Sweet smell of succession

Every few months the two women gather in the CEO’s office to talk about their problems. Both of them–the glamorous, creative type with a fondness for A-list events and the shy, no-nonsense manager who spends her days marketing to soccer moms–get a chance to give the chief executive a piece of their mind. Sometimes they even bring in a moderator to keep the discussion flowing. There’s probably a plot for a bad reality show in this scenario; certainly it’s an unorthodox use of the CEO’s time. But when you’re family, you do what you have to do. And in the case of the Estée Lauder Cos., the giant of the prestige-cosmetics world, family is everything. So CEO William Lauder and his cousins Aerin Lauder Zinterhofer, who oversees the Estée Lauder brand’s image, and Jane Lauder, a vice president at a new division called BeautyBank, gather and clear the decks: What’s bothering them? What is working and what is not? The caution makes sense. Around the world the conventional wisdom is that they will fail. Not them, exactly, but their generation: the grandchildren of a legendary founder. The Italians say, “Dalle stalle, alle stelle, alle stalle”– “From the barn stalls, to the stars, back to the barn stalls.” In Yiddish it’s “Schmattes to schmattes in three generations,” or up from rags and back down. In Chinese, it is chilly and blunt: “Wealth does not pass three generations.” But Estée Lauder’s grandchildren are doing everything they can to make sure the proverbs won’t apply to them.

The world of cosmetics and fashion is watching closely to see if they can pull it off. In April 2004, Estée Lauder, the longtime undisputed queen of the cosmetics world, died at age 96. Three months later William became CEO, taking over a job that his father, Leonard, once held. The family business–the Lauders control 82% of the company’s voting shares–continues to dominate the high-end beauty industry, with hot brands such as Bobbi Brown in makeup and Aveda in hair care. Lauder captures almost a fifth of the $33 billion U.S. beauty market overall and roughly half of the $13 billion prestige business. But it faces daunting challenges and new challengers. Estée Lauder’s empire was built during the age of the great department stores, when the destination for the latest fashions and styles was Neiman Marcus, not Target. That era ended long ago. Yet about 40% of the company’s sales still come from mostly older customers at these one-time giants in the U.S. Meanwhile, Lauder is being pressured on the high end of the market by nimble, boutique beauty brands, and on the low end by giant manufacturers such as Procter & Gamble that are determined to erase the boundaries between prestige and mass market.

To make sure the company keeps its edge in the changing cosmetics landscape, the three Lauder cousins are taking on much more than family counseling. (The fourth cousin, William’s brother, Gary, 43, is a venture capitalist in Silicon Valley.) They could easily live off the $2.2 billion the family has taken out in stock offerings since the company’s 1995 IPO, or on the millions that each makes in dividends every year. Instead, they’re hunkered over spreadsheets, ad layouts, and store plans. And they’ve all carved out roles in the company that appear to fit their personalities perfectly.

Estée’s grandkids were long ago assigned their own one-dimensional identities by the media. When you grow up as royalty in New York high society, that’s bound to happen. Still, they don’t do much to dispel the images. As the eldest, William, 45, is the responsible one, setting the direction and overseeing details. Aerin, 35, is known as the pretty, outgoing one, but she’s far more than that. She recently took over directing everything from advertising to counter displays for the flagship–and stagnating–Estée Lauder brand and personally recruited superstar designer Tom Ford (who is, of course, a friend of hers) to bring it some sparkle, sex, and buzz. The press-wary Jane, 32, is seen as serious and hard-working. She’s also a canny problem solver. Mostly behind the scenes, she is leading the company’s charge into mid-tier markets that are crucial for growth.

Despite their different personal styles, the third-generation Lauders share an intense dedication to the family legacy. William, Aerin, and Jane all exude earnestness as if it’s the next big fragrance. A few years ago they got together and decided to make sure they were all on the same page about where they wanted to take the business. So they drew up a manifesto: “We are not a family business, we are a family in business.” While hardly the Gettysburg Address of corporate mission statements, the document made it clear that the good of the company would come first–and that those looking for a family brawl should probably look elsewhere. “My grandparents did such an incredible job building this company, and gave us so many advantages, that you want to be able to keep it going,” says Jane. “It’s hard to separate your life and your work because they’re all kind of the same thing. Maybe there should be more separation, but there isn’t.”

