Certified Profits
November 03, 05Lately, there are many questions about the “non profit” structure of the Gemological Institute of America. The organization’s president, William E. Boyajian, recently reflected on an internet website on the meaning of “non-profit” in the GIA context. We quote: “GIA is a public benefit corporation, governed by a board of industry, academic, and business leaders. In effect, we perform myriad functions that address public issues set by our charter, which would otherwise remain unchallenged in the industry. We have no shareholders, so any funds we receive are reinvested in the Institute and in the many activities we conduct on behalf of the public.” [Emphasis added.]
“As a nonprofit educational and research institution, we serve the public by setting standards of professionalism and fulfilling those standards through our various divisions. We generate revenues primarily through education tuitions, laboratory fees, instrument sales, journal subscriptions, and charitable donations. The donations GIA receives are only a very modest portion of its total revenue (less than 5%), but they are important because they help provide scholarships for needy and worthy students, and they support many valuable public-service endeavors. GIA could not possibly continue its multi-million-dollar research program, its international education expansion, or the development of its new School of Business, to name just a few of these endeavors, without such outside financial support. Ultimately, these donations help safeguard the public’s trust in gems and jewelry, and ensure that our vital mission of service to the industry and the public will continue long into the future,” says Boyajian.
I would argue that the absence of shareholders, and the fact that all the rights and privileges of shareholders in commercial undertakings are, in the case of the GIA, vested in the Board of Governors, requires a higher standard of financial and other disclosures than would be expected from commercial undertakings. Nowhere on the GIA website is any hard financial data.
The absence of readily accessible financial data makes it difficult to decide whether financial support - or how much support - is warranted. The lack of transparency makes it difficult to ascertain whether selected statements on the financial affairs are supported by facts. President Bill Boyajian stresses that “in fact, few people realize that many of GIA’s varied activities need additional outside financial support. This is not due to inefficiency, but rather it is a result of our efforts to keep prices as low as possible for those we serve.” That statement warrants some further thoughts.
Certification Income Supports Research and Education
As we do recognize that disclosing current up-to-date financials might possibly affect commercial relations, and as we don’t need current figures to illustrate our arguments, we looked at GIA’s 2000-2003 period. In that three year period, the total profits of the lab services (sales of certificates) totaled $71.5 million, while the total profits of the GIA were “only” $46.7 million in these three years together. So, clearly, the laboratory services are very prominently subsidizing (or contributing) to the educational and research services provided by the GIA. In principle, that is perfectly all right – it is the GIA’s prerogative to over-price a service in order to subsidize other under-priced educational and other services. But then the President should not state that “we keep prices as low as possible for those we serve.”
We have put together the following GIA financial performance parameters:
These figures show that gross profits (and in the case of non-profit organizations gross equals net) which the GIA earns on its laboratory services is about 40%. [The 2001 year was a bad year in the entire diamond business. In that bad year the margin was about 35%.] Is that a reasonable profit margin? We’ll discuss that later. For now, we have two comments on that margin:
(1) In a way, we see the GIA as the dominant and single most important player in the diamond certification business. Almost as De Beers in the rough market, the GIA is clearly the price-setter in the diamond certification business. Though some labs produce certificates of lower perceived quality (in terms of the market’s appreciation, reputation and commercial value to the holder of the certificate) and, because of this, their ability to charge more than let’s say $25-$40 per certificate is limited, the quality labs are all able to price their certificates around the GIA figures – some are more expensive, others are slightly cheaper -- but the range is set by the GIA.
We clearly take issue with the GIA assertion that “we try to keep prices as low as possible,” because even if the certificates would be reduced to slightly more than half of the current prices, the GIA would still not be losing money. It would, however, not have sufficient funds for their other operations – and, I want to make that abundantly clear, we support the GIA’s policy to use the lab profits to finance other activities. I only would like it to be clearly stated loud and clear.
(2) The other commercial laboratories, which do not support education and research activities, are enjoying a free ride on the GIA. Economically we have a situation in which the non-profit organization sets the highest possible prices (which they need for other non-profit reasons), and this enables the commercial certificate suppliers to charge far more than they would charge if there would have been a truly competitive market. [Incidentally, this also applies to the HRD, which also applies profits to finance other worthwhile causes.]
