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“Cash”

June 3, 2004  |  Martin Rapaport
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Everyone loves cash because it gives us a sense of power and freedom. It enables us to get what we want, when we want — no strings attached. Money in the bank is also great, but it doesn’t make us feel the same way that cash does. While credit cards and bank wires provide portable purchase power, they document the details of every transaction. Cash gives us freedom without having to be accountable to anyone.

Diamonds and precious stones have always played an important role as a store of wealth. Hundreds of years ago, before the establishment of banking systems, diamonds were the backbone of international trade. In an uncertain world they provided stable currency and easy transportability, making it possible to transfer wealth over great distances. Diamonds and jewels financed everything from wars to the discovery of America. In modern times, many a refugee got his start in the new world through the sale of diamonds and jewelry — the only wealth refugees were able to bring with them.

Here is a story. Hungary, 1944. A young teenage girl has only a few hours to pack before being taken away on a Nazi transport train. She doesn’t know what to do. But of course, she takes her mother’s strand of natural pearls. Five days in the train, no food, almost no water, and people dying. The train stops on the way to Auschwitz, the girl trades the pearls for a cup of water. She survives. A strand of pearls — for a life.

In this case, the life of my mother. Sometimes wealth is more than money; sometimes it is life itself.

Diamonds have certainly earned their reputation as the ultimate form of portable wealth and personal security. Perhaps that’s one reason women love them so much. When times get tough, diamonds are the hardest currency. What wealthy person does not want to have a few diamonds on the side — just in case? Perhaps it’s a subconscious need, perhaps not. How secure is a Chinese or Russian business tycoon these days? How secure is his wife? His mistress? What role do diamonds and gold play as a form of wealth and security for a married woman in the Arab world? What exactly did Marilyn Monroe mean when she sang “Diamonds are a Girl’s Best Friend?”

Not Just A Luxury Product

Expensive diamonds are not just another luxury product — like a Mercedes Benz car or a Chanel dress. Large diamonds are the most powerful store of portable wealth known to man. They are easily and legally transportable anywhere at any time. Diamonds do not set off metal detectors at airports and customs officials do not stop women wearing large diamond rings — even a ten-carater worth $500,000. Diamonds are the ultimate security product for the wealthy and not-so-wealthy.

But diamonds are much more than a financial security product. They are the premier symbol of love and commitment. Sure, a man will make his wife feel very secure if he gives her $100,000 in cash to put in her safe-deposit box. But, if he gives her a $100,000 diamond the emotional added value is awesome. No doubt he will get more bang for the buck if he gives her a $100,000 diamond.

While old-time diamond dealers and wealthy women instinctively understand the duality of diamond demand (i.e. gift of commitment and store of wealth), the new modern Supplier of Choice (SOC) driven marketers misunderstand the fundamental basis of diamond demand. De Beers and those following them are becoming luxury marketing addicts; they are promoting diamonds solely as a luxury product. It is to be hoped that they will fail in their well-intentioned efforts to turn diamonds into “just another luxury product.”

The challenge facing us is to identify and develop the essential core of diamond demand, the DNA of diamond’s unique selling proposition (USP) and the true power of diamonds. This is very difficult, for there are many types of diamonds, consumers and retailers. Many ideas work. There may not be one true unique USP for all diamonds everywhere. Competing USP’s may be mutually exclusive or even incompatible.

So here is the question. How do we optimize and synergize the extraordinarily unique position of diamonds as a product that addresses the desire of women for one product that delivers both love and financial security?

Are diamonds luxury products that must be developed with great marketing expense and therefore sold only at very high profit margins? Are diamonds financial security and — dare I say the word — “investment” products that must be developed by creating efficient transparent markets that encourage the availability of diamonds at very low profit margins? Are they both at the same time?

How do we deal with the fact that diamonds are a luxury product and an investment product? How do we simultaneously develop demand for all diamond products and how do we reconcile profit margin issues?

Allocating Profits

A fundamental basis for the development of markets is proper profit allocation. If profits are allocated correctly, the right people get the right incentive for doing the right things. If people do the right things, the market and all the people in it prosper.

A primary advantage of free competitive markets is that they optimally and properly allocate profits based on added value. If you add value to a product — you get profits. The amount of profits you get is in direct relation to the amount of added value. If you try to take too much profit for too little added value, a competitor replaces you.

