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Reality Check

Apr 6, 2001 11:24 AM   By Martin Rapaport
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Diamonds are a very special luxury product. In spite of price lists, the internet, and a very unhealthy industry-wide reliance on sales and special price deals the average diamond purchase is still a highly emotional event. Diamond demand is most often celebration driven and based on the fact that the experience of buying and wearing a diamond makes people feel good about themselves and each other.

Smart and successful retailers realize that they are not really selling the diamond but rather the emotional experience of giving, getting and wearing the diamond jewelry. The unique role of diamonds as the ultimate gift of love and symbol of success is reliant on the ability of the retailer to define and enhance the consumer’s perception of the emotional and symbolic value of diamond jewelry. Obviously retailers must be confident and optimistic about diamonds because it is essential that they project very strong positive feelings when they sell them. The trade in general and retailers in particular must believe in the illusion, or symbolic value, of diamonds if they are to sell them successfully.

The natural tendency of the trade to be optimistic about the future and promote diamonds as a consistent store of value supports the confidence of the trade in diamonds. People don’t want to hear or believe bad news because they fear it may destroy confidence in diamonds and hurt sales to retailers and consumers. There is serious concern that discussion of weak markets may result in a self-fulfilled prophecy. After all, if retailers are afraid to buy diamonds, then they won’t and this will hurt prices as it reduces the availability of diamonds for sale to consumers.

The flip side of the coin is that if the diamond industry is overly optimistic and refuses to recognize signs of a downturn in demand they will not adjust production and inventory levels until it is too late. The financial pressures and resultant crisis will result in far greater damage to the industry. At some point the financial risk to the industry outweighs the negative impact on trade confidence resulting from a free and fair discussion of the dangers confronting the industry. Ultimately whatever happens on the macroeconomic front will happen.

In the opinion of this writer the industry is best served by opening their eyes real wide, dropping illusions and being prepared for the future. It’s good to be optimistic, but not if it costs you your business.

The diamond industry must now deal with a series of tough problems. We must honestly confront the challenges presented by the economic recession developing in the U.S. We must face the fact that diamond demand may be heading south and that some diamond prices will likely come under pressure in the months ahead. People realize that inventories have built up to unacceptable levels and that cash flow has become extremely difficult. Yet as a group the industry is in denial. Too many people are producing too many diamonds for too few customers because they think that the current slowdown is just temporary. But what if it isn’t? Frankly, it is time for a reality check.

A number of important questions need answers. How weak is demand and what can the diamond industry do about it? How will the supply side react now that De Beers is no longer the custodian of the diamond industry? Will a period of weak demand and lower prices damage trade and consumer confidence in diamonds?

Diamond Demand

Frankly, the short-term outlook for the demand side of the diamond equation is very troubling. After eight years of economic expansion and unbridled prosperity, the U.S. economy is in recession. The U.S. has been living in an artificial economic bubble that has now burst. The NASDAQ roller coaster has taken the wealthy consumer and the entire U.S. economy for an extremely wild ride and the results are very unsettling.

Between January ‘98 and October ‘99 NASDAQ increased 82 percent (3.7 percent monthly), and then went through the roof increasing an incredible 76 percent (15.2 percent monthly) from October ‘99 to March ‘00. Then the first big drop of 34 percent from March to April ‘00 followed by the fake recovery from April to September ‘00. And then the big fall of 61 percent (-8.6 percent monthly) from Sepember ‘00 to April ‘01.

Wealthy investors — more than a few of whom are serious diamond buyers — are wondering where 60 percent of their money went. In some instances you can see it in their eyes — gambler shock. The look of the gambler taking losses but still sitting at the blackjack table hoping that his luck will turn and he will win his money back.

Lots of people are still in denial. They can’t believe that they lost so much money. Three trillion dollars (yes, trillion) in six months. But you and I — we know the truth. We are not in denial. We don’t expect NASDAQ to increase 60 percent in the short term. We know that the game is over and the money is gone. Right?

Perhaps it wouldn’t be so bad if the only people that lost money were the NASDAQ high-risk crowd. Unfortunately, lots of normal people invested their pension fund money in the stock markets. Fortunately, these folks don’t need their pension fund money right now and their losses will not affect their normal living expense cash flow. However, they still feel that they have lost lots of paper profits and are now poorer. They are also very concerned about the impact of the collapsing stock markets on the overall economy. The average middle-of-the-road consumer is now going to be much more conservative with money and spending on luxury products is not a first priority these days.

Unfortunately, the problems are not merely limited to the performance of the stock markets and the resultant negative wealth effect. The U.S. economy went wild over the high-tech revolution. Increasingly unreasonable and irrational expectations of future economic performance were developed. The collapse of the high-flying, high-tech sector is having a strong spillover effect and an overall negative impact on the general economy. Firms that have nothing to do with high-tech are slowing down as the easy money generated by this sector has disappeared. Unemployment is moving up sharply. Disposable income is coming down and uncertainty about the future is everywhere.

Opportunity

A new much more conservative economic reality is developing in the U.S. This does not mean that we will have a depression and that people will stop buying diamonds. It does mean that we are going to have to change and adapt our business to the new realities. We absolutely cannot ignore the signs of change and simply go on doing business as usual.

