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By  , Thursday, September 14, 2006

GIA Symposium 2006 

'Tradition & Transition'

Maurice Tempelsman, chairman of Lazare Kaplan International, gave the following remarks at  Gemological Institute of America Symposium 2006:

"Thank you Helene Fortunoff for those kind words of introduction, and thank you Ralph Destino, Donna Baker and the GIA Board for the honor of being the closing keynote speaker at this pre-eminent gathering of jewelers, dealers and manufacturers from across the United States and indeed from across the globe, this gathering of the best and brightest within our industry.  

Today marks the third time that this privilege has been bestowed on me, I spoke at the International Gemological Symposium in 1991 that coincided with GIA’s 60th Anniversary, as well as the one in 1999 that also took place in this beautiful city of San Diego.  As then, I will come away from these proceedings with renewed confidence in our business; in the talent and vigour and integrity of those who make up our business, and will lead it into the future.

The theme of my remarks this evening is tradition and transition; and let me begin by paying tribute to one of the most memorable of those traditions, the historic and indispensable role played by GIA since 1931 in educating the public about our product, and building confidence in an industry that, more than any other I know, is dependent on such confidence.  It began with the pioneers, Richard Liddicoat, Robert Shipley, Robert Crowningshield and other farsighted visionaries who foresaw with clarity the importance of gemological education, product standards and business ethics.  Their prescience transformed the way we do business and, more importantly, laid the foundations for the way increasingly well informed consumers come to the marketplace

So, we have our traditions, honorable ones, these and many others beside.  Indeed, tradition befits a business, which, now more than ever, is based not only on the authenticity of its product, but on that product’s origins in the mists of geological history.  And yet from our own history as humans we know that there is no tradition that stands exempt from the laws of change and transition.  This too has venerable origins:  Let us recall the very first man and woman, just cast out from the joys of an immutable, prehistoric Eden, the man (as ever) fierce in his confusion and despairing;  and the woman turning to him and saying 'Adam, it looks as if we are in a time of transition.'  Or words to that effect.

So, we of this generation are not the first human beings to coin what seems the motto of our time, namely that the only constant in life is change.  But having said that, there is no doubt that the pace and frequency of today’s transitions are greater than once they were;  and bringing the matter closer to home, there is also no doubt that such transitions are relatively new and challenging for our particular industry.  For well on seven decades the diamond industry sat secure on the bedrock of measured supply.  For reasons that are well familiar to this audience, and that I thus need not dwell on, those days, and those old familiar foundations, are gone;  and they are gone forever.  The fundamentals of our industry are no longer driven by supply, but increasingly and inexorably by issues of ultimate consumer demand.  For all those who are stakeholders along the diamond pipeline, from producer nations and    mining companies upstream to manufacturers, distributors, retailers and their bankers downstream, there is no single fact, and no single transition, more important than this one.

The emblem of this transition is DeBeers’ supplier of choice or SOC.  I know it has become fashionable in some circles to caricaturize SOC as the underlying cause of most of the unsettledness and challenges now facing the diamond business, but that is one fashion I do not subscribe to.  There are other, more visible fashions I don’t subscribe to either, I still feel the need, for example, to address you in suit and tie, but that may  be a sign of age more than wisdom.  I give credit to DeBeers for having foreseen, and for having faced up to, the inevitability of this transition from an upstream center of gravity to one downstream, which rendered vulnerable if not obsolete one of the most successful business models of the 20th century.  We all know that it takes courage to reinvent one’s business model, and especially to do so proactively, before events impose their own form of restructuring.

In essence, SOC is a form of quasi-franchise.  The franchisor confers a degree of legal security and standing upon the franchisee as the distributor of its product, in this case rough diamonds.  The franchisor provides certain forms of support in addition to the product itself.  The franchisee, in turn, is expected to live up to standards that augment the value of the franchise as a whole;  to hold stock;  and to invest alongside the franchisor in stimulating consumer demand for that stock.  However novel this model may be for our industry, none of it is illogical, and none of it is in principle misconceived as a means of shaking up old complacencies, of squaring the industry up to the test of a demand-driven world.

