My View: The State of the Retail Jewelry Business

 

Too Many Diamonds
According to press reports, the huge decrease in Group was because of a 57% decline in rough diamond sales by the DTC, DeBeers’ rough diamond trading affiliate. Rough diamond production was also down in the first half to just 27% of the previous year numbers, as DeBeers shuttered mines in Canada, South Africa, Botswana, and Namibia. Those closures are supposed to be temporary, but it remains to be seen when demand will increase sufficiently to warrant their return to full-scale production.

 

There has always been more diamonds than there have been customers. DeBeers, the cartel, controlled rough diamond supply prior to 2001 at front end of the pipeline and drove demand through nearly five decades of market building advertising campaigns in the US. In the interim, it artificially created demand for specific sizes and shapes, bought up excess rough diamonds, and pushed prices 5%-6% higher each year. That was some comfort to diamond cutters that effectively financed DeBeers mining activity, and retailers that carried more than one year supply of diamond inventory. The extra financing cost was mitigated in part because they believed the extra inventory would be more valuable the following months and consumer demand would also increase. But, all that has changed.

 

In 2001 DeBeers announced a new business model in which it would go private and sell its inventory reserves, effectively letting diamond prices float with the market. While the company would still control about 40% of the rough diamond production, it would no longer buy up excess rough diamond production to control supply, effectively eviscerating the price control mechanisms that had sustained industry profitability for nearly five decades.

 

While DeBeers continued to invest in building the consumer market for diamonds, it reduced spending in the US, which some attribute, at least in part, to the decline in the prestige of diamonds in favor of greater investment in emerging markets. DeBeers would probably disagree, but they can’t deny retail demand for diamonds was declining before the recession. Now, with the downturn in its nineteenth month, US diamond demand has only gotten worse but continues to decline, except may be for the marriage market, which brings us back to the 73% decrease in rough diamond production. 

 

Prices May Decline More
With production low, the DTC has raised prices on select qualities of rough diamonds. Pundits argue production will increase as manufacturers sell through their existing polished and finished goods inventory and that the DTC’s self-induced scarcity will drive prices higher. That’s the theory, but really, it’s only a half-truth.  In reality, retailers bought very little in the first half or 2009, despite aggressive clearance sales. 

 

Now, three months before the crucial November-December gift season, jewelers still aren’t buying aggressively. A recent survey indicated nearly half of all jewelers expected diamond inventories would be less than last year, while about three in ten said they would be about the same, suggesting support for price increases will have to come from about one-quarter of the retail market. That’s a very narrow base from which to sustain any growth in production much less a price increase. 

 

In addition to reduced retail demand, there will be a lot of pressure to open

mines and increase production even if it drives prices lower. That’s because rough diamond sales are a major source of GDP, as well as foreign exchange for many diamond-producing countries, without which economic growth would slow to a creep at best, at worst crash.  Politically unacceptable, either government will use the traditional free market mechanisms to sell rough or, worse yet, resort to the gray market to sell enough goods to maintain their foreign exchange needs. That will further erode efforts to increase prices. 

 

Most recently the Rapaport Trade Wire commented, “polished prices softening with some discounts exceeding 40% below list. Rough price bubble has developed as recent rough price increases appear unsustainable”. Nevertheless, whatever your take, the point is there are other powerful forces, in addition to consumer demand, that are likely to depress diamond prices further in the coming years.   

 

Diamonds are not Competitive
It is an arguable point, but at current gold prices, diamond, and distribution costs, diamond jewelry is uncompetitive in the luxury goods market where there is no shortage of substitutes that consumers perceive as better value and better gifts too. What’s more, that perception isn’t likely to change, since the current environment is apt to persist for some time into the future. Without changing that value perception, the only way one can objectively expect the industry to return to the decade’s early prosperity is if they count on “bubble” economics to return and that is as remote as it is arguably unwanted too.

 

That’s a hell of an indictment of the jewelry industry, but it’s here for all to see. Many industry leaders will disagree, suggesting diamond jewelry is at parity with other luxury items and DeBeers will insist, publicly at least, diamonds are undervalued. Regardless, actual buying behavior is making it clear fewer customers believe the diamond value story both now and before the recession. Internally, DeBeers has been concerned for years that the perceived value of diamonds was dwindling. In retrospect, that in combination with the glut of new rough coming on the market likely prompted their change in business model and renewed branding efforts after the change.

