I read this week’s Memo from Chaim Even-Zohar with great interest. I think that Chaim is finally willing to be a bit more honest and less diplomatic about the current state of diamond industry. Nevertheless, despite the data is in his article, the collapse of the industry did not suddenly happen–it was a long process.

Chaim sees the one side of the equation –the oversupply of rough, because his focus is, as always, on the rough market. I believe that the problem is the growing under-demand. One way or another, the financial result is the same. No money is left in the industry: there’s $45-50 Bn of unsold polished stock, which amounts to a three-year supply (as I previously estimated), and huge debt which is only partially covered by diamonds that nobody wants or can buy at any price. Now De Beers is planning to lose its last proper luxury marketing element – the exclusivity of the sightholder.

They do not understand the value of the asset they plan to dispose–once it’s gone, it’s gone for good. If we look at this cynically, sightholder exclusivity allowed De Beers to wash a good amount of unneeded goods at premium prices in the last ten years. They used their clout and influence; now there’s nothing left. The Emperor is Naked. Unfortunately, this time the onlookers do not laugh.

De Beers new emphasis on “enduring value” is achieving widespread coverage.  Many in the trade, like JCK magazine, really WANT to believe the message!

Reading through the hopeful message of De Beers, it is easy to find many rational arguments that diamond prices are sound, but the truth is, the arguments are flawed.

The first of the arguments is that diamonds are of “enduring value”. I simply do not know what enduring value means here, given that we all know that diamonds are not a viable form of investment and never have been.

The second argument is that it is better to buy now because the supply of diamonds is limited – as existing mines are depleting or even depleted and no big mines are on the horizon.  The industry has been spinning this yarn for years when it wasn’t true.  So how can we expect consumers to believe us now?

It will be particularly interesting to see how this particular argument helps in convincing a retail customer who stands in front of display-case after display-case overflowing with diamond jewellery; not to mention the immensity of the diamond jewellery overhang, lying dormant in domestic jewellery boxes.

The final argument DTC makes is that among really affluent buyers, price is not an issue. I do not know who these affluent people are and what their weight might be among diamond buyers. Data shows that since the mid 1980’s the “sweet point” of diamond purchases simply did not change. In the US, with its social multi-layered demography, most of the diamonds sold are in the range between $2000-4000 while in Japan this “sweet point” still hovers around $2000.  For diamonds, sold as commodities, price does matter!

Of course this could all change if we reverse the tide of the 1980s and return to first principles.  Diamonds are luxury, pure and simple. They must be sold as such.

The one thing we know about luxury is that it is ultimately irrational (the subject of my PhD – thankfully now completed!).  Luxury is a fine example of the fact that that the value for money is NOT what we seek. When we ask people for a definition of luxury we usually get two answers.

First, we hear that luxury is expensiveness and second, we hear that luxury is unnecessary (or superfluous). In this sense, diamonds are, in principle, the pinnacle of luxury – as they are, quite literally of no use whatsoever.  When it comes to valuation, saying that luxury is unnecessary opens the door to premium and unbounded, personalised pricing – the antithesis of commodities.

Instead of recognising and embracing the irrational consumer, since the 1980s,  De Beers has adopted a rational line, looking to “educate the customer”.

This is still the producers’ strategy – at the expense of the industry , which simply has to follow the leader’s line.

However, as these ‘rational’ arguments will never convince any serious customer, we have seen and will continue to see a lower proportion of people interested in diamonds.  Other luxury offers, by contrast remains resolutely irrational – and many categories are indeed relatively resilient to economic considerations. Purchasing of luxury is ultimately an irrational activity.

Of course it is just possible that during the coming six weeks American customers will storm the jewellery stores and clear up everything still in their vaults delivering a knock-out blow to the recession.

My feeling, though, is that we are looking less at a boxing match and more at a game of Russian roulette that may well send the final blow to the de-facto bankrupt industry.  Doubling up the Christmas ad spend and pleading with consumers to value ‘their commodities’ at heavily inflated prices is a very big gamble indeed.

I propose the following short prescription for the diamond industry’s long-term recovery:

First and foremost:

A true leader must emerge from deep within the industry at the level of primary production.

(2) This leader must have the ability, confidence and commitment to squeeze supply when necessary.

(3) This leader must recognize and solve the question of “enduring value” at the retail jeweler level.

(4) Retail jewelers must be trained and retrained on true luxury and understand it inside and out. This goes far beyond anything attempted by the industry to date. It is the cornerstone to the health of the industry medium and long term. Isaac speaks to this when he mentions irrational purchases.

