Barriers to Entry and Firms' Strategies — the Cosmetics Market

Case

Table 1: Breakdown of the cosmetics market worldwide from 2011 to 2022, by product category. (Presented in the source as a figure showing the share of the global cosmetics market held by each product category — skin care, make-up (colour cosmetics), hair care, fragrances and others. Between 2012 and 2018 the skin-care and make-up segments both rose, with skin care consistently the larger share and rising by more.)

Extract 1: Impact of COVID-19 on the cosmetics market

During the COVID-19 pandemic, lockdowns and the work-from-home culture significantly reduced social interactions and thus significantly decreased the use of cosmetics compared with pre-pandemic levels. At the same time, due to supply chain disruptions, the increase in raw materials and shipping prices led some cosmetic brands to pass along those cost increases to consumers in order to maintain their profit margins. Yet, India’s makeup brand Aether Beauty and Vapour Beauty were among some firms that shut down operations during the pandemic, citing reasons such as lack of accumulated profits and stiff competition.

As a result of the pandemic, consumers care more about sustainability and the use of safe and non-toxic ingredients in cosmetics. Cosmetics made from natural ingredients have thus seen a rapid rise in popularity. With the rise in urbanisation and growth of the middle class in developed and developing countries, coupled with the relaxation of COVID-19 restrictions, cosmetic manufacturers have begun offering alternative products such as personalised products and ‘Maskne’ treatments. In 2021 the women’s segment accounted for the highest market share, whereas the men’s segment is estimated to show the fastest growth.

Extract 4: Acquisition and misinformation

Estée Lauder’s purchase of competitor Tom Ford in 2023 for US$2.3 billion is by far the biggest deal the cosmetic industry has seen for some time. Its acquisition of Tom Ford will enable Estée Lauder to compete with L’Oréal, as it adds another in-demand, luxury and high-performing brand to its portfolio, expanding the range of products. According to Statista, both Estée Lauder and L’Oréal are two of the largest cosmetic companies by revenue in 2022.

The Advertising Standards Authority (ASA) has been on watch for false and misleading claims by cosmetic companies. In 2022, the ASA in the UK ordered Wild Cosmetics, Ltd. to take down a misleading advertisement and commit not to feature false claims about its products. The advertising watchdog is banning growing numbers of advertisements that exaggerate the benefits of cosmetic products, amid fears that too many operators in the booming but poorly regulated cosmetic treatments sector are endangering clients’ self-esteem and mental health by overselling how effective the products will prove.

Questions

Q1 (i). Compare the trend in market share between skin care and that of make-up between 2012 and 2018. (compare, [2])

Q1 (ii). Using Extract 1, explain two reasons why Aether Beauty decided to shut down its operations in the short run during the COVID-19 pandemic. (explain, [5])

Q2 (i). Explain two benefits that Estée Lauder might experience from the strategy it employed in Extract 4. (explain, [6])

Q2 (ii). With reference to Extract 4, explain one reason why there might be a need for government intervention in the cosmetic market. (explain, [5])

Answers

Q1 (i) — compare [2].

Similarity: the market share of both skin care and make-up generally increased between 2012 and 2018. Difference: skin care’s share was consistently higher than make-up’s, and it increased by a larger extent over the period. (Marks: one valid similarity, one valid difference.)

Q1 (ii) — explain [5].

The short-run shut-down condition is that a firm shuts down when total revenue falls below total variable cost ($TR < TVC$), because fixed cost is sunk in the short run. Two pandemic effects pushed Aether Beauty across this boundary.

Demand side → falling TR. Lockdowns “reduced social interactions”, lowering the need to apply cosmetics — a change in tastes and preferences. This decreased demand for cosmetic products, so Aether Beauty’s total revenue fell.

Supply side → rising TVC. The pandemic caused “supply chain disruptions” and an “increase in raw material and shipping prices”, raising the firm’s unit cost of production and so its total variable cost.

Together, falling TR and rising TVC pushed TVC above TR, satisfying the short-run shut-down condition and prompting Aether Beauty to suspend operations. (Marks: shut-down condition [1]; demand → TR [2]; supply → TVC [2].)

Q2 (i) — explain [6].

This part is worked in prose; the original answer’s supporting figure is a firm-level cost/revenue (AR/MR/AC/MC) diagram outside the 9570 diagram set (see scope note below).

Estée Lauder used an acquisition strategy — specifically horizontal integration, acquiring a competitor at the same stage of production. The strongest answers pair a revenue benefit with a cost benefit.

Revenue benefit. Horizontal integration instantly raises market share: all of Tom Ford’s existing customers become part of Estée Lauder’s customer base, raising the firm’s demand and hence its total revenue.

Cost benefit. The combined firm has a higher output, allowing it to unlock greater internal economies of scale — for instance, bulk purchasing of inputs — which lowers its unit cost of production.

Higher revenue together with lower unit cost raises the firm’s profit. (Marks: state strategy [1]; revenue benefit [2]; cost benefit [2]; link to profit [1].)

Q2 (ii) — explain [5].

This part is worked in prose; the original answer’s supporting figure is a firm-level cost/revenue (AR/MR) diagram outside the 9570 diagram set (see scope note below).

Government intervention may be needed where the market fails through allocative inefficiency arising from market dominance. The acquisition of Tom Ford raises Estée Lauder’s demand and market share; with fewer close substitutes remaining in the industry, its demand also becomes more price-inelastic. A more dominant, price-setting firm restricts output below the socially optimal level. Allocative efficiency requires price to equal marginal cost ($P = MC$); a profit-maximising dominant firm produces where MC = MR, at an output below the allocatively efficient output, leaving an underallocation of resources to the good. Because the acquisition increases dominance, that underallocation widens — allocative inefficiency worsens — giving the government grounds to intervene to restrain market dominance. (Marks: type of market failure — market dominance [1]; acquisition raises and stiffens demand [1]; effect on demand [1]; $P = MC$ condition [1]; link to worsened allocative inefficiency [1].)

Note: in the original worksheet Q2(i) and Q2(ii) were supported by firm-level cost/revenue (AR/MR/AC/MC) diagrams with profit areas and the Qm–Qs underallocation gap. Those market-structure equilibrium diagrams are outside the 9570 syllabus and are therefore presented as prose here.