Sephora’s Lawsuit With Obsessive Compulsive Cosmetics Is a Staggering Case Study in How Beauty Products Are Sold
It also illustrates why beauty products cost what they do.
By Cheryl Wischhover on April 24, 2018 12:00 pm
Customers don’t know very much about how beauty retailers sell them products. The process by which a lipstick goes from factory to store to you is pretty opaque. Sure, we know conceptually that beauty has high margins and a big markup. But while newer brands like The Ordinary and Beauty Pie have started to offer a bit of transparency into pricing and how brands are ultimately made available to consumers, there is still a lot of mystery baked into the process.
The recent apparent shuttering of an indie beauty brand and its lawsuit against Sephora helps shed some light on how truly complex it is to sell beauty products — and the costs that get passed on to shoppers.
A few weeks ago, the beloved indie makeup brand Obsessive Compulsive Cosmetics (OCC) abruptly shuttered its website, its New York City store, and all its social media accounts. While the brand has not made any official statement and none of its third-party retailers like Nordstrom and Urban Outfitters have confirmed anything, it’s widely assumed that the brand has gone out of business. Founder David Klasfeld seems to have started a new Instagram account under the handle @dkwmakeup, and notes in the bio: “I founded and ran the world’s first 100% Vegan & Cruelty-Free Cosmetics line from 2004-2018.” (Racked has reached out again to OCC and will update if we hear back.)
If this is the case, what happened? The only person who knows for sure at this point is the founder of OCC, but a lawsuit with Sephora dating back to 2015, may provide some clues. It also sheds some light on things like who actually is responsible for building and filling the product testing fixtures you find in stores, what large markdowns mean for a brand, and how store exclusivity works.
There are two legal documents publicly accessible, one from 2015, first published by blogger Zadidoll, and one from 2016. These provide an incomplete record of the full proceedings, and it’s unclear if Sephora and OCC settled this case or what the final outcome was. But what is clear is that retailers hold a lot of the cards and OCC probably lost a lot of money. A representative for Sephora sent the following statement to Racked: “Per company policy, we do not comment on pending litigation.”
The terms of a Sephora contract
According to the 2016 order, OCC and Sephora signed a contract in 2012 stating that the retailer would sell the brand’s products and that OCC would be 100 percent responsible for the costs of the fixtures, which is the system of shelving and pigeonholes where testers and products for sale are displayed in the store. They can vary in size from a small box on a shelf to an aisle-long behemoth. Per industry sources, this is a pretty common arrangement. (More on what those fixtures cost in a bit. Hint: a lot.)
OCC then alleged in the suit that it entered into a verbal agreement with Sephora to alter the original contract in two ways: first, that Sephora would become OCC’s exclusive brick-and-mortar retailer with the understanding that it would place enough orders to make up for the ones OCC would have to decline from other retailers.
Second, Sephora was supposedly going to help defray the costs of the fixtures by contributing 50 percent, since it supposedly wanted to increase the number of stores selling OCC, which would then necessitate building more fixtures.
OCC alleged in the suit that Sephora reneged on these oral agreements by not placing more orders and not helping to pay for fixtures. Sephora argued that it was a moot point because the original contract stipulated that the contract could only be modified in writing and therefore the suit should be thrown out.
However, the judge ruled that OCC could continue pursuing it, because he determined that OCC had acted in such a way (turning down orders from other retailers, for example) that made it seem clear that OCC relied on Sephora’s verbal statements. (He threw out a fraud allegation that OCC made about Sephora, however.) Sephora was given 20 days to serve an answer, but the conclusion or settlement does not appear to have been made public.
But that’s not the full story. An earlier 2015 order details exactly how much money OCC stood to lose in the Sephora deal. Sephora wrote a letter to OCC to terminate the deal in 2015, stating it would sell the products it had until a certain date, while also requesting OCC to fulfill two outstanding purchase orders that OCC hadn’t shipped yet.
After the date in the termination letter, Sephora expected OCC to take back leftover product (this is called a return-to-vendor, or RTV, clause) and reimburse Sephora for the unsold product.
The bottom line? Sephora said it expected to be reimbursed $832,700 for the unsold products. Otherwise, it allegedly said it would liquidate its remaining stock at fire-sale prices.
OCC asked for a preliminary injunction, arguing that “if provisional relief is not granted it will suffer irreparable harm because an immediate mark down of the outstanding inventory would have financially devastating effects and moot any award of damages.”
According to the lawsuit, OCC never reimbursed Sephora for remaining stock, and Sephora did end up marking down the remaining products and selling them off quickly, according to Revelist. Ultimately, OCC claimed damages of $521,647.20. This is where the paper trail ends.
