Scary Romances
February 10, 05“The new man-made diamonds’ features can be even more perfect than natural ones.” This finding was made loud and clear to Newsweek’s worldwide audience in its 7-page cover story “Romancing the Stone” on synthetic diamonds. The well-written story (by Michael Hastings) certainly makes required reading for all industry players. From my vantage point, the main message for the industry was contained in the final paragraphs, when Newsweek observes: “Don’t count De Beers out yet … Should gem-quality synthetics puncture the diamond market, De Beers will most likely be well placed to jump into the game, with far greater technological and marketing resources than any other player. No doubt diamond diamonds are forever. It’s just not clear which kind.”
Hastings spent time at De Beers in preparation for the story and the foregoing may be his own conclusion or it may have been whispered to him. In any event, Newsweek is absolutely right and it deserves repeating: De Beers has spent – and is still spending – a fortune on the development of the world’s most superior gem quality synthetic diamonds. Today, it says that it needs that research in order to be able to discover the best detection methods and to manufacture detection devices. That is definitely the true position for now. Tomorrow – or in a few years – undoubtedly it will join the manufacturing and marketing of synthetic diamonds. But, as I said, that is tomorrow. What makes me so sure?
From a corporate point of view, De Beers will never - and I mean never in the forever-sense – allow other companies to capture a significant market share in the diamond market (synthetic or otherwise) if it leads to an erosion of De Beers’ profits, lead to a reduction of De Beers’ market share, or if it endangers the leading (monopoly) position of De Beers in the diamond market. It will always defend its interest.
When De Beers announces it’s jumping into the synthetic gem marketing arena, I expect it will call all Sightholders into a London theater and Nicky Oppenheimer (or his son Jonathan) will make a passionate speech about the need to protect all our common and joint interests and save the market. If it doesn’t wait too long, De Beers will still have the ability to remain a monopoly and control its position in both the natural and the synthetic gem markets; De Beers may still have the ability – through price setting policies and otherwise – to create entry barriers for other companies to get into the synthetics business. It has already taken out patents to the CVD technology in most countries in the world (but not in the United States), so it can make life difficult for other potential entries. The HPHT technologies, for which I don’t think it has patents, hold not less of a risk – there are, apparently, enormous technological improvements in this more widely accessible synthetics production methods. Therefore, De Beers’ ability to corner the synthetic gem market may have a rather limited time-horizon.
De Beers – and other producers – have embarked on global campaigns stressing that only “natural” diamonds are “real”. All the values of rareness, love, emotions, treasure, value, etc are solely applicable to nature’s creations of millions or billions of years. If we were diamond mining companies, we all would probably do exactly the same. Let there be no doubt in anyone’s minds: De Beers knows what is best for De Beers and will do anything to advance its interests.
It is quite understandable that De Beers will only sell diamonds to Sightholders who have marketing policies that will advance the interests of De Beers. If these interests happen to coincide with the best interests of the Sightholders themselves or with the market in general, no one will be more pleased than De Beers. This is called market leadership, etc. The marketing programs of the clients will be used to the fullest extent to get the “natural” message get across. But, as was said before, ultimately, De Beers will do what is best for De Beers. Clients are dispensable and interchangeable.
Back to synthetics. Intuitively – and also out of long-standing tradition – the diamond market is following De Beers – especially since today the industry’s diamond inventory, the rough and polished stocks, are squarely held by the downstream players and financed by the downstream banks, and the industry is vulnerable. Anything that can adversely impact prices holds the potential for disaster. This is the time to follow De Beers. This is quite an understandable reaction.
But synthetics are a long-term issue; it will shape the very future of the industry. Not just for the producers, but all of us. What may also have become clear in the Newsweek article is that no independent thinking, strategy planning, scenario forecasting, etc. has taken place focusing on a future industry environment in which a natural and a synthetic product would be traded alongside each other. Somehow, we are working on a scenario of “separation”, of “keeping them out”, of not having them in the jewelry stores, etc. Does that really make sense?