DeBeers had the formula right prior to the 1980’s, but steered off course…they need a map and they need to learn to read the signs

(5) The practice of ‘Memo’ing goods, except in the instance of a 10 days special request for an established client must be relegated to the past.

(6) Jewelers must gravitate to partner suppliers who can work effectively with them to eliminate bottlenecks in supply.

No diamond should sit in a jewelers inventory for extended periods of time.

(7) Primary polishers must invest their profits (which means they must first have some profits) into their business to improve infrastructure (equipment) and train a new generation of diamond polishers. If a business is profitable then good business practice will lead those who survive to take these steps independently. Those who refuse to move forward with innovation will eventually close their doors.

(8) Consumers should be allowed to rediscover the hidden value of diamonds – The essence of self expression. Being able to express in action what one can not express in words.

Forget the 4C’s. Forget about diamonds as an investment. Diamonds are a symbol of the irrational – LOVE.

(9) Bank debt must be reduced significantly. There will always be a necessity to work with others money, but it is out of control.

In my view the industry debt is most likely 5-7 times more than is healthy.

(10) Banks must be enabled regain confidence in the price of rough and the downstream distribution (this is once again a a function of strong leadership and even political guarantees by governments whose revenue depends on the diamond industry’s health).

I read the comments of DTC and confess my utter amazement…

Take a look at the Enduring Value Media Release.  Among many other things they argue that the medium and long term fundamentals of the diamond industry are strong (!?)

That’s rings about as true as John McCain stating that the fundamentals of the US economy are sound just days before the biggest meltdown of the US financial sector since the founding fathers walked the land.

I also take real issue with whatever data collection indicates that diamond jewelry is the #1 gift for holidays 2008 “by a wide margin”.  I can report to you, direct from Main Street USA, that the bigger decision is whether gifts will be exchanged at all.  It is all well and good that consumers desire “fewer, better things”, but the real pocketbook world is a bit more complex than that.

On the other hand, I do acknowledge that spending a gazillion dollars to market to consumers the idea that diamonds are a great long term store of wealth probably feels like only viable option available right now.  What other choice do they really have? Just run the ads and hope for the best.

There is a real risk that the old ‘kill the messenger theory’ will come into play here.  Being the bearer of bad tidings is never easy.

However, I think Isaac has a point.

Our industry is in a real mess. No doubt about it.

We have been looking for some time now for a new style of leader to step forward and help navigate the industry through this mess.  I’m sure DTC feels it’s acting in the best interests of the industry to protect the PRICE of diamonds, but I would urge a fundamental rethink to safeguard the VALUE of diamonds

The move of Martin Rapaport was a shot across our bows.  And it was definitely was heard around the world, but remember that it was just a warning shot.  It has had absolutely no impact at the consumer level and I have serious doubts that it has had any real impact at the jeweler level.  However, the killer shot is being loaded into the cannon – and it may be unleashed unless someone steps into the leadership role, changes the industry heading, and puts the ship on a path to safer waters.

Here is my idea – If DTC wants to really boost demand they should invest directly into the local retail jeweler.

It is the DTC, not consumers, who have lost confidence in the ‘enduring value’ of diamonds.  They are the ones who do not own any diamonds of their own.  They only borrow diamonds, sell them to consumers, and eventually pay off these diamonds when the risk has reduced to zero.

Protecting this ‘enduring value’ is the marketing question that should been receiving the undivided attention of DeBeers. Given where we are the answer of how to fix this problem is best left to the highly paid consultants. But from the street level, it seems like a matter of incentives (or disincentives) for consumers to purchase.

In an attempt to push product down the pipeline for the past 20 years, the industry has eroded and destroyed this enduring value in the eyes of the retail jeweler.  ’Enduring Value’ looks like a return to basics. And about time too.  But is it leadership?  Not in my view.

Yours, Randy Pearson,
Registered Supplier, AGS

At the ‘virtual’ centre of our industry, Martin Rappaport has reduced the prices on his price list across the board signalling the need for a major price-cut (perhaps 25-30%) across the market.

Industry insiders will argue that Martin’s prices are based on the nonexistent “New York market approximate high cash asking price.” While Martin is a market expert, his prices reflects baseless assumptions, not consumer reality.  They are hunches and beliefs in the market.  They are, ultimately, arbitrary. 

