Assuming liability
Diversion of capital forces private, non-borrowed money to exit the industry only to be replaced by borrowed funds, which brings further financial strain. This trend of moving away from an inventory-on-hand business model really gained momentum when online vendors began offering diamonds on a ‘just-in-time’ basis. Rather than holding inventory, diamond e-tailers simply ordered a diamond once the customer clicked the purchase button.
Selling diamonds direct to consumers is a strategy loosely based on ‘vertical integration.’ The classic definition of this strategy refers to a company owning different parts of its own supply chain. In the case of the diamond industry, the scenario is one in which several levels of the diamond pipeline are consolidated to direct more and more profit to sightholders and then eventually to mining companies. One example is De Beers, which looked to the Internet to create a B2C business model. In doing so, it cut out several levels of the supply chain by encouraging sightholders to find more direct routes to dispose of their polished diamonds. The rush of sightholders to supply one online vendor in particular allowed it to reach $450 million in sales in just a few short years.
There are two major flaws with this way of doing business: the assumption polished diamonds are highly liquid and the belief there is infinite demand for them. Most of us in the trade know neither is the case. Rough sights take place like clockwork every six weeks; beyond that, however, the process is much more time-involved. Once rough is acquired, manufacturers must plan the yield and polish the diamonds. Sending polished stones to laboratories for grading can take up to six weeks, while listing them and converting them into cash can take anywhere from four to 12 months. This is clearly demonstrated by the swelling polished inventory of sightholders who are unable to sell their goods to wholesalers to hold as stock. The problem is, financing a business that is constantly acquiring product and churning out inventory no one is buying is a hardship on the entire supply chain.
Previously, the traditional diamond distribution channel allowed sightholders to pass on risk (e.g. price fluctuations on RapNet, weak demand, or currency instability, etc.) to wholesalers in exchange for their cash (i.e. liquidity). However, without sufficient profit, ownership of polished diamonds becomes a risky and unattractive proposition. Risk mitigation is the most important factor in the survival of any industry; not recognizing or managing risk leads to complete industry failure.
If a wholesaler or a retailer cannot make money, they will not buy and hold diamonds as inventory, as doing so involves too much risk. Without reasonable margins, there is no financial incentive for retailers and wholesalers to stock diamonds, leaving the entire burden of risk on sightholders. The result is a pipeline clogged with polished diamonds, which is where we find ourselves today. This is the reason for the current liquidity crisis in the industry—no one below sightholders wants to assume risk of polished diamonds due to small margins and poor return on investment.
