(IDEX Online) - Once again, Blue Nile, the largest online jewelry retailer in the world, beat the jewelry industry financial averages in 2010. The company’s sales rose at an above average rate, and it posted an above-average profit. Blue Nile’s balance sheet is nearly pristine, and its productivity measures – sales per employee, etc. – are off the charts.

 

The Blue Nile name is becoming synonymous with “diamond engagement ring.” Store-based specialty jewelers report that diamond engagement ring shoppers come in their stores with a fist full of Blue Nile printouts.

 

How has this ten-year-old company captured such a large share of the online jewelry market, especially for diamond engagement rings?

 

Online Jewelry Sales Are 5 percent of Industry Sales

Online jewelry sales are roughly 5 percent of total jewelry sales in the U.S. market, or just over $3 billion annually in 2010. Blue Nile’s sales of $332 million in 2010 indicate that they have captured about 10 percent of the total online jewelry market.

 

Blue Nile’s share of the diamond engagement ring market in 2010 was just over 2 percent, based on bricks-and-mortar store sales and online sales of diamond engagement rings. The company sold nearly 37,000 diamond engagement rings (about 100 a day) for an average ticket of $6,100, for total diamond engagement ring sales of nearly $226 million during the year.

 

In 2010, an estimated 1.6 million diamond engagement rings were sold in the U.S. market. On a unit basis, the company held just over 2 percent of the total diamond engagement right market; on a dollar volume basis, Blue Nile held a diamond engagement ring market share of roughly 4 percent. There is no reliable data for the number of diamond engagement rings sold only by online jewelers.

 

It’s not as if Blue Nile has stolen the diamond engagement ring business from specialty jewelers. Rather, Blue Nile has brought price rationalization to this segment of the jewelry market. Historically, diamond engagement rings were highly profitable for specialty jewelers. While the margin might have been lower than other jewelry segments, diamond engagement rings brought in substantial gross profit dollars.

 

Nevertheless, Blue Nile has cut into the gross profit revenue stream that formerly accrued to specialty jewelers. Now, even if specialty jewelers can make the sale, their profit margins are low, and the gross profit dollars are diminished from historic levels.

 

How Does Blue Nile “Do It,” What Does The Financial Model Look Like?

The quick answer is simple: Blue Nile’s operating costs are dramatically lower than traditional specialty jewelers’ operating costs. As a result, the company can sell diamonds – and other jewelry merchandise – for lower prices. And, worse for specialty jewelers, these are the same diamonds that diamond suppliers offer to store-based jewelers. Blue Nile’s diamonds come with certifications from reputable grading labs; we can’t always say this for diamonds we see in some specialty jewelers’ stores.

 

Blue Nile keeps its costs low by operating without a bricks-and-mortar store; its occupancy costs are far lower than its store-based competition, most of whom are paying the highest rents in the mall. Further, it has dramatically lower personnel costs. As the table below illustrates, the company’s sales per employee are nearly $1.7 million each; the typical specialty jeweler generates just over $200,000 in sales per employee.

 

The following table summarizes key financial ratios for Blue Nile versus the typical specialty jeweler, based on the Jewelers of America Cost of Doing Business Survey (2010).

 

Source: Blue Nile, Jewelers of America & Other

 

Blue Nile’s Financials Are Stronger Than Most Publicly Held Competition

When Blue Nile’s key financial ratios are compared to the remaining publicly held jewelers, the company has a vastly different set of economic operating metrics. The following is a comparison of Blue Nile to the typical American specialty jeweler.

 

·         Blue Nile has a much lower gross margin – Even though it buys goods from the same vendor pool as store-based jewelers, Blue Nile sells those goods less expensively.

Simplistically, Blue Nile buys an item for $100 and marks it up to about $127, to achieve a gross margin in the 21-22 percent range. A store-based jeweler buys the same item for $100 and marks it up to $200, to achieve a 50 percent gross margin. We note that these are “reported” gross margins that include the cost of the merchandise as well as a large number of other costs such as buying and occupancy, freight (in and out), some customer credit costs and other items. “Raw” margins – which are based solely on the cost of the item – are much higher (generally 65 percent and above) for many store-based specialty jewelers. We are not comfortable estimating Blue Nile’s “raw” merchandise margin, but it is higher than its “reported” gross margin.

·         Blue Nile’s operating costs are lower, as a percentage of sales. In part, this is due to its high volume; in part, it is due to lower overall operating costs. For example, it does not need high-priced retail space, nor does it need highly compensated sales employees. This is typical of the online sales economic model.

·         Blue Nile operates with negative working capital. That is, it collects cash from its customers immediately, but pays its vendors over an extended period. It owns almost no inventory; its “vendor float” – defined as payables to inventory – is over 400 percent, meaning that it has sold its inventory long before it pays its vendors. A vendor float of 100 percent means that a retailer pays its vendors as it gets paid. Anything below 100 percent means that the retailer has inventory that is paid for, but not sold, and is therefore not financially productive.

 

·         Blue Nile has no real need for debt, though it has a little on its balance sheet. Why? The turnover of its owned inventory is nearly 13 times per year, compared with just a one-time turn for most jewelers. Blue Nile utilizes “memo” goods to achieve such a high inventory turn. It essentially has no investment in inventory (with the exception of some mounts and a few fashion jewelry items).

 

·         Blue Nile is attractive to Wall Street investors because its return on equity is a stunning 31 percent. No other jeweler comes close to this very important measure of financial return. While its pretax margin is between 6 percent and 7 percent – somewhat below Signet and well below Tiffany, Blue Nile’s business is not capital intense. Thus, its lower pretax profits yield a high return on invested capital.

 

·         Blue Nile’s advertising-to-sales ratio is about 4 percent, in line with most specialty jewelers.

 

The table below summarizes Blue Nile’s key financial ratios versus the few remaining publicly held retail jewelers. Blue Nile says its key competition is the better-end independent specialty jeweler; thus, neither Zale, nor Signet, nor Tiffany would be considered its closest competition, according to management.

 

Source: Company Reports

 

There are a couple of notes related to the figures on the table above. First, Signet Group’s accounting for its gross margin is different from the others shown on the table; however, this is offset by its lower operating cost ratio (again, due to a different method of calculation). One offsets the other.

 

Second, Tiffany produces about 60 percent of the goods it sells, so its gross margin is higher, since it keeps production profits in-house. Third, Tiffany’s ad-to-sales expense of 5.9 percent for FYE 1/10 is low; more typically, it runs an ad-to-sales ratio between 6 percent and 7 percent. Finally, Signet’s advertising spend of 7 percent of sales is the company’s gross ad expenditures, before vendor co-op.

 

Lessons Learned From Blue Nile

A store-based jeweler simply cannot operate with Blue Nile’s economic model, unless it is able to have virtually all of its goods on memo and operate with low store operating costs. Neither of these scenarios is likely to occur.

 

However, a store-based specialty jeweler can improve its inventory turn, which will generate increased gross profit dollars and reduce the need for debt. Further, a store-based jeweler can focus on personnel expense more closely.

 

Long term, the jewelry industry’s “keystone” (50 percent) gross margins will come under siege. Jewelers need to have an alternative business model, and Blue Nile’s model provides some elements for the blueprint of a potential new business model.