Article | April 10, 2024

The Rise of Lab-Grown Diamonds: A Multifaceted Challenge for Jewelers

After decades of hype, lab-grown diamonds have taken hold in the jewelry market. Manufactured stones grew from just 11% of the diamond market in February 2020 to more than half, 53%, in February 2024, according to Tenoris data.[1]

The emergence of these manufactured stones is rearranging industry economics and presenting jewelry companies with major challenges. To position themselves for the new reality, jewelers can proactively reassess their strategies and structures from financing to marketing to compensation. The shift also has implications for lenders to the jewelry industry, demanding a close look at collateral and loan requirements.

HOW LAB-GROWN DIAMONDS GREW EXPONENTIALLY

The low cost of lab-grown diamonds is disrupting the traditional economics of the trade. A lab-grown diamond typically costs about one-quarter as much as a comparable natural stone. Consumers who previously considered diamonds out of reach can now afford them, while those who could buy natural diamonds can obtain stones of greater clarity, color and weight.

Younger consumers especially have embraced lab-grown diamonds. Some buyers even consider the stones’ synthetic origin a virtue because they associate mining with human rights abuses and environmental degradation.

The surge in competition from lab-grown diamonds, combined with slowing demand for luxury goods following the post-COVID-19 boom,[2] caused natural diamond prices to plummet. The price of a natural one-carat round diamond averaged $4,875 in April 2024, down 12.34% from a year ago.[3]

In 2023, the world’s largest suppliers of natural diamonds, De Beers and Alrosa PJSC, reduced supply to stabilize prices. The move may have slowed the slide but doesn’t appear to have stopped it. De Beers reportedly cut diamond prices in its first sale of 2024.[4]

Meanwhile, the diamond giant has been positioning itself for a future in which lab-grown gems play a more prominent role. De Beers first dipped its toes into the lab-grown space in 2018 with the launch of its Lightbox brand. The company has expanded the line in the years since testing lab-grown diamond engagement rings in 2023.

CHALLENGES TO VALUATIONS & REVENUES

The rise of lab-grown diamonds has profound implications for jewelry retailers’ revenues, earnings, financing and inventory management. Thriving in the current environment will require more than simply pivoting to embrace lab-grown stones.

Lab-grown diamonds’ low prices weigh on retailers’ revenues and that pressure on the top line can hurt profits. Lab-grown diamonds generate gross margins of 60% to 65%, higher than the 40% to 45% gross margins on naturals.[5] But because they sell for so much less, manufactured diamonds produce much lower earnings in dollar terms for each unit sold. In fact, jewelers need to sell more than four lab-grown diamonds to match the earnings generated by the sale of a single comparable natural diamond.

The new landscape also presents challenges to staffing models with sales commissions likely to be a particularly thorny area. Jewelry companies’ commission systems generally have been set up for a world in which high-priced natural stones make up the bulk of sales. As lower-priced lab-grown diamonds capture more of the market, the dollar value of a salesperson’s commissions is likely to fall. These dynamics could make it more difficult for jewelry retailers to attract and retain top salespeople with traditional compensation structures.

In addition, the falling price of natural diamonds deals a blow to retailers’ ability to secure financing and manage inventory. Jewelry inventory tends to move slowly, generally turning over 0.75 to 1.2 times per year.[6] As prices fall, retailers with a high exposure to natural diamonds are increasingly sitting on inventory that has dropped in value. To the extent retailers use their inventory as collateral for loans, this has implications on credit access. For lenders, drops in the value of collateral may increase the risk profile of outstanding loans and restrict their ability to extend future credit.

STRATEGIES FOR JEWELRY RETAILERS

While there’s no undoing the market shift that produced these challenges, jewelry retailers can explore several strategies to adapt to the new climate:

Reconsider commission structures. Jewelers can consider revamping their commission policies to better suit the higher margins and lower absolute profits of lab-grown diamonds by enhancing incentives to move higher-end items.

Renegotiate leases. Companies that rent their retail spaces can consider renegotiating their leases to lower operating expenses and protect their bottom lines. Landlords have a powerful interest in the continued success of their commercial tenants, especially now with the U.S. commercial real estate market flagging.[7] Professionals with expertise in lease renegotiation can help jewelry retailers secure more favorable terms that shore up their profitability.

Reappraise assets. With the market shifting quickly, diamond sellers need to understand the value of their assets. Armed with that information, retailers can make decisions that best support their long-term success, like potentially borrowing against or liquidating inventory to invest in new product categories consumers want.

IMPLICATIONS FOR LENDERS

Lenders to this market face a different set of concerns. Jewelers’ borrowing was low in 2021 and 2022 as the companies benefited from a late COVID-19-era swell in demand. With the rise of lab-grown diamonds and cooling demand for luxury goods, jewelry retailers may look to dip into credit to fund operations and investments. With demand for loans likely to rise and fundamentals under threat, lenders may need to have frank conversations with clients in the jewelry sector. These discussions may include establishing inventory valuation updates every six months or so, so lenders can understand their risks as prices of lab-grown and natural diamonds continue to fall.

The jewelry industry’s high sales seasonality, reliance on commodity pricing, and evolving production tactics, including techniques such as lab-grown stone cultivation, make it one of the most fascinating, complex and challenging areas in retail.

Gordon Brothers has an innate understanding of jewelry asset values. In fact, our firm began as a single jewelry store in 1903. This firsthand knowledge informs the solutions we provide to support our clients’ success in the face of change. Our seasoned team of retail professionals provides customized solutions that allow clients to focus on their core business while we focus on monetizing the value of their assets and protecting their brand.

To learn more, reach out to one of our experts or contact us.