When Carter Cast and his partners were founding the online diamond retailer Blue Nile in 1999, they took on a multifaceted problem: men who were looking to buy expensive diamond engagement rings had little knowledge about what they were buying and feared that a traditional jewelry store would take advantage of them. Add to that problem the fact that there was little precedent for men buying diamond rings online in 1999, and it is easy to see why the startup needed to be very rigorous about developing its business model.
The Blue Nile team’s first task was to articulate the key assumptions that needed to be true for the business to be viable. “We believed that men would buy $5,000–7,000 diamond engagement rings online if we could create an experience, in the safety of their home, where they could get educated about the 4 C’s of diamond-buying—the diamond’s color, cut, clarity, and carat weight—and then, if we had a great assortment at lower prices than retail, they’d buy,” says Cast, a clinical associate professor of innovation and entrepreneurship at the Kellogg School.
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He knew that diving into a startup without first identifying very specifically what must be true for the business to succeed could be a recipe for disaster. But simply identifying a key assumption is only the first step in the process of launching a startup.
Once the company is able to answer affirmatively that there is a problem worth solving and that their company has a solution, then it can develop a framework to prove that it can be done. Proving that the assumption is solid is done by conducting a “killer experiment” where the team asks, “What can kill our idea?”
“Sometimes the killer questions are about the technical viability of the product,” Cast says. “But early on, they are usually about category, consumer, or competition. Is the category attractive—is there unattended-to “white space”—and is there solid evidence that there’s a consumer need we’re fulfilling?”
Are We in Good Company?
If a company finds that the category it intends to enter—in this case online diamond retail—is so small, or that there is no “white space” where a new entry could carve out an untapped subset of that category, then the business idea no longer makes sense.
With Blue Nile, “several of our board members wanted us to do diamonds and fine jewelry,” Cast says. The founders pushed back. “We said, ‘let’s just focus on diamonds—diamonds alone are a $40 billion market. The category is plenty big.”
“We asked ourselves, ‘Is the 800-pound gorilla coming to kill us?’”
And that white space? Blue Nile found that while most diamond engagement rings are purchased by men and given to women, “everybody was talking to women,” Cast says. “Nobody was talking to men.” The primary purchaser was being overlooked by the industry. The idea for Blue Nile focused on creating a product line and site-user experience for men. So there was a clear white space in the category area.
That brought Blue Nile to its target customers: Would they be interested in the product? Would they be reluctant to buy it from an online company? “Almost all my early research was asking men, ‘Under what condition would you buy this online?’” Cast says.
Those men answered the “killer” question, letting Blue Nile know what they valued and what would have to be true for them to shop on the site. “They told us, ‘It would have to be a certified diamond; it would have to be insured; I would need the time to get it independently appraised before being charged; and I’d hope that if I were buying it sight-unseen and the risk was a little higher, I’d be saving 20–25%.”
“You buy at Tiffany’s, you’re not worried about whether the diamond is real, or if the specs are in fact what they say they are,” Cast says. “We didn’t have a brand name behind us at the time. If you’re going to buy from this online guy, it must be certified.”
In Search of the 800-Pound Gorilla
When assessing the competitive landscape before them, the team had to weigh the sufficient “white space” in the category against the possibility that a larger competitor may be lurking in the shadows. If this competitor was capable—or inclined—to enter the category with enough muscle, it could sink the startup before it got out of the blocks.
“We asked ourselves, ‘Is the 800-pound gorilla coming to kill us?’” Cast says. After assessing the potential threat posed by the biggest player in online retail—Amazon—Blue Nile decided, “You know what? Amazon sells other people’s brands, but they haven’t yet proven to be good at creating unique brands on their own.”
So, from a competitive standpoint, Blue Nile felt it could establish itself—through a combination of brand building, product verification, and trust-building customer service—and build a successful business that Amazon would not be able to crush.
While Cast was most concerned with running the killer experiment through the category, customer, and competition areas, the unique product that they had chosen to offer made the killer questions around supply channels very complicated. Diamonds are a rare commodity in a long-established, staid industry in which the De Beers companies dominate extraction and distribution. That raised a huge potential roadblock for Blue Nile: access.
The company realized that its access to a steady supply of diamonds was a binding constraint or a single factor that had the potential to bottleneck the entire business. If the suppliers had closed the tap—or chosen not to open it— then the company would have had to examine that constraint and find other options, such as shifting their business model to become a reseller or establishing partnerships with other companies that would allow Blue Nile to operate behind the scenes.
“Will these site-holders that De Beers sells to—and large distributors—sell to an online diamond company, or would they think that we are commoditizing and cheapening this experience?” Cast says. “That was one of the biggest assumptions for us: that we can, in fact, receive a steady supply of diamonds from the top distributors.”
Blue Nile’s research then turned to figuring out under what conditions that would happen. The negotiation process included articulating the business model to those distributors.
“We had to lay out our proposition so that they would get comfortable with us,” Cast says. “We had to say to them, ‘We’re going to shoot all the jewelry beautifully. We are only going to sell certified stones. Here’s how we’re marketing it. Here’s the venture capital behind us, to show that we’re serious. Here are our industry insiders who understand how to source and buy.’”
Ultimately, the company did not have to resort to a work-around—its suppliers recognized the legitimacy of the business model and were willing to sell to them. A secure supply chain that ensured quality product, combined with an educational program developed to help customers through the selection and buying processes, were keys to the company’s growth into a market leader, with over $473 million in sales last year.
For Blue Nile, running the killer experiment across the key areas of the business prepared it to navigate the burgeoning world of online diamond retail with a firm grip on what would lead to—or hinder—its success.
Fred Schmalz is Business Editor of Kellogg Insight.
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