LGD is not a Diamond Business

This article was first printed in the Lab Grown Diamond Times

A majority of the participants in the LGD area have their roots in the diamond business and consider lab-grown diamonds (LGD) to be an extension of their diamond business, albeit a much more profitable one.  Anyone who runs an LGD business on the same lines as a natural diamond business is setting themselves up for eventual failure.

LGDs are physically and chemically a diamond and a large part their pipeline seems similar. So it is very possible that some may come to believe that natural diamond business and the LGD businesses are similar and that the same factors which ensure success in one business would work in the other. 

For the jewelry manufacturing and retail segments, that statement is actually correct, and those segments would continue to be driven by the existing dynamics.  It is the mid-stream, and to a certain extent the upstream, where the natural and LGD businesses differ.  A large part of the new capacity coming up to manufacture LGD is actually being driven and funded by persons who were traditionally in the diamond midstream, who might be applying their successful practices in the natural business to the LGD business.  That could be problematic.

Dialing back

The aftermath of the Covid-19 crisis proved to be a boon for the entire gems and jewelry sector and specially for the diamond industry.  The LGD industry, which is still in its infancy, also got a huge boost as the US led the market recovery, driven by huge sums of money which were pumped into its economy in 2020 and 2021.  This take-off in demand spurred a rapid acceptance of LGDs among retailers, with more doors becoming available for the product.

Apart from the demand-side factors, LGD demand was also driven by the closure of the Argyle mine, which affected the availability of natural diamonds for the cheaper fashion jewelry. At the same time, jewellers found they could convert a good portion of bridal consumers to LGDs by selling them much larger stones for the same budget.  The buoyant natural diamond prices also provided some support for LGD prices, along with the stocking demand, as more retail stores started carrying LGD products.

2022 was expected to be tougher for the diamond industry, even before the Ukraine crisis, which added to the uncertainty for the diamond industry.  One can clearly see that on an absolute basis jewelry sales have been flat from July 2021, while year-on-year growth has been trending to zero, as was predicted.  The ripple effect will cascade through the through the entire natural diamond pipeline, and to a lesser extent, the LGD pipeline.

However, the sanctions by western nations against Alrosa directly affected nearly 28% of the total natural diamond supplies, opening up another opportunity for LGDs. This could be another spectacular year for the LGD industry.

A manufacturing business

Given the intertwined pipelines, it is easy to believe that natural and LGD are the same business.  Nothing could be farther from the truth, at least at the production and midstream level.  All said and done, LGD is a manufacturing business, while natural diamonds could be considered as a resource industry.

It is important to understand the differences between these two types of businesses.  They are all common sense, but could have serious implication on how the eventual LGD business will eventually work.  Excluding the technology related factors, the top three fundamental differences are as follows:

To stock or not to stock?

The diamond industry has been traditionally comfortable holding stock, though the period from 2012 to 2019 did dent its confidence in holding stock.  There have been multiple jokes in the industry on how holding stocks is not a good business practice, but at the back of the mind, most people still believe that the inventory will still have some reasonable value if held for a few years.  That is not true of the LGD industry, where prices keep dipping on a regular basis, as production and supply grows more than the current demand.

Supply will not drop when prices fall

As natural diamond prices drop, what you usually find is that some marginal mines will be put under care and maintenance and/or producers will process differing ores so as to reduce the total rough production and leave the rough in the ground.  For LGD that is not the case. 

The variable cost of production is probably about 30-50% of the total cost, which means that it will still be better for companies to run their factories, even if the price falls below sustainable levels. Hence, the price fluctuations at the wholesale level will be much more severe and volatile.

The pricing game

The LGD industry continues to use the natural price lists for pricing its stones.  While it may be a short-term strategy to maximize profits, the industry will eventually have to move to fixed pricelists.  Just as the eskimos have 47 words for "snow", the natural industry developed the grading mechanism and the pricing as the values involved were quite large.  This is not true for LGDs as pricing is not exponential in nature.  Having consistent pricelists and lesser quality parameters can significantly simplify the entire LGD pipeline.

If one considers the LGD business to be a manufacturing one, it is not difficult to imagine an LGD industry which will fewer quality parameters with lower pricing differential.  Producers will manufacture and polish diamonds based as per advance orders on a just-in-time basis and move totally away from the traditional stock and-sell-model.  This is probably a more realistic vision for the LGD business, and those who move there first will clearly have the advantage.

Pranay Narvekar, partner at Pharos Beam Consulting LLP, is a leading expert on many of the crucial strategic, financial and structural problems facing the diamond industry pipeline.  He has been among the initial supporters of the LGD industry.  He has over 20 years of consulting experience and has previously also worked with Rosy Blue. He can be reached at pranay@pharosbeam.com