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.

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