Blue Nile and Diamond Retailing - Case Study

Blue Nile and Diamond Retailing – Case Study The learning objectives of the case are to (1) understand the link between supply chain structure and financial performance, (2) identify key drivers of supply chain performance and how they affect a firm's ability to respond during periods of strong or weak demand, and (3) develop the alignment between supply chain structure and strategic position for a firm. To this end, the case highlights the supply chain structures and performances of three firms in the diamond retailing industry: Blue Nile, Zales, and Tiffany. Blue Nile’s supply chain structure is geared toward a pure centralized e-business; Zales sells merchandise primarily through stores but recently added an online channel; and Tiffany also uses an online channel but most of its diamond and other high-end products are sold through stores. The case is designed to foster discussion of the three supply chain structures and encourage students to evaluate the firms’ performance in terms of components of customer service such as response time, product variety, product availability, customer experience, order visibility, and returnability, coupled with cost factors that include inventory, transportation, information, and facilities. 1. What are some key success factors in diamond retailing? How do Blue Nile, Zales, and Tiffany compare on those dimensions? As with most retailing, the key success factors in diamond retailing can be measured by customer service factors and cost factors. Given the varied supply chain components and supply chain costs. Blue Nile has a distinct advantage in product variety and product availability since customers can “build their own ring” by choosing from an inventory of about 75,000 stones. Customers purchasing at Tiffany and, until recently, at Zales have been limited to the inventory available at the store. Customers who are comfortable making large purchases online will find the low-pressure purchasing experience at Blue Nile, supported by the educational Web site, salaried sales support, and thirty-day return guarantee, appealing. Given that the jewelry is made to order, clients at Blue Nile must be willing to wait to receive their orders, unlike at Tiffany or Zales. The Tiffany brand is very strong and well established. It is associated with glamour, trust, and customer service. These associations allow the company to sell at higher margins than its competitors. Diamond and other high-end jewelry purchases are expensive, and many customers will trade off other factors for the Tiffany customer experience when making such purchases. Moreover, when spending thousands of dollars for a single item, customers often want to see and feel what they are buying. Zales does not have the product variety and availability that Blue Nile provides, nor does it have the brand name advantage that Tiffany enjoys. The weaker brand is reflected in the firm’s margins, which are lower than those of Tiffany. Blue Nile’s focus on low prices is reflected in the lower margins it has relative to both Zales and Tiffany. Blue Nile operates out of one warehouse, with its entire inventory at this facility. The inventories at both Tiffany and Zales are disaggregated through their stores. High-end jewelry items are high-priced, have relatively low demand, and have high demand variability. Such items realize the most savings in inventory holding cost through lower safety stock inventory when the inventory is aggregated. Further, since items sold through the Blue Nile Web site are customized, the inherent postponement allows the company to keep inventory aggregated longer, thus reducing safety inventory even more. While Blue Nile’s inventory-to-sales ratio is around 6 percent, the ratios for both Tiffany and Zales are about 40 percent. Blue Nile’s supply chain structure also gives it a major advantage in facility costs. Blue Nile operates primarily from one warehouse in the United States. Both Zales and Tiffany operate many stores, often in high-priced locations. In addition to stores all over the world, Tiffany has manufacturing facilities, a retail service center that supplies stores, and diamond processing centers in seven countries. While Tiffany has advantages from being vertically integrated, Blue Nile operates on a very low fixed-cost structure. Blue Nile’s property and equipment to net sales ratio was 2.37 percent in 2007, while Tiffany’s was more than 25 percent, down from 35 percent in 2006, and Zales’s was close to 14 percent. Blue Nile also has an advantage in facility operating costs. Because customers design, select, and order jewelry on the Web site, the company does not incur the level of human resources costs in the form of sales staff that Tiffany and Zales do. Transportation costs, as with most e-retailers, are higher at Blue Nile than at Tiffany or Zales. The outbound transportation distance and hence costs and time tend to be much higher when inventories are aggregated, as is the case at Blue Nile. In the case of Tiffany and Zales, some economies of scale can still be realized on inbound transportation at all downstream stages of the supply chain until the merchandise hits retail stores, and the customer takes care of the last mile of outbound transportation costs. The companies do not seem to differentiate themselves from each other on any other customer service components, such as time to market, order visibility and returnability, or cost of information. 