Meanwhile the collapse they foretell is being artificially accelerated.  What Martin did to the future market for polished diamonds, BHP has done to today’s rough, offloading its stock at prices 30-50% below what used to be the market price just months ago…

For the diamond industry, the writing is been on the wall.  But then it always has been. The message was  clear: if we do not change course, we are heading for a crash. The longer we wait, the faster the downward spiral and the more painful this crash is going to be…

Those who know me can testify that this has been my mantra for the last ten years.  When my message finally appeared last year (see the abstract in this recent Gem and Gemmology), it was the product of several years of research…

My message to the industry a simple one: we have been living in a bubble.

As an  industry we never took the time to stand behind the counter, to speak to the diamond consumer and to listen to his or her needs, wants and aspirations.

Instead of listening, we have spent our time looking to educate the consumer.  But we forgot to educate ourselves! If we had cared for the consumer, we would have realised that they didn’t need or even care for our education. In fact our attempts at education have backfired — so we now see fewer and fewer diamond consumers in the shops.

As a direct consequence the diamond market has been in constant decline relative to other luxury goods. The current demise (although accelerated by a falling dollar and a credit crunch and barely propped up by far-Eastern demand) is not a temporary shock, but a long-term critical illness. 

So, my dear friends and colleagues, it is time to wake up and realise what we have done to our industry with our 4Cs marketing pitch.  We have sowed doubt, not trust.

The DTC already admitted to this terrible failure three years ago. But instead of stopping this ‘ongoing malpractice’ — we intensified it, borrowing ideas from marketing literature without having the slightest idea what they meant.

Among those ideas was the call for branding. I pride myself to be personally trained by one of the world’s leading branding experts, Prof. Leslie de Chernatony of the Birmingham Business School. Leslie was diplomatic enough to call this branding drive “rubbish.”  I say ‘diplomatic’ the market shrank by about $5BN (in relative terms) due to these marketing iniquities, without even counting goods that went unsold.

Unrelated to this marketing shortcoming, and oblivious to actual level of demand, the marketplace kept raising prices without any justification in market demand.  To finance this increase in prices without a complementary increase in demand, those in the middle of the value-chain put their hands deeper into their pockets.  The more sophisticated ones even found ways to convince our generous bankers to finance this illusionary bonanza. Consequently, the market grew – but only on the back of increasing debt to the banks.

So will the present crisis really have any effect on the retail market? I doubt it.  And if it has, is only in the short term. Even with this unprecedented crisis, analysts predict that the luxury market will return to normal in 2009.  Luxury goods, but more especially diamonds are relatively inflexible to mainstream economic trends; demand for them neither brakes in a recession, nor accelerates in a boom. 

Unfortunately, while this may be true for the larger luxury market, I fear this recovery simply won’t come to pass for the diamond market.  The relative value of the diamond market, or what will be left of it, will continue to decline at an even faster pace. 

Now consider the debt, which finances these escalated and unjustified foundations.  When the diamond banks will have to finance the coming sights (De Beers’ sales of rough diamonds), on what basis are they going to estimate their risk? Are they going to finance the real trade prices of the rough, sending their customers to look for impossible extra credit, and thereby preventing them from purchasing their quota? If they do the collapse of the cash-hungry diamond producers is imminent.

Or, will they choose to honour their relationships, finance at inflated levels and take the risk of a wider meltdown.  Maybe the banks will just keep on nurturing the ailing industry without really helping healing it

Would this so bad?

After all, the diamond industry has lived on borrowed time (and money) for a decade.

But the fact is, cannot support such high levels of debt and does not have enough assets to guarantee payoff of all this debt, especially when these assets are in the form of overvalued diamonds. The industry is, de facto, bankrupt.

As long as this state of insolvency is not officially declared, there always a window of opportunity that might allow us to change course. This change must start with a new approach to marketing, led, and financed by the retailers. Once done properly, will prove far cheaper than the amount of money currently being thrown away on empty trade-branding and commoditisation, for naught.  Preparation for this recovery process must start immediately.  It’s now or never.

We face, I believe, the imminent collapse of the entire industry.  While many good people will get hurt, this is not so bad for the industry in the long-term.  After all, there is only one group who are able to pick up the pieces and rebuild the industry – us, the diamond people.

Personally, I would prefer not to wait for a phoenix rising from the ashes. We can still change course.  We must take our medicine and redirect our marketing to the self-esteem that our customers are crying out for.

