102 Chapter 4 • Designing Distribution Networks and Applications to Online Sales

Kalyanam, Kirthi , and Ward Hanson. Internet Marketing and Salcedo, Simon, and Ann Grackin. “The e-Value Chain.” Supply
e-Commerce. Cincinnati, OH: South-Western Publishing, 2007. Chain Management Review (Winter 2000): 63–70.
Lee, Hau L., and Seungjin Whang. “Winning the Last Mile of Willcocks, Leslie P., and Robert Plant. “Pathways to e-Business
e-Commerce.” Sloan Management Review (Summer 2001): Leadership: Getting from Bricks to Clicks.” Sloan
54–62. Management Review (Spring 2001): 50–59.
Olavson, Thomas, Hau Lee, and Gavin DeNyse. “A Portfolio Shapiro, Carl, and Hal R. Varian. Information Rules: A Strategic
Approach to Supply Chain Design.” Supply Chain Guide to the Network Economy. Boston: Harvard Business
Management Review (July–August 2010): 20–27. School Press, 1999.
Poirier, Charles C. “The Convergence of Business & Technology.” “The e-Enabled Supply Chain.” Global Supplement, Supply Chain
Supply Chain Management Review (Fall 1999): 52–58. Management Review (Fall 1999).
Raman, Ananth, and Bharat P. Rao. A Tale of Two Electronic Turban, Efraim, Jae Lee, David King, and H. Michael Chung.
Component Suppliers. Harvard Business School Case Electronic Commerce: A Managerial Perspective. Upper
9–697–064, 1997. Saddle River, NJ: Prentice Hall, 2000.
Ricker, Fred R., and Ravi Kalakota. “Order Fulfillment: The
Hidden Key to e-Commerce Success.” Supply Chain
Management Review (Fall 1999): 60–70.

CASE STUDY
Blue Nile and Diamond Retailing1
A customer walks into your jewelry store with printouts The Diamond Retailing Industry in 2008
of diamond selections from Blue Nile, a company that is
the largest retailer of diamonds online. The list price for For both wholesalers and retailers in the diamond
the customer’s desired diamond is only $100 above your industry, 2008 was turning into a very difficult year. It
total cost for a stone of the same characteristics. Do you was so bad at the supply end that the dealers’ trade
let the customer walk or come down in price to association, the World Federation of Diamond Bourses,
compete?2 issued an appeal for the diamond producers to reduce
This is a dilemma that has faced many jewelers. the supply of new gems entering the market in an effort
Some argue that jewelers should lower prices on stones to reduce supply.
to keep the customer. Future sales and add-on sales such However, the world’s largest producer, De Beers,
as custom designs, mountings, and repairs can then be appeared unmoved, refusing to give any commitment to
used to make additional margins. Others argue that curtail production. The company had recently opened
cutting prices to compete sends a negative signal to loyal the Voorspoed mine in South Africa, which, when fully
customers from the past who may be upset by the fact operational, could add 800,000 carats a year into an
that they were not given the best price. already oversupplied market. Historically, De Beers had
As the economy tightened during the holiday exerted tremendous control over the supply of dia-
season of 2007, the differences in performance monds, going so far as to purchase large quantities of
between Blue Nile and bricks-and-mortar retailers rough diamonds from other producers. In 2005, the
were startling. In January 2008, Blue Nile reported a European Commission forced De Beers to phase out its
24 percent jump in sales during its fourth quarter. agreement to buy diamonds from ALROSA, the world’s
For the same quarter, Tiffany posted a 2 percent drop in second largest diamond producer, which accounted for
domestic same-store sales, and Zales reported a 9 percent most of the diamond production in Russia. Russia was
drop. The chief operating officer of Blue Nile, Diane the second largest producer of diamonds in the world
Irvine, stated, “This business is all about taking market after Botswana.
share. We look at this type of environment as one of While discount retailers such as Wal-Mart and
opportunity.” Costco continued to thrive, the situation was difficult

1
This case was written jointly with Professor Roby Thomas of Elmhurst College.
2
Stacey King, “The Internet: Retailers’ New Challenge,” Professional Jeweller Magazine, August 1999.
 Chapter 4 • Designing Distribution Networks and Applications to Online Sales 103

