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In-Depth
President’s Letter
An open letter to the International Diamond Manufacturers Association from its president, Maxim Shkadov.
Dear colleagues,
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| Maxim Shkadov |
Time flies. As January 2015 is coming to a close, it is now clear that we still carry the burden of 2014 with us. As forecast last year, the reduction of diamond prices — as reflected in the Rapaport Price List — offers proof of the supply of polished far exceeding demand. In practical terms, this means that we all have to get used to the new normal in polished diamond trading: a lack of control of the volume of the goods that is released to the market.
It saddens me to see — and say — that the rift between the interests of the diamond mining companies and the companies that are represented by IDMA is becoming wider year after year. I think the seriousness of the “disconnect” between the producers and the manufacturers is such that it can no longer be ignored. However, in a recent media interview, De Beers CEO Philippe Mellier proved that from De Beers point of view, all is fine. Demand is up, and prices are on the rise. Good for them. But by taking this one-dimensional position, it negates the need for the health of all players in the diamond supply pipeline to be strong. And, as IDMA president, it is my mission to defend the interest of those players in the diamond supply pipeline who are most vulnerable to the policies of the producers.
Of course, companies like De Beers and ALROSA are required to satisfy their shareholders and to project their annual budget forecasts, which need to reflect an increase in demand for rough diamonds — and they base their projections on the demand they expect to get from existing or potential clients.
It is this — flawed — model that causes the “disconnect” between the — big — producers and the downstream pipeline. Basically, the producers consciously turn a blind eye to developments in the downstream section of the pipeline. Their sales and pricing models do not incorporate or take into account the demand and prices paid for polished, nor do they assess the cost of manufacturing, let alone the financing needed to turn rough into polished goods. As Mr. Mellier said: “…that’s not down to me.”
As I said earlier, the system of sales, where clients are cajoled into buying at prices that they know are not going to make them money, purely out of fear of being deleted from the supplier’s client list, is flawed. Industry analyst Chaim Even-Zohar called this the Prisoner’s Dilemma. In practice, it means that the mining companies overcharge current clients, squeezing the very last drop out of them.
There seems to be a fundamental flaw in how the players in the rough market perceive the diamond business. Firms like De Beers, ALROSA and others apparently want to realize their dream to sell all run-of-mine output directly to the big jewelry corporations such as Tiffany & Co, Chow Tai Fook, Sterling and so on. They are mistaken. Why so? Because the supposition that they will generate more profit by increasing these jewelers’ margins is not realistic. This is a business that cannot work without dealers, without companies that tailor a polished production to their specific needs, without suppliers that operate in niche diamond product markets. And are these jewelers ready to take on the role of dealers? Will they start holding stocks, financing them, channeling them into the downstream market, arranging for and issuing payment terms and be faced with the reality of holding significant stocks that they are unable to sell? And once they grasp what is needed to be a big client of the producers, will they gladly take on the many downsides that come with that privilege? The producers who continue this line of business are damaging the entire downstream pipeline. My advice to the producers’ clients is: Be responsible, and do not buy!
The figures that industry analysts have presented at recent industry gatherings are also pure fiction. In June 2014, during the 36th World Diamond Congress in Antwerp, Martin Rapaport said that the cost difference between rough diamonds and the wholesale cost of diamonds is 30 percent. In December, at the inaugural World Diamond Conference in India, Chaim Even-Zohar raised that figure to 35 percent. (Why he did so is beyond me since in his annually published pipeline, it usually stands at 16 percent to 18 percent.) My colleagues and I — the manufacturers in this world — are telling you: It is zero percent!
In his interview with JCK, Mr. Mellier said that it is possible to earn money on De Beers diamonds, but does not specify how and where that is possible. I take that as a complete lack of understanding of what it takes to manufacture diamonds.
So, dear colleagues, let’s tell the truth, to each other and to those who are willing to listen. There is no profitable income to be made in diamond manufacturing. There is certainly not a 30 percent to 35 percent margin, nor is there added value generated at a rate of 16 percent to 18 percent. There is only a gain of 5 percent to 6 percent but that is not added value or profit — and this percentage does not cover financing, expenses and modest staff salaries.
If the margins are as indicated by the analysts, why on earth would sightholders and other core clients be ready to sell off their boxes — wrapped and sealed — for a margin of just 1.5 percent to 2 percent? As if they are car dealers who sell a car out of the showroom?
“If you look at a business I know very well — car dealers — they make 1.5 percent, and they are all smiling and happy about it,” Mr. Mellier said. Well, maybe it is time Mr. Mellier — and others — take a moment to learn this business and the diamond manufacturing world. Unlike the car industry, the diamond industry is completely different because very different polished diamonds are produced from diamonds that start out as very similar pieces of rough — sold at similar prices. One rough stone will result in a Renault Laguna, a top luxury sedan model, but the other just a Renault Clio, a lower-end, much cheaper compact.
While we are blessed with highly advanced planning, decision making and manufacturing technologies, the outcome of production is never guaranteed. And as we members of IDMA all know, this means that we not only cannot predict the added value of our production, we also cannot guarantee or plan its quality and character.
So, for the sake of the audience, let’s continue the comparison to the car industry and describe what the result is in the downstream market of the “unpredictability” of diamond manufacturing.
Let’s say that the market demand for the Laguna model is high, and prices are firm. Unfortunately, the rough supplied that was supposed to yield luxury Lagunas resulted in compact Clios, and maybe a few mid-size Meganes, Renault’s mid-sized family car, for which demand is low. That leaves the manufacturer with a stock, and in order to sell it he will need to carry out a promotion, and thus sell at a lower price than that projected.
But it gets worse. Currently, the dealerships — the downstream market of wholesalers, jewelry manufacturers and retail jewelers — tell us that they cannot sell the cars — even the compacts — at the prices we demand, due to surplus stocks, price resistance and a lack of interest in the retail and consumer market and competition from competing industries. In other words, the price of polished is down while the producers keep raising the price of rough.
Of course, there will always be commentators and advisers who suggest that the only way to get around all this is by shortening the supply pipeline, and to get jewelry manufacturers and retailers to take ownership of part of the upper end of the supply pipeline. While that may work for some of the larger jewelry entities, it still does not solve the problem of the overwhelming majority of diamond manufacturers, our IDMA members.
Under these circumstances — and I now refer to Mr. Mellier’s words about marketing and advertising — how can we be expected to finance any generic advertising if we cannot generate the margins needed that will allow for the investment of hundreds of millions? IDMA is an early adopter of the World Diamond Mark, and we strongly believe in the need for generic marketing and promotion of diamonds. We do, however, need oxygen to breathe life into this. How many diamonds are used in the Forevermark program? I believe not more than 2 percent to 4 percent of De Beers sales. In other words, generic marketing and promotion is a must.
In conclusion, on behalf of IDMA, I want to address all key players, especially the rough diamond producers. Our sector is going through a severe crisis and suffers significant problems. We can solve them together but we simply cannot bear the responsibility and the burden single-handedly. Rough diamond prices must be in sync with polished diamond prices because polished diamond prices are determined on the basis of supply and demand, while rough diamond prices are speculative, due to the flawed, coercive supply system, as described above.
Good luck and common sense to all!
Maxim Shkadov, president,
International Diamond Manufacturers AssociationArticle from the Rapaport Magazine - May 2015. To subscribe click here.
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