Blue Nile and Diamond Retailing

What are some key success factors in diamond retailing?

How do Blue Nile, Zales, and Tiffany compare on those dimensions?

Key drivers of customer purchases in diamond retailing include quality and range of products offered, reputation, professional advice offered, and customer perception and emotional bonds, including a positive buying experience and customer service. Success is also dependent upon obtaining economies of scale through such avenues as preferential access to resources, an effective supply chain and marketing strategy, as well as an ability to control facilities and operating costs and manage inventory effectively.

Blue Nile’s, Zales’, and Tiffany’s key success factors in dealing with customers are related to the characteristics of their individual target markets. Blue Nile, for example, offers high quality diamonds and fine jewelry online that are comparable to Tiffany’s but with markups that are lower than Tiffany’s and Zales’. Blue Nile, which was founded in 1999, focuses on customers who want good value and who prefer to shop conveniently from home and without incurring high pressure sales tactics.

They also provide customers with easy-to-understand jewelry education, as well as the ability to design custom jewelry. However, its customers must forego a hands-on purchasing experience as well as the instant delivery offered by Tiffany’s and Zales’ retail locations.

Tiffany, which opened in 1834, is an independent, specialty jeweler that offers premium-priced diamond rings, gemstone and fine jewelry, watches, and crystal and sterling silver serving pieces. Tiffany’s exclusivity and prestigious brand image, extensive service, and fashionable locations allow it to maintain and gain luxury market share domestically and globally.

In contrast, Zales, a specialty retailer of diamond fashion jewelry and diamond rings in the U.S. since 1924, has high name-brand recognition and appeal to value-conscious shoppers. Zales’ chain of retail venues for its middle-class target customers includes Zales Jewelers, Gordon’s, and Piercing Pagoda’s mall-based kiosks that appeal to teenagers. Zales offers more moderately priced and promotion-driven products compared to Blue Nile and Tiffany. It also competes with discounters such as Costco.

Economies of scale and sourcing are achieved differently by each company. Blue Nile has the most cost-effective business model because of exclusive supplier relationships that allow the online retailer to offer a manufacturer’s diamond inventory without purchasing it until needed. In addition to low warehouse and inventory costs, Blue Nile avoids the facilities investment expense and operating costs of the bricks-and-mortar retailers. U.S. retailer Zales is able to obtain economies of scale because of its large number of stores, but high inventory costs due to extreme changes in product offerings and marketing strategy in 2006-2007 confused its traditional customers and severely hurt its bottom line. Tiffany sustains high profit margins through its globally dispersed locations and online presence, established third- party sourcing as well as in-house manufacturing which provided 60 percent of its products, and by utilizing centralized inventory management to maintain tight control over its supply chain and reduce operational risk.

What do you think of the fact that Blue Nile carries over 30,000 stones priced at $2,500 or higher while almost 60 percent of the products sold from the Tiffany Website are priced at around $200?

Which of the two product categories is better suited to the strengths of the online channel?

Blue Nile is able to successfully offer diamonds priced up to $1 million or more online by emphasizing the large variety of certified high-quality stones available and a markup that is significantly lower than that of its store-front competitors. The main source of Blue Nile’s competitive advantage over traditional, store-based retail jewelers is that it has lower facilities cost and inventory expense. Only one central warehouse is needed to stock its entire inventory although outbound transportation costs are high because it provides customers free overnight shipping. Additionally, through exclusive supply relationships, the firm is allowed to display for sale the inventory of some of the world’s largest diamond manufacturers/wholesalers. Selling high-priced diamonds online works for Blue Nile because its competitive strategy is based on the priorities of its target market customers. These online customers want high-quality diamonds, but place strong emphasis on receiving good value for the cost and on product variety, are willing to wait for their jewelry, and often prefer to customize their purchases.

In comparison, Tiffany successfully uses a combination of over 180 exclusive worldwide retail stores and an online channel to benefit from the strengths of both channels. Approximately 48 percent of the company’s net sales come from products containing diamonds, with more than half of retail sales coming from high-end jewelry with an average sale price of over $3,000. Its online offerings, however, focus on non-gemstone, sterling silver jewelry with an average price of $200. The company offers a wide variety of these low demand items with high demand uncertainty, and they account for more than half of its online sales. Online sales are facilitated by Tiffany’s already-in-place centralized inventory management system, in-house manufacturing, and strong supply chain and information infrastructure. These lower-priced products increase the firm’s potential customer base and improve margins by reducing operating costs.

Tiffany’s sales of sterling silver jewelry priced around $200 are more suited for the strengths of the online channel than are Blue Nile’s thousands of stones priced at $2,500 and above. With the growing popularity of e-business, competition with Blue Nile’s sole business model is increasing. In addition, with its well-to-do but price-conscious customer base, the company is more affected by the effects on difficult economic times on purchasing behavior than is Tiffany with its less price-sensitive global customers who demand luxury goods at any price. Blue Nile is also more susceptible to the rising costs of diamonds and of labor because it does not purchase the majority of its diamonds until a customer decides on a purchase.

Given that Tiffany stores have thrived with their focus on selling high-end jewelry, what do you think of the failure of Zales with its upscale strategy in 2006?

