Blue Nile’s financial results for its first quarter were the envy of almost every jeweler in America: revenues were up a whopping 34 percent, and the company’s after-tax profit margin was 4.7 percent, up from last year’s 4.6 percent. By comparison, the typical specialty jeweler in the U.S. posted a sales gain of a very modest +1.4 percent, and lost money in the first quarter of 2007.

 

When Blue Nile chairman Mark Vadon said, “Blue Nile had a terrific first quarter of 2007,” he wasn’t kidding. Jewelers, salivating over Blue Nile’s results, continue to ask themselves, “How can I replicate those results?”

 

The quick answer is this: You can’t.

 

But take some comfort in this: a vast majority of consumers still likes the store experience when shopping. About 96 percent of all jewelry – and 97 percent of all retail goods – are sold from stores.

 

The Online Leader: Blue Nile

Blue Nile is by far the most successful online jewelry retailer. There is no clear #2 competitor, though many claim to be the second largest. IDEX ONLINE Research has tried to compile a list of online jewelers, but no one will submit audited figures for the record.

 

We believe, however, that the second largest pure-play online jeweler probably has revenues of far less than $50 million annually. Tiffany has online sales of nearly $140 million, but much of that is driven by its catalog.

 

All of these figures pale in comparison to Blue Nile’s $252 million that the company generated last year. This year, Blue Nile is on track to generate $300 million in revenues, the equivalent of about 300 independent specialty jewelers.

 

There are several reasons that traditional jewelers cannot replicate Blue Nile’s results, including the following:

 

• The culture and mentality of online commerce is significantly different than the culture and mentality of store-based retailing. Anyone who does not understand this concept is destined to fail. In fact, we’d be worried if Blue Nile announced that it was going to open a chain of retail stores. A few outlet stores might make sense, but a chain of Blue Nile stores would likely be a disaster for the same reasons that a store-based jeweler can’t transfer commerce to the internet.

 

• Everyone else is late to the party. Blue Nile is to the jewelry industry what Amazon.com is to the book store industry. As hard as store-based book seller Barnes & Noble might try, they have not captured significant market share from Amazon. It is the same concept in store-based retailing: the first company to the market usually ends up as the market leader.

 

• Store-based jewelers have unrealistic expectations from online commerce. IDEX ONLINE Research has heard many specialty jewelers say things like, “I’m going to double my revenues with my online store.” Dream on. The typical U.S. specialty jeweler generates about $1 million in annual sales. If each one of these merchants gets its fair share of online jewelry sales – which represent 3.9 percent of total jewelry industry sales – they can expect to increase their annual revenues by a paltry $39,000 per store.

 

• Jacques Voorhees, chairman of Polygon, recently stated at a gold conference in Dubai, “Unless you have $100 million of capital, you can’t expect to be another Blue Nile.” He is correct; specialty jewelers who are eyeing online commerce need to adjust their expectations. Think $39,000 per $1 million of jewelry revenues, and you’ll get an idea of what your fair share of online jewelry sales are.

 

Highlights of Blue Nile’s First Quarter

• Blue Nile’s total sales were $67.9 million, up 34 percent from last year’s $50.7 million. Pretax profits were nearly $4.9 million, up 33 percent from the prior year’s $3.7 million.

 

• Blue Nile’s average ticket was $1,536, up 3.6 percent from the prior year. It was driven equally by increased traffic and a higher conversion rate (browser-to-buyer). Total orders were up over 29 percent. This compares to the typical specialty jeweler who generates an average ticket of about $350 (mass market chains and smaller independents). An AGS-type jeweler generates an average ticket of about $850.

 

• Blue Nile is proving that you can sell big ticket jewelry online. Jewelry sales above $25,000 grew by 84 percent year-over-year, and the company recorded seven transactions over $100,000.

 

• Blue Nile customers are loyal. The company’s repeat and referral business grew faster than its business from new customers.

