IDEX Online Research: Feeling the Squeeze

In the case of the two companies – Mayors and Tiffany – which reported higher margins, they are both special cases. Mayors is in the midst of a recovery, after experiencing financial distress several years ago. New management had done an excellent job of rebuilding this venerable brand, and profits appear to be headed higher, driven by sales gains as well as improvements in the company’s gross margin and cost controls. Tiffany can maintain its gross margin because it internally manufactures about two-thirds of its merchandise (by cost value), a mix that has been steadily rising for the past several years.

Factors Causing Jewelers’ Margin Decline

There appear to be three factors putting pressure on retail jewelers’ margins, including the following:

1. Increasing competition – Competition is coming from three sources:
   1. Specialty jewelers who insist that price-based promotions are the only way to gain sales and market share.
   2. Other types of retailers – discounters such as Wal-Mart, for example – who are targeting jewelry as a growth category.
   3. Competition from other luxury goods retailers who are vying for consumers’ luxury expenditures. In addition to luxury goods retailers – merchants who sell leather goods, fine clothing, luxury cars, etc. – merchants who sell high-end travel packages are targeting consumers who want a luxury experience.

2. Rising commodity prices – For the past two years, all of the major components of jewelry have risen in price.
   1. Diamond prices rose in 2005, though they stabilized last year. In 2005, aggregate polished diamond prices rose by more than 6 percent. Since diamonds and diamond jewelry represent almost 50 percent of a typical jeweler’s sales, this increase puts meaningful pressure on gross margins.
   2. Gold, silver, and platinum prices have soared in recent quarters. Gold prices are up nearly 50 percent since early 2005; platinum prices are up 40 percent; and, silver prices have nearly doubled. Jewelers have been unable to pass along the full amount of these price increases to their customers; thus, their gross margins have eroded.

3. Online merchants – Online jewelers operate with substantially lower gross margins than store-based jewelers do.
   Online diamond retailer Blue Nile generated a gross margin of just over 22 percent in 2005, less than half the level of the gross margin of the typical store-based retailer. Odimo, another former online jeweler, posted a gross margin of just over 24 percent in 2005. The table illustrates the gross margin disparity between store-based retailers and online retailers. Partly due to much lower pricing, online jewelers have captured about 3.5 percent market share of the jewelry market, while online sales of all other retail categories are only about 2.3 percent of total U.S. retail sales.

Every Jewelry Category Experienced Reduced Gross Margins in 2005

Every major category of jewelry – from diamonds, to platinum, to fashion jewelry – had a lower gross margin in 2005 versus 2004, based on data from the JA Cost of Doing Business Survey. The graph below illustrates the decline in gross margin by category.

The largest year-to-year gross margin decline occurred with platinum jewelry. Not only has the price of platinum soared, but jewelers have had to absorb some of the increased cost of platinum jewelry without being able to pass it along to their customers. Thus, platinum has become a less desirable precious metal for jewelers to sell. Suppliers who have introduced palladium as a platinum substitute could experience a surge in demand as jewelers move away from high-priced, reduced-margin platinum jewelry.

Fashion jewelry, which traditionally carries one of the highest margins, experienced a sharp decline in its gross margin in 2005. While the margin on fashion jewelry is still above a “keystone” level, it represents a category where jewelers can offer a discount to combat both aggressive price-based promotions by store-based jewelers as well as deep-discount online merchants.

Diamond margins fell by about 400 basis points (four percentage points), in 2005 versus 2004. However, diamond sales represent almost 50 percent of a typical U.S. jeweler’s sales, so declining diamond margins had a meaningful negative impact on overall corporate gross margins.

Timepieces showed very little gross margin decline, since margins are already well below average for this category.

Gold jewelry margins showed only a modest decline. We believe that jewelers were probably able to convince consumers that higher gold prices were driving higher retail prices. Therefore, jewelers were able to hold retail prices on gold jewelry.