News from All Diamond
Excess fragmentation in the diamond market and lessons from other industries
The excess fragmentation we are facing in parts of the diamond sector must be addressed to allow the diamond industry as a whole to operate more effectively and to provide the new generations of professionals with more sustainable opportunities to flourish in our sector. We can draw lessons from more consolidated industries.
As it has been a slow week in the diamond market, I would like follow-up on my previous market update where I highlighted the issue of a fragmented midstream market, where 5,000 diamond companies compete over $7 billion added-value to the $15 billion annual rough production.
Recent months showed that when too many players fight over some profits, sustainable strategies can be difficult to develop. The midstream has been buying rough diamonds at the highest possible prices just to stay in the game or in the speculative hope for future upswings in the polished market, but as I mentioned in the past has often ended up selling the resulting polished diamonds at the lowest possible prices and in low volumes.
A fragmented midstream market is also less and less compatible with rising inventory costs, high financing costs and banks’ increasing scrutiny and request for players to professionalise. As ABN Amro’s head of Diamond and Jewelry client Erik Jens explains, banks are more critical with funding decisions and are looking for a greater level of security against their loans, driven in part by the quality of financials reported across the midstream.[1]
A similar challenge exists in the downstream market, where about 200,000 retail players compete over a ~ $75bn annual diamond retail market, or $375,000 on average per year.[2]
How can retailers, who play a key role in persuading consumers to buy diamonds, be convinced to make significant investments in marketing when revenues are spread over so many players?
Failure by retailers to stimulate consumer demand puts further pressure on the already squeezed mid-stream market, which are in turn turning to the rough producers.
But as I explained in my last update, major price reductions of rough diamond that are expected by some midstream players in order to alleviate them from pressures, is not a solution.
Rough Diamond
Passing the problem to the left or to the right of the pipeline is not a long-term solution.
It may be time instead to address the more structural issues, including what feels to be excess fragmentation in the diamond industry.
This issue is no doubt complex and sensitive, but equally, how much longer can we as an industry afford to overlook it?
Addressing excess fragmentation
Suggestions that an industry should be composed of fewer players is often met with scepticism, and rightly so when this implies too low competition. But this is not necessarily the case.
Indeed experience from other industries suggest that consolidation can offer significant benefits.
For example Goldman Sachs assessed consolidation across a variety of industries including US airlines, global beer, US container boards, hard disks drives and US wireless and concluded that when consolidation is sufficiently high, this resulted in out performance for the sector as a whole.[3]
What lessons can we draw from more consolidated industries in which fewer and stronger players operate?
The downstream market
Having fewer and stronger downstream players would allow each to share a larger parts of the profits and would thereby incentive them to make more substantial investments in marketing towards diamond consumers.
Investment in branding is particularly important considering the increased consumer preference towards branded jewelry. According to McKinsey & Co, the share of branded jewelry is expected to grow from 20% today to 30-40% by 2020. [4]
The beer industry
The beer industry consolidated significantly in the last 10 years. Goldman Sachs estimates that today’s top 5 companies represent more than 50% of the global market, in comparison to just over 30% in 2003.[5]
Bain & Co believes this has been to allow large companies to invest more substantially across large and frontier emerging markets.[6]
The wine industry
The wine market is highly fragmented in the Old World, but it is much more concentrated in the New World. The Economist estimates that in Australia, four companies have 80% share of the Australian market, in the United States the five biggest producers have 62% of the market and in Chile the top five have a 50% market share.
Whilst many are weary of the impact of big wine companies, The Economist argues that “The new-world companies may seem rather more prosaic than a Burgundian smallholder, but they are also more likely to be able to invest in technology and innovation. That allows them to produce a range of wine styles and ensure consistency.” [7]
Is the downstream diamond market heading towards the same direction?
McKinsey & Co anticipates the highly fragmented jewelry retail sector, where the ten biggest groups hold just over 10% of the global market today, to consolidate in a similar way as the apparel brands industry.[8] In the 1980s, national apparel brands were clear leaders in their markets. But today, many national brands have been outpaced by international brands such as Zara and H&M. [9]
De beers also believes that retailer consolidation could be a possible response to rising consumer expectations and the increased investment required to support them. One of their Insight Reports states that the new combined Signer-Zale entity (see below) could generate substantial annual savings, for example by rationalising stores, which in turn would allow investments towards consumers. [10]
If the downstream market were to consolidate, this would also help address other big questions facing the diamond industry, including that of lab-grown diamonds. As I wrote previously, natural and lab grown diamonds are two products that can co-exist side-by-side, with natural diamonds playing on the economics of rarity and on their ability to hold value over the long-term.
A stronger group of downstream players would help reinforce this message by always reminding buyers about what makes natural diamonds so special, thereby maintaining consumer confidence.
A stronger midstream market to which we now turn, can also support by ensuring robust distribution channels for natural diamonds, from rough to polished, which are distinct from those for lab-grown diamonds. This higher level of control, which is more easily achieved through fewer large players, is necessary in order to help ensure no leakages occur whereby lab grown diamonds can for example be mixed up with natural ones in parts of the pipeline. Wouldn't this be in large part the solution to the growing threat posed by undisclosed lab-grown diamonds?
The midstream market
Some of the benefits of having strong midstream diamond players are well recognized.