We are basically talking about two products which are both diamonds – only created in a different fashion. For all practical purposes – they are the same, except that the synthetic may be both nicer and cheaper in many instances. But they are the same product. Newsweek highlighted that some of the industry’s most experienced players were unable to distinguish between natural and synthetic diamonds. Why shouldn’t consumers be allowed to choose between the two in one single store? What is better - that the same player sells both products or should there be a different seller for each product, probably leading to a fiercer competition?
Recently, at a conference in Johannesburg, a noted securities analyst asked DTC managing director Gareth Penny “if synthetics will supply the demand for diamonds in the event of rough shortages, when the natural production will decline or when demand will exceed supply?” He didn’t get a convincing answer, but the question was very logical. After all, it is the objective of technologies to widen supplies and, if possible, improve on them qualitatively.
The current industry anti-synthetics strategy, led by De Beers, aims at (1) product differentiation (convincing the world that there is an enormous “emotional” difference between natural and synthetic), and (2) ensuring that these markets don’t “mix” and become one single market. The recent rule by the Israeli bourse prohibiting the trade in synthetic diamonds in the Israeli bourse complex is symptomatic of this strategy.
Without prejudging the outcome of research that hasn’t taken place yet in earnest, I strongly believe that the trade and industry ought to define its own best interests – it ought to contemplate its own vision of the future. If it concludes that the interests of De Beers and of the downstream players on synthetics converge, or are even similar, that would be an ideal outcome. But that outcome should not be assumed; it should be the result of considerable research, discussions and, most important, consumer surveys. What does the consumer really want or not want. Moreover, some of the basic assumptions on which De Beers operates need to be tested.
The Newsweek article quotes DTC’s Stephen Lussier saying that “research has shown that 94% of women would choose ‘the real thing’ over a synthetic diamond.” That all depends on the survey question. Indeed, depending on the wording of the question and everything else being equal – same qualities, same price – women might prefer natural over synthetic. But, everything else isn’t equal: today synthetics (man-made) are traded at 30% lower than their natural counterparts.
In fact, our limited research (and other more substantial research known to us) shows a high level of potential receptiveness by women to synthetics. If a lady consumer has a choice between a natural 3-carater G-color VS2 stone for $13,000 p/c, or a man-made 3-carater D-color IF stone for $5,000 p/c, the much better looking less expensive man-made diamond will win almost any time over a three-times more expensive lousy color, full of piques natural stone. Don’t take my word for it; check it out in your neighborhood – but ask “real consumers”, not ladies with a vested interest in diamonds.
The point is that the industry must independently determine how it wants to cope with the threat or challenge (depends how one looks at it) of man-made diamonds. The diamond industry finds itself on the eve of major technological changes.
The technology to make man-made diamonds is here. According to Newsweek, Apollo will sell 2-carat sized stones in 2006 and, if our information is correct, by that time it may have reached a million carats a year capacity. And it is not alone. By the end of this decade there may well be a dozen Apollo's, Genesis's and others operating.
Technological changes can potentially improve or erode industry attractiveness. If only a few companies have access to the technologies, it may impact the bottom line of everybody else. Martin Rapaport once wrote that the natural price may eventually go down to the level of the man-made prices.
As technological changes in the industry can neither be stopped nor reversed – and they shouldn’t – a strategy of “delegitimizing” the man-made product, embarking on a “real” versus “fake” strategy is bound to backfire. It may, however, help us all gain some time. It is important to spend that time well. Fine jewelry retailers are told that if they carry man-made diamonds, they may find themselves without suppliers of natural diamonds. These are scare tactics. Not wise; certainly not sustainable; and probably quite illegal.
