Blue Nile, which has sent the standard for online jewelry retailers, recently reported that its fourth quarter sales were up by only 13.5 percent – well below most expectations.

 

Worse, Blue Nile’s management is saying that its first quarter (January-March 2006) sales could be up by as little as 7 percent, though they suggested a range of 7 percent to 11 percent would be realistic. For the year 2006, revenues could rise by as little as 8 percent at the low end; if conditions improve, sales could be up by as much as 21 percent. 

 

Is the bloom off the rose? Or is this merely a pause in an otherwise solid long term growth trend?

 

IDEX Online Research believes that Blue Nile – and the online channel – may be entering a “maturing” phase when sales gains will begin to moderate. However, we look for continued above-average growth for the foreseeable future from this new sales channel. 

 

Blue Nile’s Sales Gain Was In Line With Peers

Blue Nile is no longer a “new” company. After six years of operation, its sales are $200 million annually. It is entering a “maturing” growth phase when sales increases are expected to moderate. In part, this is the result of math: as Blue Nile’s sales base grows, its percentage increases will moderate. In part, as companies mature, their sales increases moderate, but usually become more consistent and predictable.

 

How did Blue Nile’s fourth quarter and holiday sales gain – +13.5 percent – compare with other “mature” companies’ online sales gains?  Here are results from others in its peer group. The average “direct channel” sales gain from this representative sample of retailers is +11 percent.

 

• Fingerhut – Up 15 percent
• J.C. Penney – Direct sales up 4 percent
• L.L. Bean – December sales up 17 percent
• Neiman Marcus Direct – December sales up 25 percent
• Restoration Hardware – Direct sales up 15 percent
• Sharper Image – December direct sales down 26 percent
• Tiffany & Co. – Direct sales up 14 percent
• Victoria’s Secret Direct – December sales up 17 percent
• Williams-Sonoma – Direct sales up 16 percent

Fourth Quarter Online Jewelry Sales Were Mixed

Fourth quarter online jewelry demand was mixed.

 

• Blue Nile reported moderating sales gains of +13.5 percent; revenues were $73.2 million versus last year’s $64.5 million. 
• Tiffany & Co. reported that its direct marketing sales (internet and catalog) rose 14 percent to $63.7 million due to substantial growth in Internet sales tied to increases in the number of orders and the average order size. 
• Abazias, a small publicly held online jewelry retailer, reported a revenue increase of 161 percent, but its revenues are too small to be meaningful. In 2005, fourth quarter sales were just $1.3 million, up from last year’s $500,000.
• Odimo, the only other pure internet jewelry competitor, has been silent on its fourth quarter sales trends. If its trends were strong, the company likely would have issued a press release.
• Amazon.com reported that its jewelry sales more than doubled. Again, we believe that its sales base is too small to make meaningful comparisons. 

ComScore Networks says online U.S. retail sales (all retail categories except travel) during the 2005 holiday selling season were up 25 percent. While apparel and accessories were strong, none of the major internet sales reporting agencies mentioned jewelry as a strong online category for the fourth quarter.

 

What Did Blue Nile Management Cite As Reasons for Sales Trends?

Blue Nile management cited four reasons for its weaker-than-expected sales. We generally agree with all of these reasons. 

 

• Online competition for eyeballs was intense – Blue Nile cited Zale and Macy’s as two competitors who were aggressively trying to target the same online jewelry customer as Blue Nile. In addition, apparently there were several “wildcatters” who were also spending heavily in an attempt to reach potential online jewelry buyers in the fourth quarter. These “wildcatters” did not show up in prior quarters, and they are mostly gone now. 

• Blue Nile cut back on search word advertising – Online search advertising programs allow companies to pop up as “sponsored results” on major search engines such as Google. Online search advertising prices have been rising over the past two years, but spiked in the fourth quarter of 2005. As a result, Blue Nile’s management cut back on search ad spending in an effort to maintain profitability.

• Blue Nile was overly reliant on search advertising – Over the past two years, Blue Nile has cut back on other forms of advertising – including offline advertising such as radio, for example – in favor of search advertising because it has proven very cost effective. However, when prices spiked late in 2005, the company was unable to implement alternative advertising programs quickly enough to be meaningful.

• Big stones reflected soft demand – Blue Nile noted that demand was softer than expected for big expensive diamonds in the fourth quarter.

• Jewelry demand was weak – While fourth quarter statistics have not been tallied yet, preliminary figures show that year-to-date through November 2005 U.S. jewelry sales were up a very modest 1.9 percent. Jewelry sales in November advanced by 2.4 percent (preliminary), but this was well below the 8.5 percent increase for total U.S. retail sales (all categories except autos and food). 

Internet Jewelry Sales Are Disproportionately High

In 2004, online jewelry sales were about 2.8 percent of total industry sales. By comparison, total online retail sales were only about 2.0 percent of total U.S. retail sales (ex-auto and food).  In 2005, IDEX Online Research is estimating that online jewelry sales were 3.2 percent of total industry sales. 

 

Why are online jewelry sales disproportionately high? Most online jewelry sales represent more expensive diamond jewelry. For example, Blue Nile’s average ticket is about $1,450, almost five times as great as the industry average ticket of about $300. 

 

Source: IDEX Online Research

 

Further, fashion jewelry – which is often an impulse purchase at the mall – represents a much lower average ticket. Very little fashion jewelry is sold online. 

 

There are two facts that will help jewelers keep the internet in perspective:

 

• The internet is simply another sales channel – The internet is not a new market full of new consumers. It is simply another way to reach existing customers.  Retailing is a sum-zero game. Before the internet, there were roughly 290 million Americans; after the internet, there are still roughly 290 million Americans (plus a few million births). The internet may allow merchants to expand their market, but it does not create more dollars or new consumers. 

• Roughly 97 percent of all jewelry sales still take place in a store – The internet is not going to put traditional store-based jewelers out of business near term. About 97 percent of all jewelry is still sold through traditional sales channels – stores, catalogs, and other venues. Online sales will continue to grow by evolution, not revolution. 

Blue Nile Remains the Industry Standard for Online Jewelry Sales

Blue Nile has been the how-to blue print for online jewelry sales. Some jewelers even acknowledge that they have used Blue Nile’s legal filings and information gleaned from its conference calls as a play book for their internet sales game.

 

We believe that Blue Nile’s economic operating model is sound, and that it will fuel long term growth for the company. Further, we believe that it will set new operating standards for the jewelry industry, including new standards for traditional store-based jewelers. 

 

Operating Metrics Comparison    Blue Nile  Chain Jeweler Average Ticket  $1,450  $300 Engagement Ring  $5,700  $2,700 Marketing Spend   4%  4% Bridal Sales  75%  40% Gross Margin  22%  49% Net Margin  6%  4% Source: Company reports

 

Conclusion: Look for Consistent, Moderating Growth

In our opinion, Blue Nile’s operating model is sound. It was one of the first online jewelry sellers to the market, and it has strong consumer recognition. Its management team is one of the best in the industry. 

 

We believe that Blue Nile, with sales of $203 million in 2005, is capable of producing a sales increase of at least $25-30 million annually in 2006, and perhaps an incremental $35-40 million in 2007. By 2008, its annual sales gain could reach an incremental $50 million; Blue Nile’s sales that year could top $325 million, making it the 20^th largest retail jeweler in the U.S. Based on the industry average sales per store, Blue Nile’s sales would represent the equivalent of a 325-store chain. 

 

However, as the company’s sales base continues to grow, its percentage gains will continue to moderate. That’s the way the math works.