Rapaport Magazine
Op-ed

Commoditization: Diamond Industry to Establish Fair, Open, Competitive Markets

By Martin Rapaport
RAPAPORT... Commoditization: the transformation of a product into a commodity is often seen as undesirable. Sellers believe that unique products cannot be effectively priced because they cannot be compared to similar products. The inability of consumers to compare or discover prices enables sellers to charge higher prices, resulting in higher profit margins. At the core of this thinking is the idea that the less consumers know about a product and/or its price, the greater the retailer’s profit margin.

In the early 1930s, there were no diamond grading standards. Many retailers would call all their diamonds “perfect,” or “blue-white.” Honest retailers who fairly described their diamonds as less than perfect lost customers to dishonest retailers who falsely described all diamonds as “perfect.” Confusion about grading standards created a situation whereby big liars built big businesses and honest retailers went out of business. The situation got so bad that the U.S. Federal Trade Commission (FTC) outlawed the description of diamonds using terms such as “perfect” or “blue-white.” The American Gem Society (AGS) established grading standards as well as the Gemological Institute of America (GIA) laboratory to grade diamonds objectively.

Ever since, the diamond industry has had a love-hate affair with standards. On the one hand, standards are necessary to maintain a level playing field among honest firms and provide basic consumer confidence. On the other hand, standards are communicated to consumers, who use them to compare prices, resulting in lower retailer profit margins. (See Tivol’s Dilemma, RDR, October 2, 1992.)

It would seem that the more honest and transparent retailers are, the less money they make. While most retailers would never tell an outright lie, the question of just how much to tell consumers is a big issue. Many ethical jewelers spend hours educating consumers about cut, and a few might even show a consumer a Rapaport Price List. However, it is unlikely that any jeweler will ever provide consumers with competitive price information or show a consumer an internet price list. There is this great fear among retailers that if consumers knew how much profit retailers were making, consumers would not buy diamonds from them. Jewelers lack self-confidence about the price they charge for their added value proposition.

There is an “understanding” that it is okay to educate consumers about the product, but not the price. In general, retailers provide enough partial information to convince consumers they are being educated and that the product being offered is worthy of purchase. Competitive price information — something consumers really need — is never discussed or disclosed.

Ethics

Many retailers believe that it is unethical to disclose competitive price information to consumers. They feel that retailers are entitled to interdealer price information, but that consumers are not. Furthermore, they expect the wholesale trade to “protect” them by not selling to consumers, or providing consumers with prices.

In the early 1980s, when wholesale diamond prices were plummeting, I was thrown out of the New York Diamond Dealers Club because I dared to provide retailers with New York wholesale prices. Dealers at that time felt that retailers had no right to interdealer prices. I believe that the democratization of price information must be universal. If retailers have access to price information they need, why shouldn’t consumers? More to the point, is it ethical to deny consumers the price information they need to make informed decisions? Is it ethical to “protect” retailer profit margins at the expense of consumers?

The real questions are: Can retailers justify the price they are charging above the interdealer price by the added value they provide? Can retailers survive in a transparent environment? Is an educated consumer our best customer?

Amazingly, some retailers think that it is perfectly okay for them to cut out their dealer/wholesaler suppliers and buy direct from overseas manufacturers, but that it is unethical for wholesalers to sell directly to consumers. What are 47th Street wholesalers to do? Commit financial suicide to protect the retailers who are bypassing them after years of loyal service and credit? Clearly some retailers have a skewed sense of ethics and reality.

It’s no use blaming each other. The fact is, the world is rapidly changing and all of us have to adapt and evolve to stay in the diamond business. The diamond manufacturing, wholesaling and banking sectors are all being shaken to their core. Old distribution models that pamper retailers, provide unrealistic credit terms and absorb retailer inventory risk are bankrupt.

While we acknowledge the tremendous added value retailers provide, we also encourage them to change. Business cannot go on as it has in the past. Retailers need to recognize that as pricing transparency increases, their future profits will be defined by the cost benefit of their added value and not by protection from the wholesale trade.

Added Value

As the diamond industry moves into the twenty-first century, increased product standardization, internet communication and consumer integration of product and price information are facts of life. Consumers are staking their legitimate right to fair market information and they are obtaining competitive price information from third-party sources.

In the new world of pricing transparency and product commoditization, consumers often know the low internet price for certified diamonds and other commoditized products before entering brick-and-mortar stores. Consumers know they can get a better price on the internet, yet they visit stores because they don’t just want the lowest price; they want the right bundle of price, product and added value. Consumers are shopping for the added value a store offers and weighing the cost benefit of the added value provided.

The challenge for retailers is to identify the optimal added value package complementing the product and charge a fair price for that added value. Retailer profit margins are no longer based on the cost and sales price of the product but more importantly on the cost and sales price of the added value components.

Commoditizing Diamonds

To a large degree, GIA and other laboratory-graded certified diamonds are already highly commoditized. Third-party independent grading along with the Rapaport Price List and unlimited internet price and availability information have created highly transparent B2B and B2C markets. When it comes to pricing certified diamonds, the cat is out of the bag. Few cutters, wholesalers or dealers can make extra profits from certificates based on their customer’s lack of price information. Profit margins are squeezed with little left to lose by commoditization. While the diamond industry experiences what some consider the “disadvantages” of commoditization, it does not enjoy the benefits that commoditization can bring. The battle against the price transparency that commoditization brings has already been lost.