Estée Lauder’s world headquarters is on the 40th floor of the General Motors building, a soaring tower of white marble and glass at the southeast corner of New York City’s Central Park. Step off the elevator, and suddenly you’re in Lauderland. Spanning the floor are Chinese vases, blue wingback chairs, and crystal lamps and chandeliers. One wall holds a glass curio case filled with delicate plates, teacups, and porcelain figurines; another, a five-foot painting of the face of Estée herself.

Most striking of all is the sea of carpet: wall-to-wall, deep-pile, blue carpet. And it’s not just any blue, but Estée Lauder Blue, Pantone color 655. For a time in the mid-1940s, when Estée Lauder was just starting out, she carried a purse full of sample jars when visiting friends or fancy restaurants. After holding up a variety of different-colored containers for inspection in an array of powder rooms, she settled on a specific blue-green that, as she wrote in her autobiography, “whispered elegance, aristocracy, and also complemented bathroom wallpapers.”

Around the company, employees still use the tag line “that’s so Estée.”

Each day, William has to walk through this lobby, a relic of his grandmother’s era, to get to the hallways of the modern office beyond. “That expression about the first generation and the second generation and the third generation–I’m extraordinarily mindful of that,” William said in mid-August, the day before he was to announce Estée Lauder’s fiscal year-end numbers, a report card of sorts on how he did in his first full year as CEO.

William does not fit the bill of the stereotypical beauty-business executive. He’s a fireplug of a guy, more mid-career banker than metrosexual, and he speaks candidly, albeit in a manner that makes it seem as if he’s accessing a vast database of speeches each time he answers a question. “Something I’ve always felt was the inner thing that drives me is that I have to work twice as hard for half the credit, primarily because of who I am and why I am here. I would never be able to be successful if I perceived that to be successful in my job, I had to step into my father’s shoes. I am who I am.” He stops and lets a small smile cross his face. “To paraphrase Popeye, ‘I yam who I yam.'”

The next day he showed that he was someone who wouldn’t be bound by history. Estée Lauder stock jumped 9% as the company reported solid gains in annual sales (up 9%, to $6.3 billion) and profits (up 8%, to $406 million). What got Wall Street excited? William’s announcement that he doesn’t intend to simply maintain the family franchise. He’s looking at axing low-performing brands and searching for cost savings in what is a surprisingly low-margin business. (While it costs the company only $25 on average to buy the ingredients, create the bottles, and put together a $100 product, Estée Lauder shells out another $63 to advertise it in women’s magazines and promote it in stores. In the end, Lauder reports operating margins of just 11.4%.) For a company that has long been about spending whatever it takes to make its brands great, this is a radical change. “We can’t just say because we did it in the 1960s and ’70s this way, we will continue to do it in the 21st century,” he told analysts.

To get a firsthand look at the breadth of the Lauder beauty portfolio, walk into the tourist-packed ground floor of Saks Fifth Avenue in New York. Back near the elevators is the counter for the Estée Lauder brand. On a recent morning, it was empty. The crowds were thronging around some of the hipper, younger stands: MAC, Darphin, Michael Kors fragrance. That’s hardly a disaster: The Lauders own them all. In the mid-1990s, under Leonard, the company started on an acquisition and licensing binge that, by 2005, left it with 26 brands in four categories–cosmetics, skin care, fragrance, and hair care–ranging from the $1,200 moisturizing Crème de la Mer to the $12 Stila lipstick. For men with a sense of their own superiority, there’s even Donald Trump, the Fragrance.

Estée Lauder Cos. has beauty rivals that are much bigger: With $17 billion in sales, L’Oréal owns everything from Maybelline to Kiehl’s. And P&G, which sells mass-market favorites like Oil of Olay and CoverGirl, spends as much on research in a month as Estée Lauder does in two years. So far, though, no one has the kind of lock that Lauder does on the types of consumers who seem to be spending freely these days: the rich ones.

