Bad Boys and Foolish Dreams

Opinion piece
07/01/2016 21:40

Louis Pearl, rough diamond consultant and gemologist, takes a hard look at eroding profit margins throughout the diamond pipeline from a historical perspective and - for a change - does not place all the blame on the major miners. 

Recently, I have read articles bemoaning the seemingly out of skew relationship between the high cost of rough diamonds and the low price of polished diamonds. The authors correctly state that the high price of rough does not reflect the realities of the polished market. Of course, everyone blames DeBeers, Rio Tinto, Alrosa, and all the other mining companies for their unrelenting greed in setting the price of rough far beyond its real value. They demand the mining companies open their eyes and hearts and adjust their pricing in order for the people who manufacture, export, import, wholesale, broker, and retail diamonds be given a fair shot at realizing some kind of reasonable profit in their businesses.

Those bad boy mining companies always seem to come out smiling. It is unbelievable that mining companies should look out for the interests of their stockholders, governments and mine owners before caring about the poor people in the diamond supply chain. It’s as if the mining companies only care about profits and their own costs and problems. How could you not hate them?

Consolidation

Before we grab a rope and string them up, consider this: margins in the diamond supply chain have been eroding steadily for 25 years. In the past, there were many small and medium sized retail jewelry companies. This meant there were a large number of companies that could afford to buy diamond inventory for their stores and life was good for all who were engaged in supplying them. Then a terrible calamity took place.

Larger chains found that the only way they could increase sales and profits was to open new stores unrelentingly. Because there are a limited number of great locations, the large chains began gobbling up the small chains and even single stores that were in prime locations. Before long, the mom-and-pop stores, and small to medium chains disappeared and we were left with relatively few large chains like Zales, Sterling, etc. 

The large chains then bought whatever chains they could purchase and this further reduced the number of retailers that could afford to buy diamond inventory. In addition, because competition became so fierce at the retail level, some large chains that did not adapt soon were out of business, further limiting the number of retailers in the market.

This consolidation was difficult for the industry to adapt to, as it resulted in fewer retail customers. Suppliers at all levels were in a bad predicament: too many suppliers, too few customers in the market. Many diamond suppliers watched their margins erode dramatically as manufacturers and wholesalers had to compete for a much smaller pie. Some manufacturers with deep pockets enticed the large chains with memo programs and very generous terms. In order to combat these programs, their competition had to lower their prices in an effort to make the memo programs less attractive to the chains.

This, of course, caused the companies doing the memo programs to reduce their margins in order to keep the business with the chains. This created a mess and the negative effects are now evident throughout the industry. The only saving grace for the industry was the opening and development of Asia as a serious market. (Please do not give DeBeers credit for single-handedly turning Japan into a diamond buying powerhouse, even though they were single-handedly responsible for this.

At about the same time as this was all taking place, two new factors began to emerge that would completely change the way diamonds were bought and sold at the wholesale level. These two factors were at first embraced as a way to modernize the industry. Many an article was written on the virtues and advantages these two companies would bring to the diamond business. I am speaking of course of G.I.A. and Rapaport.

G.I.A. benefits and fallout – even a monkey could buy diamonds

G.I.A., as most in the industry know, is the dominant diamond grading lab in the world. It is the Holy Book when it comes to diamond certificates. In the beginning, G.I.A. appeared to be a blessing to the industry. For the first time in the history of the diamond business there was an accepted worldwide grading system. Consumers and the unskilled in the business benefitted greatly. Both consumers and the unskilled were now able to know exactly what grade their diamond really is, and were able to compare prices from various sources with verified data.

For diamond manufactures, importers, wholesalers and brokers, G.I.A. seemed to make it easier to sell more diamonds. In addition, those of us who were buying diamonds directly from the manufacturer could use our knowledge of grading to our advantage: buying a stone as a G color that came out F; or buying a stone as an SI1 that came out VS2.  A dealer could increase in his profits instantly and had an easier time competing with other dealers. Because of this, G.I.A. was embraced by the diamond industry. All was fine as long as G.I.A. certificates were only made and available in America.

When G.I.A expanded and certificates became readily available in the world bourses, and when just about every manufacturer began to certify their productions, the inevitable happened. Almost overnight, diamond knowledge and skills learned over many years were now needed only for those diamonds not of value to justify a G.I.A. certificate. This meant that even a monkey could buy diamonds.

It also meant that the people in the supply chain who could increase and maintain their margins using their skills lost one of the few advantages they possessed. What began as a great tool to the industry is now a curse to the very people who originally glorified the G.I.A. Because almost no skill is needed to buy G.I.A. certified stones, profits once garnered with skill have disappeared into the darkness of the past.

Rapaport benefits and fallout – acessibility eroding advantages of skill

The Rapaport Company was not looked upon with respect in the first few years of its existence. Over time, like the G.I.A., it was embraced by the industry because it made it easier for those who had limited knowledge of the value of the various grades of diamonds. The Rapaport sheet made it easy to know the value of any diamond it listed. Once one knew the correct discounts to apply to any particular shape and quality, one could accurately value a stone.