Need to lower the price of certificates
The industry is confronted with ostensibly a most peculiar situation. When cutting the better quality goods (in Israel, South Africa, Belgium, etc.), the cutting cost may be in the range of $50 per carat. However, the certificate for the resulting stone is often double that price. With debates on labor costs waging in Southern African and other cutting centers, the focus should really be on how to reduce the costs of certificates.
Objectively speaking – and this has nothing to do with the GIA per se – the business of diamond laboratories is one of the most profitable enterprises in the diamond business and in business in general. Business plans show that one can establish a very well equipped gemological laboratory for less than $3 million [in rented premises]. Equipment is basically the only investment.
Such a lab can produce some 200,000 certificates per year. If these are sold for an average of $75 per certificate, the lab’s gross income would be $15 million. Main operating costs are salaries of graders, which are paid from current income. So the cash flow is positive. At a minimum margin of 40% the initial capital expenditure would be recovered in half a year. Of course, a new lab would need to build a client base, etc., and that may take some time. But the nature of the certification business is repeat business – clients come back, and back, and back.
The market considers the GIA lab as either the best, or the best among equals. Certainly, a GIA certificate generates a premium on the diamond – and that is the best evidence that the status of the GIA certificate does bring considerable added value to the holder of the grading report. In terms of overhead – salaries etc. – the GIA operation is certainly expensive. It is fair to assume that other labs – with maybe less sophisticated equipment or lower salary and other overhead costs – will easily achieve greater margins. Moreover, if the initial capital expenses are recovered within a year – and, at a maximum, two years, then every margin represents huge profits in terms of capital employed.
My point is simple: because of the GIA’s price levels, other labs may be making a higher profit than they would be making if the market was truly competitive. From this angle, I want to “dedicate” this article to the GIA Board of Governors, which will be meeting shortly for its yearly 3-day meeting in Carlsbad, California. The Board of Governors ought to weigh the best interest of the GIA with the best interest of the diamond community at large. The GIA’s certificate pricing policies is greatly helping not only itself, but also significantly increasing the profits of all the other commercial laboratories.
There may even be some legal implications here. The certification business is dominated by a handful of companies, in which the GIA probably is the largest player. [If, in 2002, the average cost per certificate was >$90, than in that year about 700,000 certificates must have been issued by the GIA alone.] For 2004, we estimate the number of GIA certificates to be between 700,000 and 800,000. If the GIA is clearly overpricing for the lab service to the unintended benefit of other commercial competing entities, the Board of Governors ought to take a broader view on its certificate pricing policies.
Maybe it is “pay-back time” and, as part of the GIA overhaul reorganization being contemplated, a significant reduction in certification costs ought to be contemplated. The industry would welcome having GIA certificates at cost – as that would be very much in accordance to the spirit of non-profit organizations and, indeed, consistent with the GIA’s own president's words. Whatever pricing policy is followed, we hope the GIA would become more transparent.
GIA Gem Laboratory Chief Executive Officer Thomas C. Yonelunas recently went on record that since 2001, "The total number of items processed by the laboratory has increased by more than 20% each year. In 2004 alone, the demand for all GIA Gem Laboratory diamond grading services increased by 22%. The number of reports generated annually is astounding, and we are constantly searching for ways to better serve our clients," Yonelunas noted recently. It is a pity he didn't specify how many certificates are issued. In 2005, we expect the turnover to exceed $125 million, for nearly a million certificates.
President Bill Boyajian stresses that donations are important, but they don’t represent more than 5% of total revenues. In the same sentence (read above) he mentions that these donations are important as they provide for scholarships for needy and worthy students. We tried to ascertain the total sums spent on scholarships. In 2002, for example, the League of Honor Dinner had gross revenues of $295,000 (of which some $200,000 was viewed as “donation”). In the same year, only some $38,000 was spent on scholarships and grants. In 2005, the GIA awarded scholarships valued at nearly $100,000 for the school year. The GIA's growing Endowment Fund has presently a balance of $58 million. The GIA proudly states that this money is invested and will never be spent. Scholarships will only come from interest earned. So the fund will be perpetual - forever.
As the “donor honor roll” shows that virtually all these donations come from lab clients – is it really necessary to use the lab to take, indirectly, even more from these very same people?
The purpose of this article is not to discuss the GIA’s finances, but to raise question marks about the pricing of the certificates – which is well above their actual cost. In a non-profit environment, the clients of the GIA might expect better. And it would be my guess that by lowering the price, we might see a downward adjustment of certification services throughout the industry. The GIA will be thanked for accomplishing this.
Have a nice weekend.