In rational and efficient markets, diamonds move down the distribution pipeline through a series of added-value transactions. Buyers pay more than sellers for the same diamonds because sellers are able to add value and sell the diamonds at a higher price. A cutter adds value by changing the product from a rough diamond to a polished diamond and a dealer adds value by sorting diamonds so that each of his customers gets the exact diamonds he needs rather than mixed assortments.

Retailers add value to diamonds in an unlimited variety of value-added propositions (VAP). Some charge high prices for diamonds bundled with prestigious branding, extreme quality control and a first-class shopping experience. Others provide low prices with limited added value. Consumers vote with their dollars for the price/product market mix they want. Some consumers want to pay high prices for high added value, others do not. The coexistence of Tiffany, Costco and everyone else proves that there is no one optimal way to sell diamonds, but rather a series of price/product market mixes that meet the diverse needs of a broad consumer population.

The best way to deal with the luxury/investment diamond dilemma is to recognize that luxury and investment demand are value-added propositions that must be added to the market mix. The level of markup is a function of VAP and competition and is not really important. Profits make the world go around, not markup.

While low markup retailers drive out high markup retailers offering the same VAP’s, they do not damage retailers selling higher VAP’s at higher prices. Costco is not going to put Tiffany out of business. Competitors with lower prices do not win your customers if you are providing your customers with a higher level of added value. On the other hand, Wal-Mart might put many low added value independent retailers out of business if these retailers continue to offer Wal-Mart level VAP’s at higher prices than Wal-Mart.

Some retailers are concerned that the establishment of efficient, commoditized, low-cost electronic diamond markets will destroy their business. They do not have or believe in their unique value-added propositions. They are afraid of commoditized competition. They believe that an educated consumer is their worst customer. Perhaps they are right. Perhaps they should go out of business.

Other retailers recognize that while low price competition exists, it does not threaten them because they have a well-developed unique selling proposition with a properly priced value-added proposition. They know that consumers get unlimited price information on the internet and they understand how and why an internet diamond retailer like Blue Nile can grow sales to $140 million and reach a market capitalization of $635 million. While they recognize the competition, they are secure in their unique selling and value-added propositions.

Patriot Act

The fact that diamonds are a most powerful store of portable wealth has ramifications well beyond our understanding of diamond demand. It’s not just wealthy women who appreciate the “investment” value of diamonds. Terrorists, weapons dealers, drug dealers and a host of other dangerous underground economy payers have been using diamonds in ways that has attracted the attention of government.

The U.S. government has decided that the war against terrorism requires the elimination of the underground “cash” economy. They believe that terrorists use the underground economy to move funds and finance international terrorism. Diamonds and gems are perceived to support the underground economy. Accordingly, new regulations will require diamond and gem dealers to take on the same responsibility as bankers. We must carefully document and monitor who we buy from and sell to and report all suspicious transactions involving diamonds. We are not just talking about cash transactions. We are talking about monitoring, documenting and reporting requirements for all diamond transactions.

Friends, please wake up. Get out of the “cash” business! The buying and selling of diamonds for unreported cash is no longer merely a tax department issue, it is now a matter of national security. It is a matter that attracts the attention of the FBI, CIA and other high-level government agencies.

We must recognize that the “cash” diamond business is supporting the underground economy that is supporting international terrorism. It is not just a legal issue anymore. Do you want your diamonds to play a role in helping to finance the next terrorist attack? Do you want to be put into a position where you must inform on your friends or get arrested?

The time has come for the diamond industry to get out of the underground cash economy. We must fully legitimize the diamond markets and international diamond economy. This will not be easy, especially in markets where diamonds have traditionally played an important role as an unofficial store of wealth. How will jewelers deal with customers who come in with beautiful estate jewelry and are only willing to sell for cash so that they can avoid estate taxes? How will the diamond industry replace the demand for diamonds as a store of value now being served by the “cash” markets? How will the diamond industry replace the liquidity lost as we eliminate the “cash” economy?

Legitimization

This writer believes that the establishment of efficient internet-based diamond exchanges are a prerequisite for the rational development of the diamond industry. The best way for the diamond industry to eliminate the “cash” markets is to replace them with legitimate markets that offer transparency and accountability as well as free and fair market access. Good markets drive out bad markets.

The need for efficient diamond exchanges is not just a result of the problems we have with the underground economy. De Beers SOC exclusive distribution system, increasing banking debt and liquidity requirements, severe shortages of select products, volatile and speculative pricing, investment diamond demand, globalization of diamond supply and demand, new enabling technology and a host of other factors all call out for the establishment of electronic diamond trading networks.

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