This sounds great, and it did make it easier for all of us. And, herein lies the rub, so to speak: because anyone could determine the price of any diamond quality on the Rapaport list, the ability to make profit, and hence, the profit one could make using market knowledge, also disappeared into the darkness.

Not only did everyone in the industry have a Rap sheet, but the public found out about the Rap and retail jewelers soon found themselves dealing with customers walking into their stores with Rap sheets in their pockets. Once again, what was initially praised as a blessing is now one of the main causes of the loss of profitability in the industry. It could be argued that G.I.A. and Rapaport have had more to do with destroying margins in the polished diamond industry than all other factors combined.

FedEx

Misery loves a lot of company. Another important factor that has contributed to a loss of margins and profitability must be mentioned. The culprit is FedEx. Yes, FedEx. Before FedEx, most retailers were forced to buy diamond inventory for their stores. When you have inventory in your store, you can stop the customer from looking elsewhere. In the event a customer came in to the store and the retailer did not have the stone the client requested, he would call his local diamond dealer and the dealers would send him a stone through the U.S. Mail.

This was a problem, because by the time the package arrived many days later, the customer had time to visit other jewelers and the stores lost a great number of sales. When FedEx became available for shipping and insuring diamonds, the jeweler could keep the customer’s interest by bringing in several stones within one day. This meant the jeweler no longer needed to stock inventory, and by calling several diamond dealers for the same size and quality stone, he was able to pit one diamond dealer against the other.

Knowing this, diamond dealers further cut their margins in order to compete with rival companies. Before long, it became very difficult for diamond dealers and brokers. The retail jeweler would seem to enjoy the benefit of this situation. Alas, it is not so. Because every retailer can do this, customers soon realized they could easily see as many stones as they desired simply by having several retailers bring in stones for their viewing and inspection. Yes, they did not have to wait many days, but they still had time to visit as many jewelry companies as they desired because there are so many jewelers in the same mall.

The poor retailer was faced with a public requesting G.I.A. certificates and walking in with a Rap sheet. The customer could view as many stones as he wished from several of the retailer’s competitors, all within easy walking distance within the mall. Yes, you guessed it, this further increased costs and lowered margins, thus lowering profits for the retailer and the other ‘schmoes’ like me in the supply chain. Thank you FedEx.

Online sales & big box stores

Lest you think we are finished, let me add two more factors contributing to the erosion of margins and profit: big box stores and the Internet.  With companies like Wal-Mart and Costco in the mix, retail jewelers, like other retail businesses, found themselves under incredible pressure. These stores have taken a huge chunk out of the traditional jeweler’s business and, again, are a major cause of diminished margins and returns.

Last, but certainly not least, is the Internet. With companies like Blue Nile and others of the same ilk, retailers watched with horror as diamonds were being offered to the public at near wholesale levels. In order to compete, brick and mortar companies created websites and did everything they could. The pressure put on the retailers reverberated all the way up the supply chain.

New type of buyer

Interestingly, in the years that all this was going on, new buyers of rough diamonds emerged. These are people and companies who buy rough with no intention of polishing the stones. These investors are not in the jewelry industry and care not one iota about polished prices. These companies consist of private investors, banks, hedge funds, and wildcat investors looking for a safe haven in tumultuous times. Some buy rough and just put it away. Others flip it to their clients, while some put it into platform trades.

Generally, these companies do not buy directly from De Beers or the other major mining companies. However, they indirectly buy up rough from these companies and often buy from African government and private mining companies all over the world. Their presence in the industry has been a boon to the mining companies and diamond producing governments, as they buy up much of the oversupply of diamonds available in the market.

If you doubt the investor-speculator’s impact on the mindset of the mining companies of the world, you need only look at the “I-could-care-less” attitude of the mining companies in response to the pleas and curses of their traditional customers.

People in the diamond supply chain are rightfully worried about their future. They lament the passing of the good times. Many are leaving or have left the industry. Fewer are bringing their children and close relatives into the business. The diamond business is capital intensive and has ever-diminishing margins. Only the very large and the very innovative can survive and flourish.

Stop complaining. Stop blaming the bad boy mining companies; free yourself from foolish hopes. Face reality, innovate, and create a niche for yourself. If you can’t do this, get the heck out of the business. “The person, who says it cannot be done, and cannot do it, should not interrupt the person doing it.” (Chinese Proverb)

Louis Pearl (www.roughdiamondgemologist.com) has more than 40 years experience in the diamond trade, working in mining, importing and distribution of rough diamonds and polished diamonds. He graduated as a gemologist from G.I.A (Gemological Institute of America) in 1975. For many years he imported polished diamonds from Antwerp, Israel and India supplying the largest chain stores in the US. As his knowledge, experience and understanding of diamonds and mining grew, he was drawn more into dealing with rough diamonds in Brazil and Africa, serving as director and vice president of publicly traded Springer Mining and Sao Luis Mining.

He has worked as an advisor and advocate for rough diamond sorting, rough and polished diamond grading, evaluation and pricing throughout the world, including: Africa, North and South America, the Far East and the Middle East. He has spent his life following his passion for diamonds and for international business.