Fortunately, diamond demand is not as whimsical or frivolous as many of us believe. Diamond demand is deeply rooted in the consciousness of consumers and is particularly sensitive to life-cycle events that have nothing to do with the economy. Recession or no recession, consumers will still have birthdays, get engaged, celebrate anniversaries and have other gift-giving occasions. Sure, consumers will not have as much easy money as they have had in the past. They will be more conservative and much harder to sell. But fortunately for us the core source of diamond demand — the gift giving occasion and the need for emotional affirmation — will remain as strong as it always has been.



Frankly, we face a tremendous opportunity. To define diamonds as the conservative gift to give when times are tough. To differentiate diamonds from other gifts that are indeed frivolous because they do not last — because they do not symbolize anything. As an industry our task is to tune in to the new psychology of the consumer and take advantage of the fact that they now want to spend their money much more conservatively. We must understand that the purchase of a diamond is much more than simply a nice way to spend extra money. Over the past few years we have been spoiled by easy money and lost sight of what our product is all about.

We must understand and learn to sell the core basis of what diamonds are really all about. Consumer demand for diamonds should not be based on the easy availability of money, it must be based on the need for a symbol of love and commitment between people. When we sell a diamond we are not selling a product — we are selling an emotional experience. An experience that is tied into love and commitment, things that are recession-proof and perhaps even more in demand in times of uncertainty. Once we understand this we can break away from our insecurity about the role of diamonds and our over-dependence on marketing, selling price and getting a good deal. Wal-Mart has run away with the diamond business and it’s time we took it back. Sure the recession is going to challenge us and things may get a tough for a while. But it may be just the thing we need to force us to redefine our product in our own eyes and in the mindset of the consumer.

The Supply Side

As discussed in our January article, "Slow Down," a primary problem is that retailers anticipating a strong holiday season last year bought too many goods, as it turned out that holiday sales were much weaker than expected. Retailer inventories are much too high and their finances are extremely tight. The current situation is that retailers are replenishing items that sell well but they are not ordering new items. The consensus is that most retailers will not be open to buy significant quantities of diamonds until they sell through what they already have. Unfortunately, sales during the first quarter have been very weak. Valentine’s Day was off by about 4 percent from last year and Mother’s Day will probably be more of the same.



Not surprisingly, goods are backing up in the cutting centers. The cutting centers are getting stressed out financially. They have paid for rough but can’t sell new goods and they are having a very difficult time collecting money from retailers. The large retailers are paying bills but they are working feverishly to return as much unsold merchandise as possible. It’s not a very pretty picture.

De Beers played the game very well last year. It sold off its inventory, made a huge profit and got paid. Essentially what happened is that the banks gave the money to De Beers and De Beers gave the goods to the trade. Now the trade is stuck with too many goods and not enough money. Everything is sort of frozen until retail sales to consumers pick up and no one knows when this will happen.

De Beers has been doing a very good job controlling supplies of larger better color diamonds. Prices for white 6/4 and up polished are very firm as supplies of rough and polished are tight. Can or should De Beers restrict supplies of smaller and lesser quality diamonds?

A primary problem for De Beers is that if it holds off sales, the Canadians, Australians and Leviev will keep selling ahead of it. Sure, the market may firm up, but De Beers is going to have to absorb inventory — something that it has said it no longer intends to do. De Beers wants to be the supplier of first choice, not the supplier of last resort.

If De Beers keeps selling through along with all the other rough sellers and if demand does not pick up significantly, the logical outcome is that prices will fall because supply will exceed demand. Furthermore, if it keeps on selling rough at a higher rate than the polished can be absorbed by the market, it will have to lower its rough prices fairly soon or risk de-capitalizing and eventually bankrupting its sightholders. De Beers is facing a tough decision — lower prices or increase inventory.

Over the long term De Beers will try to micromanage supply by strictly controlling the sizes and qualities of the rough they release. If their "Supplier of Choice" program works out as planned, sightholders will be receiving narrower assortments of rough for which they already have polished buyers. This way De Beers rough can be sold without polished hitting the market. It is a good idea but not likely to be implemented quickly enough to impact the current problem.

The De Beers "Supplier of Choice" program provides a lesson for the rest of the industry. It is not a good idea to buy rough and cut diamonds if you do not have a customer for the polished. Simply put, don’t polish what you have not pre-sold. All too often cutters look at an attractive parcel of rough and buy it without any thought of who will buy the polished. That’s the old way of doing business and could prove fatal in the current environment. The last thing little guys should do is get in the way of an already difficult situation. If you can’t sell it, don’t buy it.

Conclusion

In conclusion, we are very concerned about the short term outlook for polished diamond sales. Except for larger, better color goods, princesses and a few other areas the market is overstocked with, there is no indication of when things will clear up. If you are a small cutter without firm polished orders, this is probably a good time to take vacation.

Concern about the level of trade and consumer confidence in diamonds is not misplaced and the issue should not be ignored. However, we must not shy away from taking a hard look at the realities of the marketplace and adjust our inventory levels and our marketing strategies to meet the new challenges.

The diamond trade must recognize that the impact of the declining U.S. economy will be far reaching. Aside from a short term slowdown in polished diamond consumption and possibly lower price levels it is likely that we will see a significant shift in consumer attitudes to luxury products. The psychology of the consumer is changing and the diamond industry will have to adapt. The diamond industry needs to invest significantly more effort on marketing and repositioning diamonds to meet the challenges presented by consumers in the new economy.
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Tags: Banks, Consumers, De Beers, Economy, Jewelry, Leviev, Luxury Products, Production, Sightholders
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