Insanity of the Diamond Industry

Op-Ed: Insanity of the Diamond Industry
By Neil Reiff  

Published:  “RapNet – The Diamond Market” –  August, 2015
Published:  “World Diamond Magazine” –  January, 2016

RAPAPORT… Veteran Philadelphia, Pennsylvania jeweler Neil Reiff last month published the following commentary on LinkedIn. With “Insanity of the Diamond Industry”, the president of N.D. Reiff Company Ltd. raises a number of compelling concerns and questions for our industry. The article is reposted here with Reiff’s permission.

It has been stated repeatedly that the cost of rough diamonds is too high with the result being lack of profitability in the diamond industry. It is my position, as one who has spent a lifetime in the trade, that it is the retail pricing of diamonds that is too low.

Diamonds are not an “elastic commodity” of which demand increases with increased supply or lower price. Diamonds are not a disposable or consumable product that someone needs to buy repeatedly. The purchase of a diamond is, to many, a once-in-a -lifetime event. A lower price will not stimulate more diamond sales. At best, a lower price simply saves the consumer money or increases the carat weight of his purchase.

As a former business student at a well-regarded University, I learned that the purpose of a business enterprise is the creation of profits. Profit is essential to the success of any business enterprise for without it and the positive cash flow that it creates, a business model is not sustainable. Profit is the excess of revenues minus the cost of goods sold and the many other expenses that are incurred in operating the business enterprise.

Gross profit is the measure of revenues in excess of cost of goods sold. It is from this excess of revenue minus CGS that profit flows to the bottom line. It has been said by many astute business people that gross profit margin is the key to assessing the financial health and future of any business. With few exceptions (ie, Amazon.com), revenue growth is meaningless if the business model does not generate positive cash flows. Such a business is not sustainable over time.

I had a recent encounter in business that led me to author this discussion. The situation was this:

A wholesale customer was attempting to sell a 3-carat PSH diamond to a long-time valued retail client with whom he has established a professional and trusting relationship. He quoted a fair retail price to the client who was excited at the prospect of having a beautiful new diamond for his wife of many years. The wholesale customer/retailer was astounded when his customer telephoned him to tell him that he could buy the same diamond for less money on the Internet.

I cannot say how much less because I do not know the retail price that my customer quoted. I do know that the Internet seller was quoting a price of $24,996.00 for the same diamond that I own and am wholesaling for $24,575.00! This represents a gross profit of $421.00 on a $25,000.00 diamond – a gross profit margin of less than 1.7%!

To this, my customer and I both said, “This is Insanity! . . What is the point?”. There is no point and no purpose in selling anything at a profit margin of 1.7% over cost. No matter how efficiently one may run a business. No matter how much one may grow revenues.

There are a multitude of possible outcomes to this story. Perhaps the customer will now abandon his desire to purchase a diamond for his wife as his perceived value of a diamond has been destroyed as well as the trust he had placed in the seller. Perhaps he just walks away from the transaction because he has a bad taste about the whole thing and it’s best to just turn away from it.

Or perhaps he ultimately buys it for the price of $24,996.00. In this case, the buyer has purchased a valuable diamond for 1.7% above the wholesale cost! In this case, it is the industry that has lost. No one has made a profit, as 1.7% cannot be considered to be a profit. More significantly, no additional sales have been made that would not have otherwise been made. In the end, thousands of dollars have been lost – in profits and in value to the industry and to the consumer public – for the perceived value of the billions of dollars of diamonds held by the public and by the industry has been greatly diminished.

With regard to the issue of profitability of the industry and the effect of “high” rough prices, the above story demonstrates that there are players in our industry that are willing to negate profitability within the industry at any price level. If the price of rough was to drop and, subsequently the price of polished diamonds was to drop as well, these industry players would still find it necessary to make diamonds available to the public at the same ridiculous and unsustainable gross margin levels. Lower wholesale diamond prices will simply lead to lower retail prices – in essence, a Catch-22 situation.

Tiffany and Co. and Signet Corporation are two examples of success within our industry. They both sell several billions of dollars of diamonds and jewelry to the consuming public. Both of these companies understand that profits are essential to their ongoing enterprises. Both of these companies are extremely successful. Their revenues and gross profits continue to rise despite the fact that others seem to believe that the only way to conduct business is by selling diamonds at cost – or perhaps 1% or 2% above!

Tiffany and Co. recorded annual sales for 2014 of $4.249,913,000 – a 5% increase over the prior year. Tiffany achieved this sales figure with a gross margin of 64.3%! Tiffany’s markup on cost was 280 percent! To put this into perspective, Tiffany realized a sale price of $28,000.00 on $10,000.00 of cost whereas the Internet retailer above would have realized a sale price of $10,170.00 on the same hypothetical item!

