Key Changes Offer Bright Future for Diamond Industry

I often think about the way a consumer makes decisions, whether he lives in New York, Hong Kong, Shanghai, or anywhere else. Obviously it is he who sets the price of diamonds, both polished and (indirectly) rough. He is the one who decides if a diamond ought to be offered at a certain price, or if he even wants a diamond at all. Every supply chain is supposed to work according to this assumption. When the consumer decides that he wants, and is able, to pay the nominal price for a given diamond, he simultaneously sets the price of that diamond. This in turn determines the price of the rough diamond (from which the polished diamond was produced). The difference in these two prices is the total gross profit of of the supply chain: the miners, the polishers, the setters, and the merchants.

In previous articles, I have argued that in light of the current crisis, the diamond sector will never return to its earlier structure. Even if we manage to solve the current problems (i.e. high cost of rough diamonds, profit margins, inventory, marketing etc.) in the foreseeable future, these will be only temporary solutions. In my opinion, these same problems are sure to rise again in due course. All this leads me to the conclusion that there is a need for deep, fundamental change in the industry. Only a dramatic change will stabilize the diamond trade and make it profitable. This must be a change that benefits all players in the industry, and one that will first and foremost prioritize the consumer.

Problematic circumstances

However, before I go into the kind of change required, we should examine the circumstances that led the industry to the current situation.

Fragmentation: The diamond sector’s pie is shared among an enormous myriad of companies. The small share that each company gets, if it gets any, erodes the company's profit, prevents capital accumulation, makes it difficult to maintain the value of the diamond, and hurts the company's ability to market this luxury item effectively, as has been done in the past (link).  Many of the players in the diamond sector are reliant on a "low-cost labor force" and are willing to compete with each other in order to sell at any price, including by making deals without any return on the investment (link), or even at loss, just in order to maintain the business and keep it alive. In such a situation, rational diamond companies will divert their profits to investments in other sectors. This may leave the industry in the hands of relatively weak companies that would not be able to provide sufficient and suitable services to consumers.

The oligopolistic regime of rough diamond suppliers: This situation leads to controversial practices that ultimately lead to defeat in the most important battle of all: the battle for the consumer. Such practices include: temporary improvements to the coloration of diamonds, including undocumented synthetic diamonds, exploiting the gray area between benchmark demand and the final transaction, lack of transparency, confusing consumers with the Four Cs characteristics, and so forth. 

These practices damage profitability, hurt the industry’s reputation, harm the consumer, and lead financial institutions – who could be boosting the industry – to take their business elsewhere. These problems are exacerbated by the constant struggle for market share that creates urgency around acquiring rough diamonds at any price.

All the above can be seen in the below graph prepared by Mercury Diamonds and speaks for itself:

The blue line, which indicates rough prices, is almost always above the red line, which indicates polished. The rest is clear. 

Synthetic diamonds: a hidden advantage 

So far we’ve dealt with the structural aspects of the diamond industry and their implications on the current situation. However, there is another aspect: how consumers perceive the value of diamonds, i.e. marketing. The industry must wake up and search "outside the box," because relying on De Beers’ fantastic "diamonds are for ever" does not work any more. The industry needs to read the writing on the wall. The meteoric rise of synthetic diamonds (laboratory diamonds) poses a considerable threat to the demand for natural diamonds, and is only growing stronger.

But this should not necessarily threaten the industry. On the contrary, the rise of synthetic diamonds could be the dawning of a new era for the industry, if we succeed in leveraging it and transforming it from a weakness into a strength. How will we do this? By recognizing that we are dealing not only with a luxurious and beautiful product, but with a very unique item that belongs to a group of products for which "the economy of rarity" is master. 

What is the "economy of rarity" and how do we belong there? First, I would like to clarify the terms scarcity and rarity, both of which appear frequently in the context of rarity economics and are sometimes confused. Scarcity refers to a lack that can be filled either by expenditure or by time but will ultimately be filled. In contrast to scarcity, rarity describes merchandise that occurs infrequently in nature. These products are naturally limited and their reserves cannot be replenished. In other words, the more it is produced, the greater the deficiency which can never be restored. This is a zero-sum game, in which one party’s profit comes at the expense of the other, such that the sum of profit and loss for both sides is zero. This situation normally leads to either a rise in price of that resource (as in most cases) or long-term stagnation of the product value (as in the worst-case scenario).

To return to our industry, documented synthetic diamonds should be considered as belonging to economy of scarcity as they can be mass produced with unlimited capacity. The more these laboratories multiply and develop more sophisticated means of production, the lower their prices will drop. This is not a limited resource, but rather a productive industry. 

Conversely, the natural diamond can and is considered a rarity – a product which can only be produced in a limited volume, and whose occurrence declines over the years, despite the development of new prospecting techniques and major investments. Other factors also contribute to the sense of rarity and economic value of natural diamonds. These include intensifying regulations under the Kimberley Process Certification Scheme, government appraisals, customs appraisals, the short transition between raw material and the polished product, and meticulous documentation of the final product. Natural diamonds are intensely regulated in order to maintain quality and provide the consumer with a system of multiple securities when buying a diamond.

