By Joyce Lee and Hyunjoo Jin
SEOUL (Reuters) - At a factory two hours south of Seoul, women clad in plastic caps and masks put peach-coloured eye-shadow into cases, right next to a machine churning out a skin-colour face powder.
The difference between the two lines: the first is supplying one of France’s best-known premium cosmetic brands, while the second is serving a South Korean budget firm.
The plant is operated by Cosmecca Korea <241710.KQ>, the country's third-biggest contract cosmetics maker, which produces a range of products for more than 300 customers, all the way from high-end brands like Estee Lauder <EL.N> to nimble domestic firms such as Clio and Dr.Jart.
It is factories like this that have made South Korea the epicentre of fast beauty, a world in which the time it takes to get a product idea onto store shelves has dropped dramatically, often by years. This is vital as fickle millennial consumers can easily leave last year's hits as this year's busts.
Their dominance of the world of contract manufacturing for cosmetics may have become as important to the industry as Apple <AAPL.O> iPhone manufacturer Foxconn <2354.TW> has been for electronics.
Some of the major Korean brands they work for have been acquired by global cosmetics companies such as L’Oreal <OREP.PA> and Unilever <ULVR.L>, and according to people with direct knowledge of the matter, the manufacturers themselves have received investment offers, some from foreign cosmetics firms.
South Korea's three largest contract manufacturers - Cosmax<192820.KS>, Korea Kolmar <161890.KS> and Cosmecca - have allbeen approached by foreign investors about buying a minority stake in recent years, three people with direct knowledge of the situations told Reuters. The sources asked for anonymity and declined to elaborate further citing confidentiality of the approaches. One of the sources said one of the manufacturers had rejected a 2016 offer from an overseas cosmetics company for a minority stake, partly due to concerns that such an alliance could upset its broader customer base.
Representatives for the companies declined to comment.
DEMAND FROM CHINESE BRANDS
Though largely staying in the background with little public recognition themselves, contract manufacturers stand to benefit as Korean brands they work for rapidly grow in China's $53.5billion cosmetics market. That's thanks to their value for money image, fast turnaround times for new products, and smart online marketing. China's own fast-growing cosmetics brands, albeit still small, are also driving the revenue growth of South Korean manufacturers, although margins on these contracts can be low, company officials say.
The stock market performance of the three has been mixed, though they have all outperformed the main benchmark in South Korea. Shares of global No.1 Cosmax <192820.KS>, has gained 34percent year to date, far outpacing a 8 percent drop in the wider South Korean market <.KS11>. Cosmecca shares rose 8 percent and second-ranked Korea Kolmar <161890.KS> fell 3 percent in the same period.
All three have, though, outperformed the 21 percent decline in shares of Amorepacific Group <002790.KS>, South Korea's largest cosmetics powerhouse.
Amorepacific, which uses both in-house and contract manufacturing, reported revenue fell 10 percent and operating profit slumped by nearly 30 percent in the first three months of2018. Its brands include the top-end Sulwhasoo, mass market Innisfree, and young makeup offering Etude House.
Even as all the top three contract firms, which are also known as original equipment manufacturers (OEMs), posted revenue growth in the same period.
"The surge of smaller players gives tough times to beauty giants like Amorepacific. By contrast, this is a favourable environment for OEMs," said Park Jong-dae, an analyst at Hana Investment & Securities.
"While brand companies have up and downs, OEMs garner stable earnings. They are most suited to the industry's structural changes - Asian growth and diversified distribution channels."
STRUGGLING TO CATCH-UP
In particular, they are central to the success in the high-growth China market of small Korean brands with new ideas but no production or research capabilities, industry executives and experts say.
When French luxury giant LVMH's <LVMH.PA> private equity arm was conducting due diligence on Clio before buying a stake in2016, among its key questions was: "How do you come up with new products at such a fast speed?," said Lim Mira, a manager atClio's strategic planning team.
Contract manufacturers such as Cosmax deliver on orders much more quickly, in as fast as three months compared to about a year overseas contract manufacturers require, Lim said.
The firm used to source products from an Italian contract manufacturer in the past, but has now shifted to Korean manufacturers, she said.
"Many global players are struggling to catch up as the lifecycle of any success has shortened, pushing them to come up with new innovations at a much faster speed," said Laura Chu, a China-based account director at researcher Kantar International.
In China, Unilever's share declined from 3.2 percent in 2014to 2.8 percent in 2017, while L'Oreal's share fell from 9.4percent to 8.5 percent during the same period, according to research firm Euromonitor.
Seeking to turn the tables, both Unilever and L'Oreal, as well as other European and American majors, have paid big premiums in the last two years to scoop up South Korean brands thriving in China.
Unilever announced a 2.27 billion euro ($2.67 billion) deal for Carver Korea in September - maker of the A.H.C. cosmetics brand, whose China sales rose more than 30 percent in 2017,according to Kantar International.
"Geographically it will enable us to strength our position in two of the top five largest skin care markets - China and Korea," Lizzy Chen, a U.K.-based executive at Unilever, told Reuters. South Korea-based Nanda, which was acquired by L'Oreal for an undisclosed sum in May, saw sales of its flagship cosmetics brand 3CE double in China last year.
The strong performance was particularly notable given thatlast year a major spat between Seoul and Beijing over South Korea’s installation of a new U.S. missile defence system led to an unofficial boycott of South Korean brands in China.
South Korean contract manufacturers have been expanding China production to meet surging demand.
Cosmecca's chairman Cho Im-rae said that in recent years it has been running its factories in China at full throttle. It is planning to open a third factory there.
"China's cosmetics demand is growing enormously," he said in an interview with Reuters.($1 = 0.8514 euros)
(Reporting by Joyce Lee and Hyunjoo Jin; Additional reporting by Dahee Kim; Editing by Soyoung Kim and Martin Howell)