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Blue Nile's Diamond Prices

Editorial

Aug 15, 2014 8:00 AM   By Avi Krawitz
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RAPAPORT... Blue Nile is being challenged by rising diamond prices, forcing the online jeweler to seek out growth in other areas. As diamond prices rise, eroding Blue Nile’s competitive advantage that its lower online prices offer, consumers will increasingly seek traditional assurances from their more personable brick and mortar jewelers.

Last week, Blue Nile reported that sales and net income fell below expectations during the second quarter that ended June 30, noting that its performance was impacted by higher diamond prices. In short, the company was unable to transfer the higher prices charged by its suppliers to consumers.

That inability can be explained by Blue Nile’s business model as the company does not own the inventory presented on its website. Rather, the online jewelry retailer works with diamond suppliers and applies its own mark-up to prices set by the supplier. Therefore, when diamond prices rise, the effect is more immediate than for other jewelers who can ease in the price inflation as they sell off inventory they bought previously at lower prices.

Blue Nile’s vendors set their prices according to the market as they upload their inventory to the website. As a result, when polished diamond prices rose in the first quarter, particularly toward the end of March when prices were very strong, Blue Nile’s earnings were affected in the subsequent second quarter.

Harvey Kanter, Blue Nile’s chief executive officer (CEO), explained in an earnings conference call that when diamond prices rise, Blue Nile has a choice to “invest in its margins” in order to maintain steady prices. In other words, the company has to decide whether to cut its own mark-up in order to drive sales at steady prices, or charge the higher prices at the risk of deterring customers.

This time around, the company chose not to reduce its mark-up, or margins, as it had in previous years when price inflation took effect. Rather, Kanter explained that Blue Nile is using efficiencies in other areas of the business to offset the impact of higher prices. As a result, cost of sales was reduced by 2 percent.

More importantly, the company is trying to salvage better margins by diversifying its product offering and emphasizing its non-engagement line. Simply put, jewelry provides better margins than diamonds, and the company recorded strong sales growth in its non-engagement segment during the quarter, with wedding band sales being the outstanding performer.

For now, U.S. diamond engagement rings remain Blue Nile’s core product and also the area with the lowest growth potential. Apart from the tighter margins, and the impact of higher diamond prices, it appears that consumers are still cautious about buying high-ticket items such as diamonds via the internet.

A survey conducted by McKinsey & Company published in February 2014, noted that online jewelry sales have underperformed in the past decade compared to other products such as apparel and electronics. Participants in the survey – consisting of 20 executives at global fine-jewelry and fashion jewelry companies and industry associations – believed that online sales of fine-jewelry will reach 10 percent of total sales in that category by 2020, but won’t grow much beyond that. The number is a bit higher for fashion jewelry.

“Most consumers prefer to buy expensive items from brick and mortar stores, which are perceived as more reliable and which provide the opportunity to touch and feel the merchandise – a crucial factor in a high-involvement category driven by sensory experience,” McKinsey wrote while explaining feedback from the jewelry executives.

To Blue Nile’s credit, the company is willing to think out of its internet box. Earlier this year, the company ventured into brick and mortar retailing with displays of diamond rings at two Nordstrom stores. Shoppers can try them on to get the sensory feel for the product but must still visit the Blue Nile website to make the purchase.

Analysts suggested that the move was primarily a branding exercise to improve Blue Nile’s name recognition in the U.S. Despite its leading position in the online jewelry space, people don’t know Blue Nile as well as they do Kay Jewelers, Jared or Tiffany. The verdict is still out whether the displays are significantly driving up traffic to the site and subsequent sales. Few are expecting it to make an immediate impact and view it as a mere experiment for now.

Indeed, U.S. engagement sales fell 5 percent year on year to $61 million during the second quarter and the company lowered its guidance for the year. Numerous analysts consequently lowered their outlook for the share. Prospects for the company’s core engagement ring segment are weak given the long-term bullish outlook for diamond prices, and the apparent limitations of consumer spending on diamonds and fine jewelry online.

That leaves Blue Nile needing to accelerate its jewelry business and its international expansion – particularly in China. The company delivered steady second quarter growth in both areas, which continue to be emphasized in its growth strategy. For example, management said they’ll soon be working with new designers to complement their existing partnership with Monique Lhuillier. Meanwhile, international sales outperformed the U.S. while sales in Asia Pacific grew a healthy 15 percent – albeit off a low base – with growth driven by expansion in China.

Currently, non-engagement sales account for about one-third of Blue Nile’s U.S. sales, while international sales make up approximately 17 percent of the total. One expects those numbers to rise in the future. While diamond prices have softened recently, which should help stabilize sales for the rest of the year, they’re expected to rise in the long term, which will place continued pressure on Blue Nile’s business.

The company has little leeway to manage volatile diamond market conditions, except to drive sales volume in new markets such as China, and garner better margins from other product categories such as non-engagement jewelry. There certainly is opportunity for both. If the second quarter is anything to go by, Blue Nile’s expansion strategy into new markets and products is necessary to ensure long-term success and to balance the short-term volatility that is characteristic of the diamond market.

The writer can be contacted at avi@diamonds.net.

Follow Avi on Twitter: @AviKrawitz and on LinkedIn.

This article is an excerpt from a market report that is sent to Rapaport members on a weekly basis. To subscribe, go to www.diamonds.net/weeklyreport/ or contact your local Rapaport office.


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Disclaimer: This Editorial is provided solely for your personal reading pleasure. Nothing published by The Rapaport Group of Companies and contained in this report should be deemed to be considered personalized industry or market advice. Any investment or purchase decisions should only be made after obtaining expert advice. All opinions and estimates contained in this report constitute Rapaport`s considered judgment as of the date of this report, are subject to change without notice and are provided in good faith but without legal responsibility. Thank you for respecting our intellectual property rights.
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