Staff Writer: Judith Graham (4/4/00)

Estee Lauder (NYSE: EL - Quotes, News, Boards)has long been a category killer, but it may need an Internet upgrade to maintain its dominance.

Lauder controls 56% of the prestige color and skin treatment market, and with profits growing at a 28% average annual clip over the past five years, the company�s shares have been handsomely rewarded. Trading at around $50, or nearly 42 times consensus estimates for the current fiscal year, which ends in June, the stock is priced like a hot growth company.

But after rising impressively in 1998 and early1999, Estee Lauder�s shares have been trading in narrow band of between $40 and $50 per share for the past 12 months. Lauder is expected to grow earnings by 16.5% this year to $1.20 per share and another 15% to $1.38 in 2001.

Not too shabby but not enough to support its huge multiple. Why the high expectations? The Internet.

Analysts and market watchers are hoping the �Net will boost Estee Lauder�s current growth rate. But, like many old-line manufacturers, the company is resisting the urge to peddle its products online. Its worries: Jeopardizing relationships with distributors, price erosion, less control of distribution, and diluting brand equity.

Lauder hasn�t ignored the web altogether � it sells some goods on its own sites, such as Clinique and Origins, and an Estee Lauder brand site is scheduled for roll out later this year.

But the longer companies like Lauder delay wider distribution on the web, the more they miss out on the opportunity to fatten profits and tap into new revenue streams. It goes without saying that e-commerce is hot. Jupiter Communications expects online commerce to reach $41 billion in 2002, up from $7 billion in 1998.

Unlike brick-and-mortar store operations, cosmetics companies like Lauder have typically relied on middlemen to distribute their products. But as Lauder demonstrates, the rules don�t always apply evenly across all channels. The company currently won�t allow third party sites to distribute its brands on the web. The reason: preservation of brand equity.

The company, which sells exclusively to higher-end retailers, doesn�t want to risk tarnishing its image by relinquishing control of distribution. By selling through a third party beauty site like Beauty.com, Lauder believes it risks having its brands placed alongside lower-end brands, which might detract from its prestige.

But Michael Drapkin of Drapkin Technology, a technology and management-consulting firm, points out that retail success in the new Internet economy is about more than brand strength. �Just having a great brand name does not guarantee success,� Drapkin says. �The bottom line is if you do nothing, you can only coast downhill.�

At Women�s Wear Daily�s Beauty CEO Summit in January, Estee Lauder chairman Leonard Lauder chocked up the company�s qualms about broader web participation to channel conflicts, citing concern for its relationships with major retail partners. Lauder management has also said it has no plans to sell to Internet pure-plays.

But in the end, it really comes down to whether prestige brands like Estee Lauder can afford not to sell through third parties. As business ramps up for the Beauty.coms, the allure of online profits could ultimately outweigh the fear that the web will tarnish brand image.

In a recent Harvard Business Review article, Nicholas Carr points out that manufacturers have not been big winners when it comes to e-tailing. Consumers want a broad selection of goods when they go shopping, not just one brand or product line.