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When Buying a Diamond Starts With a Mouse


#1

There is an interesting article in today’s New York Times

When Buying a Diamond Starts With a Mouse

MARK C. VADON is one of the world’s top diamond retailers, but
wholesalers often decline to meet with him on the convention
floor at jewelry trade shows. At the very least, many ask him to
flip over his nametag so that no one knows who he is or what
company he runs.

There was a time not long ago when pundits generally dismissed
Mr. Vadon’s company, the online jewelry purveyor Blue Nile, as
one of the dot-com boom’s more lamebrain creations. People might
be willing to buy a book online, or a CD, and maybe a toaster,
they said, but a $3,000 diamond engagement ring? The jewelry
industry or at least the high-end jewelry trade seemed
impervious to the Internet.

Not any more. Only a decade after it was founded in the infancy
of the Web, Blue Nile ranks behind only Tiffany & Company in
diamond ring sales, according to industry analysts. Experts also
believe that probably only Tiffany’s and the Zale Corporation,
which operates more than 1,500 chain stores and an additional
800 kiosks, bought more diamonds from wholesalers than Blue Nile
last year.

While Blue Nile has grown and its stock has soared 54 percent,
to $38.53 a share on Friday from $25 when it was first sold to
the public in May 2004 Main Street jewelers have seen their
profit margins shrink and many of their brethren shutter their
store doors. As a consequence, many retail jewelers refer to
Blue Nile as the “evil empire” or worse.

So far, the Blue Nile effect has been felt mainly by mom-and-pop
jewelers on Main Street and in malls; much bigger, high-end
retailers like Tiffany have been affected only on the margins.
And Blue Nile’s influence is limited largely to diamond sales,
particularly diamond ring sales, but those are often the cash
cow for smaller jewelers, accounting for a disproportionate
share of their revenue.

“Blue Nile is just busting the chops of everybody, especially in
the sale of diamonds,” said Ken Gassman, a former Wall Street
financial analyst who runs the Jewelry Industry Research
Institute. Diamond jewelry accounted for nearly half the $59.4
billion in jewelry, including watches and costume pieces, that
United States retailers sold in 2005, Mr. Gassman said.

Blue Nile and other Internet jewelers are not solely responsible
for smaller profits at traditional jewelers nor for the loss of
more than 3,000 independent jewelry shops since 1999. Main
Street jewelers, after all, have faced tough competition for
decades, from the Home Shopping Network and other television
creations beginning in the 1980s to, more recently, Wal-Mart,
Costco and other big-box retailers that are grabbing a large
share of the low-end jewelry market. A spike in the price of
gold and other precious metals has also eaten into jewelry store
profits.

Still, Blue Nile’s influence has been big enough that many
smaller jewelers have been threatening to boycott wholesalers
that supply online retailers. At the same time, consultants have
been earning a handsome living advising retailers struggling to
compete with Blue Nile teaching them to “romance the stone,” as
one consultant, Shane Decker, put it, using industry-speak for
stressing the whole diamond-buying experience over merely the
price.

Blue Nile operates no stores, so jittery men browsing its Web
site in search of an engagement ring that matches their love and
budget cannot compare diamonds side by side or even see what
they have bought until they tear into an overnight-delivery
package.

But still they buy. The average diamond ring bought at the Blue
Nile site costs $5,500, twice the industrywide average of
$2,700, according to Mr. Gassman and other analysts. Blue Nile’s
finance chief, Diane Irvine, says that nearly every day, the
company sells a ring costing $20,000 to $40,000. Last month
alone, more than a dozen people bought diamonds that were so
expensive $50,000 or more that Blue Nile delivered them in
armored trucks with armed guards. (All sales come with a 30-day
money-back guarantee.)

“I don’t get up every morning and curse Blue Nile, like some
do,” said Mark Moeller, owner of R. F. Moeller Jeweler, a
three-store chain in St. Paul. “But the Internet has certainly
affected profitability; there’s no doubt about that.”

Gary Gordon, chief executive of Samuel Gordon Jewelers in
Oklahoma City, was more blunt. “Ours is an industry in big
turmoil over Blue Nile,” he said.

