes, the distribution channels within Japan, will there be less physical selling points and higher quality selling points in Japan?

Yes. So especially for the Japan is a very comprehensive for the current channel situations. And we are much more focused on to the e-commerce and in order to achieve the 30% of the e-commerce ratios. But there is 3 pillars in order to achieve all the 30%. One is that we renovate to our own EC platforms. And secondly is that we much more focus on to the pure player like Amazon. And the third is that we give it to the retail.com. So those 3 pillars is make it to accelerate our E-Commerce business.

Okay. Thank you. So now perhaps shifting to talk about China. Approximately JPY 8 billion savings going to come from China. 2023 was a very difficult year for Japanese brands in China. I guess, firstly, do you see the political issues that impacted growth as a permanent headwind to Japanese brands and then why do you need to optimize costs in what is seen by many as a long-term growth market?

Yes. So I have to be saying no. We do not think it's going to not -- it's going to be the permanent headwind. So I don't think so. As I mentioned earlier, the Fukushima impact is in past us. And if we look back to our history, we also have seen the worse situations, but all those were only temporary. The most important things that continue to be our brand value and well-diversified brand portfolio. And China market continued to represent great growth opportunity for Shiseido. The size is obviously too big and to ignore. The China -- just to give you the example, China market is the #1 skin care market in the world and #2 beauty market. And number -- the luxury beauty market is currently grew by 13%, even despite the economic slowdown last year. Then number of the middle class and affluent people are expected to achieve over the 500 million population. That's huge. So this is a market with a great potential despite the fact that the competitions are intense. However, the fierce competition is nothing new, right? So it has always been challenging yet exciting. And local competitors are becoming increasingly active and they are good at creating for the buzz and the trends. So I admire their agility and the speed. However, in terms of price points, so we are different. And also, we have a strong competitive edge, innovation and R&D capabilities, efficacy and long-standing tradition and the trust in the market. So we continue to focus on to the fact we really need to do is that brand equity building for the long-term and sustainable growth. So I believe Shiseido is well positioned to win in this competitive yet exciting market with our 40 years history of the operation in China as well as the localized talents and the capability.

Okay. Thank you. Perhaps now we'll switch from a country focus to more looking at the categories and brands in the time we have left. You have skin care leadership in the beauty market and a strong R&D infrastructure and heritage. How is your strategy in skin care evolving currently? And which brands do you see as encapsulating your strategic priorities?

So our competitive advantage, R&D will further strengthened in the 2 directions. First is the strengthening of the innovation from the region. We are already overwhelm our global competitor in terms of the number of the winner of the IFSCC, so which is the world's largest cosmetic technology competition. And the source of the success is spreading beyond to the Japan into the other region. So in the future, each region will strengthen the system to develop the value by capturing the local needs. And the second is strengthening the new market creation. We have 2 approach for maximizing the value creation. So firstly, it is a crucial, important to win in the major category. So in the existing areas such as Lotion, Emulsion, Cream and Suncare, there is a must-win area so where our competitive edge. So we set the winning category and reinforce our investment globally with strong technologies. And the these part also need to work as a cash cow. So continued to corporate-wide effort to be the winner in existing major markets is the first approach. And the second approach, so which I'm personally very passionate is niche top. In other words, so approach is to be the big fish in the small pond. So we are trying to create the new beauty value and the new beauty categories is to solidify our presence as a leader in the beauty innovation. The first-mover advantage in the market is very enormous, I guess. And since we create the market ourselves, we can take it for the dominant position in that area. And in other words, there is less competition in the market. So we can get for -- not only for the top line, but also the profit. So here is the first success story. This is a category of the Foundation Serum. This is Shiseido's exclusive technology using the serum-first technology, this is a new category for consumer who after COVID has stopped or reduced their use of the foundation. So in case of the Foundation Serum, only 2 products contribute to the 6% of the Q1 revenue growth in Japan business.

And Fragrances have seen significant growth and at the market level and for you. Is this something that you could scale up more within the organization?

Yes. So I really want to do that. Especially for the Europe is approximately 50% of the market is a Fragrance market. So therefore, we could expand to this category in Europe. In addition, so there is a Fragrance business acceleration on the global business, including China.

Okay. And as we are discussing market growth, and you've given some of the performance statistics and some of the results from Q1. As we're discussing that and your priorities, please could you -- I ask you for maybe your current view on beauty market trends and how you see these evolving over the course of this year and into next year?

So we stay positive and optimistic for the future beauty market, especially the Prestige and Luxury area. So with China becoming to the more moderate growth, so the quality growth with better pricing and better mix is really the key, I guess. So given the increasing volatility in the Asian market, we put great emphasis of rebalancing our global footprint. So in order to realign the geographical presence, we are accelerating the growth in America, Europe and APAC by making sure the strategic marketing investment behind those areas. So if I look back, both America and EMEA used to be unprofitable. But after the painful yet needed for the transformation, now is both other divisions it became to the profit and ready to growth. So thanks to the talent acquisition efforts and the localization of the capability from here, our priority is to grow the top line so we can enjoy the operating leverage. So we expect Americas, EMEA and APAC to become a profitable driver to entire group.