I guess we are all scared. Change often is scary. But “scare” seems to be the only strategy on the table today. It might prove to be the best available or even a brilliant one, but one shouldn’t draw premature and unwarranted conclusions. The issue needs to be looked at from an industry, rather than from a mining, perspective. The industry only gets the “added value” – the value between the purchase of the rough and the sale of the resultant polished. If there were no inventories, it wouldn’t make a difference whether the rough was man-made or otherwise. More supply sources would probably give the industry cheaper sourcing. A lower price level for the resultant polished is no big drama if the rough is cheaper as well. The industry might even be less capital intensive; profits and return on capital may be higher – these are all just thoughts. They may well be wrong – but they must be entertained, explored and answered. No doubt, at a lower price level, De Beers and other producers might see erosion in their profits. There is no reason, however, to think that other levels of the pipeline would be similarly affected – again, if the horrendous stock issue is not somehow neutralized.
We cannot run away from these questions. Technology can – and will – dramatically change the nature of the diamond industry. Whether we like it or not, there will be a product substitution impact – consumers may have to make a choice. Today, there is no substitute for a diamond (though one can buy other kinds of stones.) Man-made diamonds may revolutionize the jewelry industry. They may attract new players, new companies, new suppliers, new consumers – we don’t know yet. Companies like Apollo, General Electric, De Beers, Gemesis and others have the advantage of holding the technological leadership at present.
As “first comers” (and I include De Beers, although it isn’t yet marketing the product) these man-made diamond producing companies are pioneering, trying to reduce costs, finding the most efficient way to generate values. They hold a distinct first-mover advantage. They will, eventually, have to prove the sustainability of their technological lead. Will those who come later be able to compete? Can future players afford to wait? Are those who are reluctant to even think about man-made losing time, missing opportunities?
We do not know that, but we assume they might. Inevitably, there will come a wave of “technological followership” of companies succeeding to imitate, to adapt, and to produce similar man-made diamond products with only a fraction of the present huge research and development cost. The entry barrier will be lower. Will these players all come from the “outside” or will they be mostly current industry participants who have adapted their businesses to new realities?
For example, should an Antwerp or Tel Aviv diamond manufacturer who has no rough – or who cannot compete with a low labor cost country – close his factory and make his workers redundant or use the expertise of the workforce and infrastructure to cut and polish man-made diamonds? One way or the other, he is only getting labor cost and some profits in both instances. I do not have the answers – but I think that it is time to ask these questions.
A few things seem certain. There is no doubt whatsoever that the current downstream players (at least those who are holding stocks) and the diamond mines (who have made huge investments) and exploration companies (who are spending money on mines which may not be needed) are all going to be affected. If the new technologies could have simply been “bought” and “stored or destroyed”, that would have been preferred by most players. That is, however, not realistic – or, more precisely, not realistic any more. It wasn’t done.
The Newsweek cover story has brought the man-made diamonds (“synthetics” or “cultured”, whatever one calls them) to an enormous audience. This will raise the level of the yet limited public awareness of synthetics. Questions will be asked. With due respect to the producers (especially De Beers), they are dictating the current agenda – and, at the same time, also holding all the options. De Beers pro-actively fights against synthetics – it defines the messages (as was seen at the Antwerp natural diamonds conference it sponsored) and, simultaneously, spends enormous amounts in research and development to maintain all these options. In theory, De Beers one day might hold a monopoly position in both natural and man-made diamonds. They have that choice.
What I am concerned about is what are the options open to all of the other participants in the diamond and jewelry industry. What I wonder is whether the “ability to differentiate” between natural and man-made, which ostensibly is the objective of making all these detection instruments, will – by itself – guarantee the existence of two separate markets. If the consumer wants to buy man-made, who needs all these detection instruments? I wonder whether the convincing emotional message tied to natural diamonds is strong enough to overcome substantial price advantages. And what about the “emotional” messages that can be tied to man-made diamonds? They are not tainted by anti-trust, child labor, conflicts, NGOs, Kimberley etc. They don’t have a long, complicated and distant value chain, something Newsweek pointed out. American consumers today are technology-minded, are open to innovations (they may even be attracted to new items), they are nationalistic and patriotic. Synthetic diamonds, made by American technology, manufactured with American labor, and sold in American stores might also hold enormous emotional attractions to consumers.
Might “love forever” be stronger than “American love”? This is only one of the plethora of questions to ponder about over the weekend.