For their spring break in college, Leonard took his sons to Tokyo—to spend time meeting with retailers

Estée targeted the high-end market from day one. Or rather Josephine Esther Mentzer did. Esther, as she was called (she dreamed up the name Estée around the time she dreamed up her business), was born in 1907 to Eastern European Jewish immigrants in Corona, Queens. Her father owned a hardware store in a part of town known for its trash: Neighboring boroughs roped manure-filled barges to Corona’s dock, and the Brooklyn Ash Co. dumped so much burned refuse there that it changed the landscape. In The Great Gatsby, F. Scott Fitzgerald called Corona the “Valley of the Ashes.” In that environment, who wouldn’t dream of looking and smelling beautiful?

In high school Estée fell under the tutelage of an uncle who made facial creams in Manhattan. He agreed to let his niece peddle them, and she did so with a passion–in beauty salons, poolside at classy hotels on Long Island, and even while strolling down the street. The young Estée was not shy about stopping strangers, doing an instant makeover, and giving away samples–standard industry practice now but almost unheard-of then. After she married Joe Lauder in 1930, she started mixing her own creams, which put her in the vanguard of the burgeoning beauty industry.

Over the next few decades, Estée built the business by never letting anything stand in her way, including family. When she felt Joe was dragging her down, she divorced him and moved to Palm Beach. Three years later she remarried him and moved back to New York. (First son Leonard was born before the divorce; second son Ronald, who has been a Lauder exec and ambassador to Austria, after.) In 1948, two years after incorporating Estée Lauder Cosmetics, she badgered her way into a counter at Saks. To grow, she took her three-minute makeovers into stores across the country and made a point of touching every face she could, even if it meant running after prospective customers.

For all Estée’s marketing moxie, it was her decision to branch into fragrances that vaulted Lauder into the realm of larger rivals like Helena Rubenstein and Elizabeth Arden. The scent business was less than 1% of the $1 billion beauty market in 1950. Then she came up with Youth Dew, a product that was a bath oil and a fragrance, allowing women to put a little in their bath and smell of it the rest of the day. In a classic Estée move (around the company, employees still use the tag line “That’s so Estée”) she didn’t seal the bottles but used a stopper; a woman who pulled off the top to take a sniff wound up with the scent surrounding her no matter where she went.

When Leonard joined full-time in 1958, he identified a major problem with the company’s booming business: It had a serious case of Youth Dew dependency. Around 80% of the firm’s $800,000 in annual revenues were coming from the Youth Dew line. Leonard, who called his mother Mrs. Lauder at work, looked for a way to fix that. And the principle he decided to apply was born out of his own experience as a father of two boys: the power of sibling rivalry. Rather than look for a way to enter the mass market, Leonard decided to create a new high-end brand that would compete with Estée Lauder and, he hoped, capture its own slice of the prestige market. So in 1968, Leonard launched Clinique.

Aerin feels comfortable representing the company image. “I think I’m the link between the past and the present,” she says.

On a sunny afternoon in August I asked Leonard, 72, how he made sure the corporate siblings challenged but didn’t kill each other. We were sitting in the office he still keeps down the hall from William’s (Leonard’s is much bigger). And he was looking dapper–Leonard is always dapper–in a stiff, blue, button-down shirt with a white collar that appeared to have been pressed minutes before. “Through a lot of hard work. That’s all I can say,” he answers. Then he arches his eyebrows and glances at my hand. “I see that you’re married. Do you have children?” One, I reply. “Wait till you have two, okay? Then you won’t ask me that question.”

Over time Leonard’s paternalistic streak came to define the culture as much as his mother’s drive to touch every customer. While the brands were expected to compete hard, they were also expected to exist harmoniously. Workers who do well still get “blue notes” from Leonard: hand-written comments, frequently signed with smiley faces, on paper from his Lauder-blue notepad. When Lauderites leave, senior management often waves them goodbye with a smile. One employee told me that when she quit, the parting words from her bosses were: “See you soon.” And, indeed, she came back.

If work was supposed to feel like family, family time often felt like work. Leonard and Evelyn, who still oversees fragrance development at Lauder, regularly grilled William and Gary about business at the dinner table. In the early 1980s, Leonard even took the boys to Tokyo for their spring break from college–to spend time meeting with retailers. When William said he was ready to follow in his father’s footsteps, Leonard set two conditions: First, he had to work for someone else. Second, he had to learn a foreign language. William did both, studying French and putting in three years at Macy’s before joining the company permanently in 1986.