SHOP owners, if they wish to curse anybody, might better aim
their invective at one of their own, Doug Williams, a Seattle
jeweler who in late 1995 took to heart all the radio
advertisements he was hearing that implored business owners to
adopt an Internet strategy.

The personal computer boom had been very kind to Mr. Williams,
who for years had made a good living selling jewelry to
Microsoft employees and other newly minted millionaires. Yet
when he paid a consultant $2,000 to create a basic Web site he
called Internet Diamonds, he did not even own a PC. “I was like
a caveman looking at a television,” he said of the first time he
visited his online creation.

Mr. Vadon stumbled on Mr. Williams’s site after a frustrating
visit to the Tiffany’s in San Francisco, where he had gone in
search of an engagement ring. This was late in 1998, and Mr.
Vadon, a recent M.B.A. graduate from Stanford, was a well-paid
management consultant at Bain & Company.

Yet as he tells it, the sales clerks initially ignored him,
presumably because he was dressed in a T-shirt, shorts and
Birkenstocks. He felt still more exasperated once one of their
lot deigned to wait on him and was not much help. "He said, ‘Buy
the one that speaks to you,’ " Mr. Vadon said. "And I’m
thinking, ‘This is absolutely nuts.’ "

Tiffany’s declined to make a spokesman available for this
article, but in a prepared statement said its diamond sales
continue to grow, despite Blue Nile, confirming “the strong
appeal of Tiffany’s diamond jewelry and the Tiffany & Company
shopping experience.”

The two rings that Mr. Vadon was considering, at $17,000 and
$12,000, would have represented the most expensive purchase of
his life, automobiles included. So in search of what he
described as a “Consumer Reports-like site,” Mr. Vadon ventured
online, where he discovered a basic tutorial written by Mr.
Williams. There he learned enough to consider tradeoffs between
size, shape and his tolerance for imperfections and also found,
for $5,800, a diamond ring nearly identical to the less
expensive of the two he had viewed at Tiffany’s. He bought it.

A more unlikely diamond retailer is hard to imagine. Mr. Vadon,
who sports a permanent stubble look, wears no jewelry not so
much as a ring. On a recent day in Seattle, where Blue Nile is
based, he was dressed in a rust-colored zippered pullover shirt
and tan corduroys, and looked every bit like a man not quite
comfortable in the spotlight but a numbers cruncher who finds
himself the chief executive of a publicly traded company through
happenstance.

By chance, Mr. Vadon was in Seattle on business a few weeks
after he bought his engagement ring, and he stopped at Mr.
Williams’s store. When Mr. Vadon offered that he had probably
been a very good customer, Mr. Williams told him not really: he
sold one or two diamonds a day online, and at just under $6,000,
Mr. Vadon’s purchase was more or less an average sale.

Standing inside Mr. Williams’s modest, two-employee store near
the Seattle airport, Mr. Vadon did a quick calculation in his
head. At that point he may have known little about diamonds, but
he recognized that an Internet site that cleared $250,000 a
month in revenue despite no advertising budget and a bare-bones
design could be extremely valuable. So at dinner that night, he
offered Mr. Williams $5 million, which he did not have, for an
85 percent stake in his company a deal penciled on a napkin and
contingent on his raising the money.

Mr. Vadon was then 29, and unlike most of his Stanford business
school classmates, had shown no great interest in the Internet.
He had no experience selling jewelry. But this was Silicon
Valley circa 1999, so in just eight weeks he raised $6 million
to buy the site and ramp up its development. Over the next 12
months he raised an additional $44 million without, he said,
having to work terribly hard at it.

The overabundance of cash engendered bad habits. The company,
which at the end of 1999 switched to the more exotic Blue Nile
name, booked $44 million in revenue in 2000, its first full year
under Mr. Vadon, but managed to lose $30 million, largely
because it spent $40 million advertising on television.

