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Crisis
Sep 5, 1997 12:22 PM
By Martin Rapaport
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RAPAPORT...
Something important happened in Singapore last week. The president's
meeting of the World Federation of Diamond Bourses (WFDB) and
International Diamond Manufacturers Association (IDMA) was more
focused, united and outspoken then ever before. No doubt about it, the
leadership of the international diamond trade is waking up to the new
realities of the diamond business.
There is a 'sea change' in attitude. The leadership is no longer
willing to sit back and allow De Beers to manage the diamond industry.
The WFDB and IDMA have developed a new aggressive and proactive agenda
that highlights the trade's need for consistent rough supplies at
prices that allow for reasonable profit levels. Furthermore, for the
first time, both organizations have publicly issued unanimous
resolutions that declare a state of crisis and that De Beers pricing
and marketing policies have resulted in unacceptably low profitability
which threatens the viability of the diamond trade.
While the strongly worded resolutions speak for themselves and
represent a broad consensus of trade opinion we must recognize that
resolutions, by themselves, cannot change the reality of the
marketplace. Words without actions cannot help us. The key question
is, what can De Beers and/or the diamond trade do to improve profits?
It is important to recognize that the problem of profitability in the
diamond trade is extremely complex. One interesting aspect of the
profitability problem is that it is hurting all levels of the trade.
Everyone everywhere is feeling the squeeze. Rough dealers, diamond
cutters, polished dealers, regional wholesalers and retail jewelers in
the consumer markets are all under pressure. The broad based nature of
our profitability problem is a clear sign that a number of independent
factors are simultaneously affecting our markets. Our traditional
industry is under attack from more than one direction and we must
recognize that part of the solution may be well beyond our control or
the control of De Beers. In fact, structural changes in the way our
industry processes and distributes diamonds may be required before we
can return to more rational and profitable levels of activity.
The primary factors affecting current trade profitability are:
1. A major restructuring of the diamond distribution network in the
U.S. This includes the increasing market share of large mass
merchandise and discount retailers as well as the trend towards
diamond and jewelry marketing programs that are replacing cash diamond
sales to large chain stores. There is also a trend towards the
commoditization of the better quality larger diamonds which are most
frequently sold with grading reports and priced based on price lists.
2. Macroeconomic forces that have severely reduced demand in the Far
East. This includes the prolonged recession in Japan and recent
foreign currency devaluations that have hurt markets in the Pacific
Rim.
3. The role of De Beers in the industry. Specifically, De Beers
policies regarding the pricing and distribution of rough diamonds as
well as De Beers open market buying activities.
Our review of the retail sector is presented in this issue as a
separate story "Retail Profit Margins." This article will now discuss
macroeconimc events and their impact on the cutting centers. Finally
we will review De Beers policies and provide suggestions of what can
be done to help improve overall trade profitability. A number of
previous articles that provide greater insight into these topics and a
bibliography is included at the end of this article. All are available
in the Rapaport Library at www.diamonds.net under the category trade
profitability.
Economics
Macroeconomic events such as recessions and volatile foreign currency
rates have a direct impact on profitability in the diamond industry.
The prolonged Japanese recession and recent foreign currency
devaluations in the Pacific Rim have reduced profitability even more
than they have hurt sales volume. In the diamond industry it is not
how much you sell, but rather what you sell at what prices that
determines overall profits. Diamond cutters produce a range of
polished diamond qualities and need to merchandise these qualities at
optimal prices in order to realize a profit. Far East demand accounted
for a disproportionately large share of diamond trade profits since
Far East buyers were more selective and paid premium prices. U.S.
demand can not make up for Far East demand. The loss of profits from
the Far East hurts all the cutting centers and is one of the main
factors contributing to the current crisis.
Obviously, external economic factors such as Japan's recession or
volatile foreign currency rates are well beyond the control of De
Beers and the trade. No one can blame De Beers for poor Far East
demand. However, we must recognize that the key to industry survival
is how we react to problems beyond our control.
