Janus Thinking

Diamonds are truly priceless

It took me many years to understand how diamonds are priced and what a “good price” for luxury goods and diamonds really means. You will not find this information elsewhere as the subject was never researched and assumptions about pricing were never examined.

We have always been told, following the basic assumption in economics that prices are the result of supply and demand. The higher the demand, the higher the price is and the more the supply, the lower the price. Without challenging this assumption head-on, I can testify that the diamond industry does not follow this basic formula or any adaptation of this assumption anywhere in its entire supply chain.

In general, we have three systems of pricing: the pricing of rough diamonds, the pricing of polished diamonds within the pipeline and the price of the polished diamond for the consumer.

Each system of diamond pricing reflects the needs of the particular market but none follows the supply/demand assumption.

The main problem of the rough mining companies is the enormous long-term investments that involves in developing a mine. Apart from the expensive exploration process, when a diamond mine is found, it takes many years until it becomes fully operative. To make the Venetia mine, one of the largest in South Africa, operative it took ten years for De Beers, the world’s most efficient mining company, to accomplish. Even when the mine is fully operative, it is very expensive to operate. Diamond mines are the world largest earth movers and we measure a yield of a mine by carats (1 carat = 0.2 gram) to 100 tons of gravel.

On average, we need to earth ten times the Wembley or the Shea stadiums to get one 1 CT diamond of the D IF quality.

So as to reduce the risk involved in such a long-term investment, De Beers followed by other producers developed a system that, when applied can indicate clearly the value of the diamonds to be mined. This information is relatively stable as well as the life of the mine. Thus, while the mining companies have to invest vast amounts of money over many years, they are able to predict the level of production and, consequently, their revenues.

The system that De Beers uses is based on a 5000-categories price list. This price list is based mainly on the relative rarity of various diamonds but it takes into consideration the diamond’s shape, quality, difficulty to manufacture and other factors. You can get similar polished diamonds out of different-in-price categories.

The pricing system that the polished-diamond industry uses is complicated as well. On the one hand, it is based on relative rarity – the larger, whiter and cleaner the diamond is, the more expensive it is. The shapes plays a role as well as round diamonds are usually more expensive than other shapes. The other element involved in the pricing system is risk. There is no guarantee that a certain diamond will be sold and people buy diamonds into their stock with the hope that they will be sold eventually. Thus, the price of the diamond that is based on its relative rarity is discounted to reflect the risk of not selling it. When the market suffers from sever illiquidity, the risk of not selling is higher and prices drop. In an active market, the discount becomes smaller and the gap between different quality and rarity categories increases. Unfortunately the diamond industry is far smaller that the market of options and derivatives and the Black-Scholes formula was never applied in the diamond market.

How about you, the consumer? Are any of these considerations concerning you? I doubt it. Is there a fair price for diamonds? I doubt it as well. After all, if you buy a diamond that you cannot enjoy, you just wasted your money.

All you have to check is whether you are happy to spend on your loved one the amount that you are asked for and whether she is going to be happy with what she is going to get. If the answer to both is “yes”, go ahead and enjoy your spending.

Are these ‘USB SLIPPERS’ via spluch - the ultimate piece of crass Christmas giving, or a legitimate form of luxury?

Who cares. They look hilarious…

According to Rapaport, the availability of rough diamonds will be less during the first half of 2007 due to several reasons.

Lynette (Hori) Gould of De Beers said:

There will be fewer Russian goods in the mix ($100 million less in 2007) as a result of formal commitments agreed with the European Commission.

Gould added that De Beers Canada production would not yet be available yet, and Botswana producer forecasts are slightly lower. He adds:

In addition, the DTC is committed to supporting the intentions of the southern African governments, with whom we work, to develop their diamond cutting industries, so we are selling a greater volume of rough (that is suitable for processing in local beneficiation enterprises) in southern Africa

Is this plausible?

The fact is that 98% of the world production are diamonds less than .7 CT. My feeling is that the Russian and the Canadian have relatively larger goods and to feed SA polishers you need larger goods as well…

There is a need to wash the excess supply of the tiny and cheap goods somehow and this, if you see this week’s comments on Rappaport, is not easy, the only way to sell these less desirable goods is to bundle them with more demanded goods that the DTC is increasingly being deprived of.

I suspect that we see here a growing stockpile in 2007.

Hiding the problem from the public is an acceptable tactic as long as the industry does not start to believe in that the stockpile does not exist…

Martin Rapaport is urging industry professionals to join his new fair trade jewellery association.

We are also establishing a non-profit organization — The Fair Trade Diamond and Jewelry Association — that will work to ensure fair compensation and beneficiation to the poorest members of our industry.

The Rapaport Group is establishing a non-profit fund for the education of the children of artisanal diamond diggers in Sierra Leone.

Rapaport will be donating $100,000 to kick off this program. We have asked and hope that others will work with us so that we may do something powerfully good for the people of Sierra Leone.

This action is a proper response to the public perception.

Luxury brands command a premium because they infuse the act of buying with emotion. Shopping is turned into an experience. But what distinguishes a quality, luxury product from one at the mediocre end of the market range?

According to Haupt, a senior advisor at Steuben Glass in New York, the product has to ‘speak for itself’. A luxury item is not dependent on cost. ‘Throwing money around … just creates a lot of noise’ (David Birnbaum). Rather, the creation of a luxury product is dependent on quality.

Today, it seems that a whole range of products, including Costa Coffee, Lindt chocolate, and Haagen Dazs ice-cream, have been elevated to the pinnacle of connoisseurship. It is about creating an experience that enables the customer to develop a particularly personal relationship with the item. In February 2004, Louis Vuitton opened a four-storey boutique on Fifth Avenue, detailing flashing LED screens and a staircase made of bronze and chestnut. The idea was to produce a sensory journey through the store using light, colour and texture. Sensory experiences such as this, as opposed to discrimination are of primary importance.