By the early 1990s, the beauty retail universe was changing. Women were seeking out smaller, more personal brands instead of simply going with Estée Lauder or Clinique. So Leonard started a buying binge, amassing smaller players and letting them operate mostly as they had. He also expanded the company’s culture of sibling rivalry. When, for example, he bought MAC, he also bought one of its rivals, Bobbi Brown, figuring the two would push each other. That approach helped Estée Lauder grow sales from $2.6 billion in 1994 to $4 billion by 1999, when Leonard stepped down after 17 years as CEO and handed over power to longtime right-hand man Fred Langhammer.

“When you live in the shadow of a big tree, you have to run twice as fast to get into the sunlight.” That’s how Leonard, speaking to the New York Times in 1987, summed up the pressure of building his own reputation. But if Leonard was shadowed by one big tree, William–who everyone assumed would one day take the top job–was under two.

Anyone who doubted that William could find his own place in the sun only had to check out one of the odder brands at Estée Lauder: Origins. At a company that has always prized itself on being fashion-forward, the brand’s bath and body products are all about Mother Nature. While the Estée Lauder brand employs pop culture stars such as Gwyneth Paltrow as spokesmodels, and the edgier MAC uses rapper Missy Elliott, Origins links itself to health guru Dr. Andrew Weil, who looks like a bald Santa Claus. Most important, Origins is the only Lauder brand that gets a big chunk of its sales from freestanding stores.

William, Aerin, and Jane all exude earnestness as if it’s the next big fragrance.

Origins is William’s baby. His dad was dead set against its retail strategy. But in 1990, William, then the head of the upstart division, decided he was sick of watching brands like Ralph Lauren manage to sell both in department stores and at their own standalone outlets. He thought Estée Lauder’s brands could do the same and started pressing his father–who was resistant to antagonizing his department store peers–to make the change. “There’s a consumer out there,” he argued, “who would rather shop in our four-walls environment than in the department store world.” William didn’t just stop with Origins. He pressed his father for standalone Estée Lauder brand stores, launched online sales, and as CEO has continued to move beyond department stores. The company now has 518 freestanding stores.

William has also pushed to soften the company’s sibling-rivalry environment. Rather than keep the personnel in each division discrete, he demands that managers move between brands and learn from one another. Speaking to a group of product-development execs in late July, he let them know that he expected the thawing to continue: “We’ve tried over the last few years to create a spirit of collaboration amongst you so that you’re not looking at, say, Clinique as a mortal enemy, but as a partner with whom we can both attack the mortal enemy–who are the French guys.”

Jane could be the next CEO after William. “She’s got the smarts and tenacity,” says someone close to the company.

I have seen the future, and it is sun-drenched. I know that because next spring Estée Lauder will be giving away some five million kiwi, raspberry, and light-denim-blue little purses to those who buy certain Estée Lauder brand products. The idea for the colors came from Aerin and her team, who spend a lot of time meeting with trend specialists and at fashion shows; the idea for the bags came from Estée, who pioneered Gift With Purchase, now an omnipresent staple of cosmetics marketing.

In certain ways Aerin is the truest descendant of her grandmother. Estée willed herself up from the Valley of Ashes and onto the society pages with the New York elite–and Aerin is right at home there. Blessed with the looks and poise of a model, she’s been called one of the most beautiful people in the city by New York magazine, name-checked in the bestselling The Devil Wears Prada, and profiled (at just 24) in Vogue. When she’s walking down the street or getting a manicure at Bergdorf Goodman, she’s often approached by strangers asking her opinion on makeup. And she thrives on it.

Today she’s at a photo shoot at Manhattan’s Chelsea Piers, wearing tight Levi’s and open-toed, Christian Louboutin shoes and riffing almost jazzlike on the look she’s trying to create. She has given a stylist detailed instructions for how to outfit spokesmodel Carolyn Murphy for a July 4, 2006, promotion: “We said we wanted it to be casual. Spring. Fashion. Comfortable. Approachable. Directional. If you notice, it’s more casual. Real. Smiling. A headband. Great straw hat. A white oxford, white shirt. Everyone has a white shirt in their closet. It’s really making sure we relate to the customer at all levels.”

