Friday, December 20, 2019

The Future of Jewelry, Part 5: Man-Made Diamonds


Here is the list of issues we have been covering — we are up to number 5.
  1. The Gig Economy
  2. Millennials
  3. Climate Change
  4. Consolidation and/or Decline
  5. Natural Diamonds vs Lab-Grown
  6. Banking
  7. Image 
  8. Demographics
  9. Retail Evolution
  10. Industry Structure

Natural Diamonds vs Lab-Grown

Not a day passes where we don't read news about the steady expansion of the production, distribution, marketing and retailing of man-made diamonds (I have called them MMDs for years, even though the popular term these days is lab-grown, or LGDs).  The issue is topmost in the minds of anyone in the diamond business.

I have been cautioning diamond dealers about this disruptive technology for over twenty years.  (I have posted on this blog for years about the subject - see "The three tipping points of man-made diamonds"; and the post on De Beers announcing their jewelry venture using MMDs - Lightbox.)  Production of MMDs started with GE and Sumitomo some 70 years ago, but until relatively recently it was primarily for industrial uses.

Over the last 20 years, most people reacted negatively to my stating a conviction that MMDs will find a willing market.  De Beers had done a remarkable job of building the image of diamonds over a century, endowing diamonds with great value, and supporting that value by dominating the sourcing of diamonds and controlling its distribution.  People have seen how synthetics of all kinds - CZs, YAGs, Moissonite, emeralds, rubies, amethysts, etc, have all failed to have any significant impact on the sale of the genuine item.  That fact led people to believe that the same would be true for diamonds.  But some agreed early on that this time the effect may be different.

Rather than repeating the views I expressed in my posts from years ago, I will assume that everyone, by now, sees what is happening these days is very different, and grasps that this case is unlike anything we saw with the advent of simulants in the past.  Some quick points:
  • Just recently, Harrod's of London, announced they will be carrying a line using MMDs.  One can visit super high end Place Vendome in Paris and see a store carrying only jewelry using MMDs.
  • A while back, Rolls-Royce showed the dash of a car with the clock surrounded by MMDs.
  • Independent jewelers have led the way in adopting MMDs, with some reporting, with surprise, that as much as 75% of their engagement ring business is with MMDs.  I have long felt that independent jewelers will be the first adopters, as they can react quickly, and they do not possess the deep natural diamond inventories held by large chains.  But, over the last year or two, even the chains have jumped in. Recently, Signet announced that MMDs will be sold in all their stores.
  • Just as an example, I checked to see what the three retailers owned by Berkshire Hathaway, Borsheim's, Helzberg's and Ben Bridge were doing.  The first two have a ready selection of MMDs, and they are listed together with natural diamonds, if the choice made by a visitor is to see both types of diamonds.  No big deal is made to distinguish them.  MMDs are roughly 60% under the price of naturals (no perfect comparison was available).  Ben Bridge offers no MMDs, but does offer a choice of CZ centers in their process of creating a customized engagement ring.  I was able to assemble a solitaire with a platinum ring, a CZ center of about a 1.50 carat size, and a few small side diamonds, for $2,000.  Wow.  I never cease to be surprised by what companies will do to reach a needed price point.  Everybody, in their way, is fighting the battle.
  • I observed an informal survey of diamond dealers and manufacturers - midstream companies - that found about 70% of them are considering entering the MMD business at some level.  De Beers is not making any effort to deter the sightholders from entering the business (how could they when they are in that business themselves?), as long as they do not promote those lines as environmentally and socially preferable.  More about that later.
  • Even a casual search of web sites selling MMDs finds a large number.  Here is a good-looking one I stumbled over that does a straightforward job of selling engagement rings.  This site, like others, talks briefly about "sustainability."  But the big point is the pricing and the super basic selection of mountings. (full disclosure - I have no interest or involvement at all with this site.)
OK, we could go on and on about the explosion that is happening.  So what does it mean now, and what does it mean for the future?  Some comments:

Competition from MMDs has been building for years, but everyone ignored it because there were minimum productions; the technology was difficult and still in early development; and there was little, if any, marketing behind it.  But the disruption was evident for anyone who realistically assessed it.  I always felt that many consumers looking at cleaner, cheaper diamonds would have little problem opting for MMDs.  

