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Uncertainty

May 3, 2001 5:35 PM   By Martin Rapaport
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While the diamond industry has had more than its share of ups and downs in the past, it is hard to remember a time when so many knew so little about the immediate future of the diamond trade and their role in it. These days everything is up for grabs and nothing can be taken for granted. It is as if a magic spell has been cast, freezing a moment in time when all of us, from Nicky Oppenheimer down to the smallest retailer, have come to the realization that our future is beyond our control. All of us in our own way confront a season of uncertainty as incredible forces of change sweep through our industry and the global economy.

As we go to press, De Beers management is about to preside over an extraordinary shareholders meeting that was scheduled to decide whether or not De Beers transforms itself from a public company with liquid assets of over $10 billion, or into a private company with over $3 billion of LBO debt. The Oppenheimer takeover bid has been a real cliffhanger with groups of institutional investors banding together to oppose the bid and a last minute $800 million increase in the offer by the bidders. The latest news is that the vote scheduled for May 4 will be postponed until May 18 to allow time for the bidders to regroup their supporters. At this time it appears that the takeover bid will succeed, but nothing is certain until the final votes are counted.

While Oppenheimer has said that the privatization of De Beers will not change the company’s policies it is obvious that the large debt assumed in the leveraged buyout will severely limit the company’s ability to restrict rough diamond sales in order to support rough prices. If the takeover bid goes through as expected the rough diamond market is going to be much more demand driven and sensitive to short-term competitive forces. As De Beers focuses on reducing debt by selling through rough production the diamond trade will have to focus on dealing with the pricing uncertainty generated by external economic forces on the demand side of the diamond equation. As the diamond trade grows more independent of De Beers it will have to take more direct responsibility for maintaining price levels in the face of a declining global economy.

Sightholders

The De Beers takeover story and resultant uncertainty is just an example of how change is challenging us. The implementation of De Beers new supplier of choice program this July is also scaring the wits out of the sightholders. In the current environment firms are not sure what is expected of them and what it will take to maintain their preferred position with De Beers.

The notion that sightholders should add value to the diamonds they sell through focused channel distribution and downstream strategic marketing initiatives is a very good idea and strongly supported by this writer. Furthermore, De Beers needs to clean house and optimize its rough allocation policies. It is only reasonable to expect that plans set in motion a year ago will be implemented. Having said this, we must consider the very negative impact on diamond demand due to the declining U.S. economy and over-inventory positions at the retail level. Sightholders rushing off to implement fancy marketing programs in order to impress De Beers run the risk that they are moving too quickly into a very weak diamond market. Should they implement these marketing programs now? If they don’t move on marketing will De Beers reduce their sight come July when De Beers is expected to announce the new revised list of sightholders? Sightholders are uncertain about what to do and when to do it. While the trend of what they have to do is clear, the timing of when they should implement new marketing strategies is anything but clear. Many sightholders are not just uncertain, they are also afraid. Competition among sightholders for the most saleable rough is fierce and many are concerned that any delay in implementing marketing programs will threaten their ability to obtain priority allocations of rough from De Beers. For many sightholders, uncertainty about market conditions is but a minor inconvenience compared to the uncertainty they face about how to deal with De Beers and how to implement new strategic marketing initiatives.

Small Cutters and Dealers

The uncertainty faced by De Beers and its sightholders are mild compared to what the smaller diamond manufacturers and dealers are going through. The problem for them is not what to tell De Beers or when to implement new marketing strategies. For many the problem is simply survival.

Small diamond manufacturers are under great pressure. For generations they have traveled to Antwerp, bought rough, cut the goods and then sold into their local markets. But these days market demand in the dealer markets is almost non-existent. Sure you can sell all the 4/4+ G+ goods you can manufacture but you can’t find the rough at anything near workable prices. Market demand for the rest of the goods is weak or even non-existent. Small cutters don’t know what to do. They can’t get the rough and they can’t sell the polished.

The natural market for the small cutters are the dealers. But here too, there are problems. The dealers provide selections of diamonds to small and medium sized retailers — each according to their needs — and they provide a host of additional services such as credit, memo and next-day delivery. Unfortunately, the small and medium sized independent retailers are not buying these days. They are over-inventoried and undercapitalized. Some limited activity is taking place as retailers reorder specific items they have sold and sales of larger stones for specific memo calls are doing reasonably well. However, in general there are no “open to buys” or buying for inventory.

The small diamond manufacturers and dealers are not merely uncertain about the market, they are uncertain about their future in the diamond industry. Should they remain in the diamond business? How long will the current situation persist? Should they continue manufacturing or dealing at break-even profits or slight losses?

The restructuring of De Beers, the direct channel marketing of diamonds from sightholders to retailers bypassing the diamond trading centers, the advent of branding by De Beers and many others, and the increasing market share of large diamond manufacturers and retailers all threaten the existence of the small diamond manufacturer and dealer. Are the current challenges faced by the smaller firms in the diamond trade merely temporary due to a weak economy or perhaps the restructuring of the diamond industry is making them obsolete? Should these folks hang around?

Retailers

The retail sector of the diamond industry is of course directly affected by the economic slowdown in the U.S. Last year’s optimism has translated into this year’s over-inventory positions. For many the problem is not structural, or strategic, but rather simply a matter of time. The cyclical nature of the economy is nothing new and while it may take some time for inventory to be sold off, the fundamental basis of retail business is solid. Once excess inventory positions have been sold off these firms will once again resume normal purchasing activity and support the flow of diamonds through the distribution pipeline.

It is important for the diamond cutters and dealers to recognize that business at the retail level is not necessarily as bad as it appears from the dealers perspective. The drastic reduction in demand from retailers reflects their current over-inventory position as much as it does the significant slowdown in demand. While consumer demand is relatively weak compared to last year, consumers are still buying. Retailers are not replacing what they sell because their money is tied up in excess inventory which must be sold off before they can replace goods at the rate they sell them.

Uncertainty about the level of consumer demand this year is a major concern of retailers and will likely result in very conservative buying patterns this holiday season. For most retailers the decision not to buy new goods until current stocks are sold off is a financial necessity and sound policy. Sophisticated retailers however, need to differentiate between inventory positions of saleable inventory and non-saleable inventory. One does not want to run down inventory to the extent that only unsaleable inventory remains in the store. It is important to have fresh and attractive merchandise if one wants to attract customers. There is concern that retailers may overreact to the current slowdown and limit purchases to the extent that it hurts the potential for future sales.

From a strategic perspective many retailers are very concerned about the De Beers and other branding initiatives that may take away their market share. Many independent jewelers are simply not in a position to develop competing brands and lack the size scale necessary to compete in a marketing-oriented competitive environment. There is also serious concern that direct marketing initiatives by De Beers sightholders will result in a severe shortage of the most popular sizes and qualities of diamonds for retailers that are not in these programs.

While De Beers expounds on the big picture outlining the benefits of branding and increased marketing expenditure for the overall industry, no one is excited about having a De Beers store open next door, or a competing mutli-million dollar advertising campaign that directs consumers away from one’s store. For many the handwriting is on the wall. Get big or get out.
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Tags: Consumers, De Beers, Economy, Manufacturing, Production, Sightholders
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