Aerin could easily be working on one of the hipper brands in the Lauder portfolio, the kind that don’t need to lure customers with giveaways. Instead she’s decided to put her energy into making Estée Lauder, the brand that started it all, relevant to a new generation. The brand isn’t exactly dying. It’s still the third-biggest in prestige cosmetics after Clinique and L’Oréal’s Lancôme, but the market has grown, and the extra dollars are going either to new players or to Lauder’s younger brands. “There’s no sex appeal in Estée Lauder; the brand has become all about the research,” says Brent Smith, a former Estée Lauder executive who now runs a brand-consulting firm in Los Angeles. “You have to do that for skin care–the end goal is to look younger–but people still want to believe that by using the products they’re going to look sexier, to have better sex, and have more sex.”

For the Lauders, reviving their grandmother’s flagship brand is a personal quest as well as a professional one. But it’s going to take more than just correctly colored swag. Aerin’s social calendar–long packed with swank fundraisers and charity events–is an asset. Her biggest coup so far: bringing in superstar Tom Ford. As creative director at Gucci, he turned the tarnished brand into a must-have, driving sales from $264 million in 1994 to $3.2 billion in 2004. When he left last year he began plotting his own fashion brand. Aerin and Ford knew each other from parties and events over the years. So when a friend of a friend told her that Ford had started talking to another cosmetics company about a beauty line, she swooped in. “I said before he gets anything, he should really talk to people at Estée Lauder, because we are the best of the best, and we’ll give him good advice,” she says. “And as a friend, I kind of owe that to him.”

Those talks turned into a partnership. Lauder agreed to license Ford’s name and give him complete creative control over a standalone beauty line called Tom Ford. The Lauders also asked him to look for ways to bring new life to the Estée Lauder brand. So with Aerin and her boss, John Dempsey, the executive who made MAC into a hit for Lauder, Ford started combing through the archives. They looked through old ads, checking to see what images Estée herself had used. To their surprise, the original image used to sell Youth Dew–a peek at a nude woman about to enter her bath–was quite risqué. Ford declared that he wanted to relaunch the scent.

In mid-November, Youth Dew Amber Nude will debut under a line of products called Tom Ford Estée Lauder Collection. The rest of the 11-piece collection features similar updates to Estée’s original products. And in a return to the days before the brand became terminally wholesome, the mockup ad I saw featured a nearly nude Carolyn Murphy in an alluring recline, staring right into the camera. “Estée herself said this was an incredibly sexy fragrance,” says Ford. “The heritage of nudity is part of Youth Dew. It’s not just that I like naked women.”

Aerin loves the ad. “That, to me, is modern Estée Lauder,” she says. “It’s unexpected but still glamorous and elegant. I think Estée Lauder”–and here she’s talking about her grandmother–“would have been very excited about that shot.”

Tom Ford is certainly generating buzz for Estée Lauder, but few think that alone will be enough to get the brand growing again. Some retailers see Aerin herself as the key to boosting the brand’s profile. “What Estée once did in her era, Aerin has the potential to do with a younger generation,” says Terry Lundgren, CEO of the company’s biggest customer, Federated Department Stores. “What you’re seeing in our business is that celebrity names allow a product to get a close look from consumers. Aerin has wonderful relationships with the fashion celebrities. She knows them, she’s connected to them, and she speaks their language.”

Aerin is getting more comfortable with that idea. “That’s something I’m going to do more of,” she says. “But I also think it’s very modern to be behind-the-scenes, to be very involved with the day-in and day-out running of this department. I think I can do both. I think I’m the link between the past and the present.” And she’s pretty happy just being that. When I ask her if she’d ever want to hold William’s job, she turns to a press person and says, “Is it okay for me to say no?”

“We’re going to use this visit for a couple of days now, telling customers, ‘Jane Lauder was here!'” says Carol Carroll, the beauty manager at Kohl’s Department Stores in Wayne, N.J. Jane, shifting uncomfortably as Carroll effuses over her, has come here to survey the result of Estée Lauder’s second major attempt to go downmarket.

The odds are against the Lauders in the future. Only 20% of family businesses survive longer than 60 years.