for traditional jewelry retailers. Friedman’s filed for Customers selected the stone of their choice, followed
Chapter 11 bankruptcy protection in January 2008, by the setting they liked best. Blue Nile also allowed
followed by Chicago-based Whitehall in June. When it customers to have their questions resolved on the
filed for bankruptcy, Friedman was the third largest phone by sales reps who did not work on commission.
jewelry chain in North America with 455 stores, while This low-pressure selling approach had great appeal to
Whitehall ranked fifth with 375 stores in April 2008. In a segment of the population. In a BusinessWeek
February 2008, Zales announced a plan to close more than article 3 in 2008, Web entrepreneur Jason Calacanis
100 stores in 2008. This shakeup offered an opportunity was quoted as saying that shopping for his engage-
for other players to move in and try to gain market share. ment ring (for which he spent “tens of thousands of
With the weakening economy, the third and fourth dollars”) on Blue Nile “was the best shopping experi-
quarters of 2008 were particularly hard on diamond ence he never had.”
retailers. Even historically successful players like Blue The company focused on providing good value to
Nile, Tiffany, and Zales saw a decline in sales and a its customers. Whereas retail jewelers routinely marked
significant drop in their share price. As customers up diamonds by up to 50 percent, Blue Nile kept a lower
tightened their belts and cut back on discretionary markup of 20 to 30 percent. Blue Nile believed that it
spending, high-cost purchases such as diamond jewelry could afford the lower markup because of lower invento-
were often the first to be postponed. The situation ry and warehousing expense. Unlike jewelry retailers
worsened as competition for the shrinking number of who maintained stores in high-priced areas, Blue Nile
customers became fiercer. In such a difficult environ- had a single warehouse in the United States where it
ment, it was hard to judge which factors could best help stocked its entire inventory.
different jewelry retailers succeed. The company strategy was not without hurdles be-
cause some customers did not care as much about under-
pricing the competition. For example, some customers
Blue Nile
preferred “a piece of fine jewelry in a robin’s egg blue
In December 1998, Mark Vadon, a young consultant, box with Tiffany on it”4 to getting a price discount.
was shopping for an engagement ring and stumbled Also, it was not entirely clear that customers would be
across a company called Internet Diamonds, run by willing to spend thousands of dollars on an item they
Seattle jeweler Doug Williams. Vadon not only bought had not seen or touched. To counter this issue, Blue Nile
a ring but also went into business with Williams in offered a 30-day money back guarantee on items in orig-
early 1999. The company changed its name to Blue inal condition.
Nile by the end of 1999 because the new name “sound- In 2007, the company launched Web sites in
ed elegant and upscale,” according to Vadon. Canada and the United Kingdom and opened an office in
On its Web site, Blue Nile articulated its philoso- Dublin with local customer service and fulfillment oper-
phy as follows: “Offer high-quality diamonds and fine ations. The Dublin office offered free shipping to several
jewelry at outstanding prices. When you visit our Web countries in Western Europe. The U.S. facility handled
site, you’ll find extraordinary jewelry, useful guidance, international shipping to some countries in the Asia-
and easy-to-understand jewelry education that’s perfect Pacific region. International sales had increased from
for your occasion.” $17 million in 2007 to more than $33 million in 2009
Many customers (especially men) liked the low- despite poor economic conditions.
pressure selling tactics that focused on education. By 2007, Blue Nile had sold more than 70,000
Besides explaining the four Cs—cut, color, clarity, and rings larger than a carat with 25 orders totaling more
carat—Blue Nile allowed customers to “build your than $100,000. In June 2007, the company sold a sin-
own ring.” Starting with the cut they preferred, cus- gle diamond for $1.5 million. Forbes called it perhaps
tomers could determine ranges along each of the four “the largest consumer purchase in Web history—and
Cs and price. Blue Nile then displayed all stones in also the most unlikely.” 5 The stone, larger than 10
inventory that fit the customer’s desired profile. carats, had a diameter roughly the size of a penny.

3
Jay Greene, “Blue Nile: No Diamond in the Rough,” BusinessWeek e.biz, May 2000.
4
King, “The Internet: Retailers’ New Challenge.”
5
Victoria Murphy Barret, “The Digital Diamond District,” Forbes.com, October 2007.
(Continued)
104 Chapter 4 • Designing Distribution Networks and Applications to Online Sales

