(FORTUNE Magazine) – THE ALLURE OF THE LITTLE BLUE BOX seems to be fading. While luxury-goods brands like Louis Vuitton, Cartier, and Gucci are expecting a robust holiday shopping season, Tiffany & Co., whose stock has fallen 27% this year, saw earnings collapse ahead of the holidays, prompting management to slash earnings estimates for the rest of the year.

Tiffany's problems stem largely from its long-term strategy to grow its business by drawing younger, less affluent customers to its stores. As other retailers have found over the years, the mass and class plan began to backfire in the late 1990s as customers clamored for more and more exclusive goods. The results are especially evident in Japan, Tiffany's second-largest market. "The Japanese luxury consumer takes her purchases very seriously," explains Richard Baum, an analyst at Credit Suisse First Boston. "If she's going to spend several thousand dollars on a piece of jewelry, she doesn't necessarily want to be buying it next to a teenager buying a piece of silver jewelry for $100." Tiffany's sales in Japan were growing at around 12.5% a year between 1994 and 2000, but have since fallen 2.7% per year on average. To try to reverse the slide, the company recently replaced some managers in Japan and has opened more modern, standalone stores in Osaka and the Marunouchi area of Tokyo that will focus on high-end jewelry pieces.

CEO Michael Kowalski is also searching for ways to boost sales in Tiffany's biggest market, the U.S. (Tiffany's said Kowalski was unavailable for comment.) Here, as in Japan, Tiffany is trying to attract more big spenders by shifting its marketing away from low-priced jewelry to higher-end pieces that cost $2,000 and up. The jewelry giant is also trying to diversify and reach out to new customers--but not by luring them into Tiffany stores. In 2001, Tiffany acquired a chain of duty-free jewelry and watch stores in the Caribbean islands called Little Switzerland. Then, in 2002, it took a stake in trendy, upscale jewelry designer Temple St. Clair. And this year Tiffany launched a new retail venture called Iridesse that will specialize in selling pearls priced from less than $100 to $40,000. Over the next five years Tiffany plans to open 20 Iridesse stores. (You won't find Tiffany's name or little blue boxes in any of the ventures; they're connected to Tiffany by balance sheet only.)

But the biggest shift at Tiffany isn't visible to shoppers. In 1999, Tiffany took a 14% stake in Canadian mining company Aber Diamond Corp. Under the agreement, Aber will supply the retailer with $50 million in rough diamonds every year for ten years. (Tiffany got its first shipment of gems in March 2003.) The venture, says Bear Stearns analyst Dana Telsey, allows Tiffany to source, cut, and polish more of its diamonds in-house, which should improve its margins. Unfortunately, the cutting and polishing center it opened in Canada a year ago is still ramping up, and Tiffany's profit margins in the first three quarters were still being walloped by rising platinum and diamond prices. Hence, this year, instead of something sparkly in its stocking, Tiffany is more likely to get a lump of coal. -- Julie Creswell