Greater financial health will help companies better absorb shocks and manage the increased costs discussed above. Stronger business plans and compliance with relevant standards will also enable them to get better lending conditions, Erik Jens of ABN Amro believes. [11]
Building scale will also allow companies to operate more cost-effectively and improve profits, as seen in other industries. According to Bain & Co, the search for reduced cost is a key driver for the approaching wave of consolidation among midstream players in the oil & gas industry for example. [12]
And importantly, consolidation will provide midstream players with the necessary strengths and bargaining power to develop stronger and more balanced relationships with both upstream rough sellers as well as downstream jewelry buyers.
A stronger midstream may at first not be welcome by the rest of the pipeline; for example some rough diamond dealers may find it easier to dictate their terms to a fragmented set of clients.
However focusing on the big picture, a strengthened midstream market will enable the industry as a whole to act more efficiently and prevent situations such as today where companies struggle to purchase additional rough diamonds.
Automotive services
As a result of consolidation in the wholesale automotive sector, the four largest purchasing alliances share over a third of the market according to the Boston Consulting Group. The management consultancy believes that a key benefits of these alliance is that it helps them function as umbrella companies which in turn provides them with leverage in regards to parts prices. [13]
It is relevant to note that this sector is composed of many independent players that haven’t all merged formally, but that sought to join forces to gain scale and achieve better prices.
Pharmaceuticals
The pharmaceutical sector has also seen consolidation and collaborations across the supply chain aimed at streamlining distribution of pharmaceuticals and drive efficiencies in the supply chain.
Forbes cites the example of Walgreen (the largest U.S. drugstore chain) completing in 2012 a significant investment in Alliance Boots (the largest European drug retailer). The magazine believes this allowed the combined group to jointly source generic drugs at better prices and generate logistical efficiencies. [14]
Prospects for the diamond industry
The examples above indicate there are many ways an industry can consolidate, including typical mergers and acquisitions but also more tailored solutions such as alliances between smaller independent companies. A strong industry can be composed of big as well as niche players that can both benefit, directly or indirectly, from investments made by the large few.
But we must all consider our role in this process and how we each can best adapt to continue adding value to our industry. It is also our duty to involve the new generation of professionals in this planning process in order to equip them to succeed in a more consolidated environment and to ensure they can grow in an industry with inspiring and sustainable prospects.
Many avenues are possible. For example, should some midstream companies join forces, formally or through partnerships, in order to form more robust groups that can have longer lasting values to the benefit of the younger members of our industry? Should some players who are able to, find ways to reach further downstream to sell their polished diamonds?
The trend towards consolidation in our industry seem to have started, pointing to some of the options available. This includes acquisitions in the downstream market, notably Bulgari by LVMH in 2011, Ultra Diamonds by Signet Jewelers in 2012 and Harry Winston by the Swatch Group in 2013.
It also includes players who have adapted their business model, for example through integration across the pipeline. In China for example, Chow Tai Fook and Chow Sang Sang have integrated cutting and polishing operations with manufacturing and retailing.
Despite these developments, progress towards consolidation in the diamond market remains slow overall.
Some trends could see this process speed up. Continued recovery in the US market and demand growth in the Far East could stimulate retailers to further consolidate, thereby making investments in branding worthwhile. Strong consumer demand for diamond will drive prices of rough diamonds upwards, which could increase financing costs of midstream players even further and in turn compel them to accelerate consolidation.
Can we afford to wait?
We must not forget that unlike cars and pharmaceuticals, diamonds are not a necessity.
Our industry therefore cannot expect consumers alone to drive this process. As I stressed above, continued investments are necessary to grow and sustain consumer demand for our industry’s beautiful product.
Whilst the price of polished and rough diamonds are ultimately determined by the end consumer, the diamond industry must show leadership to stimulate and sustain consumer demand.
This is particularly the case given that some trends such as the growth of lab grown diamonds, if not managed carefully, can affect consumer confidence vis-a-vis natural diamonds.
Such leadership existed in the past. Players who held a larger share of the rough pipeline in comparison to what they hold today, had a vested interest in growing the end market and so developed what many consider to be part of the most successful consumer marketing campaigns.
Less leadership today means we must wait and see how the dynamics of consolidation will play out - but can we afford to wait much longer?
In the meantime, the industry must respond to immediate challenges faced by the midstream with short-term measures, for example by trying to manage the supply of rough diamonds.
The views expressed here are solely those of the author in his private capacity. No one should act upon any opinion or information in this website without consulting a professional qualified adviser.
[1]http://insightreport.debeersgroup.com/cutting-polishing-and-manufacturing/midstream-challenges.html
[2]http://www.bain.com/publications/articles/global-diamond-report-2014.aspx
[3]Quoted in: http://www.valuewalk.com/2014/02/high-levels-of-consolidation-result-in-sector-outperformance/
[5]Quoted in: http://www.businessinsider.com/global-beer-industry-consolidation-2014-2#ixzz3XTwZwL00
[6]http://www.bain.com/Images/INDUSTRY_BRIEF_Ahead_of_curve_in_emerging_markets.pdf
[7]http://www.economist.com/node/268112
[11]http://insightreport.debeersgroup.com/cutting-polishing-and-manufacturing/midstream-challenges.html
[12]http://www.bain.com/Images/BAIN_BRIEF_Midstream_oil_and_gas.pdf
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