The "Real is Rare" program being run by DPA (the association of De Beers and other mining companies created to promote diamonds) emphasizes the unique rarity and value of natural diamonds.  We know that rarity applies almost entirely to larger diamonds, say two carat and larger.  But 90% or more of all jewelry manufactured uses small stones.  People looking to sell their ordinary diamond jewelry find that those small diamonds have practically no value to speak of, certainly when one gets down to imperfect qualities that have been used so widely.  

Not only does the "rarity" pitch completely fail at such levels, but the advent of MMDs in small sizes, say under a third or half a carat, is slowly replacing low quality diamonds, and with each passing day that is happening faster and faster.  Imagine the impact on mines producing a high percentage of low quality stones.  The viability of such mines may fade well before the final extraction of their assets.  I have no way of knowing, but I would guess that this trend played a role in Rio Tinto's decision to close their huge Argyle mine in Australia next year.  

MMDs may be getting a boost in a way that may be hard to divert.  Some observers have been steadily looking to debase MMDs by proposing that over-expansion - so typical of an exploding consumer focused technology - will eventually make MMDs worthless.  That is possible, but unlikely.  But we have all seen the price of diamonds decline over the last couple of years.  Is it that MMDs are pulling down the price of naturals?  Doubtful, maybe excepting low quality smalls, where competitive price pressure has already been recognized.  We do know that decades of stunted wage growth has played a role.  We do know that Boomers were spenders and acquirers, but are now unloading personal jewelry as they plan retirement.  We do know that Millennials, and even Gen-Zers, prefer experiential activities rather than accumulating property.  We also think that miners see the coming tsunami of MMDs as a threat to natural diamond prices, and are pushing sightholders to buy.  Unfortunately, too many sightholders still suffer from FOMO - fear of missing out - and buy goods they don't imminently need.

But the problem runs much deeper.  The diamond business grew up with De Beers fully managing it with three important principals in mind.  First, dominate sourcing.  Secondly, prices have to be stable and supply balanced if prices are to slowly rise.  That leads to growing profits, especially for them.  Thirdly, sell to many sightholders, as this builds mid-level competition, which in turn shortens markups, which in turn gets diamonds to the consumer at a better price.  In effect, controlled release of diamonds into the world market raised prices, and generally allowed dealers and cutters to grow in size and worth, spite of the low margins.  That worked so long as diamonds were cut and passed downstream at a steady pace with each sight, ten times a year.  Simply put, five percent gross profit turned ten times a year yielded 50% ROI.

This process fell apart once the monopoly was gone, which started its slide over 20 years ago.  Prices now react to market conditions.  But the industry structure has remained, and many companies fought to maintain their businesses with lowering turnovers and shrinking margins.  The many companies that grew under De Beers market control are now out there fighting to survive.  This is leading to profound changes in the industry, and part of the answer for many is turning to MMDs, where margins are available now, even though that may not be the case in the future. 

The potential danger of ever-lower MMD prices, as production expands and exceeds demand, is real.  There are more and more companies getting into manufacturing both CVD and HPHT diamonds, and the momentum is only building.  I think the bottom will be reached in a couple of years, probably at a level where production costs approach market prices.  It will not be zero.

De Beers, in my opinion, made their jump for good reasons (see my post!) but it isn't for the stated reason - turning MMDs into disposable fashion, and selling finished jewelry at a cheap price. No, they must see that this may be the future of the diamond business, especially after mines continue to close.

The big marketing push that miners are making is that a) natural diamonds are real, b) only natural diamonds retain value, and c) the environmental impact is no worse, maybe better, that MMDs.  As I noted, does a .03 carat imperfect brown diamond have value?  No.  Is it rare?  Of course not.  Further, it is already common that jewelers are selling jewelry mounted with a mix of both naturals and MMDs.  I saw lines several years ago that were set with MMD centers and natural side stones. This will inevitable lead to jewelers and consumers equating the value of both.  As for environmental impact, an important consideration, MMDs have a chance to attain sustainability as the world switches away from fossil fuels, and as technology keeps improving the process.  Mining could make some advances, but not ultimately.