But if, as I have suggested, the introduction of SOC took courage and foresight, it also benefited from that other business essential that we all know well though our egos may sometimes tempt us to downplay it, namely, good luck.  At the same time as DeBeers was bringing its new model to market, the world’s central bankers were pumping liquidity into the financial system, pushing down the cost of funds and effectively propping up prices for other assets.  This, too, had a clear logic to it;  and looking back to the dark events and mood of five years ago we can all be thankful to Alan Greenspan and others for having erred on the side of taking risk out of markets at a moment when global confidence, and the global economy, needed it.  Certainly, the tide of buoyant prices and easy credit in the diamond business helped smooth waters that might otherwise have been roiling from the subsurface shifts in the industry’s fundamentals.  Or, viewed less benignly, that rising tide concealed the new dangers and difficulties that would have to be addressed by all when, inevitably, the high waters of liquidity began receding.

I think we would all agree that the macroeconomic tide has now turned.  Differences of opinion, and of analysis, may lead us to disagree on how fast, and how far, it will run in the other direction.  Differences of sentiment, and of temperament, may lead us to disagree on how hard, or how gently, our industry will be set down.  These differences matter, they are, of course, what markets are made of, and as a relative optimist who believes that optimism is itself a vital prop for our industry, I hope that others will share my confidence.  But it would be irrationally exuberant, if you allow me to borrow this phrase from Alan Greenspan, to believe that discretionary consumer spending will be unaffected by higher interest rates and higher oil prices, or that credit lines will be unaffected by a higher perception of risk in financial markets. 

There is another sea change that deserves our attention.  No one in this audience needs any education in the Kimberley Process, or in the anti-money laundering and anti-terrorism financing measures introduced in this country and others in recent years.  What is less well-known is that a similar move toward greater transparency and oversight is underway in the diamond banking sector as well.  In short, under the rubric of Basel 2, banks are set to look beyond the old, familiar criteria of creditworthiness and commercial risk.  They will focus, much more than ever before, on the operational or systemic risks their clients’ activities may pose for them, put simply, they will want and need to know far more about how a client runs its own business:  not just the mechanics, but the extent to which the business is operated sustainably, transparently, ethically, and so on.

Make no mistake:  As the chairman of a publicly-listed company I see this trend toward greater outside scrutiny as not only inevitable in today’s world but also desirable.  It will, ultimately, strengthen the tradition of straight and honorable dealing that is fundamental to a business so heavily dependent on public and consumer sentiment.  But it will also prove challenging for many.  Not all companies are geared or set to thrive in the spotlight, much less under the microscope, which is inevitably what it becomes when challenges arise.  And even for those companies that are, there is of course a real financial cost that comes with establishing and maintaining the necessary systems to accommodate such scrutiny, again, the experience of being publicly listed is instructive.  These increased systemic costs, and the increased fickleness of bankers in extending, pricing, and supervising credit would be one thing in an industry healthily profitable and healthily geared.  They pose a much sterner test where, as in the case of the downstream diamond sector, profitability is already squeezed and debt is at record levels.

To summarize, then:  We have an industry undergoing a historic shift away from the governing fundamentals of over a half-century;  we have SOC, coinciding with a transfer of the inventory burden downstream and the assumption by downstream players of greater financial and other responsibilities; we are emerging from a period of extraordinarily benign economic and credit conditions which has held in check some of the latent pressures and contradictions flowing from the industry’s transition;  and despite these benign circumstances we have razor-thin downstream margins and record levels of downstream indebtedness, at a time when bankers are starting to take a harder look.

Does all this portend the worst?  Not in my view, though some correction does seem inevitable.  Does it signify the bankruptcy of SOC as an idea or in practice?  No again, though it does seem to me that SOC in its present form is a holding point rather than an end point, that SOC is part of a process, rather than a final destination.  Nor do I believe that that ultimate destination will come inevitably or automatically.

In short, ladies and gentlemen, I see the industry neither on an assured upward path nor on a steep slope to the abyss, but instead at a vital crossroads.  And I see three routes available to us at this crossroads.

