Summary
Despite Piercing Pagoda's current sales performance, the business may be making it more difficult for management to get its core business back to profitability. Here's more.
Analysis
Taken in isolation there is a lot to like about Zale’s Piercing Pagoda operation, especially right now. For instance, lower price points make it attractive to value conscious consumers, which have helped top-line sales grow for the division. So, the comment that the business is in the right place at the right time is correct. But, that hasn’t always been the case. Historically, PP sold primarily gold chains and earrings when gold jewelry was a growing fashion category. When gold declined in popularity, so did kiosk sales. Nevertheless, it remains to be seen whether this business is as good a retail investment for Zale as suggested, especially for the long term.
The important question for management and investors is just where does Piercing Pagoda fit in the Zale’s strategic business mix. Granted it is relatively more profitable now, but that’s not because it’s a superior business model, but because Zale’s core fine jewelry business is performing so badly. Moreover, unlike the insurance business, which is synergistic with the Zale brand, Piercing Pagoda offers no such franchise building synergies.
Another point Ken Gassman makes is also correct. Piercing Pagoda probably lacks adequate management focus, but his assertion that the fine jewelry stores are getting the lion’s share of the attention misses the point. The fact is none of Zale’s businesses is getting the supervisory time they need, especially after the reduction in non-selling sales staff and operating personnel.
Also, Piercing Pagoda’s profitability is suspect if viewed from a standalone point of view. In large part, Zale’s excess capacity absorbs much of the operating cost and it isn’t clear how those costs are allocated. Moreover, based on the numbers presented, gross margins might actually be low depending on how distribution costs are apportioned to COGS. PP operations account for about 55% of Zales total units sold, but only 12% of sales. While the company operates a 20,000 square foot warehouse dedicated to Piercing Pagoda, it still isn’t clear if all the distribution charges are apportioned to PP and by what method, sales or units sold.
Truthfully, the business is a distraction, especially for operating supervisors that have to recruit personnel, constantly, for over 700 kiosks. If there’s really is a serious buyer for PP as the article suggests, Zale should consider selling it and reinvesting the cash in its fine jewelry business or in another synergistic jewelry business.
Clearly, the company would benefit from a free standing, off mall format to compete with Signet’s Jared Jewelers. Another possibility would be to invest heavily in e-commerce. Candidly, it’s shameful that the industry has virtually vacated the large diamond Internet business, leaving Blue Nile a free hand to operating with virtually no competition. Lastly, Zale’s supply chain is likely to need an overhaul, especially given the continued fragmentation of the diamond pipeline. That probably means new investment in buying and store management technology among other things
Unfortunately, short-term thinking has paralyzed Zale for the better part of the last decade. Company management has looked for the quick fix to solve its problems. A turnaround was always one Christmas away. That was management’s view last year and Piercing Pagoda, once a problem, is now the example of a successful management turnaround, suggesting Zale will rebound shortly.
Still, the facts suggest PP was a bad acquisition, which has accidently found a place in the company’s business mix because of the recession. That hardly raises it to the level of a management led turnaround or a strategic opportunity. In better times, the company could afford the distraction. But now, anything less than a fanatic determination to turn Zale’s money losing fine jewelry business into a profitable one is doing a disservice to its shareholders.