(Continued)
Blue Nile did not have the stone in inventory, but its competitive position”; however, 2008 turned out to be a
network of suppliers quickly located one on a plane challenging year with net sales dropping by just under 10
en route from a dealer in New York to a retailer in percent and operating income falling by more than 25
Italy. The stone was rerouted to Blue Nile headquar- percent. In 2009, however, both sales and income had
ters in Seattle and transported in a Brinks armored improved for Blue Nile (see Table 4-14).
carrier to the buyer. The whole process took only
three days!
Zales
In November 2008, Blue Nile offered more than
75,000 diamonds on its site. Of these diamonds, more The first Zales Jewelers was established by Morris (M. B.)
than 30,000 were one carat or larger with prices up to Zale, William Zale, and Ben Lipshy in 1924. Their mar-
$1.9 million. Almost 43,000 diamonds on the Blue keting strategy was to offer a credit plan of “a penny down
Nile Web site were priced higher than $2,500. In 2010, and a dollar a week.” Their success allowed them to grow
the company CEO Diane Irvine was quoted saying to 12 stores in Oklahoma and Texas by 1941. Over the next
“We’re not positioned as a discounter. We are selling a four decades, the company grew to hundreds of stores by
very high-end product but selling it for much less.” buying up other stores and smaller chains.
In 2007, the company had sales of almost $320 In 1986, the company was purchased in a lever-
million with a net income of more than $22 million. By aged buyout by Peoples Jewelers of Canada and
November 17, 2008, however, its stock had fallen from a Swarovski International. In 1992, its debt pushed Zales
high of more than $100 in October 2007 to less than $23. into Chapter 11 bankruptcy for a year. It became a pub-
In the third quarter of 2008, the company saw its first lic company again in that decade and operated nearly
decline in sales with its reported sales of $65.4 million 2,400 stores by 2005. The company’s divisions included
being 2.9 percent less than the same quarter in 2007. In Piercing Pagoda, which ran mall-based kiosks selling
an upbeat announcement, the company stated, “Blue Nile jewelry to teenagers; Zales Jewelers, which sold dia-
is well positioned to generate profitability and cash flow mond jewelry for working-class mall shoppers; and the
even in difficult market conditions. We remain confident upscale Gordon’s. Bailey Banks & Biddle Fine Jewelers,
in our ability to continue to gain market share and to which offered even pricier products out of fancier malls,
emerge from this economic downturn in an even stronger was sold by Zale in November 2007.

Table 4-14 Select Financial Data for Blue Nile,

Inc. (in thousands of dollars)
2008 2009
Net sales 295,329 302,134
Cost of sales 235,333 236,790
Gross profit 59,996 65,344
Selling, general, and administrative 44,005 45,997
expenses
Operating income 15,991 19,347
Current Assets
Cash and cash equivalents 54,451 78,149
Trade accounts receivable 984 1,594
Other accounts receivable 725 241
Inventories 18,834 19,434
Total current assets 76,733 115,844
Property and equipment, net 7,558 7,332
Other assets 89 145
Total assets 89,665 130,415
 Chapter 4 • Designing Distribution Networks and Applications to Online Sales 105

Three years of declining market share, lost mostly ending July 31, 2007, but same-store sales fell by 0.5
to discounters such as Wal-Mart and Costco, put pressure percent. In February 2008, the company announced a
on Zales to decide on a makeover by 2005. Zales dumped plan to close approximately 105 stores, reduce inventory
the lower value 10-karat gold jewelry and modest quality by $100 million, and reduce staff in company headquar-
diamonds. The goal was to make the jeweler more ters by about 20 percent. The goal of this plan was to
upscale and fashion conscious, moving away from its enhance the company’s profitability and improve its
promotion-driven, lower end reputation. Unfortunately, overall effectiveness. However, the company lost more
the move was a disaster. There were delays in bringing in than $200 million in 2008 (Table 4-15).
new merchandise, and same-store sales dropped. The
company lost many of its traditional customers without
Tiffany
winning the new ones it desired. It was soon passed by
Akron, Ohio–based Sterling (a subsidiary of the Signet Tiffany opened in 1837 as a stationery and fancy goods
Group) as the largest jeweler in the United States. The emporium in New York City. It published its first catalog
chief executive officer of Zale Corporation was forced to in 1845. The company enjoyed tremendous success,
resign by early 2006. with its silver designs in particular becoming popular all
In August 2006, under a new CEO, Zales started a over the world. In 1886, Tiffany introduced its now
transition to return to its role as a promotional retailer famous “Tiffany setting” for solitaire engagement rings.
focused on diamond fashion jewelry and diamond rings. The Tiffany brand was so strong that it helped set
The transition involved selling nearly $50 million in diamond and platinum purity standards used all over the
discontinued inventory from its upscale strategy and an world. In 1950, Truman Capote published his best seller
expenditure of $120 million on new inventory. As a Breakfast at Tiffany’s, which was released as a success-
result of the inventory write-downs, Zales lost $26.4 ful film in 1961. After more than a century of tremen-
million in its quarter ending July 31, 2006. dous success with its jewelry and other products, the
The company had some success with its new strat- company went public in 1987.
egy but was hurt by the rise in fuel prices and falling Tiffany’s high-end products included diamond rings,
home prices in 2007 that made its middle-class cus- wedding bands, gemstone jewelry, and gemstone bands
tomers feel less secure. Its core customers hesitated to with diamonds as the primary gemstone. The company
buy jewelry as they battled higher prices for food and also sold non-gemstone, gold, platinum, and sterling silver
fuel. Zales reported a profit of $1.5 million in the quarter jewelry. Other products included watches and high-end