It's been very strong growth. So Mr. Fujiwara-san, Ms. Hirofuji-san, thank you very much for what you said so far. Lastly, though, I'd like to run through. This is a considerable modernization framework that you've laid out for the company. At the same time as making structural changes to the model, there have also been significant changes to the governance structure, critically of the business. And this has been a key tenet of the ESG changes that have been made. External directors are now the majority of the Board as well as on the nominating Compensation and Audit Committees. And as discussed, you're making the difficult changes to headcount and operating models. Please, can you expand on the changes to the corporate governance structure and also the oversight of what is a significant modernization for the company?

So corporate governance is the foundation of our corporate activities and the cornerstone for our sustainable growth and the enhancement of our corporate value. So Shiseido has been dedicated to the corporate governance throughout in the past. So not just to inform -- just in form, but in substance, by continually pursuing the ideal state of the company and striving for the enhanced effectiveness. So in 2024, so we took the step further by transitioning to the company with 3 statutory committees. The decision to change our governance structure was made deliberately to strengthen both oversight by the Board of Directors and our agility and the speed of execution. I think that there is no one-size-fits-all solution to the governance and the optimal form of the governance vary for the company to company. So similarly, so even with a single company, the ideal form of the governance change depend on the stage of the growth and its aspirations. So as society rapidly changed and the company are forced to adapt. So it is necessary to strategically evolve our governance practices. So at Shiseido, we aim to the company that demand vital for the next 100 years and to meet to the expectation of our diverse for the stakeholders, we will continue to challenge ourselves and evolve.

So we have a couple more questions. But if there are any questions in the audience that you'd like to ask, then please do raise your hand, and I think someone will come around with a microphone. But I may just ask a further question now. Please, is it possible to run through the capital allocation priorities and whether through this restructuring, you would still consider M&A or indeed any portfolio management?

Right. So for capital allocation, I would say that investment towards growth really comes first, and it has always been, but I would like to reinforce that because it is after all a gross margin business, and we'll continue to do that. Major investments behind factory or R&D centers or IT systems has already been done in the past. And I feel that now gives us room to really drive brand growth and leverage those investments further. M&A, of course, would be within the picture. We do have aim for optimizing our global footprint and hence, would be seeking for organic growth as well, just as you see from our most recent acquisition in the U.S. called Dr. Dennis Gross Skincare, which we believe is a great opportunity. So we will be seeking for such filling in white spaces as well. And of course, shareholder return continues to be important. We will be driving dividend increases together, and aligned with our net income, sales operating profit net income eventually increases as well. So that will be an overview that I can talk about just now.

Okay. Interesting, thank you. And perhaps a final question from me, and we've heard from many companies the -- about what they're doing with the introduction of AI and how do you see, or what do you see as the impact of AI across the world of beauty in areas, particularly like product development and marketing?

So we believe AI brings a lot of the significant changes. For me, I think that the UX, user experience and the value chain in the beauty field. So that's most disrupted area by the AI. So in the UX, so there will be more personalization by the variety and the huge data sources. So can evolution of the UX by accumulating the variety of the huge data like not only for the purchase history in the past, but also more detailed skin diagnosis and also food and health and even maybe AI can reading into the emotions for the future. So by combining for those kind of plenty of the data, AI completely make suggested to the full personalization services or the recommendations. So it's a really dramatically change of the user experience. And the second part is the value creation. This is also the very interesting for me is to how implement for the AI. So AI may contribute to the design of the product development based on the consumer data, in-house R&D technologies and also the past example of the formulations. Maybe one day, AI is a suggested to some of the product developments and with the recipe of that. So that's also the big transformation or the evolutions by AI. And of course, is the operational efficiency like AI give us automated or the more accuracy of the estimations. Those kind of area is AI is really make it for the innovations for our business.

Okay. Well, thank you very much. And there are no further questions, then just to Ms. Hirofuji-san, Mr. Fujiwara-san thank you very much indeed for joining us again this year, and thank you very much to everybody for joining us for this session.

Before we wrap up, may I just introduce one upcoming event this Friday. We are very proud about our progress that we have made in Europe. Here, we have our EMEA region CEO presenting our strategy, what has been the success behind it, upcoming Friday 10:00 a.m., 11:00 a.m. Let me advertise this, and you can scan this QR code so that you can listen in further some details behind our success story. So if you do have time, please do attend. Thank you. It's an online event. Thank you.

Yes. Thank you very much. Thank you.