And by discrimination, I mean class divisions. A tub of Ben & Jerry’s often costs 100% more than a store’s own brand ice-cream, but it is nevertheless accessible to the ordinary buyer. As Michael J Silverstein, SVP at the Boston Consulting Group has indicated, old luxury revolved around aristocracy and high prices. Today, luxury is tailored to the requirements of the vast middle income market. It is the result of higher incomes, rising home values and a self-permission that has given to the ordinary consumer a taste for fineness, distinction and sophistication. It is quality rather than price that identifies a luxury item. A palate for quality can only be a good thing.

The former connection between connoisseurship and class distinction is to an extent, still existent. But the trend analyses indicate a sharp turn-around in the form of connoisseurship: the new symbol of high status in a market governed by luxury that is available to the masses is blatant non-consumption, by which the super-rich might be identified.

As David Brooks describes in his book Bobos in Paradise, the rich wear scruffy clothes and drive run-down cars. Celebrities sport clothing lines such as Von Dutch, the idea being that only the very rich or very pretty are able to pull-off trucker–style caps and tops, and still manage to look good.

So the new message seems to be that the rich have more money than they know how to spend: welcome to paradoxical luxury in the modern world.

Connoisseurship is not a closed product area. Increasingly, everyday items consumed by ordinary individuals are making their way into the realms of mass-market connoisseurship. Luxury has opened its gates, paving the way for items such as fine cheeses, chocolate and coffee to enter.

Taking the example of Starbucks, its stellar performance in the coffee industry is set to expand, and is based on the accessibility of the positive lifestyle that is associated with its brand. Content Research forecasts predict that Starbucks may overtake McDonalds as the world’s largest fast-food brand. The company has turned a staple beverage into an indulgence associated with connoisseurship. Or has it?

From the point of view of indie coffee houses, vast companies such as Starbucks have replaced skillful barristas with the cold rattle of the automatic machine, drenching its espressos in a milk and syrup mix, thereby driving smaller shops out of business.

But simultaneously and somewhat paradoxically, Starbucks is promoting cafe culture and generating a new generation of coffee drinkers. Tully’s, a small chain admits to locating new stores within the vicinity of existing Starbucks locations. People are given a taste of what they like, the gourmet coffee experience, after which they can venture beyond the land of the big green giant.

Jim Twitchell, author of ‘Adcult USA: The Triumph of Advertising in America’, attributes a demand for luxury items to the search for a higher sense of worldliness or epiphany. Fresh’s Crème Ancienne is made by hand at a monastery in the Czech Republic, spouting words such as ‘calm, renew, inspire and connect’.

Apparently, there’s a certain undeniable sense of virtue that accompanies queueing up for masala-spiced potatoes at one of Gary and Isabel Mac-Gum’s restaurants. You’re eating spinach, cheese and tomato-flavoured potatoes. What you’re receiving is a stamp of virtuosity that says, ‘I’m in touch with my spiritual side’.

Or is this just a cover for a sense of elitist satisfaction that amounts to luxury consumerism? In the end, perhaps all that this trend really comes down to, termed ‘metrospiritualism’, is bling consumption.

Having analysed almost every model of luxury branding for my PhD thesis, I ultimately decided that Dubois and Paternault’s model was being the most complete and explanatory power. D&P propose 6 attributes of luxury brands:

They are:

extreme quality expensiveness
scarcity
aesthetic appeal
superfluousness
and time incorporation

Despite being an excellent distillation of the nature of luxury brands, these criteria are clearly insufficient to explain the full range of luxury experiences.

Superfluousness is clearly a ‘qualifying criterion’ for luxury. That which is needed cannot, de facto, be luxury. But all the other criteria are open to challenge at some level.

Extreme quality, for example can be challenged by brands whose quality is utterly questionable - TVR sportscars, for example or more pertinently, Ferrari itself.

Expensiveness is less open to debate. Even allowing that expensiveness is a relative term, both in competitive terms, and from the perspective of the individual, some luxury brands are not differentiated on price.

Examples here would be brands that pull of the trick of becoming discretionary, while being functionally similar. These are brands that attract the attention of connoisseurs by branding heavily on the basis of being ‘an acquired, specialist taste’. In spirits, for example, limited release batches, or special finishes can be luxury brands, without necessarily being more expensive. From a marketing strategy the point is to sell greater volume to heavy users rather than increase margin on individual units.

Another example would be limited release handbags, or signed copies of books, which are luxury because they require effort and expertise on the part of the brand purchaser.

Scarcity is a very marginal criterion and has been widely challenged in branding literature. In the east social ubiquity does not undermine perceived brand cachet at all. In the west the growth of masstige brands like Molton Brown cosmetics has been dramatic.

The value of aesthetics is superficially the weakest criterion. We can all think of brands who have brutal aesthetics - Bristol, Hummer cars or Toughbook computers spring to mind, but they are still luxury on other measures. These sort of brands do at least have distinctive aesthetics, though, which appeal to connoisseurs, and lean on their brand heritage - but consider Lexus. Definitely a low-level luxury brand, but with zero aesthetic appeal.

The most intriguing category is ‘time incorporation’. When people talk about craftsmanship, or discuss a designer’s style, or talk about the quality of the purchase experience, this is what they are alluding to. Luxury brands compress and distill the process of design, manufacture and ownership of a product into their relationship.
When individuals buy a Ferrari, they buy 60 years of racing heritage. When they buy Chanel, they engage in nostalgia for a bygone age.

Based on Dubois & Co’s criteria, I wonder what the world’s most luxurious brand is…Rolex? or Patek Philippe? Linn Hi-Fi?