Expert Q&A: What do changes in the lab-grown diamond market mean for your collateral?

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The jewelry sector is bracing for changes following De Beers' announcement that it is entering the lab-grown diamond market. Many lenders are assessing how this may affect their borrowers.  Our jewelry expert, Lenny Polivy, weighs in on leading questions for lenders to the jewelry sector. 

What are lab-grown diamonds?

In 1955 the General Electric Company first announced the method to grow diamonds using a high-heat and high-pressure process (HPHT), which mimics the natural way diamonds are created. Lab-grown diamonds have the exact composition as natural stones, but are sold at a discounted retail price due to the efficiency of lab-grown manufacturing.

What is changing in the lab-grown diamond market?

Lab-grown diamonds have found their way into retail jewelry stores over the past several years, and are being sold as an alternative to mined or natural diamonds. These stones are marketed to consumers as lab-grown with full disclosure, and offer an eco-friendly and conflict-free option for customers who may object to purchasing a natural stone sourced and brought to market via traditional channels. 

Lab-grown diamonds have been around for years and if they are identical to natural stones, why is this happening now?

Over time, advances in technology have allowed lab-grown stones to be more cost efficient to produce, which positions them to compete with natural stones in the marketplace. The major shift underway now is that market leader De Beers, which maintains over a 40% share of the diamond market and is known for its mined diamonds, is now launching its own lab-grown program called Lightbox. The company plans to price its product at significantly lower prices than its established competitors. The strategy De Beers has deployed has the potential to re-classify this product industrywide, putting it in competition with higher-end costume or fashion jewelry as opposed to fine diamond jewelry. De Beers is betting on the probability that natural diamonds will continue to hold their current financial and emotional value with consumers. The company also hopes that natural stones will increase in value due to a reduction in competition and confusion with lab-grown stones at the retail level. Nevertheless, the actual impact that De Beers’ entry into the lab-grown market will have on the market value or retail pricing of natural stones is still to be determined. 

What does this mean for on-hand lab-grown collateral?

Since De Beers has announced the significantly reduced pricing of its lab-grown offering, this will likely cause others in the lab-grown space to lower prices on commensurate quality product, or risk rendering their products over-priced and not salable. 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 to 8,000 per carat. As a result, the profit margins of competing lab-grown diamond producers are expected to fall significantly. Retailers with inventory on hand should consider a sales strategy to reduce their stock position until the dust settles on this market development. 

How quickly are values changing for this inventory?

The announced plan is for De Beers to begin launching lab-grown product in September 2018, which would make it available for the holiday season; however, it could also be an early announcement that may likely be delayed. The question of whether De Beers will move quickly or slowly is being hotly debated in the marketplace. Ultimately, when this product does hit retailers, values for on-hand product will likely be impacted. 

Should I reserve for this inventory now?

That is the million-dollar question, and there is no clear answer. While the sales of lab-grown diamonds continue even as this is unfolding, retailers and lenders must decide at what point they will continue to lend on this inventory. Alternatively, retailers may decide they do not want to replace stock for fear of it not having any value as consumer perceptions and pricing shift. 

Should I still consign this inventory?

If consignment is the option, yes, to avoid owning a potentially declining value stock item. 

What are the implications for borrowers’ customers who have just invested in lab-grown diamonds? Is their reputation at risk?

Retailers must weigh whether they want to expose their business and reputation to selling something that they have historically charged a premium for and may now have very little value. The customer may try to return the item or ask for compensation to offset a recent purchase if the price is dramatically reduced. This change is expected to play out over time. Retailers currently selling lab-grown stones may cite recent market changes while others who do not sell this product may use it to prove natural is rare and has intrinsic value over lab-grown. 

What can I do to mitigate my risk for borrowers with owned lab-grown diamond inventory?

Borrowers should strongly consider selling down inventory until a new low floor has been established, then decide if the product still has a place in their business model. Many may find the post-Lightbox lab-grown price point too low to maintain gross margin and remain competitive and push to sell natural diamonds that have a history of increasing in value over time. 

Change

Potential Impact

Lender Implications

Borrower Implications

De Beers announces entry into lab-grown market (May 2018)

Disruption of retail sales of lab-grown diamonds 

Timing of launch creates uncertainty in the interim market 

Identify a sell-down strategy for owned lab-grown inventory in anticipation of a decline in commodity pricing

De Beers announces retail pricing for lab-grown diamonds 

Current retailers for lab-grown diamonds will have to compete against De Beers’ pricing 

Lab grown inventory at current costing will be threatened by new lower cost inventory availability

Retail values for lab-grown stones drop

Gross margins on lab-grown stones drop

Expect issues around decrease in lab-grown pricing on retail and cost to impact consumer perception

Post-launch

New floor is established for lab-grown diamond pricing 

Consider reserving for or eliminating lab-grown inventory from collateral until market establishes direction of acceptability

Execute sell-down strategy on lab-grown inventory

Transition to consignment for lab-grown stones if maintaining product category