The first route is to carry on our present course without alteration, trusting in fate, or habit, or rising markets to unwind some of the pent-up pressures that have grown in these years of transition and are now visible, particularly downstream.  There is a part of me that would like to believe in this route, and not merely because it is the path of least resistance.  The business cycle is not new, and riding out downswings is another venerable tradition in our industry.  Sometimes staying the course makes good sense, even when storm clouds loom ahead, both because we humans, especially those of us with an entrepreneurial bent, tend to be resilient;  and also because we  tend sometimes to overmagnify the severity of the storms we can see coming.  I am reminded of a quote from that greatest of American authors and wits, Mark Twain, who said toward the end of his days:  'I’m an old man who has known many troubles, most of which never happened.'

But regrettably, in this instance I must part company with Twain and instead heed the advice of another American whose wisdom I have come to value.  Former Treasury Secretary and Secretary of State George Shultz once observed that, 'if something is unsustainable, sooner or later it will grind to a halt.'  Well, at the end of the day I believe that our present industry course is just not sustainable.  Boiled down to basics, the reason it is not sustainable is that there is simply not enough margin capturable downstream to support the new investment that I agree must be made in this segment of the pipeline, investment in stimulating consumer demand, investment in technology and markets, and investment in the systems and practices to cater for greater transparency and outside scrutiny.  Nor is there enough margin to offset the structurally enhanced risk we face now that the old, traditional industry foundations of price stability underwritten by a single dominant player are no more.

So, if we do not self-correct, I very much fear that a correction will be imposed upon us.  And while many would survive such a correction, and some even profit greatly from it, the process would be messy, painful and unpredictable.  Nobody really knows what unintended consequences might flow were an industry cloaked in an image of solidity, exclusivity and timelessness, an industry uniquely dependent on discretionary consumer perceptions,  to be  marred by business failure on a large scale, by potentially reckless dealing on the part of those threatened with such failure, by dramatic price volatility, or by any number of other ills that can beset troubled markets.

The second course available to us stands at the other extreme, indeed, it would largely take for granted that old traditions, old ways, are irrevocably lost, and take for granted also that market volatility and, at the extreme, market chaos, are now our inevitable companions, and thus to be embraced rather than avoided.  This course would treat diamonds as a commodity like any other.  And, as in any commodity market, price would become the ultimate regulator.

At the risk of overdramatizing, this would be the course of revolution;  and it would come with all the unknowns that inevitably accompany the overturning of an established order.  One has to ask, again, whether revolution would work for an industry whose defining catchword has been forever, more specifically, whether price volatility is readily compatible with public perceptions of diamonds as an enduring store not just of values, but of value.  And the issues are not just ones of consumer perception.  Unlike every other commodity market I know of, the diamond industry has no existing or readily available tools for laying off the risk of price movements.  There are no financial hedging mechanisms.  Everyone in the pipeline, from producer to consumer to varying degrees, of course has a long position.  For those of us downstream, always being long was tolerable in times past, when there was an assurance of relative price stability.  It could still be tolerable today, were margins high enough to cover the added risk premium that flows from the removal of price stability.  But as I have already noted, there are no such healthy margins, nor any evident prospect of them.  So if the course of revolution, the course of commoditization of diamonds, is to be pursued, the development of workable hedging mechanisms would be essential.

Is this possible?  Leaving aside the bigger issue of whether price volatility is good for our product, could we devise a futures market for diamonds that would effectively tackle the problem of pricing risk for individual industry players, and provide a potentially valuable source of new liquidity for the diamond sector besides?  Here I will freely confess to being out of my depth when it comes to specifics.  But at least in theory it does not seem out of the question.  Producers have some capacity to standardize boxes, and already do so to an increasing extent.  They would probably also have to be the anchors of an assured physical delivery system, and at least at the outset effective underwriters of any futures market.  These are not minor matters.  As even the most ardent of revolutionaries in the broader world would admit, there comes a time when every revolution must deliver on the details, or itself face obsolescence.  And many a revolution has come unstuck on simpler details than these.

