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High Rough Diamond Prices Cutting Margins to the Limit
Q&A With Vishal Doshi - Executive Director of Shrenuj & Co.
Aug 10, 2014 2:11 PM
By Rapaport News
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RAPAPORT... Shrenuj & Co. was founded in 1906 as a diamond manufacturer and launched jewelry manufacturing in the 1990's. Today, the company does diamond and jewelry manufacturing and wholesaling, and has a retail presence with kiosks in 190 stores in India and seven in Hong Kong. Vishal Doshi serves as group executive director of Shrenuj and explained to Rapaport News his goal to grow the company’s presence across the value chain.
Rapaport News: How do you assess the global market so far in 2014?
VD: For the first time in a while, we are seeing promise and growth in all regions globally. The U.S. is gaining momentum as money that has been pumped into the economy through quantitative easing is creating consumerism. Also in Europe, this year has been much easier compared to its low base from last year.
The Middle East is also doing well because a lot of money from troubled countries has been redirected toward better governed economies in the region. There is now a concentration of wealth resulting in increased consumer spending, giving the jewelry industry access to wealth that it didn’t have before.
In India, 2013 was a tough year, particularly for the gem and jewelry industry. We’re used to double-digit growth, but last year we saw barely any growth because of faulty government policies, a declining stock market, less access to foreign capital and poor industrial growth. Things came to a standstill this year before the May elections, but the election results were positive. Already the stock market has increased and we expect restored growth in the next three to four years. So the market in India is looking positive even though the numbers haven’t shown it yet.
China was also a difficult market in 2013 because there was a leadership change and uncertainty regarding policy. However, the new leadership appears to be more liberal and growth oriented, and we’ve seen the market reviving quite well in 2014. I think there will be more stable, mature and controlled growth in China than we’re used to, which will resonate in the rest of the region. We’re also seeing improvement in Japan’s economy.
Rapaport News: Has that positive outlook filtered to the diamond and jewelry trade in 2014?
VD: There has been a nominal increase in loose diamond demand because many of those economic developments are still a work in progress. In the U.S., we have seen a substantial increase in demand but as you go east, a strong platform is being developed which will only deliver in the years to come. This was the year of setting the equilibrium straight.
Rapaport News: How do you assess the mood in India since the election of Narendra Modi as Prime Minister?
VD: Very few prime ministers have taken office and been able to start executing so quickly. We get the feeling that the government really means business. They have taken steps which will be beneficial in the long run and have already implemented more pro-business policies. More importantly, we’ve seen policy action, which has already resulted in more money coming into India and there are more people looking to invest once the prime minister executes his policies.
We are looking at forex results improving and the rupee stabilizing, which is very important for local consumption. I believe the government will need six to eight months to start implementing policy that will result in economic growth. It will take at least a year to permeate to the gem and jewelry industry, which tends to be a dragger because it is the epitome of luxury. I expect the stock markets will rise and company valuations will grow and that will lead to greater overall wealth and ultimately increase the consumption of gems and jewelry.
Rapaport News: That will influence domestic demand but the diamond industry is essentially an export industry. How was the recent budget announcement for the industry?
VD: The budget was a bit of a disappointment because people were hoping the customs duty on polished diamonds would be scrapped and instead they raised it slightly to 2.5 percent. However, I think this is a government we can work with and with a strong industry representation, I am sure that within the next five years there will be more positive steps for the industry.
Rapaport News: What are the biggest challenges facing manufacturers today?
VD: The two biggest challenges are profit margins and rough costs. Our margins have declined in favor of mining companies, and this has forced manufacturers to be more efficient than before. A manufacturer operates with a benchmark margin to get a reasonable return on equity. We’ve reached a point where we are on the border of sustainability in spite of all the efficiencies. It is very important for the health of the industry that manufacturers have reasonable margins and can make a reasonable return on equity.
The rough diamond market is influenced by speculators, traders and genuine manufacturers. Often this dynamic results in abnormal behavior, as we saw at the last De Beers sight when premiums rose in spite of weak polished demand. The primary mining companies need to consider in their pricing policies that manufacturing margins have to be preserved at a reasonable level for the rest of the market to remain efficient.
Rapaport News: Is rough demand being driven by manufacturers who need rough in order to have polished ready for the season?