2. What do you think of the fact that Blue Nile carries about 30,000 stones priced at $2,500 or higher whereas almost 60 percent of the products sold from the Tiffany website are priced around $200? Which of the two product categories is better suited to the online channel? There are different reasons why these two firms carry very different types of items on their Web sites. In the case of Blue Nile, the primary reasons could be the savings in inventory holding cost due to lower safety stocks and the broad product variety and product availability that the firm can offer customers. Stones priced at $2,500 or higher are unique, high-value items with relatively low demand and high demand variability. The high demand variability necessitates carrying larger safety stock in order to meet required customer service levels. Given the high price of the stones, the cost of holding them in inventory is proportionally higher. Aggregating inventory reduces the amount of safety stock required since the demand variability is less than in a disaggregated scenario. By aggregating the inventory in the online channel, Blue Nile also broadens the product availability and variety available to customers. It is a smart move for Blue Nile to aggregate and carry its high-priced products with low demand and high demand variability on an online channel. The Tiffany brand is built on the glamour, luxury, and quality that customers perceive when visiting a Tiffany store. This perception is a result of both the products and the service. The company’s inventory includes a wide variety of items ranging from very high-end diamond jewelry to basic but elegant tableware. Tiffany has stores as small as 1,300 square feet, and in 2008 the firm began opening stores of about 2,000 square feet selling high-margin products in affluent U.S. areas. Given the strategic importance of the brand image, the breadth of inventory, and the push toward smaller facilities and lower cost, it makes sense for Tiffany to position the high-end luxury products at the store and move the D items to the online channel. This allows it to utilize the limited facility space to highlight the high-end items and customer service and offer the lowerend items online, where product substitution can be used as means of aggregating inventory and lowering safety stocks for the D items. This structure, however, puts Tiffany at a cost disadvantage relative to Blue Nile because Tiffany decentralizes its high-value items with low demand and high variety while centralizing its lower-value items. Such a cost disadvantage can be justified as long as Tiffany can maintain its strong brand and associate it with the store experience. 3. What do you think of Tiffany’s decision to not sell diamonds online? Although on the surface, this strategy would seem to be an appropriate approach for better market penetration and customer reach, Tiffany is in danger of exacerbating its inventory and property expenses. Opening the smaller retail outlets will provide Tiffany’s an opportunity to reach out and “touch” customers in these areas, a key success factor for them in the diamond business. It will provide the opportunity for these customers to experience the Tiffany “service” and “brand” without having to go the larger cities. However, opening these stores will require Tiffany’s to up the inventory level throughout the supply chain. Not only will they have to have additional inventory at these stores, but the overall safety stock will increase. In addition, Tiffany’s property expenses will increase as stores are opened. This is a strategy that seems flawed and should probably be reversed. Its model is better suited for larger stores in cities that will draw significant traffic. Moving into smaller cities with smaller stores is likely to raise costs far more than revenues. 4. Given that Tiffany stores have thrived with their focus on selling high-end jewelry, what do you think caused the failure of Zales upscale strategy in 2006? What products should Zales focus on? Zales’s upscale strategy was in response to fierce competition it was facing from mass merchant department stores such as Wal-Mart, national chain department stores such as JCPenney, and home shopping networks. Middle America had been Zales’s target market since its founding in 1924. A large portion of the company’s revenue came from value-oriented customers who frequented malls. The success of the Zales brand was built on the perception of the good value one got for the money, but with that came the perception of being inexpensive. While one can see why the company decided on the competitive repositioning, one must question the implementation. It takes much time and effort to educate new customers