coffee

Unmined potential: how coffee could save the diamond industry

How coffee could save the diamond industry

As we stand today, diamond industry manufacturers – the global organisations that buy and polish rough diamonds – are more than $10 billion in debt, a figure that represents rather more than 60% of their annual sales.

Sadly, the pain felt by these organisations is far from isolated within the industry. At the May 2006 AGS (American Gem Society) Conclave in the US, many retailers privately admitted to chronic levels of overstocking, with up to three years' diamond supply on hand, albeit with much of it on 'sale or return' to the manufacturers. At De Beers' recent 'sight', the auction where the mining organisation sells diamonds to its preferred manufacturers, anticipated price rises were curbed and a proportion of stock returned unsold, despite previous commitments to buy. The arteries of the diamond industry are clearly clogged. But can a heart attack be avoided?

INDUSTRY DIAGNOSIS

Switching medical metaphors, this present pain is not just 'a touch of stress', but a chronic fatigue, reflecting a fundamental systemic weakness in the health of the industry. Research for my own PhD, based on applying consumer psychology to luxury marketing, portrays an industry incapable of innovating in ways that will actually appeal to the consumers of luxury.

Neither the emergence of new sources of supply, the growth in antimonopolistic pressure, nor De Beers' imaginative, 21st-century efforts to create marketing-based competition among its distribution channels have altered one fundamental fact: the diamond industry remains reliant upon a distribution 'push' approach to take its commodity to market.

In offering a product of zero intrinsic worth, but with an incredibly high perceived value, the industry has historically relied upon commoditisation, supply-chain control and emotionally-based demand manipulation to get as close to a vertically-integrated chain as possible. Its transition to a market-led approach is thus proving a painful one.

ENGAGING WITH MARKET FORCES

In the year 2000, threatened with a formal break-up of its business on the basis of an alleged monopoly, De Beers separated out, but did not legally split, its mining division (De Beers Consolidated Mines) and its marketing division (The Diamond Trading Company, commonly known as the DTC).

The DTC then created the 'Supplier of Choice' (SoC) programme, under which it would restrict direct sales to those organisations that met its stringent marketing criteria and committed to accept stock allocation, which could be varied at De Beers' discretion.

Would-be participants now effectively have to tender for the right to participate in the distribution scheme. If successful, they pay a substantial fee, based upon projected volume of sales, for the right to access stock. In return, they receive guaranteed stock of reliable quality at advantageous prices compared with those forced to buy in the 'aftermarket'.

The overarching marketing objective behind SoC was to increase aggregate demand and average margins, thereby closing the steadily growing price gap between diamonds and other luxury goods. This so-called 'luxury gap' has been climbing since the early 1980s, and accelerated from the early 1990s onwards as diamond prices fell behind GDP growth (See Figure 1).

The SoC initiative takes four approaches.

  • Efficient distribution – only working with manufacturers whose financial soundness and flexibility meet DTC criteria.
  • Effective branding – requiring manufacturers to institute branding strategies that would reach the end consumer and create brand-based competition in the marketplace.
  • Increased advertising – requiring manufacturers collectively to match De Beers own levels of spending, thereby effectively doubling global advertising spend behind diamonds as a jewellery ingredient.
  • Customer confidence – introducing a supply-chain self-certification standard (The Kimberley Process) to reassure consumers over the origins of diamond supply in the face of concerns over 'blood' or 'conflict' diamonds mined in areas or war and used to fund state repression or terrorist activity. This would be made visible through the laser-engraving of a symbol on Kimberley-compliant diamonds – the DTC 'forevermark®'.

REAL WORLD IMPACT

The DTC's strategies make sense. Under SoC, it intends to continue to use high-level advertising to protect the emotional integrity of the entire category. It will continue to reinforce the ethical integrity of its chain of custody and will also create and promote generic new diamond-wearing formats such as the three-stone 'trilogy' ring and the 'right-hand' ring.

However, in addition, it intends to catalyse brand-based competition within the diamond marketplace by creating a competitive intensity that should, on average, raise prices. From a producer's perspective, it's a smart approach.

The principal effect of this SoC investment has been to unleash a tidal wave of marketing activity. Literally hundreds of diamond brands have now flooded the market: brands based on innovations of cut (Prince-cut, Princess-cut, PrincessPlus-cut etc.), on fashion association (e.g. Vera Wang diamonds) and on colour (pinks, blues, yellows, browns, and so on).