Stores take a big chunk of a brand’s potential profit
As this whole winding tale illustrates, selling beauty products is not straightforward. When a brand sells its product wholesale to a retailer, it loses about 50 percent or more in gross profits compared to what it would have made selling direct-to-consumer.
Looking at wholesaling very simplistically, let’s say it costs a company $4 in “hard costs” to produce a lipstick and it sells that lipstick directly on its own brand website for $16. That’s a $12 profit.
But according to an industry source, when a retailer wants to sell a company’s products, the retailer buys those products at 50 to 65 percent less than the retail price, with Sephora at the higher end of that scale, meaning it pays less to brands than some other retailers do.
So the company sells those lipsticks to the store at a much lower rate that it would if it sold them to customers. The company in this example will have to sell its lipsticks at wholesale to a retailer for $5.60 to $8 each. This means that it will have to theoretically sell twice as many (or more) at the retailer to equal the profits it could potentially make on its own website.
The $832,000 worth of product that Sephora wanted OCC to buy back but ultimately just sold at a discount was possibly worth more than $1.6 million at retail.
Those lipstick testers are more expensive than most of the furniture in your house
Racked spoke to the founder of a small beauty brand who sells products at a national independent beauty and skin care retailer and who was willing to discuss specific costs. (She asked to remain anonymous to protect the relationship with the retailer.)
“Break-even can take quite a bit of time [for a brand],” says the founder, describing the challenges inherent in the wholesale model.
The store fixture issue is basically just adding insult to injury. Brands are usually responsible for producing their own fixtures to be used in the store. While the fixtures are a big part of the OCC lawsuit, the cost is never stated in the documents.
The founder here says it cost her $13,000 for 78 small fixture units that could be moved around and used in different parts of the store. There is usually a setup as well as a design fee, but she saved money by using an in-house designer.
Obviously, the bigger and more elaborate the fixture, the more it costs. And sometimes a retailer will ask brands to change out fixtures in the middle of the year, requiring them to build new fixtures from scratch.
There are only a small number of firms that design fixtures for pretty much everybody in the business. (One of the most well-known is Array, which has designed for Sephora, Ulta, and many major beauty brands. Array did not respond to a request for comment for this story.)
$13,000 sounds relatively reasonable, until you factor in all the other costs that go along with it. The founder gifted each store’s associates — about three to seven per store depending on size — about $100 (retail value) worth of products, which she says have a total retail value of $25,000, or about $12,500 wholesale and $6,250 in hard costs.
“This is known as gratis and is viewed as critical to moving products, as associates can only sell what they know and like,” the founder says.
Then there are the product testers that go in the fixture. This brand spent $8,000 in retail value ($2,000 of hard cost) for products over a one-year period, as well as a dedicated part-time retail person (paid $48,000) to oversee the account, which includes a weekly store manager check-in, sending gifts like flowers or cupcakes to get the associates excited, and in-store training. The founder characterized the gifting as “well below average and should have been higher for proper support.”
So with the cost of fixtures, gratis products, the manager, internal designer, tester products, and non-product gifting and support, she estimates it costs $73,250 in total costs for one year to “have a modest retail footprint at one chain.” And this doesn’t include the sunk cost of all those products that are used as testers and gratis, which in her case equals $33,000 in lost retail sales.
This is a very small brand with not a ton of products. OCC offered dozens of lipstick colors and nail polishes, so you can conceivably multiply these numbers by many times more to understand what others costs likely were.
Not everyone can be direct-to-consumer, though
Getting picked up by a beauty retailer like Sephora is a dream for a lot of small beauty brands, especially if they can’t afford real estate for their own stores or don’t have Glossier levels of savvy and a rabid fan base built in for a really robust direct-to-consumer business.
Direct-to-consumer has its own financial challenges, like warehousing, logistics, and shipping costs. Sephora is also known for actively helping brands get themselves up to snuff. For example, Biossance, a squalane-based brand that sold out of its debut eye gel several times, was told by Sephora to “refine its message” and redo the packaging. It must have worked, because the brand has significantly expanded its product offerings. Retailers can also help beauty brands get more recognition and a wider reach. Obviously, if they sell enough, the volume makes up for the lower wholesale pricing.
The case of OCC, whether or not the brand has gone out of business permanently, illustrates that having a retailer presence can still be a double-edged sword. Other potential factors, like not updating formulas and packaging and not having enough capital, could obviously have had an impact on OCC’s overall dire financial situation. But the sheer numbers involved in the lawsuit really shows how much is at stake for beauty brands and retailers alike.
It also shows why we as consumers pay as much as we do for beauty products.