So revolution, like inaction, is possible, perhaps even plausible , but comes with its own significant challenges. Between these two ends of the spectrum, inaction on the one hand and revolution on the other, there lies in my view a third plausible course,  evolution.  And, as ever, evolution holds the greatest chance of marrying the two strands of tradition and transition on which I have based my speech, and on which I believe our industry’s future depends.

To consider this third course we must return to SOC, which is emblematic of where the industry now stands, and which I earlier described as a quasi-franchise.  Why did I append the qualifying word quasi?  Because SOC in its present form stops short of the fully-fledged franchise model we know from other business sectors, a model predicated on a much closer partnership, or symbiosis, between franchisor and franchisee.  Let us take, for the mere sake of familiarity, the example of a car dealership.  The dealer and the supplier enter into a long-term mutual commitment in which, among other things, the franchisor, the supplier, contractually binds itself to support the franchisee, the dealer, in tangible ways: by ensuring the dealer a sufficiently large and attractive geographical or product market for the dealer to operate in and penetrate;  by providing credit lines;   by co-sponsoring and co-financing advertising and promotions that give the dealer a specific competitive edge;  by adjusting prices downwards when necessary and upwards only when sustainable;  and by these means and others, providing the solid base that enables the franchisee, the dealer, to go out and risk substantial amounts of his or her own capital in building and mastering the market.  Looked at another way, the franchise itself creates a capital value on which the franchisee can depend.

Now in making this case I do not want to overstate it.  Of course cars are not diamonds;  nor does the upstream brand power in the automobile business correspond to the downstream brand emphasis of the jewellery sector;  nor would the mutual commitments of car dealers and suppliers be identical to those appropriate to our industry.  But the essential point remains:  A true franchise entails more security and support for those on the downstream end of the pipeline than is now provided under SOC or any other operative model in the diamond industry.  And without that, the ability downstream to carry inventory;  to invest in a defensible market niche;  to stimulate consumer demand through product differentiation and advertising or otherwise;  to develop or apply new technologies that not only improve business processes but lend sizzle to our underlying product;  even the ability to access financing on optimal terms, the ability to pursue all these vital goals will continue to be limited, and our business as a whole will be the worse for it.

Nor by suggesting a true franchise model as the viable third way forward for our industry do I want to focus attention exclusively on that point in the diamond pipeline where producers meet dealers and manufacturers.  That is, as you know, an important part of my company’s business;  but it is not the only one.  The essence of what I am calling a true franchise is stronger, more mutually supportive, backward and forward linkages between different players and points within the pipeline, and that essential element need not, in fact should not, be confined to any one segment of that pipeline.  Some players will seek to achieve this through so-called vertical integration within the bounds of a single company or group of affiliated companies.  But that is neither easy to achieve nor right for everyone.  Our industry will continue, and rightly so, to have a multiplicity of actors and specializations.  It is making them work more symbiotically that is the key.  And there, too, lies the key to building upon, rather than discarding, our rich heritage of tradition.

We are blessed to live in a time,  and at least most of us in this room are blessed to live in a place, where the opportunities for open dialogue, whether of the commercial or political kind, are more readily available than ever before.  I dare say this makes us more the masters of our own fate than any generation of citizens or businesspeople that has preceded us. It also makes distinguishing and choosing between incessant background chatter and words and ideas of true value more difficult, but that is something for another speech, at another moment.  In our extraordinarily globalized business, those who have a stake in the issues I have addressed run far beyond this gathering, and far beyond this country’s borders.  The major diamond-producing nations, from Botswana to Russia, can no more rely on a healthy, steady market for their goods than can the mining companies that operate in those nations, if the pipeline is clogged or dysfunctional at any given point.  Nor can the bankers who finance that pipeline be complacent about its vulnerabilities.  The stake of rough dealers and manufacturers, very arguably the pipeline’s weakest point at present, is self-evident.  And I would strongly suggest that no polished distributor or retailer can afford to ignore the health of their supply chain.  All five of these constituencies, producing nations, financiers, mining houses, their immediate customers for rough, and the ultimate customers for polished, are crucial;  and I would hope that at this crossroads where I believe we now stand, we can find and engage one another to define a common vision, and perhaps even a common way forward.