While Aerin attacks the high end of the cosmetic market and makes herself ever more visible, Jane is attempting to connect with the mass consumer while maintaining something like anonymity. She is wholly uninterested in publicity. When she got married three years ago, she turned down all attempts by the press to cover the wedding. “People kept calling and saying, ‘Well, at least give us a picture of you in your wedding dress,'” she says. “I felt like, ‘That’s private.'” That is so not Estée.

Neither, until now, were mass-channel sales. The first time Lauder tried to leave its upper-class clique was when it bought a teen cosmetics line called, coincidentally, Jane, in 1997. The company’s skills were no help, however, in a market dominated by much larger players. In 2004, Lauder sold Jane at a loss. William didn’t give up: Instead of trying to take on P&G, Unilever, and L’Oréal on their own turf, he built a new playing field. While still COO back in 2003, he started talking to Kohl’s, a fast-growing chain of 670 stores catering to middle-market, thirtysomething moms who are pressed for time. The chain had no cosmetics department. William didn’t want to just put his products in Kohl’s, he wanted to create–and rule–its beauty business.

The result is what Lauder internally calls BeautyBank, a collection of four new brands that, for now, are sold only in Kohl’s. There’s no easy way to identify the brands as Estée Lauder products. But each seems to be a doppelgänger of the company’s existing brands (though Lauder bristles at the assertion). There’s the wholesome, Estée Lauder–like brand American Beauty, with Ashley Judd as spokesmodel; Flirt, which, like MAC or Bobbi Brown, is targeted toward women who want to play with colors and want attitude in their cosmetics; Good Skin, a Rodan & Fields type of skin-care line with the de rigueur dermatologist endorsement; and Grassroots, a line of lotions, shampoos (for both pets and people), and bodywashes that mimics the “natural” appeal of Origins. Unlike in drugstores, however, there are plenty of open products to test, and a trained beautician–such as Carol Carroll–is always around to apply the Estée touch.

Jane heads two of the brands: Flirt and American Beauty. While William talks in full speeches and Aerin in a breezy riff, Jane is more reserved, punctuating her thoughts with “you knows” and nervous laughter. Just about everyone comments on her work ethic: in early, no lunch, and addicted to her BlackBerry. Like the rest of the folks at BeautyBank, she works out of a cubicle in an office a block from the headquarters.

If she can nail BeautyBank, it’ll be another indication that–as some company watchers have posited–she could be next in line after William. “She’s got the smarts and tenacity, and I think she can develop the business savvy and experience,” says someone close to the company. “But it’s a 15- to 20-year time frame.” Until then, Jane will only say that–unlike her sister–she’s not ruling out the possibility that she’ll want the job. Still, she’s not thinking about it yet. “There are so many things we can do to grow this company. You know, Aerin is doing a fantastic job with bringing a younger generation to Estée Lauder, revitalizing it, bringing a new spirit to it. Hopefully, I can build new relationships and grow this side of the business. That’s what we’re all focused on now. The future? We’ll see what happens.”

The odds are against the business’s staying in Lauder hands. Today large, public, generation- spanning businesses like Estée Lauder are rare birds: Of the FORTUNE 1,000, only 79 are true family companies, controlled by family members descended from the company’s founder, according to recent research by John L. Ward, a professor at Northwestern University’s Kellogg School of Business. And only 20% of family businesses last beyond 60 years. But then, the odds were never in Estée’s favor to begin with. Who would have thought a young woman from Corona could have climbed so far and created so much?

Estée, it appears, had a premonition that her family would be able to buck the odds. In her autobiography, she rattles off the fates of her onetime rivals. By then, Charles Revson’s Revlon, Elizabeth Arden, and Helena Rubenstein had all been taken out of family hands. “The personal love and involvement are gone,” she wrote. “They’re companies now, not a family’s heart and soul. It won’t happen to Estée Lauder.”

A few weeks ago, Aerin was leaving for work when her preschool-age son started crying and asking her why she had to go. She explained that she loved what she did, and she told him about his history. “I said, ‘Estée worked so hard for what she created, and it’s really important to continue that and make her proud and happy and to be happy with what you do and to continue that tradition.’ And I said, ‘I hope when you get older, whatever you do, you’ll do it well and with passion.'” That may seem heavy for a mere tyke. But at Estée Lauder, the family is serious business.