 

Still, about one-half of all diamond sales come from the US. That’s the good news, the bad, that “one-half” has gotten smaller and is likely to continue to decrease unless the industry does something to change the trend. That means more than just waiting for the economy to turn around. Keep in mind, what we see today may be how retailers define normal for some years to come. Worse, it may look good. Remember the good old days in 2009. Let’s hope not, but the only way make certain that future gets better is to reestablish the diamond’s value in comparison to its luxury competitors in terms of both real cost and perceived utility. That means changing the industry’s cost structure as well as its image too.

 

Leadership is Scarce
Historically, the leadership for change came from DeBeers and large retailers like Zale Corporation. But, that may not happen today. For example, while De Beers Societe Anonyme (DBSA), the management company of the DeBeers Group, has one of the largest interests in rebuilding the diamond’s image in the US market, it appears to lack the clarity of purpose of its predecessor and possibly its financial where with all too. According to an article in The Star South Africa, “fears remain that De Beers might be unable to refinance a $1.5 billion (ZAR 11.7 billion) loan that expires next March, which could force the diamond giant’s shareholders, including Anglo American, the Oppenheimer family and the Botswana government, to step in to help”. Clearly, DeBeers management is distracted now and may be even more unfocused in the future depending on the specific objectives of its surviving shareholders if the banks want out.

 

Likewise, America’s largest diamond jeweler, Zale Corporation, with about 60% of its sales in diamond related products, has an equally large interest n seeing the diamond market rebound. But, like DeBeers, its management is distracted since the company will lose a lot of money in FY 2009. Frankly, Zale may have neither the skill nor the financial resources to turn itself around, much less act as a catalyst for changing the retail jewelry’s cost structure.

That means the leadership position may fall to large jewelry manufacturers like Stuller. Certainly, that company’s recent conference with owners is a step in the right direction. Other sources of leadership could come from magazine editors of trade publications and trade groups. However, the recession has taken has taken its toll on those businesses too. For instance, editorial staffs have been downsized, the Modern Jeweler ceased publication, and most recently, the AGS significantly reduced its office staff. 

 

Other organizations like the JBT and the JVC can support industry change, but aren’t likely to lead the charge either intellectually or from a hands on point of view. Of all the trade organizations, only the JA has the financial power and breadth of reach to influence thousands of single jewelry storeowners and small chain operators. However, it remains to be seen whether they perceive the need or have the will to do so. In their defense, retailers attending the Las Vegas Jewelry Show commented there were more “how to” seminars on topics relevant to retailing during the recession. But that by itself isn’t sufficient to foster the kind of change that is needed to make the industry more competitive. 

 

Numbers Can Be Deceiving
Some analysts say number of jewelry companies closing today isn’t that much different than in non-recession periods. One prominent researcher said “while most of those in the jewelry industry – retailers, wholesalers, manufacturers, and others associated with the industry – have a decidedly pessimistic view of the future, we note that the numbers – sales, census, and profits – have not been as bad as some had feared. Certainly, the numbers have not been as bad as the mass media has tried to make them look.” He was probably talking about conjecture that the industry could decrease in numbers buy 25%. He is right about the numbers now, but we haven’t seen how the industry will perform during the critical November-December sales period. Specialty jewelers frequently earn more than 90% of their annual profits in the last two months of the year, probably even a greater percentage this year.  A further material decline in sales could be a disaster for many companies, large and small alike.

 

Another thing not factored into that sentiment is the fact many jewelry company’s are out of “wiggle room”. Simply put, they have sold inventory, cut staff hours, and reduced marketing spend to a point where there aren’t too many places left to cut. Add specialty jewelry sales are expected to decline about 10% this year and its becomes clear the next six months are the decisive time for the industry, not the first half of 2009 as many had thought.

 

The question is how much of the market will substitute products and non-jewelry retailer’s gain this year, the next, and what will be left for jewelers. The multibillion-dollar diamond jewelry market was in play before the recession and is even more so now. So, it’s clear specialty jewelers and the industry that supports them have to rethink what they sell, how they sell it, and how they buy it too, if they are to overcome the competitive advantage of bigger, non-jewelry retailers that differentiate themselves by cheap prices and frequently low quality. Surprisingly, the technology and resources are available to solve most of the problems. Most importantly, consumer attitudes are in flux, which means changing attitudes and buying behavior, while still difficult, can be achieved. 

 

What is needed is leadership.