Diamonds, like captivating works of art, rare automobiles and fine wines, will always have a rigid demand curve. Collectors, investors, and market players will always be looking for special, prestigious products – those exclusive, rare stones that aren't considered a commodity. This situation amplifies demand for the product and therefore normally should lead to a rise in its price and value over time.

A diamond whose value will be preserved over time will not be subject to "changes in fashion." Acquiring such a diamond is a stable investment, as it is a physical object with a set value that does not go in and out of style. A natural diamond has two important characteristics in this context. First, its unique beauty means it can be set in jewelry. Second, its rarity causes its value to constantly rise and accordingly, its price constantly rises. A synthetic diamond, on the other hand, has one central advantage – its beauty. It lacks the quality of rarity, however, and therefore will not preserve its value over time (its price will decline as production technology for synthetic diamonds advances and they become more common).

An opportunity to be seized

This difference opens a window of opportunity for the diamond sector, which could signal the dawning of a new era. This is the moment to preserve the value of real diamonds and not undermine ourselves. This is the moment to leverage and promote the uniqness of our industry and to take it to an all-new level. I believe that the principal focus must be a concerted marketing campaign that directly addresses the consumer. This campaign must show the consumer the uniqueness and advantages of the natural diamond, and why it is preferable to other elite products. 

To allay any doubts, of course there is room in the market for both natural and synthetic diamonds. It is simply important to establish the difference between the products and to help consumers understand that natural stones and lab-made stones are two completely different things. For those who want to buy a beautiful piece of jewelry at an affordable price, synthetic diamonds are an excellent choice. However, for those who want to enjoy the beauty of a diamond that has the potential to maintain its monetary value over time, the natural diamond is clearly the better option given its rarity. 

So where does all this lead? What does it mean for us? It means that we should treat our natural diamonds differently. They must be sold in a different environment, better suited to their unique nature. Perhaps even "diamond banking" practices should be established in order to orient the end seller: What is he buying? Where is he buying? What is the historic behavior of the given diamond? Does it behave speculatively? Is its value volatile or stable over the long-term? 

If this vision were to come true, it could be the key to a new chapter in the history of natural diamonds. This will have two new effects. First, new consumers  who would never have thought to buy diamonds for their beauty may be tempted by them having the potential to maintain value over time. Second, current buyers who are considering opting for other luxury goods will understand that they can buy jewelry made from natural diamonds and enjoy the best of both worlds – the special beauty of a delicately-crafted piece of jewelry and  its potential ability to preserv the value of their savings.

A whole new perspective

All this calls for a new outlook, in which suitable attention is paid to natural diamond marketing and pricing. For example, I invite you to look at the “Crystal Clear" method. Meanwhile, emphasis must be placed on the dual value of the natural diamond – its beauty and its potential to maintain value. Thus, every change calls for new thought and providing the consumer with a new perspective.

Let's imagine how the supply chain will operate in this new system. The value of rough diamond production is traditionally estimated by the mining companies and sold according to the price that the consumer is willing to pay. If consumers show interest in purchasing diamonds on a larger scale (because of their dual benefit – beauty and value maintenance), the price of rare, natural diamonds has the potential to rise significantly, perhaps even reaching $30 billion per year in value of polished diamonds.

To illustrate: the current crisis is a result of a squeezed marginal profit split among the many players in the midstream. The solution can be found in reducing the miners’ share, in increasing the marketing budget, in directing the focus on the value and the uniqness of the diamond and its potential as an investment product, and the inevitable treatment in the fragmented structure of the midstream. An improved gross profit margin distributed to fewer companies will lead to a strong industry with an economical and logical return on capital. 

Such value can be achieved when diamond consumers properly understand this dual benefit and when they are convinced that they will be able to attain the monetary value of the diamonds upon resale in accordance to economic principles such as those developed by Mercury Diamond's "Crystal Clear" method. In this scenario, the difference between annual global mining production costs, which we estimate today to be around $7-8 billion, and the final price of polished diamonds that could reach up to $30 billion annually, will allow for a different attribution of the industry's profit pie. To this end, it is on the industrial diamond sector to safeguard prices of rough diamonds. Appraisals of rough diamonds are based on outcomes of polished diamond sales while keeping an economically reasonable share within the industrial sector. Raising prices on rough diamonds won't be possible without reasonable economic justification.

In this new supply chain, the difference between mining costs ($7-8 billion) and $30 billion will be split up fairly between the components of the supply chain by setting high standards for mining companies, production companies, and marketing firms (which regardless will limit the number of these companies relative to the number of currently-existing companies). Then the pie will be divided in such a way that profits will be financially reasonable. This will encourage investment of personal capital and allow for growth, which will further inspire financial institutions to fund the sector. The subsequent profits will allow for the allocation of enough resources to support a marketing campaign that will laud the dual benefit of buying natural diamonds, and show why they are preferable or at least worth to be considered amongst other luxury goods.

What doesn't kill you makes you stronger. This is a golden opportunity for changing the trends in the natural diamond industry and for creating a different marketing strategy. We all enjoy the profits – the consumer, the players in the diamond sector, and the entire industry.

The views expressed here are solely those of the author in his private capacity. None of the information made available here shall constitute in any manner an offer, invitation, or promotion to buy or to sell diamonds. No one should act upon any opinion or information on this website (including with respect to diamonds values) without consulting a professional, qualified adviser.