Tiffany’s upscale strategy, affluent customer base, and business model evolved over a period of more than 100 years, and changes such as adding an online distribution channel were made gradually and as an extension of Tiffany’s current business practices. Zales, on the other hand, handled a strategic shift to upscale retailing within a time period of one year and failed drastically as shown by the following chain of events.

Feeling the pressure from discounters Wal-Mart and Costco, Zales decided to give up its long-time strategy of selling promotion-driven diamond fashion jewelry and diamond rings in order to pursue high-end customers. In this 2005 ambitious move to become more upscale, Zales invested heavily in higher-priced diamond and gold jewelry with higher margins and dumped its inventory of lower-value pieces. Led by an ambitious CEO, this new strategy initially sounded as if it would work. However, trying abruptly to undo an 81-year-old strategy and brand reputation for selling moderately-priced items was doomed to fail.

The company lost many of its traditional customers who were put off by the suddenly higher prices, and it did not win the new ones it had targeted. As a result, Zales abandoned its new strategy in 2006, hired a new CEO, and began transitioning a return to its traditional strategy of attracting the value-oriented customer. This change involved selling off nearly $50 million in discontinued upscale inventory and spending nearly $120 million on new moderately-priced inventory. The actions severely affected Zales’ bottom line for at least the next two years, not to mention alienating its middle-class customer base. The situation was further compounded by rising fuel prices and falling home prices in 2007 which caused a decrease in consumer discretionary spending.

What do you think of Tiffany’s decision to open smaller retail outlets, focusing on high-end products, to reach smaller affluent areas in the United States?

Opening small, fashionable retail outlets in smaller affluent cities is a good move for Tiffany. Doing so provides the company a quicker, more cost-effective way to expand its store base and its target-market reach in the United States. A smaller store format offers lower operating costs and a shorter payback period on capital investment, both of which help increase margins and returns. With it strong brand equity attracting well-to-do customers and with efficiencies in terms of a high¬¬-margin product mix, lower inventories are required, faster turnover results, sales per square foot are higher, and overall store productivity is increased.

Which of the three companies do you think was best structured to deal with the downturn in 2009?

Zales was most affected by the 2009 economic downturn in the U.S. which severely damaged the country’s retail jewelry industry. The Texas-based company, with retail stores located only in North America, was more vulnerable to adverse U.S. market conditions than the geographically-dispersed Tiffany and Blue Nile. The company was still trying to regain market share among its middle-class customers and handle merchandising issues in light of its failed strategy begun several years earlier to go upscale. Additionally, a new CEO in 2006 who began the company’s return to its traditional strategy based on diamond fashion jewelry and moderately-priced diamond rings, had not been able to restore the company to profitability.

Blue Nile, with its already low operating costs and small inventory holdings, was in a better position than Zales to weather the economic downtown. Because Blue Nile does not purchase the majority of its diamonds until a customer places an order, its bottom line was not as severely impacted by customers who began purchasing less expensive jewelry and by those who stopped buying completely because of strong price-sensitivity.

Before the downturn, the company had already increased its international Web site presence by launching sites in Canada and the United Kingdom and opened an office in Dublin. The Dublin office offered free shipping to several western European nations, while the U.S. office handled shipping to Asian-Pacific countries. In spite of the above, Blue Nile saw its first decline in sales in the third quarter of 2008.

Tiffany, as a jeweler and specialty retailer, was the best structured of the three companies to deal with the 2009 U.S. economic downtown. There is not as strong a correlation between its sales and consumer confidence levels as there is with Blue Nile’s customers. With over 100 stores in international markets, Tiffany’s operations are much more globally diversified than Blue Nile’s. In addition to its extensive global and domestic retail outlets, Tiffany also has the benefit of its e-business distribution channel and of catalog sales. With its strong business model and high margins on a broad range of offerings, tightly controlled supply chain, and the exceptional power of its brand image, Tiffany fared better than Zales and Blue Nile during the economic downturn.

What advice would you give to each of the three companies regarding their strategy and structure?

In light of the previous answers, I would recommend the following:

1. Zales needs to expand to markets in other than North America to lessen the severity of the effects of future economic downturns in the U.S. With its longstanding presence in the U.S. retail jewelry industry, it should also focus on reinforcing the value of its brand with consumers in its target market. Zales should increase its marketing efforts and continue to expand its e-commerce business. This will generate revenue and improve its margins by lowering operating costs.
2. Blue Nile should continue focusing on its low price for high-quality diamonds and on its unique online customer experience to further differentiate itself from Tiffany’s and other retail jewelry competitors. It definitely needs to expand its international presence by launching more country-specific Web sites, as well as continue enhancing its current Web site. Just as importantly, it needs to diversify its marketing efforts to online communities and to the public in general to increase its brand name recognition and appeal.
3. Tiffany should continue to increase its small-store formats in the U.S. and develop a stronger presence in its direct selling channel. It needs to grow its sizable international operations, particularly the fast-growing Asian luxury market, in addition to entering untapped emerging markets. With the increasing cost of diamonds and gold, it might assess the advisability of participating in sales promotions which it has never before done. Most importantly, Tiffany should continue increasing its supply chain efficiency and protecting its brand equity at call costs.