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How Gatekeepers Can Turn Loss into Profit – Part 2

How Gatekeepers Can Turn Loss into Profit – Part 2

Two weeks ago, I showed the diamond manufacturing's economy of loss, defining the midstream as the diamond pipeline’s gatekeeper of rough diamond prices for the entire industry. The report centered on an analysis of diamond manufacturing costs and how they result in a loss, and presented an alternative approach that would result in profit. This week, I will conduct the same analysis, based on the latest prices and costs.

The analysis was straightforward: the cost of a specific and common rough diamond assortment plus the cost of manufacturing, while comparing the total cost to concurrently achievable polished wholesale prices.

A reality of loss vs. the prospect of profit - Updated

In October of this year, a major market supplier sold its contracted clients boxes of 2.5-4 carat fine goods for about $2,245 per carat. It cost approximately $146 per carat to manufacture the rough diamonds in this box. The cost of the rough and manufacturing increased the cost to $2,391 per carat. The yield of polishing these goods is 46%, bringing the total cost per carat to $5,198. This is the cost of the polished diamonds produced from this parcel of rough diamonds.

Sadly, with all their efficiency, know-how and hard work, the manufacturers sold the polished yields of rough diamonds for only $4,619 per carat, based on real price transactions as tracked by Mercury Diamonds™. They stand to lose an average of $579 per carat.

b2ap3_thumbnail_Anatomy-of-loss-Oct2015.png

The wholesale price of polished diamonds is fairly rigid from the perspective of a manufacturer. As previously stated, consumers pay what they feel is a fair price, or choose to buy something else if they perceive the price as being too high. The cost of manufacturing is relatively fixed as well; the costs of labor, energy, machinery, property taxes, etc. are all set by external forces that manufacturers are unable to influence – these inputs are already as lean and efficient as possible. 

This leaves manufacturers with just two courses of action – either to accept the rough at the cost it is offered or turn it down. If they turn it down, as we learned over the past few months, miners might reduce prices just as retailers and consumers refuse to pay for a product deemed to have a price that is too high.

Setting out to generate a profit, I’m suggesting an alternative course of action: start from the end and work your way back to the cost of rough. Start with the real wholesale price of polished. If you don’t have it, there are sources for it.

In our case, the wholesale price for polished is $4,619 per carat; that is our starting point. From that, we must subtract 15%, i.e. $693 per carat. This 15% includes the cost of manufacturing (in this case, $146 per carat) and profit margin. Taking into account the 46% yield, the resulting figure is $1,806. This should be the maximum sum the manufacturer agrees to pay per carat for this specific rough diamond parcel. 

b2ap3_thumbnail_Anatomy-of-profit-Oct2015_20151007-135426_1.png

This approach makes the difference between losing and making money. Now we are providing the polished diamonds at a cost that the consumers can afford, the retailers are willing to pay because they know they can sell this polished, the manufacturers yield a reasonable gross margin, and the miners can still make the goods available at this cost because they did so in the past! This creates a win-win situation for all.

This box generates some very nice goods, mainly VVS1-VS1 clarity in E-I color, averaging about 1 carat in size. An analysis of sales of this box from the beginning of the year shows that manufacturers might lose money throughout the year. 

According to my analysis, a manufacturer is likely to face losses from polishing and selling the resulting polished diamonds, even after recent price reductions, as I demonstrated in recent articles

It must be noted that the figures above are based on several assumptions: the assortments are not changed, that output changes very little and the cost of manufacturing is consistent. 

The Manufacturers’ Stand

Had manufacturers used the reverse engineering methodology specified above, they could have seen a gross margin after every allocation week this year, instead of the losses from which they might have suffered in reality. 

The above proves the importance of having a gatekeeper and that the diamond pipeline midstream must be this gatekeeper. The midstream is capable of transforming the whole diamond industry. 

It also emphasizes the importance of having a clear, well known and reputable source of real market transaction prices - not asking prices. The high asking price benchmarks do not reflect real trading, the final prices. The industry needs a better source of transaction information for another reason. The miners may be relying on the higher end of the benchmark prices, which may explain why they did not reduce prices this month. The benchmarks do not react to market conditions fast enough. If miners were to base their pricing on real transaction prices, they would price their goods much more profitably for all.

The real transaction prices are based on a wide sample of transaction data collected from the market. The prices relate to wholesale transactions, based on multiple sales in each color/clarity category while taking all possible comments and/or other irregularities into consideration. 

Below is a sample grid for real wholesale transaction prices for perfect (no comments or irregularities) round stones, 1.00-1.49 carat diamonds during the first week of October. All values are in hundreds of US dollars and per carat. They were compiled as part of my own ongoing market research.

b2ap3_thumbnail_analysis-of-real-transaction-prices-Round-1-1.49---Sept-2015_20151007-135518_1.png

The grid above does not include the full range of output goods from the Fine 2.5-4 ct box, only the 1.00-1.49 ct goods. The goods manufactured from this box also include smaller items such as 0.70 and 0.90 carat goods. This is why the values here are slightly different than the $4,619 mentioned in the calculation, which is an average of the box output.

There are a few other factors that we should take into account. In particular, there is a time delay between the purchase of the rough and the sale of the resulting polished. In the current market, this period is critical and increases manufacturer uncertainty. A low volume of polished purchases results in rising inventory levels and reduced polished prices, which is a further destabilizing factor.

The importance and necessity of the gatekeeper are no longer open to question. The current manner of pricing rough diamonds is out of touch with the product that it eventually yields. A change is needed now, and it includes having access to high quality data about real transaction prices. Hand in hand, the market should adopt a new mindset of taking charge of its destiny by determining the real-time maximum they can afford to pay for rough before losing profitability once again.

The views expressed here are solely those of the author in his private capacity. None of the information made available here shall constitute in any manner an offer or invitation or promotion to buy or to sell diamonds. No one should act upon any opinion or information in this website (including with respect to diamonds values) without consulting a professional qualified adviser.

 

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