Signet Corporation, the parent of Kay, Jared and Zales, reported 2015 annual sales of $5,736,300,000 in their last fiscal year. Sales at Signet increased by 36%.1 Signet amassed this revenue figure with a gross margin of 36.2% – a markup over cost of more than 156 percent!

It is interesting to note that in Signet’s 2015 Annual Report, there is this quote that is highlighted: “Our research consistently tells us the main reason people buy jewelry where they do is NOT PRICE . . . but TRUST” (caps added for emphasis).

This affirms what a friend once told me about why her family purchases jewelry from Tiffany. She explained that she knows she is getting quality and, though the price may be high, she is getting the same price that everyone else receives. Again, a matter of trust!

I made reference to Amazon.com earlier in this discussion. I assume that many of the Internet diamond sellers attempt to rationalize their non-profitable selling by giving themselves too much credit and comparing their endeavor with that of Amazon.com. These Internet sellers have the mistaken belief that someday they will achieve enough revenue growth to become profitable.

This is a fallacy. To begin with, Amazon achieved sales revenues of $88,988,000,000 in 2014. Amazon’s sales are more than the entire jewelry industry. Amazon does more business in two days than Blue Nile in one year! More significantly, Amazon continues to grow at 20% per year whereas Blue Nile had sales growth of 5% in their latest fiscal year.

Amazon, unlike the online diamond retailer, sells consumable products that people buy repeatedly. Many Amazon shoppers make hundreds of purchases – every year. Unlike Amazon’s customers who will continue to purchase it’s products for many years, Internet diamond customers will never become multiple-repeat customers.

More significantly, Amazon had a gross profit of $26,236,000,000 – a gross margin of 29.5%! This equates to a mark-up of nearly 40 percent compared to the Internet diamond company at 1.7 %! To put it simply, Amazon’s markup is more than 23 1/2 times that of the Internet diamond retailer who wants to flatter himself in thinking he is following the Amazon model.

So where does this bring us.

There is no doubt that our industry is in a state of disarray. Many, myself included, might say we are in a state of destruction. We are. I would say it’s going to get worse but I cannot imagine getting worse than where we are – except for the prospect of retailing diamonds below their wholesale cost. We, as an industry, have destroyed profitability. More significantly, we have destroyed the perceived value of a diamond.

An artist understands that his work is more valuable than simply the price of the canvas and the cost of paint. A doctor understands that his services cannot be given away to the patient for free if he is to support himself and his family. An appliance dealer would never consider selling $10,000.00 of home appliances for $10,170.00. A home builder understands that he cannot build houses and sell them at cost. A diamond retailer who thinks he is succeeding when selling diamonds at a 1.7% markup to the consuming public is only fooling himself as he surely heads into future bankruptcy!

There is little doubt that the Rapaport Price list was the first step in the downward spiral of our industry. I wrote of this in 1998. (See JCK- July 1998 “Martin Rapaport – One Man’s Destruction of an Industry”). Today, it is not the wholesale price list that is the problem but the ability of desperate and senseless Internet sellers to upload wholesale diamond database information to consumers at wholesale pricing.

It is the mistaken belief among those in our industry that price is all that matters that will destroy our industry. Increasing one’s revenues without making a profit is a pointless endeavor that leads nowhere. Selling diamonds to the consumer public at wholesale pricing accomplishes nothing except lowering the value of diamonds. The end result of this price-cutting actually diminishes the revenues of the industry as a whole.

An old timer in our industry told me of the advice he received from his earlier generations upon coming into the diamond business. The advice was: “Protect the Inventory”. Rolex, – unlike Seiko, which has been discounted into oblivion – understands this premise and has been masterful at upholding value by restricting Internet pricing and discounting.

As a result of my recent encounter with the 3-carat PSH diamond discussed above, I have changed my business practices. No longer will I permit my diamond listings to be indiscriminately downloaded to anyone who wishes to post my diamonds on their website. I am willing to give up these sales by unscrupulous and unprincipled Internet retailers. I believe that my diamonds have value. I believe it is necessary to forego sales to those who want to destroy this value.

I urge other wholesalers to do the same. Forbid others from indiscriminately uploading your diamonds to their retail websites at senseless retail prices – for their senseless prices affects the survival of your well-intentioned customers and the industry. This is necessary in order to stop the race to the bottom and the extinction of the diamond industry. It is simply a matter of one check box in your Rapnet account settings.2

Protect your diamonds. Do business the old fashioned way. Care about whom you choose to do business with. Utilize your relationships. Re-establish trust and value in diamonds.

Notes:
1. Signet Corp sales revenues for fiscal 2015 includes results of Zales acquisition. Sales growth was 6% in fiscal 2013 and 5% in fiscal 2014.
2. It is also possible to allow or deny specific companies within Listings Policy. To manage Listings Policy, Rapnet> Home> My Account> Listings Policy.

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