The profitability problems in our industry are not merely the result
of economic events, but rather the result of how our trade and De
Beers respond to these events. Here are the important questions. What
policies should De Beers implement in the face of declining diamond
demand and profitability? Can De Beers minimize damage to the trade in
the face of declining profitability? What exactly is the role of De
Beers as a 'swing producer'? If De Beers does not help us what can the
trade do to protect itself?
De Beers Perspective
It might help if we briefly view things from De Beers perspective. De
Beers does not want to subsidize the diamond trade and implement
policies that are not economically viable over the long term.
Furthermore, they believe that the fiercely competitive nature of the
polished diamond markets works in their best self-interest.
Competition forces the trade to adapt to changing markets in an
efficient manner and allows for the survival of only the best,
brightest and fittest firms. By making sure that the polished diamond
markets remain competitive, De Beers is insuring that they have the
best possible distribution channel for their product. It is ironic, we
have a monopolist that firmly believes in the efficiency of
competitive markets when it suits them.
In fact, the root of our profitability problem lies in this dichotomy.
De Beers is a monopoly using a competitive market to get the best
prices. Having cutters compete to become sightholders suits De Beers
just fine. Having firms in the polished diamond marketplace compete
with each other to bring in the highest possible price for diamonds
also suits De Beers just fine.
It should come as no surprise that De Beers no longer sees their role
as 'guardians of the trade' and that they are not acting to 'insure
profitability for the overall trade.' Why should they? Anything they
do will reduce competition. Better to let competitive forces 'take
care' of the trade. From De Beers perspective they have to be careful
about how they 'help' the industry. A subsidized trade would become
less efficient, less competitive and perhaps no longer able to adjust
to volatile market conditions or be aggressive when seeking out new
markets and trading opportunities. De Beers fears if they 'help' the
trade 'too much' or in the wrong way they can create an inefficient
industry which no longer adapts to market conditions but instead
relies on De Beers for their daily bread.
The Trade Perspective
Let us now consider the trade's perspective. De Beers uses monopoly
power to control the pricing and availability of rough diamonds that
are the sole source of raw material for the polished diamond industry.
Their monopoly power extends into the polished markets because they
control the supply side of the polished diamond equation. De Beers has
us by the throat.
Unfortunately, the great tragedy of the diamond industry is that De
Beers controls the supply side of the diamond equation but they do not
control the demand side. We have an awful situation whereby there is
no direct interdependent relationship between rough and polished
prices. If demand decreases and polished prices fall De Beers does not
automatically lower their rough prices as would happen in a normal
competitive marketplace. More often than not De Beers maintains high
monopolistic prices and cutters are then forced to decide if they
should overpay for rough and give up profit margin or go out of
business and fire long term employees. De Beers has taken away our
industries ability to normally and naturally adjust to increasingly
volatile market conditions in the competitive polished diamond
marketplace.
Even worse, in some instance when polished demand and prices fall, De
Beers keeps their prices high and does not reduce the amount of rough
they sell. This floods the market with too much goods which then choke
cutters, wholesalers and retailers. Cutters buy goods with the hope
that demand and prices will improve. When this does not happen they
and their customers are destroyed.
Even worse, De Beers manipulates us. De Beers lies to us. Statements
from George Burne like "If you don't make profits, we don't make
profits," are an insult to our intelligence and demeaning. Whom is De
Beers kidding? They make $510 million on one half year of diamond
sales and we eat dirt. Perhaps the greatest injustice is that De Beers
does not even recognize or admit the injustice they are doing the
industry. They blame Angola, Russia, Japan, Argyle and everything
else, but they do not take responsibility for their pricing and
marketing policies. Policies which are destroying the diamond
industry.
Make no mistake about it. De Beers is directly responsible for the
overall level of profits in the polished diamond trade. They control
polished profits because they directly control the cost of our raw
material - rough diamonds. If they price rough lower than polished, we
make money. If they price rough higher than polished, we lose money.
It really is that simple.