VD: That may be so but you have to ask if polished prices will go up in the next two months to justify current rough prices. We are already paying 5 percent to 7 percent more on rough to account for the premiums and price increases. If polished prices go up by 7 percent and you just bought rough, you are still at break-even from today's level. So that is a call manufacturers need to make.
The other option is to buy polished. You could easily find polished in most categories during the softest period of the year because there is a reasonable liquidity crunch in the market. You could buy polished and hold onto that inventory for two months and be assured of their price.
I believe that you should take the risk on rough only if there is enough of a margin to buffer the high rough prices. The problem right now is that there is no buffer, so everything depends on how much you expect polished prices to go up.
Rapaport News: How are labor costs affecting operations?
VD: As India prospers, new opportunities are being presented to workers in other industries with more attractive salaries, work environments and structures. We have to compete to keep our workers in order to retain and grow manufacturing. Labor costs will definitely go up, which again affects manufacturing margins.
You have a factory in Botswana and one in South Africa. Is there a trade-off between gaining access to rough and the higher labor costs to manufacture there?
It’s the better-quality, larger diamonds that we manufacture in southern Africa because the cost of labor as a percentage of the selling price is quite small for these goods. That is why I can afford to pay a higher labor cost.
However, developing the necessary skills takes time. In Botswana, the availability of a skilled workforce is limited because it’s a relatively new industry.
Rapaport News: What is the state of bank credit in India?
VD: The banks have been hit over the past few years with a number of non-performing assets in an industry which historically did not have many bankruptcies. The banks have not changed their view toward the industry and I wouldn't say that there has been a credit reduction. However, they are looking to maintain their credit and so they are managing it tighter in order to weed out any weak accounts or issues they may have.
Rapaport News: How do you ensure your margins in this environment?
VD: Almost all of the main diamond manufacturers have jewelry lines and are integrating downstream. The more diamonds you can sell as jewelry rather than as loose helps to improve your gross margin. Not everyone can execute this because you can’t just take your diamonds, mount them in jewelry and sell them. It requires a different business model.
Rapaport News: Are retail jewelers also changing their models?
VD: Everyone wants to do what they are good at. The big retailers are integrating backwards in the same way that we are integrating forward. However, the average retailer is good at retailing jewelry and doesn’t want the headache of buying gold and diamonds, outsourcing jewelry manufacturing, quality-checking it and keeping the excess inventory. They would rather just buy the finished product and spend their time doing what they are good at – selling jewelry.
The second important point is product innovation. As manufacturers, our job is not just to manufacture jewelry, but also to merchandise and come up with innovative product ideas and concepts. This is something the average retailer can’t do, so manufacturers have taken on the role of creating innovative products and presenting them to retailers.
Rapaport News: What advice would you give to someone entering the industry?
VD: When you look at manufacturing, you have the option to either go scale or niche. Mid-scale players need to migrate to one or the other because margins are very low and have been shrinking for some time now. So you either need to grow your scale or specialize in specific products and categories for which you can charge a higher margin.
Rapaport News: Was that a decision that Shrenuj made at one point?
VD: Absolutely, and today we can really be flexible in terms of our entire business model because we have a global presence and operate across the entire value chain. So we can move product between global markets and also within the value chain.
Our goal and strategy is to be present across the value chain, but you have to sell what your market wants. A lot of jewelry manufacturers had to close because they had dead diamond inventory that they converted to jewelry to try and sell without assessing the market. You have to judge what the market wants and use the right tools to grow your business. If you don't produce the right goods, source them, which is what we did.
Rapaport News: What's the next phase of growth for Shrenuj?
VD: We have a two-pronged growth strategy to drive margins and turnover. Our margin growth strategy is to use more of our own diamond production in our jewelry. The majority of our jewelry today comes from sourced goods, but I would like to change that because that is where the real margin growth lies. The goal is to align our diamond manufacturing to the jewelry we sell, which is a very difficult process.
In order to ensure sales growth, loose diamonds currently account for a majority of our overall revenue and we would like to increase jewelry as a percentage of our total revenue. That doesn't mean that our diamond business will drop, but it means that our captive consumption will grow. As the jewelry business grows, diamond manufacturing will also grow, but it will contribute more to our jewelry sales rather than our diamond sales.
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Tags:
diamonds, India, jewellery, Jewelry, Rapaport, Rapaport News, Shrenuj
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