Sightholder status from the Diamond Trading Company (DTC) is bestowed the world’s top diamantaires (as chosen by the DTC) for “their ability to market diamonds effectively and distribute them efficiently.” DTC Sightholders get access to rough diamond supplies, and in return “deliver specified diamonds in predictable quantities, assure the quality and integrity of their diamonds, and provide value-added marketing support.” (Both quotes from the DTC’s site here)

Recently, six companies lost their DTC Sightholder status following the result a criminal case in Antwerp. On December 6, 2007, the Antwerp Correctional Court convicted these diamantaires (and seven others) of fraud, fictitious invoicing and smuggling between 1994 -1999.

The judges refused to approve a settlement between the Belgian prosecution and the thirteen diamantaires, and gave the companies a six months suspended jail sentence. The DTC is also suspending these companies’ diamond supplies.

This editorial, “The Genie is out of the Bottle,” by Chaim Even-Zohar, makes an interesting argument that it wasn’t so much fraud as industry practice at the time that these (relatively small) companies were doing–they were actually increasing their taxable income by moving values that were ‘hidden in inventories’ to actual revenues, which the law now makes companies do. Their conviction is merely for show when larger companies with greater transgressions at the time were not targeted in the lawsuit. In any case, Even-Zohar believes the decision will accelerate growth of transparency, good governance, and Best Practice Principles in the diamond industry. Do you agree?

This is the final post in our mini-series documenting an email exchange between Randy Pearson, of Allied Diamonds and Isaac Mostovicz of Janus Thinking.

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From: Isaac Mostovicz
Sent: 09 October 2006 20:39
To: Randy Pearson

Dear Randy,

Here are my comments:

You raise a classical point as companies under a pressure to produce short-term successful results, act against their long-term goals. There is no doubt that the act of the DTC was brilliant in the short-term and the SoC is only four years old. They managed to get rid of their stockpile and turn it into money. However, what happened in the last years shows that they did not take into consideration long-term consequences and as a result, they are unable to sell their entire intake and, effectively they build a second stockpile, they have a problem with their profitability and in spite of an increase of volume and price, their profits raised only marginally (I think that the figures for 2005 were 3%).

In regarding the Millennium experience, I have several observations to make. While we advocated high prices (we sold at +30% or more), other participants did not even thought that these prices are possible. Together with this, we advocated top make and had to fight with the other participants (mainly Americans) who wanted a much more lenient standard. To add insult to injury, the level of rejection by us was 3-4% and I knew beforehand most of which will be rejected. On the other hand, the rate of rejection by others was 30-40%! Last, but not least, to become a Millennium distributor we had to submit a marketing plan. When all participants met in April 2000, the DTC introduced them to the 4Ps which was considered by many as a brilliant novelty. My question is how exactly looked the marketing plan of the other participants? Taking into consideration that the DTC was not involved in the marketing of the product, it is not a surprise that the program crashed. Give a F1 to someone who does not know how to drive and he’ll crash it in no time.

Your last question is excellent. I must say that my imagination is limited and not every diamond is appealing to me or can be considered a luxury. Thus, I do not exclude Indian junk as long as it is presented properly. Rolex is a junk of a watch, unless you use it as a calendar but it is the finest example of what luxury is. The legendary Jaguar E Type is of the same league. However, when you treat cheap diamonds as junk, that’s what happens.

Isaac

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We hope you have enjoyed this mini-series; do let us know what you think – the comments field is open!

This is the fifth of six posts documenting an email exchange between Randy Pearson, of Allied Diamonds and Isaac Mostovicz of Janus Thinking.

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From: Randy Pearson
Sent: Monday, October 09, 2006 8:55 PM
To: Isaac Mostovicz

To extend this a bit more, I see this point as one example of how SoC has worked as intended. DTC had a problem of stock that was unsuitable. Their existing sightholder base was not equipped to produce and distribute these type of goods that they had stockpiled. By bringing in “new sightholders” they were able to move out these goods and leave it to the banks and these clients to find a way to cash these goods. The banks took the sightholder status as collateral for the loans based on the experiences of the past and now they have a problem. These goods were consumed into the marketplace via the sightholder transfer of ownership from DTC to the SOC, but then we have a bottleneck as there was low demand at the consumer level for this article (that’s why they stockpiled them in the first place – remember there was no reason for them to stockpile other than low demand back in 1999 as markets were healthy). In one viewpoint, their tactic was brilliant as they did this on the backs of these “new SOC sightholders”, but on the other the banks that support the industry will suffer.

