Date June 2018
Approximate net recovery on cost
- The De Beers Group is set to disrupt the market with its lab-grown diamond collection
- U.S. jewelry stores continue to generate positive sales trends
- Although jewelry store closures continued in 2017, the total number of store closures was down 36% from 2016, indicating a shift toward stability for brick and mortar retailers
Lab-grown diamond shakeup: The lab-grown diamond market is potentially in for an industry-changing shift. Lab-grown diamonds have been on the retail market for years, but the De Beers Group, which owns over 40 percent of the diamond market, has historically not been a producer. After years of downplaying lab-grown stones as less desirable (and less valuable) than natural stones, De Beers has recently announced that it will launch its own lab-grown program, Lightbox, in fall 2018. Per industry experts, recent growth of the lab-grown diamond market has become a growing threat to natural diamond dealers and polishers. Bonas & Company Diamond Brokers and Consultants estimated that global annual production has increased to 4.2 million carats in 2017 from only a few hundred thousand a few years ago. However, lab-grown production is still relatively small when compared to 126 million carats of natural diamonds produced in 2016.
De Beers joining the lab-grown market has multiple implications for the diamond industry. Some speculate that its entry into the lab-grown market signals that lab-grown stones may now be considered a legitimate alternative. De Beers’ marketing message for its lab-grown collection leads with the message that diamonds can now be considered as fun and affordable fashion accessories, or an alternative to traditional “formal” diamond jewelry. De Beers’ underlying strategy appears to be targeted at reaffirming the superiority natural diamonds. The company will continue to feature a traditional and innovative advertising campaign stressing the intrinsic value and unique, timeless beauty of natural diamonds. As has been the case with its fellow lab-grown stone producers, De Beers will target millennials for its lab-grown collection, highlighting it as a less expensive, cruelty-free, and more eco-friendly alternative to mined diamonds. At the same time, De Beers is raising its global annual natural diamond marketing budget from $140 million to $170 million to focus attention on its core business.
To emphasize that lab-grown gems are unlike natural stones, De Beers’ initial retail price will be just $800 per carat, compared to the current retail range of similar quality lab-grown stones at $3,000 – 8,000 per carat. As a result, the profit margins of competing lab-grown diamond producers are expected to fall significantly. Diamond analysts expect some existing companies to either merge or fail in the wake of this launch. This development is expected to play out in the industry over time, and the implications are as yet not fully known. Understanding the implications of changing values for owned lab-grown diamond inventory may require an updated appraisal or the implementation of a sell-down strategy to reduce risk for a potentially devaluing asset pool.
Jewelry sell-through assumptions impact gross recovery value: For liquidations in the jewelry sector, it is assumed that a percentage of the retail inventory would be sold through wholesale channels in a going-out-of-business event. For all jewelry appraisals, Gordon Brothers assumes a portion of the inventory would be sold to consumers via the retail stores with the balance sold through wholesale channels concurrent with the retail sale term. Separate gross recoveries and sell-through percentages are assigned to each category of inventory, with a blended recovery value, representing a consolidation of both the wholesale and retail portions, calculated on a departmental level. Typically, the portion assumed to be sold through wholesale channels would not exceed 5 percent of the total retail inventory; however, this percentage can be higher if sales capacity is constrained by high inventory levels (especially in non-peak periods) and/or if lowering recovering categories, including those assumed to be “melt” or “scrap,” comprise a larger portion of the total inventory.
For traditional jewelry retailers, lower demand categories that could be expected to sell through wholesale channels include semi-mounts, loose melee diamonds, loose colored stores, wedding bands, remounts, and watch straps and supplies.
Branding and its impact on value: Brand names like Tiffany & Co., Harry Winston, and Cartier are synonymous with luxury and quality and have achieved iconic status in the jewelry industry. For many consumers, a brand name defines the value of their jewelry as much as the precious materials used to make it. Branded items already account for 60 percent of sales in the watch market. While branded jewelry accounts for approximately 20 percent of the overall jewelry market today, its share has doubled since 2003 and is expected to continue to grow. Research conducted by Deloitte in 2017 noted that younger generations are particularly drawn to Swiss high-end watch brands. Millennials surveyed in China, Italy, the U.K., and U.S. would choose a luxury mechanical watch over the latest release of a smartwatch.
Brand names can have a substantial impact on the recovery values achieved in a liquidation event. Names like Rolex, Tag Heuer, Brietling, Patek Phillipe, David Yurman, Cartier, and others present the opportunity to achieve a high recovery on retail; in some cases, minimal discounting would be required to sell through this product. The caveat to clients lending on these exclusive assets is to ensure that all branded product would be available for sale in a liquidation and that significant branded product is not encumbered by additional liens or vendor sales restrictions that may kick in under a distressed asset sale or bankruptcy scenario. Timely appraisals that take into consideration the variability of the Net Orderly Liquidation Value with and without proprietary product can provide clarity to lenders with luxury jewelers, and brands, in their portfolios.
The impact of human rights and environmental protection on jewelry retailers: Globally, over 100 million carats of rough diamonds and 1,600 tons of gold are mined for jewelry every year, generating over $300 billion (U.S.) in revenue, based on reporting by the organization Human Rights Watch. Although the topics of responsible sourcing of diamonds and other precious stones, as well as concerns over the damage done to the earth and environment as a result of precious stone and metals mining have been part of the public discourse for years, there is a changing culture around how these practices are impacting retailers as a younger generation comes of age in the fine jewelry consumer market.
What can companies do to address this concern and educate their customers on their own responsible sourcing practices?
- Adopt and implement a robust supply chain policy based on International human rights and humanitarian law;
- Show chain of custody for gold and diamonds, including efforts to trace these minerals to their mines of origin by requiring full supply chain documentation from suppliers;
- Complete assessment of all human rights risks throughout the supply chain;
- Take concrete steps to mitigate identified human rights risks, including by severing contracts with non-compliant suppliers;
- Conduct third-party audits of companies and their suppliers;
- Provide annual public reporting on company human rights due diligence; and
- Publish the names of gold and diamond suppliers on an annual basis
As compliance with international standards for responsible sourcing and production of fine jewelry continues to gain momentum with consumers, it may become something that every jewelry manufacturer, wholesaler, and retailer must address in order to build and maintain customer loyalty.