Aside from creating new branded cuts and brands based on the reinterpretation of existing cuts (Hearts on Fire®, Hearts and Arrows, Love Diamond® etc.), manufacturers have also run promotions to promote particular categories of stock through retailers – including flawless diamonds, large diamonds and blue-white diamonds. Manufacturers have also tried 'specials' and 'collections', running limited editions based on bespoke quality criteria.

Finally, manufacturers have worked with their own retail channels to fund innovations of format – such as promoting ranges of day-wear jewellery – which make use of small diamond chips, or more natural ranges that can utilise off-colour diamonds.

However, all of the energy above has had no discernible impact on the luxury gap. In sales terms, between 2000 and 2004, global rough diamond sales fell from $5.6 billion to $5.4 billion. Although sales perked up in 2005 to $6.5 billion, underlying margins have barely moved. According to industry economic commentator, Chaim Even-Zohar, 'the consumer hasn't really paid more for a diamond than he paid a few years ago' (idexonline.com).

Despite around $200 million of annual marketing spend, directly matched by its manufacturers, the DTC has not been able to affect the real source of customer value – the customer experience. It is not to blame for this: the fact is that increasing the real intangible value of diamonds is simply not within its control. But it is within its influence.

DIAMONDS ARE NOT FOREVER

It is only fair to acknowledge up front that marketing of any sort is something of a cultural paradigmshift for the diamond industry.

Traditionally, value has been added incrementally through the production cycle, and reflected consistently in increased prices at each production stage. Diamond value-chain participants have relied upon rigid price control and longstanding personal relationships to set and secure their margins.

Aggressive competition, either through price or other forms of brand-based differentiation, has been minimal. Moving from a monolithic market to one that embraces hundreds of branded variations is a seismic change. Pain for the industry was thus inevitable.

However, acknowledging that there is a lack of marketing and sales skills within the industry is not a sufficient explanation for what is occurring, or rather, failing to occur. It is quite possible, and increasingly compelling, to argue that pushing an ingredient brand strategy out through manufacturers simply cannot work for De Beers. The industry is bursting for a fundamental rethink.

THE STARBUCKS MOMENT

At this point in the industry's evolution, there are, in fact, intriguing parallels with another more or less valueless commodity – coffee. A coffee-style paradigm shift is not only necessary, but inevitable, in the diamond industry. The critical coffee industry lesson for De Beers is that the industry value shift must come at the retail end of the equation, not from producers or the manufacturers.

Coffee offers some intriguing parallels. Although never subject to a monopoly at the production end, coffee was historically traded in broad and simplistic categories; beans were defined in the simple quality categories – either arabica or robusta. A healthy and liquid global market (including sophisticated futures and options markets) existed to smooth out inconsistencies in supply and demand, but this was largely detached from consumer pressure. Processing of the raw material occurred in very narrowly-defined ways (freeze-drying, grinding, or packaging as whole beans) and a very small group of manufacturers (principally Kraft and Nestlé) took these raw ingredients to market under barely half a dozen brand names, exerting what economists call monopsony buying power in the process.

Into this superficially cosy, but actually highly fractious, status quo came Starbucks – or at least the retail movement which it embodies. The ripples of this effect are still spreading around the world.

In marketing terms, among many other things, Starbucks realised that:

  • coffee is the not the product – the social encounters which surround it are the product
  • controlling the branded retail environment is at least as important as manipulating the ingredient itself
  • branding can differentiate the most humdrum commodities by the experience it creates around them
  • giving consumers choice in the way they augment the core ingredient enables a retailer to charge significant premiums for that ingredient
  • consumers can be educated to become connoisseurs, and connoisseurs will pay even more to exercise their expertise
  • the role of staff is critical to the product experience – simple friendliness, engagement and politeness goes a long way when the status quo is taciturn compliance
  • customers will wait an unheard of amount of time to engage in a fresh experience, and will actually value a component of self-service
  • if you can create an enjoyable experience, customers will seek out ways to replicate that experience at home.

ONE INNOVATION SPAWNS A NEW INDUSTRY

Starbucks's impact is not confined to its own customer base: its impact on the value-chain for the coffee industry has been equally profound.

Direct relationships now exist between the retailers and their individual producers, and these producers now have long-term security of distribution and can accurately plan their production.

Experience-based innovation has also enabled a complex portfolio of ingredient brands to compete on the basis of their supply-chain history, whether as fairly-traded, by country of origin, by environmental context (shade grown) or on the basis of a special mix. Catalysed by real insight and delivered within a meaningful, controlled environment, these brands now have real consumer salience.

Equally, coffee lifestyle peripherals have become ubiquitous in middle class homes in the form of take-to-work cups, grinders, home coffee machines and syrups.