Of course, I do not have privy to how gets which box and assortment of goods, but you can get a clue based on who the new players are and who was eliminated. New Indian companies and new firms that polish in Africa. If they divert this unsuitable rough to these firms then they satisfy the political problems while liquidating dead assets.

Yes the standard of what is jewelry quality has slipped greatly. There is no doubt of this point. It has opened markets to the masses, but I would argue has greatly damaged the diamond dream and the symbolic value of diamond. On one hand you can argue that everyone should share in this dream and I tend to agree, but at what cost and where do you draw the line. Recall the decision of DTC in 1999 regarding the Millennium Diamond. They set a standard of rarity that was far higher than their average production. Do you imagine they did this without research to indicate that if you place the range too low it would not appeal to certain demographics or targets? Why did they not select smaller goods in promotional quality range? Were they concerned about the image of diamond as a symbol?

These are just thoughts, but it may very well come to pass that we have further segmentation in the industry when the dust settles. I would much prefer to be selling our range of goods than bags full of promotional goods selling on a volume basis during the next few years.

One question to explore is, “what is the definition of a diamond that represents the symbolic diamond dream?” Where is that line and how do we know if it is crossed?

Randy Pearson
S. Muller & Sons

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Don’t forget to check back at the same time tomorrow for the final installment.

This is the fourth of six posts documenting an email exchange between Randy Pearson, of Allied Diamonds and Isaac Mostovicz of Janus Thinking.

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From: Isaac Mostovicz
Sent: 10/9/2006 6:24:12 PM
To: Randy Pearson

I think that Randy raises a point that needs a further exploration. Until the 60s the range of what were considered diamonds suitable for jewellery was much more restricted. The Indians learned how to produce rough that was previously considered unsuitable for jewellery. I raise the following question: is it possible that the market became too large in the sense that many of the goods that are offered are unsuitable for consumption? In other words, the production of real diamonds is very limited and if we manage to market only these goods, the offer will be limited but we will be able to raise prices to very high levels as the availability will not be there.

One of the reasons for the SoC was the unsold stockpile of $5bn (US). The claim of the shareholders was that the worth of this stockpile is nil, something that the DTC tried to prove wrong by selling the stockpile for the price they wanted. However, selling the stockpile was not an indication that the need for these goods exists. To take an analogy from what we have on hand, we, at Allied, have plenty of goods but if we want to be faithful to our program, only a limited part of this stockpile is suitable as need satisfiers. Nevertheless, it is our responsibility to find ways for using these goods for satisfying clear and existing needs.

Another example is Patek Phillipe that produces only 18000 watches per year regardless to more markets that open. It is very tempting to try and to cater to the entire world but there are other ways for making money and mass marketing may not be suitable for diamonds.

The last point that Randy raises is interesting. Good manufacturers burned their fingers in the last years by manufacturing. It is possible that people will try to slow down manufacturing as keep prices of rough at bay and gain from selling his existing stock, effectively lowering the level of stock. I am not sure that all will follow but as a different policy is the way of those manufacturers who might suffer and even close down, we are facing an interesting period.

Isaac

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Once again, check back at the same time tomorrow for the next installment.

This is the second of six posts documenting an email exchange between Randy Pearson, of Allied Diamonds and Isaac Mostovicz of Janus Thinking.

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From: Isaac Mostovicz
Sent: 10/8/2006 5:08:29 PM
To: Randy Pearson

Randy,

It is very difficult to give such an estimate, as you know and comment. Some take 1ct or 0.5ct as a benchmark but this is not better either. Therefore, I preferred to rely on Even-Zohar as a source. He is honest enough to know the complexity of the market and provide these numbers as an illustration only. There are so many factors in building such a graph: the type of diamond (size and quality), the geographical market, the type of outlet, the time that the data was collected (now the situation is worse) and more. However, this complexity is more pronounced at the retail level.

You are correct about the squeeze at both ends, or throughout the pipeline. In the past, people were ready to suffer blows as they knew that in the long run they will win. This was the case with sightholders who were ready to overpay for their boxes, knowing that the DTC will pay back its loyal customers for the losses by offering special goods. Unfortunately, I believe that the DTC is not making money either, even when their mining operations are considered to be the most efficient in the market. De Beers is now a private company but did they stay a public company we’d see a hostile takeover. This article in IDEX confirms this squeezing trend.

Isaac

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Once again, check back at the same time tomorrow for the next installment.