Table 4-15 Select Financial Data for Zale Corporation

(in thousands of dollars)
July 2008 July 2009
Revenues 2,138,041 1,779,744
Cost of sales 1,089,553 948,572
Selling, general, and
administrative expenses 969,769 934,249
Operating earnings 7,172 (208,964)
Current Assets
Cash and cash equivalents 61,342 24,987
Other current assets 106,340 51,973
Inventories 799,181 740,257
Total current assets 966,863 817,217
Property and equipment, net 297,887 238,138
Other assets 35,946 29,480
Total assets 1,415,260 1,230,972
(Continued)
106 Chapter 4 • Designing Distribution Networks and Applications to Online Sales

(Continued)
items for the home such as crystal and sterling silver manufacturing facilities. Tiffany had a retail service
serving trays. Besides its own designs, Tiffany also sold center in New Jersey that focused on receiving product
jewelry designed by Elsa Peretti, Paloma Picasso, the late from all over the world and replenishing its retail
Jean Schlumberger, and architect Frank Gehry. stores. The company had a separate customer fulfill-
By 2010, Tiffany had 220 stores and boutiques all ment center for processing direct-to-customer orders.
over the world with about 80 of them in the United Until 2003, the company did not purchase any
States. Of its global outlets, Tiffany had more than 50 in rough diamonds, focusing entirely on the purchase of
Japan and almost 45 in the rest of the Asia-Pacific region. polished stones. Since then, the company established dia-
Stores ranged from 1,300 to 18,000 square feet with an mond-processing operations in Canada, South Africa,
average of 7,100 square feet. Its flagship store in New Botswana, Namibia, Belgium, China, and Vietnam. In
York contributed about 10 percent of the company’s sales 2007, approximately 40 percent of the diamonds used by
in 2007. Besides retail outlets, Tiffany also sold products Tiffany were produced from rough diamonds purchased
though a Web site and catalogs. The company, however, by the company. Not all rough diamonds could be cut and
did not offer any engagement jewelry through its Web polished to the quality standards of Tiffany. Diamonds
site as of 2010. Its high-end products, including jewelry, that failed to meet Tiffany’s standards were then sold to
were sold primarily through the retail stores. The direct third parties at market price, sometimes at a loss.
channel focused on what Tiffany referred to as “D” In 2007, 86 percent of Tiffany’s net sales came
items, which consisted primarily of non-gemstone, from jewelry, with approximately 48 percent of net
sterling silver jewelry with an average price of $200 in sales coming from products containing diamonds of
2007. Category D sales represented about 58 percent of various sizes.6 Products containing one or more dia-
total sales for the direct channel. In contrast, more than monds of one carat or larger accounted for more than 10
half the retail sales came from high-end products such as percent of net sales in 2007. Select financial details of
diamond rings and gemstone jewelry with an average Tiffany’s performance over this period are shown in
sale price in 2007 higher than $3,000. Table 4-16.
Tiffany maintained its own manufacturing facili- The Tiffany brand’s association with quality, lux-
ties in Rhode Island and New York but also continued ury, and exclusivity was an important part of its suc-
to source from third parties. In 2007, the company cess. No other diamond and jewelry retailer enjoyed
sourced almost 60 percent of its jewelry from internal margins anywhere near those enjoyed by Tiffany. In its

Table 4-16 Select Financial Data for Tiffany & Co.

(in thousands of dollars)
2008 2009
Net sales 2,848,859 2,709,704
Cost of sales 1,202,417 1,179,485
Gross profit 1,646,442 1,530,219
Selling, general, and administrative expenses 1,153,944 1,080,727
Operating income 394,659 440,492
Current Assets
Cash and cash equivalents 160,445 785,702
Trade accounts receivable 164,447 158,706
Inventories 1,601,236 1,427,855
Total current assets 2,048,734 2,445,666
Property and equipment, net 741,048 685,101
Other assets 145,984 173,768
Total assets 3,102,283 3,488,360

6
Tiffany Annual Report, March 2008.
 Chapter 4 • Designing Distribution Networks and Applications to Online Sales 107

annual reports, the company listed the strong brand as a Web site are priced at around $200? Which of the two
major risk factor because any dilution in its brand product categories is better suited to the strengths of the
image would have a significant negative impact on its online channel?
margins. 3. What do you think of Tiffany’s decision to not sell
diamonds online?
4. Given that Tiffany stores have thrived with their
Study Questions focus on selling high-end jewelry, what do you think
1. What are some key success factors in diamond retailing? caused the failure of Zales with its upscale strategy
How do Blue Nile, Zales, and Tiffany compare on those in 2006?
dimensions? 5. Which of the three companies do you think is best
2. What do you think of the fact that Blue Nile carries more structured to deal with weak economic times?
than 30,000 stones priced at $2,500 or higher while 6. What advice would you give to each of the three compa-
almost 60 percent of the products sold from the Tiffany nies regarding its strategy and structure?