 

• Blue Nile management cited several factors which drove the dramatic gain in their first quarter sales, including the following:

 

o       Sharp prices on diamonds – Last year, the company reduced its margins on diamonds to the high-teen to low-20 percent range on smaller diamonds and to a single-digit margin on large diamonds. This has had a dramatic impact on its diamond engagement ring business which represents more than 70 percent of the company’s sales.

 

o       Demand has been strong at entry-level price points – The company has increased its mix of sterling silver jewelry and smaller ticket diamond jewelry in an effort to reach new customers.

 

o       Reduced transit time – The company cut the time to deliver a customized order from four days to three. In other words, a customer who orders a custom diamond engagement ring on Monday will have it in his hands by Thursday, in time for the fateful “will you marry me?” question he plans to put to his significant other during the weekend.

 

o       Increased conversion rate – An improved website, coupled with shorter shipping time and other programs (we won’t mention for competitive reasons) have helped boost Blue Nile’s conversion rate (browser-to-buyer).

 

o       Many categories strong – Blue Nile’s management noted that, in addition to diamond engagement rings, several other categories were very strong in the first quarter. Wedding bands were the second largest category, followed by customized jewelry, sterling silver, pearls, and gemstones.

 

o       Order fulfillment is an art – Management has created the concept of the “Perfect Order.” For example, there are 26 criteria related to boxing and shipping an order that must be met. The shipping label is put on the box in an exact location. The bubble wrap in the box is placed precisely; and, the list goes on. The “Perfect Order” is all about attention to detail.

 

o       Marketing expense is 4 percent of sales – Blue Nile has historically spent about 4 percent of revenues on marketing and advertising, a level that management says will continue for the foreseeable future. This is slightly lower than the typical independent specialty jeweler who spends about 5 percent of sales on promotions and advertising. Tiffany & Co. spends about 6.2 percent of revenues on advertising.

 

o       $1 billion total revenues – Blue Nile shipped its first order in 1999. Sometime during late March, when it shipped a $195 garnet pendant, the company booked a cumulative of $1 billion in revenues since inception. Most jewelers will never meet this threshold over several generations.

 

• Blue Nile’s net (after-tax) margin in the first quarter was 4.7 percent, up from 4.6 percent last year. Its after tax profits grew faster than sales growth, despite a sharp increase in stock-based compensation expense. How did this happen?

 

o       The company’s gross margin fell by 90 basis points to 19.5 percent from last year’s 20.4 percent.

 

o       Its operating cost ratio fell to 14.1 percent from the prior year’s 15.1 percent. Thus, its net margin rose by 0.1 percent.

 

o       The typical specialty jeweler in America has a gross margin of 50 percent, more than two-and-a-half times as large as Blue Nile’s gross margin. Further, independents have operating costs of about 42 percent of revenues, nearly three times as high as Blue Nile.

 

o       Most independent specialty jewelers in America post an operating loss in the first calendar quarter of the year. Chain jewelers such as Zale and Kay typically post a moderate profit.

 

Is Blue Nile Unstoppable?

Blue Nile chairman Mark Vadon is very smart, but each morning he puts his pants on just like the rest of us: one leg at a time.

 

He knows his market. He would never suggest that online commerce will wipe out traditional store-based jewelers. He would suggest that he has a better idea than most of us about the demographics of the best online customer.

 

He would likely also acknowledge that some customers will never be online buyers. They may be the people who enjoy shopping as a recreational and social experience. They may be buyers who must touch and feel the product before buying. They may be more likely to be extroverts who go to the mall to see and be seen.

 

The internet has not created any new consumers. The birth rate has not increased in the past ten years, the internet has not created any new money, the printing presses at the U.S. mint are not cranking out dollar bills any faster than a few years ago. Retailing is a sum-zero game. The internet is simply a new channel of distribution that represents another way to reach consumers.

 

Some merchants, like Blue Nile, have leveraged online commerce. Other merchants have leveraged store sales. So far, no one has been able to declare dramatic success by utilizing both channels.