The Diamond Selling System Is Broken. Can It Be Fixed?

Everyone agrees: The diamond market, and the way diamonds are sold, is a mess. The system has broken down. While producers continue to post strong profits, manufacturers’ margins have been whittled down to nothing, and the middle market’s woes have brought the industry to a crisis point.

On paper, the way miners sell rough has not changed for decades. Most producers still sell to a set list of clients, at a set number of sales, at prices that the producers determine. De Beers originated the “sight” system and most (but not all) of its competitors still follow its template. It is, in theory, a sensible model, offering consistent sales and supply to both producers and manufacturers.

What’s changed is pricing. In the cartel era, prices stayed mostly static, and De Beers announced increases every year or so. (Decreases were kept quieter.) But now rough pricing has become much more dynamic. In 2010, De Beers’ prices rose 27 percent. So far this year, it has said prices have dropped 7 percent, though the final tally will likely be far higher.

The price changes are seemingly driven by several factors, including the growing influence of tenders and increased pressure on miners from corporate parents and diamond-producing countries. Sometimes these factors converge. Botswana is now selling around 12 percent of its production through a new company, Okavango, via spot auctions and tenders. When those sales achieve high prices, how can De Beers explain to its longtime partner why its sight prices are lower?

On top of this, information now is more instantaneous, so producers have better and more accurate data about what’s happening with polished. So the question for miners becomes: What is an acceptable return for manufacturers?

For the last year, the producers’ answer has seemingly averaged in the single digits. That isn’t much, especially when you consider that manufacturers also incur costs, overhead, and interest on the financing required to pay upfront. While all cutters have different models, there is almost universal agreement that transforming diamonds is no longer profitable. And companies that don’t make money don’t stay in business. They also don’t receive bank financing. The current situation cannot continue.

If I had to sum up the industry consensus on how to escape the current mess, it is: First, demand needs to be increased, as that will boost polished prices. (Another, less long-term, way to firm up polished prices is by restricting supply or cutting production.) Second, miners must adopt a general policy of allowing manufacturers greater profits, which would possibly stabilize the market, grant cutters the ability to purchase during hard times, and win back the support of the banks.

Other ideas are more radical, involving fundamental changes to the current sales system. Here is a list of possible tweaks and alternate models, their pluses, minuses, and chance of adoption. It is by no means exhaustive, and I would be interested in comments.

– Cost plus

Often, when producers are criticized for their price increases, executives will note they face price pressures too—in particular, the escalating costs associated with deeper underground mining. So then why don’t diamond producers just base prices on their costs? The producers can pocket a set profit, and let the market find its own level.

Advantages: It’s easy and transparent. It doesn’t punish suppliers for developing new markets for certain items (another weakness of the current system). It allows producers stable, guaranteed profits.

Disadvantages: It could lead to a major change in diamond pricing, unsettling the market. It leaves money on the table, which would irk producers and corporate parents. As tenders will not go away, it could create two “tiers” of rough prices, causing some to incur big losses or bank big profits. Plus, how do you calculate the cost of each diamond? Most of the big sellers have multiple mines, which vary in profitability. It also discourages producers from implementing cost efficiencies and acting to boost demand.

Chance of being adopted: Zero.

– Producers extend credit to clients

Advantages: This helps manufacturers, who are currently being squeezed on one side by miners that require payment up front, and retailers that demand terms and credit. Freeing them from delivering cash up front could offer them breathing room to buy in difficult markets. It would also give producers another income stream (interest).

Disadvantages: It introduces a risk for producers. Mining isn’t cheap, and they want to recoup their investments as soon as possible.

Chance of being adopted: This summer, after De Beers’ head of commercial development Howard Davies extolled the financial strength of its customers to an audience of bankers, one asked, if your clients are so credit worthy, why doesn’t De Beers’ extend credit to them? “That’s a tantalizing prospect,” he responded. “But I see zero chance of that happening.”

Perhaps if financing to the industry remains constrained, the odds could improve to slightly better than zero. But clearly, for mining companies, a bird in the hand is better than chasing after diamantaires to whom you extended 90-day terms.

– All goods are tendered

Auctions have become a much more important part of the market. Alrosa and De Beers both sell part of their production via auction; now-departed miner BHP sold all its goods that way. Even though tenders still compose a minority of the industry’s overall sales, they play an outsized role in setting market prices.

Advantages: Tenders are transparent. They let the market set the prices, and let producers (usually) maximize value. They allow clients more selectivity in purchases, so they are not tied to allocation agreements forged in different circumstances. They also don’t force clients to pay prices that don’t work for them.

Disadvantages: Auctions can be volatile and exaggerate market swings, pushing the highs higher and the lows lower.  They don’t help manufacturer margins, since they push prices as high as they can go. Most importantly, they don’t let manufacturers plan ahead. (In recognition of this,  BHP developed a tender-sight hybrid.)  

Chance of being adopted: It’s a long shot. While we may see more goods being tendered, the major producers and manufacturers clearly prefer the sight system, even if one of its main selling points—stability—seems to have vanished.

– Let clients negotiate on prices

This has been proposed by Guy Harari, cofounder of BlueDax, an online rough brokerage: “The producers could say to clients: If you don’t want the item, tell me what price you are ready to pay.”

Advantages: It’s a hybrid between the tenders and sights. It guarantees clients a certain supply, but it doesn’t force them to buy at unprofitable prices.

Disadvantages: “How would a bank finance a sight?” asks veteran industry commentator Chaim Even-Zohar. “You don’t know if your client got it cheap or paid full price,” And Harari admits you would need some constraints, given how much diamond dealers like to negotiate. Otherwise, sights could take months.

Chance of being adopted: Another long shot, though it’s possible a variation of it might be happening now.

– Prices stay steady through a contract period

One of De Beers’ main innnovations in recent years has been the Intention to Offer system, which gives manufacturers a clear sense of what goods to expect. Could this happen with prices as well? This has a precedent with other commodities; it would be like buying a future contract for rough.

Advantages: Manufacturers and producers could better plan ahead. Cutters would have the possibility of greater profits (and losses too). Price changes would in theory be better considered, based on sustained movement in the market. It might even place more of a “floor” on prices during tough times.

Disadvantages: Unmooring rough prices from polished—even temporarily—risks some of the problems associated with “cost plus,” such as unhappy stakeholders.

Chance of being adopted: Probably small. However, it does seem producers must choose between two options: staying steady or instituting changes every month. Going the monthly route means the adjustments need to closely mirror the market, including declines (and factor in the aforementioned breathing room).

– More transparency

Given that all these alternatives are long shots, one clear way forward involves better communication from miners to the market about how they price their goods—including when prices go up, when they go down, the factors used to derive them, and their general relation to the price of polished.

Advantages: Let’s take a recent instance. The initial reports about De Beers’ August sight said prices declined about 9 to 10 percent. Afterward, many called that number high, as the price decreases often accompanied assortments with lower-quality goods. (De Beers denies this.) But those initial reports created an expectation in the market that rough prices had sunk across the board.

We live in an information age, and price chatter often ends up on websites (including this one) even before sales have ended. Given the information is getting out there anyway, why shouldn’t producers issue official, reliable data to guide the market (as well as banks and the financial sector)?

Disadvantages: It flies in the face of how the industry tends to act. But given how things are now, that might be a good thing.

Chance of being adopted: Not great. But you never know.

JCK News Director