and transform a brand. Zales tried to make too many radical changes in too little time. The firm drastically changed its portfolio of products, 15 percent of the suppliers in the supply chain network were new and included new overseas vendors, and holiday promotions and monthly payment plans were eliminated, to name a few changes. All this resulted in the firm’s losing not only its core customer base but also sales due to delays in bringing merchandise in on time and not making inroads into new target markets. The basic premise of its strategy to move into selling high-end jewelry through its stores is also questionable. Given that it has a much weaker brand than Tiffany; Zales’s strategy of bringing high-end jewelry to its stores raised its inventory costs without raising its margins enough to offset this increase. Zales’s inventories in FY 2006, when it tried the high-end strategy, rose to 47 percent of sales, even higher than Tiffany’s; its margins, however, remained lower than Tiffany’s. Poor execution hurt it further, but given that its brand is weaker than Tiffany’s, one can question whether such a strategy would have had any chance of success even in the long term. Zales is better off focusing on products that are lower end and somewhat more standardized. It will continue to be challenging for Zales to compete with the likes of Walmart and Costco in this space. 5. Which of the three companies do you think was best structured to deal with weak economic times? A lean and nimble structure is an advantage in weak economic times. Blue Nile has a distinct advantage in this regard with its very low fixed-cost structure compared to Tiffany and Zales. Property and equipment to net sales ratios are 2.38, 13.93, and 25.46 percent for Blue Nile, Zales, and Tiffany, respectively. Both Zales and Tiffany are contractually tied up in many medium- to long-term leases for their facilities. The selling, general, and administrative expenses at Tiffany and Zales are about four times those incurred at Blue Nile. Much of this discrepancy can be attributed to the costs of operating stores. Blue Nile also has a very low investment in inventory compared to the other two companies. The cost of sales at Blue Nile is higher, but this can attributed to the lower margins and the higher cost of outbound distribution. The low cost structure at Blue Nile is well suited for times when demand shrinks in the industry. Blue Nile should take advantage of its low cost structure and lower prices to get more market share. Zales is perhaps in the weakest position to handle weak economic times, given the inventory write-off it had to take when its high-end strategy failed. With tightened credit, Zales may find it difficult to survive. Tiffany certainly has the strength to survive but is hurt significantly by dropping sales, given its relatively high fixed costs. 6. What advice would you give to each of the three companies regarding their strategy and structure? Blue Nile has a strategy that focuses on lower prices on a large variety of high-end stones that aligns very well with its centralized structure. Its marketing focus on convincing customers that the four Cs and third-party validation are the key ingredients when valuing a diamond is also well aligned with its structure, which does not allow customers to touch and see the stone before buying. Given its significant cost advantages and customers’ tendency to try to save money during difficult times, Blue Nile has a significant opportunity in this downturn. Blue Nile can take an aggressive position, emphasizing its lower prices with similar quality to very high-end diamond retailers. Although this is a difficult message to sell in general, it may be easier in the difficult economic environment of 2009. For Zales, positive recommendations are more difficult to make. From a financial perspective, Zales needs to get control of its inventories. One way to do this is to centralize more of its expensive diamond inventory, making it available to stores as needed. Lower-value diamonds could be stocked and sold from retail stores. For higherend diamonds, rings with imitation stones could be used to help customers select a style, followed by having the real diamond installed later at a central location and shipped to the store for customer pick-up. Zales’s ideal situation seems to be one in which it stocks and sells lower-cost products from decentralized locations with highervalue stones centralized and provided on demand. Tiffany finds itself in a bit of a bind. It cannot centralize its high-end stones because that would conflict with its brand image. Pricing pressure at retail is likely to continue with the growth of Blue Nile at the high end and retailers such as Wal-Mart and Costco at the lower end. As a result, Tiffany has to continue working hard to maintain its brand image. Its move into the wholesale part of the diamond business has potential pluses—it gives the company the wholesale margin and could give it some form of exclusivity on its stones. For now, its sources of stones are very similar to those of its competitors.