A personal view on naturals: De Beers has consistently promoted their value as being born in the depths of the earth billions of years ago.  Certainly true that naturals are old.  So is a lump of iron. But is this what people really think whenever they are asked about their diamond pieces?  Not ever in my experience.  They talk about the high felt at the moment when that piece was bought, given or received as a gift. They vividly recall where and when it happened, with whom and for what event.  People are excited about and love their jewelry.  But the age of a diamond fades when compared to those memorable personal moments we all have.

So, let's be real about MMDs.  where are we?
  • MMDs are, and will continue to be, very much part of the diamond business.  Period.
  • Every time an MMD is sold, it is a sale not made of natural diamonds.  This is definitely nibbling away at natural diamond sales.
  • The prophets of doom, saying that MMDs are worthless, just have no basis for saying that.  Are they dropping in price?  Yes, as would be expected with so many companies jumping into the business.  But they miss the point.  They are filling a real consumer need, and expanding the diamond business at. time when it is struggling to capture luxury dollars.  So a better approach would be to help the diamond business survive.  Bashing MMDs, which is a reality, only does harm without any benefit for anyone.
  • The time will come sooner than we think when most mines will be closed.  It would be wise to have a healthy business which will look primarily to two sources for diamonds - recycled diamonds, and MMDs.
  • It may be convenient to just consider the top of the market, where naturals will continue to sell in fabulous pieces of jewelry.  But the business as a whole needs broad distribution and acceptance.
Every week I hear from people who are trying to decide how to adapt to MMDs.  They never worried in the past about so-called competitors like CZs.  Now they wonder if the diamond world is entering a strange new paradigm.  It is.  


Hedda Schupak said...

Ben, I think you're spot on. As you know from the many discussions we've had, I think anything that gets consumers interested in fine jewelry is a good thing, especially as Boomers age out of the market and Millennials and Gen-Z are interested in other things. Gazing into my own crystal ball, I predict natural diamonds settling into the luxury end of the industry, and eventually the cheap lower end moving into MMDs. My gut reaction is that the tipping point for the shift will be when MMDs retail for about 70% off the price of comparable naturals. I don't think it's going to spell the end of the jewelry industry at all--if anything it could give it a boost, but to your point, it will be a paradigm shift. I look at it like this: a Kia and an Audi are both cars. Both have engines, brakes, steering wheels, and seats. Both will get you from point A to point B. The differences are in cost, performance, and how important it is to the driver to have a top-of-the-line Audi vs. a stripped-down Kia while they're getting from A to B. Ditto with diamonds.

Abe Sherman said...

"The prophets of doom, saying that MMDs are worthless, just have no basis for saying that. Are they dropping in price? Yes, as would be expected with so many companies jumping into the business. But they miss the point. They are filling a real consumer need, and expanding the diamond business at. time when it is struggling to capture luxury dollars."

Ben, I believe that current prices of LGD's, sold at a "discount" to natural diamonds is one of the things that is very wrong with the LGD model. Yes, as more machines come on line, supply will catch up to demand and then their prices will fall sharply. Not for any other reason than there will be competition for market share among the growers (owned by whom, exactly?) and the cost of production is FAR less than the cost of opening and operating a diamond mine. Because of relatively low manufacturing costs, especially as crystal sizes increase, their prices will continue to fall.

The Diamond Guy said...

The most interesting aspect of the current situation, natural vs. mm diamonds is the pricing and the value. The retailers that I have spoken with regarding the inquiries and the sales of same "in store" all have taken the approach that they will not take back the mmd's that they sell for a trade in or for an upgrade. Signet has an actual policy statement of such. So what is the value of the mmd, I believe nothing if that is what the retailers positions are. An interesting dilemma and enigma as we go forward into 2020.

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