Blue Nile was hardly the only dot-com to burn through so many
millions so quickly. Miadora.com, another jewelry site, raised
more than $50 million in venture capital and managed to stay in
business for just 15 months. Similar fates awaited Ijewelry.com,
Mondera and others.

Shrewd business decisions kept Blue Nile afloat. First, it cut
its work force sooner than most dot-coms, beginning in the
summer of 2000. Second, its backers invested an additional $7
million in the second half of 2001, when many investors would
not sink another dime into a consumer e-commerce Web site. Mr.
Vadon, meanwhile, eliminated the advertising budget and hoped
that consumers would still find his site.

“Either we were going to build this thing through word of
mouth,” said Darrell Cavens, Blue Nile’s marketing chief, "or we
were going to see revenues collapse and we would all go home."
Sales slowed in 2001, rising barely 10 percent, but then grew 30
to 50 percent annually over the next three years. That let the
company start advertising again limiting itself almost
exclusively to the Web while showing the kind of steady growth
in profits that Wall Street now needs to see before most
companies can go public.

After the dot-com bubble burst, “there was this giant sigh of
relief” among jewelry retailers, said James S. Porte, the former
chief marketing officer of Diamond.com who now runs a marketing
firm in Fort Lauderdale, Fla. "People hated Diamond.com and Blue
Nile and the rest of them, and so they could say, ‘See, I told
you it would never work,’ " he said.

When Blue Nile refused to die, jewelry store owners reacted by
pressuring wholesalers to cut off its supply. “People would meet
at conferences and talk about embargoes like this was the Cuban
missile crisis,” said a New York-based diamond wholesaler and
Blue Nile supplier who declined to be quoted by name because, he
explained, “I don’t need the grief.”

IT is easy to sympathize with the Main Street jeweler
confronting a rival like Blue Nile. It operates no stores, only
an office in downtown Seattle and a modest-size warehouse on the
outskirts of town, so overhead eats up just 13 percent of its
revenues, compared with 30 to 40 percent at a traditional Main
Street retailer.

That allows Blue Nile to sell its diamonds at roughly 20 percent
over cost and still make money, Mr. Vadon said and analysts
confirmed. By comparison, the typical jewelry store sold its
rings for 48.7 percent above cost in 2005, though that is down
from 51.6 percent in 2002, an annual survey by Jewelers of
America found.

As a result, Mr. Gassman, the analyst, found in one study that
Blue Nile sold rings for 35 percent less than comparable rings
at Zales.

David H. Sternblitz, the treasurer of Zale, in Irvine, Tex.,
said: “The Internet business serves a target customer looking
for a commodity that’s basically sold on price. There’s still a
large segment of the population that wants to come into a store
and inspect the jewelry, and wants the extra services we provide
like cleaning and repair.”

In addition to its lower overhead, Blue Nile has a second
advantage, at least over smaller jewelers. It bought roughly
$170 million worth of diamonds last year, giving it the
purchasing power to sometimes sell its diamonds at a cost below
the wholesale price available to smaller stores.

“You can buy diamonds cheaper from Blue Nile than you can from
most brick-and-mortar stores, including mine,” said Jerry
Robbins, the chief executive of Robbins Diamonds, a five-store
chain in the greater Philadelphia area. “But their big
disadvantage is that customers cannot see the diamonds, they
cannot touch them and they cannot compare them side by side.”

For now, diamond rings account for 70 percent of Blue Nile’s
sales, and other diamond purchases diamond post earrings, for
instance account for an additional 20 percent. The mark-up on
designer jewelry as well as on pearls and colored stones like
sapphires and emeralds still exceeds 50 percent, according to
Jewelers of America.

But diamonds serve as the financial backbone for jewelers
nationwide, and while some have tried to match Internet prices,
many still refuse to compete on that basis. "Their attitude is,
‘Our prices are higher but we provide you services, and we’ll
hold your hand, and we’ll wrap it up all pretty and such,’ " Mr.
Gassman said.

Will that work?

“I think it’s relevant that we have seen an acceleration in the
closure of specialty jewelers in recent months,” he replied.

Joel Schwalb
@Joel_Schwalb1
www.schwalbstudio.com