Finally, and most gratifyingly for the rest of the value-chain, prices of the underlying commodity have risen, the impact of its cultivation on the environment have been reduced, and the communities farming it have witnessed improved social benefits.

Even based on this one parallel, the potential opportunities for the diamond industry are inspiring.

LESSONS FOR THE DIAMOND INDUSTRY

The Starbucks lesson is real and transferable. If the diamond industry is to extricate itself from its current crisis, innovation must come from those who are closest to the customer.

The coffee industry is merely a helpful precedent to show that a retail experience can indeed be created around a single ingredient. The key lesson is that the customer experience must emphasise the underlying emotional benefit of the commodity – the experience of luxury, not the features of the product.

If the industry embraced this reality, all the prior commoditisation – the infamous 4Cs (Cut, Clarity, Colour and Carat weight) – that seemed so critical as a trust-building mechanism in the face of pricing uncertainty could be swept away, as it is largely irrelevant to the customer. It is the reverse process that is now necessary – to decommoditise.

Potential retail innovators, developing a well-crafted customer experience could create superpowerfulglobal, franchisable brands around the world's most emotionally powerful ingredient.

Just like Starbucks, these retail brands could potentially transcend the limits of the category. The experience innovation opportunity need not even stop with diamonds; there is no reason, in principle, why a brand that starts out selling diamonds cannot end up also selling shoes, perfume or any other luxury experience.

WINNER AND LOSERS

Just as Starbucks did, I believe that encouraging value-innovators into the luxury experience marketplace can potentially spawn entirely new, diamond-dependent markets. At the same time, educating customers towards genuine diamond connoisseurship will increase the range of product permutations they seek out, creating further value opportunities for entrepreneurs and private capital investors.

A PRESCRIPTION FOR CHANGE

Reinventing the diamond industry by delivering new diamond experiences will depend upon several fundamental shifts in behaviour.

Enablers and Extractors

While SoC is already creating some attributes of a competitive marketplace, its execution and motivation perpetuates the industry logic of vertical integration. The historic ethos of market control, rather than market empowerment, thus remains intact.

Just as the oil industry now sees itself as a broad-based energy producer rather than solely as an oil extractor, so today's diamond-mining sector must come to see itself as a luxury enabler. Its role in the supply-chain is not to control distribution, nor even share its knowledge, but to grow its partners' capabilities so they can respond together to genuinely customer-focused innovation.

Providers and Producers

A natural consequence of the shift away from a 'mining' perspective is the realisation that diamond retail is not about packaging carbon crystals, but providing a service.

Service industries live not on their ability to sell a particular product, but on their ability to develop and nurture relationships. The existing retail value chain is not set up to deliver a valued service.

From the moment the 4Cs were introduced, the industry commoditised its product, thereby opening the luxury gap and consigning itself to a transactional marketing paradigm. The only way back demands a new, relationship marketing paradigm and a totally different sales approach. The consequence of the retail status quo is that most diamonds bought today are not actually suited to their wearers, and their purchase evokes minimal retailer loyalty.

Just as in the coffee example, retail-led innovation would inevitably spawn a plethora of new markets and genuinely valuable brands – everything from diamond-cleaning, storing and viewing products on the one hand to mine-of-origin-based diamond brands on the other.

Relationships and Revenues

At present, the entire industry is structured around a single lifetime transaction in which the real beneficiary is only partially involved – the purchase of an engagement ring.

As brilliant as it was to associate diamonds with engagement, this transaction-based approach is clearly running out of juice. The future of the industry depends upon retailers' ability to cultivate loyal relationships that drive repeat purchases. Diamonds will only close the luxury gap when they become the kernel of a luxury experience.

Most critically, embracing an experience ethos would move the industry beyond the gift-giving ghetto. If women (and men) actually started to buy diamonds for themselves, as they do with other luxury categories such as clothes, perfume, audio equipment and cars, the industry would be totally transformed. But kick-starting this transformation demands a totally different retail approach.

DE BEERS FOREVER?

My research indicates that the industry's future success does not depend upon encouraging more brands into the market, nor on increasing the weight of product advertising. These are necessary, of course, but not sufficient. Closing the luxury gap certainly does not depend upon better explaining a diamond's features. It depends, I believe, on catalysing a relationship marketing revolution, and investing in the tools, capabilities and networks to make it happen. The heart attack can be avoided. There is a better way.

This article featured in Market Leader, Summer 2006.

NOTES & EXHIBITS

FIGURE 1: THE INCREASE IN PRICE OF DIAMONDS COMPARED TO OTHER LUXURY GOODS


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