Estee Lauder "Modern Muse" fragrance.
Photo by Kevin Mazur—Getty
By Phil Wahba
November 4, 2014

Estée Lauder (ELC) realized years ago that there is more to China than Beijing, Shanghai and Hong Kong, and made sure to build a presence in smaller (though still big) cities in the world’s fastest growing luxury market. The beauty products company has a bricks-and-mortar presence in 90 cities in China now, something CEO Fabrizio Freda told Fortune in an interview will give it an edge over rivals and sustain its growth even as China as a whole is maturing as a market for high-end beauty products.

Still, the company, famous for brands ranging from M.A.C. to Lauder to La Mer, lowered its annual profit forecast on Tuesday and warned investors of slowing trends in China caused by a bunch of factors, such as a crackdown on corruption that has curbed gift giving, turmoil in Hong Kong and a drop in travel by the Chinese. Earlier this week, rival beauty company L’Oréal reported that global sales in its luxury unit rose 4.9% last quarter, slower than the 7.5% pace a quarter earlier, raising concerns that the China juggernaut is losing some steam.

Freda told Fortune why he thinks China, and Russia, which is facing its own issues, will long be important growth markets for Estée Lauder.

What is behind the slowdown in China sales?

“China is slowing down as a luxury market but is still growing very solidly as a luxury cosmetics market, I would like to clarify. The reason (China) growth has slowed down is first, because the affluent group of consumers in the high end and middle class has reached a certain level of saturation (in the biggest cities).”

“So the growth now comes mainly from the new consumers, while growth in consumption by the affluent consumer has normalized.”

What has been the impact of some of the Chinese government’s actions on luxury and the events in Hong Kong?

“This anti-corruption campaign in the last 12-18 months has reduced the amount of gifting in China of luxury goods, including to a lesser extent, prestige cosmetics. So the consumption for personal use remains very solid, but the gifting habit has decreased.”

“The political turmoil in Hong Kong has reduced the number of visas, particularly for short-term travel. The combination of this has reduced the number of Chinese traveling and, by extension, those exposed to luxury goods. Many of these people live in tertiary cities where luxury goods do not exist and can only buy them when they travel.”

Estée Lauder was one of the first Western brands to branch out in China beyond the five or so biggest cities and is now in 90 cities there—what impact is that having on your China growth?

“This was a very important move. When you go deep into populations and you go into cities which are very big but much less international and less exposed to the rest of the world, you become more local.” [Some 70% of the company’s online sales in China are from cities where this is no distribution yet, something Freda said bodes well for its expansion.]

“I still believe that the luxury cosmetics market in China will remain in the long term one of the most vibrant and interesting opportunities in our industry.”

You warned of the impact of sanctions on the Russian market—what are your prospects there?

“Russia is obviously a volatile market. But we are doing very well there because we have a diversified portfolio of products there and of retail partners.”

“Russia is softening because the economy is softening. But in the long-term, I still believe Russia will be a superlative market because women there are enthusiastic beauty consumers.”

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