What can De Beers do when polished prices fall? Easy they can decrease
rough prices or decrease the quantity of rough available in the
market. The trade expects De Beers to adopt rational policies that
insure rough prices are lower than polished prices and that the supply
of rough diamonds to the marketplace is not greater than the markets
ability to absorb the resultant polished. Is that too much to ask?
If the trade is not making profits in the diamond industry there is
only one reason - De Beers has failed to establish the proper balance
between rough prices and the quantity of diamonds available in the
marketplace. The fact is, we are losing money because the nice people
in London are not doing their job properly.
All this talk about Russia and Angola is pure bull manure. It is a
smokescreen that De Beers uses to avoid taking responsibility for its
actions. The fact is that De Beers currently has total control over
rough prices and availability. Its open market buying activity has
this rough market locked up tighter than a drum. Furthermore, De
Beers has the financial resources and market presence to buy up
anything Anglo, Russia, and yes, even Canada can throw onto the
market.
The bottom line from the trade's perspective is that De Beers has
direct control over profit margins in the diamond trade because it
independently determines the price level and availability of rough
diamonds. It is now time for De Beers to take responsibility for the
impact its pricing and marketing policies have on "overall trade
profitability."
The trade is in crisis because De Beers is absorbing a
disproportionate share of industry generated profits. In fact, De
Beers is unfairly using its monopoly market power to steal trade
profits. Its single channel marketing system has turned into a single
channel profit system that the trade is no longer willing or able to
support.
De Beers Policy Issues
Communication: De Beers and the trade must develop better
communication. The relationship between the trade and De Beers must
evolve from adversarial to cooperative. De Beers cannot rely on
sightholders as a primary source of market information because their
direct relationship with De Beers makes objective reporting
impossible.
Proactive Policy: De Beers policy making regarding the trade is much
to reactive. You can't run this industry based on "The squeaky wheel
gets the oil." We need forward planning that incorporates the needs of
the overall trade and anticipates problems and solutions well in
advance.
Less Rough or Lower Prices: This is a big discussion, well beyond the
scope of this article. Right now, please recognize that the industry
is in crisis and people are struggling to survive. Short term, do
whatever you want, but somehow, quickly, fix things so rough prices
are lower than polished. That is the only way we can survive.
Outside Goods: Traditionally, access to outside sources of rough have
helped cutters buy rough at profitable levels. Often cutters averaged
out prices with rough from the CSO. De Beers needs to ease up on
outside buying activities and allow the availability of outside rough
to provide "breathing room" for cutters. It is a mistake for De Beers
to over-control the market by absorbing too much outside rough because
outside rough acts as a profit buffer for the trade.
Specials: Specials should not be used to provide basic profitability
to the diamond trade. If the quality and or price level of regular
boxes are unprofitable, then fix them. Don't play around with specials
instead of fixing what needs to be fixed.
Sight Assortments: Assortments need to be of consistent quality from
sight to sight. Playing around with the quality of rough from sight to
sight is inefficient and unprofessional. Furthermore, fiddling with
quality most often hurts profit margins. Allow cutters to make money.
Every time someone figures out a way to develop a new market and make
a few extra dollars, be it Trillion cuts or small light pinks, the CSO
immediately changes assortments to capture the extra profits. Stop
punishing trade creativity and market development by taking away our
profit incentive.
Sight Size: Make sure to provide bite-size sights that normal cutters
can use. Taking the 2-4 MLG from $300,000 to $1.5 mil was a mistake
because you cut out all the little guys. By the way instead of running
witch hunts out of London, you should be encouraging the trading of
boxes in the cutting centers. Let small people - new people - young
people -cut your rough. They have as much right to make a living in
this industry as you do. In short, stop playing G-D. You need
a "good hand" policy instead of a "strong hand" policy.
Note: We will discuss trade policy issues in a future editorial.
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Tags:
Angola, Argyle, De Beers, Japan, Jewelry, Martin Rapaport, Russia, Sightholders, Sights, World Federation of Diamond Bourses (WFDB)
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