‘Shooting themselves in the foot’
to injecting sparkle back into diamond sales.
No doubt, the problems we are experiencing today have been building for several years. By the late 2000s, sightholders decided the most profitable way to dispose of polished diamonds was to upload their inventory to several large online diamond retailers. As wholesalers began holding less inventory, sightholders became less and less liquid and more dependent on online vendor sales, which were destroying margins for the entire industry. In essence, sightholders were shooting themselves in the foot without knowing it. Severe competition began to emerge amongst sightholders, which caused them to fight tooth and nail to earn a spot among the first three lines on the results grid of RapNet and other trading networks. They dropped their prices (and consequently shrunk their margins), effectively adopting a just-in-time model themselves and selling at bargain basement prices, an unprofitable way of doing business.
This war to get the top spots is like King Kong fighting a mouse with a toothpick and winning—the result was minuscule, though the consequent damage was significant, as it decimated margins across the board. Of course, not all consumers were buying diamonds online, but many were using online prices as leverage to negotiate better deals in brick-and-mortar stores. While this fight to the bottom was taking place at the counter, retailers and wholesalers were being offered little financial incentive (e.g. better prices or better terms) to buy and hold diamonds, making the just-in-time model of acquiring product more attractive, since you only bought what you needed when you needed it, and, more importantly, for the same price.
Margin destruction is taking place regardless of the size of the last sight or what Rapaport tells us diamonds should be worth. This malady is chronic and ongoing. Consider the example of Blue Nile. If you analyze this publicly traded company’s 2014 financial statements (the most recent available at this article’s writing), you will note it has been running average gross margins of 18 per cent. Keep in mind Blue Nile sells on demand with no initial outlay of capital (i.e. liquidity) and by assuming no inventory-related risk. Conversely, retailers who put out money to acquire polished diamonds assume significantly higher risk, and if given the choice, would likely prefer to not buy and hold diamonds, and by extension, tie up much-needed capital.
Historical tolerances for assuming polished risk for wholesalers is 10 per cent, while for retailers it is 30 per cent. These minimum values need to be restored to inject capital from the trade back into the polished pipeline.
We can rebuild margins from the bottom up rather than top down, but this starts with sightholders offering wholesalers and retailers better margins to assume the risk of owning diamonds. Top-down solutions, such as reduced sights and lower list prices, are just benchmarks; they will not stop margin destruction, improve consumption, or increase sales as long as there is no incentive for capital to re-enter the pipeline. Sightholders have to move away from relying on online vendors and instead build relationships among the various levels of the pipeline. Investing capital needs to be rewarded. Without consideration for this fundamental economic theory, sightholders will be forced to sell diamonds one stone at a time at the lowest possible price with the lowest possible margin. A business model such as this does little to solve anything.