As the De Beers monopolistic market structure disintegrates about us, the industry is at grave risk. Trade credit is maxed out at $12 billion — double the level of four years ago. Banks refuse greater credit limits and a liquidity crisis looms. Highly selective rough diamond distribution schemes have destroyed the ability of the market to balance rough and polished prices. Too-high rough prices destroy industry profitability and liquidity. A plummeting volatile dollar interacting with the globalization of diamond demand is creating extreme pricing uncertainty. Suppliers who maintain large inventories and guarantee customers fixed pricing to meet seasonal demand are taking unacceptable risks.

Inexpensive smaller diamonds may undergo a period of decline as the ability of a saturated mature U.S. market to absorb polished may decline faster than the ability of India and China to increase demand. At the same time, surging global wealth and a declining dollar are boosting demand for 3-carat-and-larger, better-quality diamonds. A speculative boom that will make the boom/bust cycle of the late 1970s look like child’s play is developing.

Let me be clear. The diamond industry is undergoing a complex transition from monopolistic cartel control to free markets at a time of great global change. The level of risk is increasing exponentially. The diamond trade no longer controls the diamond industry. If we do not move forward and replace the old monopolistic order with new and better ways of managing risk and doing business, the diamond industry will spin out of control within the next few years.

Moving Forward

The diamond industry must establish fair, open, efficient, competitive diamond markets. While not all diamonds can or should be commoditized, total price transparency must be established in select areas so that futures markets can be developed. The diamond industry must get its financial house in order. The wall between the financial commodity sector and the diamond industry must come down, allowing billions of dollars of finance and liquidity to enter our trade.

The establishment of diamond futures markets will provide our industry with an unimaginable cornucopia of benefits. Futures markets will allow us to properly manage risk, obtain unlimited finance for worthy projects and establish unprecedented levels of consumer confidence. Speculation will evolve from a threat to a benefit, as the financial risk speculators assume is channeled through the futures market to provide reduced risk and greater financial liquidity to our industry. Diamond trading opportunities will expand exponentially as professional commodity and diamond traders interact on a global level. New ideas, products and opportunities will flourish.

The Rapaport Group is fully committed to establishing spot cash markets and futures contracts for diamonds and will be taking important steps to accomplish this goal in the very near future. Our first step is to establish, communicate and commit to a number of best practice principles that will ensure that the markets we create will be fair, open, efficient and competitive:

Inclusiveness. All members of the diamond industry will be given the opportunity to participate in and enjoy the benefits of the markets we create.
Regulation. We will seek U.S. government regulatory approval for all of our activities and establish best practices that ensure compliance and eliminate conflicts of interest.

Transparency. We will disclose our plans and actions in a timely manner. Our methodology and mode of business will be transparent.

Communication. We will communicate with all stakeholders and seek their perspectives. We will work to eliminate the negative unintended consequences of our actions. We will add to and modify our best practice principles as necessary, based on communication with stakeholders.

Creating Futures Markets

The creation of our diamond futures markets will, with G-d’s help, be a two-step process. First, we will establish a formal monthly Spot Cash Auction market that will generate well- defined cash transaction prices for finely selected diamonds. Second, we will create a diamond index based on the cash transaction prices realized at auction. The regular monthly index will serve as the basis for a cash settled index based futures market. All of the above is subject to regulatory approval and discussion with stakeholders.

Our initial Spot Cash Auction will take place in New York, September 17 to 20. It will offer Rapaport select, certified and guaranteed, GIA graded, Round, 1.01-1.19 ct., D-H, IF-VS2, X-VG diamonds on a regular monthly basis. Terms are Cash, FOB Rapaport NY. Diamonds will be available for inspection at Rapaport New York and offered for sale on the internet at Diamonds.Net in an ongoing auction mode. The auctions will be open to everyone, including the public. There will be a 3 percent fee to sellers. A yet-to-be-determined buyer’s premium will be charged to the public and waived for members of the trade. Anyone wishing to offer diamonds for sale in the auction is urged to email auction@diamonds.net as soon as possible.

The initial and future auctions may offer diamonds in additional sizes, qualities and grading reports. No decision has been made as to the exact specifications of the diamonds that will be included in the indices used to establish one or more futures contracts.

Establishment of the futures exchange will require U.S. government regulatory approval and may take well over one year. Discussions with the diamond trade, as well as other stakeholders in the financial markets, will be taking place on an ongoing basis. Readers are encouraged to contact me personally via email — martin@diamonds.net — with comments. Additional information, a FAQ and interactive online forum will be posted on Diamonds.Net in the near future.

As we embark upon this important process, I take this opportunity to assure fellow members of the diamond and jewelry industry that we will do everything we can to ensure that the implementation of our programs is done fairly, taking into full consideration the concerns and perspectives of the trade. We are committed to working together with all stakeholders to ensure the development and expansion of fair, open, efficient, competitive diamond markets.

Article from the Rapaport Magazine - July 2007. To subscribe click here.

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