Ladies and gentlemen, distinguished guests:  That concludes my remarks on the main matter, which I was invited to address with you this afternoon.  But having just enjoined us all collectively to an open and honest dialogue for the sake of the industry, I feel I must in that spirit say a few more words on two topics that strike closer to home.

The first is the time of troubles, which has recently beset our good host, the GIA.  Every one of us knows that there is no institution, whether public or private, whether good or even great, that can deem itself forever immune from such troubles.  Human nature remains, and will ever remain, human nature, as will human frailty.  And we all know, too, that the best way to deal with these problems when they arise is as directly, as forcefully and, to the extent one is, like the GIA, a public institution, as openly as possible.  In this regard I think we can only applaud the leadership of GIA, starting with its Chairman Ralph Destino.

There is something else we know, too, and that is, when problems such as this arise, we must be alert to whether, below the visible surface of wrongful and remedial action, events are asking us some more fundamental question.  And while I would never presume to speak for a body such as the GIA, it seems to me that in this case the question is:  Who does the GIA exist to serve, the public, or the industry?  Like most such questions, this one grossly oversimplifies by implying that the public and the industry somehow sit at opposite poles, which clearly they do not.  And in the ordinary course the simple answer that the GIA could and should provide is both.

But, then again, there are times and circumstances outside the ordinary course;  times when tensions arise between otherwise compatible goals;  and I would go so far as to say that it is in such extraordinary times and circumstances that institutions truly define themselves.  I would also respectfully submit that in such instances, consistent with the best of its traditions and the ethos of its founders, the choice for the GIA is clear.  We dare not in this industry risk, much less forfeit, consumer confidence in the integrity of our product, or we will have no industry.  That was true back in Dick Liddicoat’s day, and it is even truer today, when substitutes for our product are so readily at hand.  We thus look to the GIA, as a leader of the industry and as a symbol of the industry’s implicit, enduring compact with the public,  to set a firm moral compass for the next 75 years of its existence and beyond;  and to this end we once again commend the steps taken so far by the GIA’s leadership.

Of course, it is also true that no institution, however firm its moral compass, and however venerable its tradition, no institution has a monopoly on the truth, which brings me to the second postscript to today’s speech.  The GIA has now hit 75, which by Chinese standards begins to qualify it for wisdom.  LKI is over 100, so I suppose we might just be considered even wiser.  We have collaborated over many decades on many projects together, which, at the risk of immodesty, I believe have served not only our respective interests but also the interests of the industry as a whole.  And now, what seems actuarially inevitable in America has come to pass, we elders are in litigation against one another, over the use of LKI’s patented laser-inscription technology.

It would be inappropriate, not to mention impolite, for me to try and press LKI’s case in this forum.  Indeed, it is measure of the respect in which I hold the GIA that I deem it necessary simply to say why we at LKI have felt sufficiently strongly about the matter to resort to the courts.  Put bluntly, intellectual property is a growing issue for our industry, as technology creates new opportunities as well as challenges.  Intellectual property is a growing issue for our country, as American prowess in an increasingly competitive and interdependent commercial world is ever more knowledge-based. At LKI, we have been fortunate to be leaders in several aspects of the diamond industry’s technological advance;  and we owe it to our shareholders, our employees, and our partners not merely to try and build on that tradition but also to protect by all means what we believe is rightfully and lawfully ours.  We regret that this has brought us to litigation with the GIA, among others, and we hope and trust that at the end of the day not only justice but also common sense will be served.

A moment ago I took a backhanded swipe at the American penchant for resolving differences in court.  I would not retract those sentiments;  but at the same time I know well enough to temper them with the recognition that America’s courts system, and the ability and willingness of Americans to resolve irreconcilable differences through that system, are a source of ultimate strength, not weakness.  The legal tradition and the commercial tradition in human history grew hand in hand.  We are the fortunate heirs of them both;  and we do them honor by recognizing the distinction between adversaries and enemies.  I would not have had the privilege of being here this afternoon were the GIA, or LKI, unable to make that distinction;  and so I close with a final tip of the hat to our hosts, and to you all.

 

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