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A Warranty of Discontent

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The proposed Diamond Source Warranty Protocol is problematic and full of flaws, but not a surprising creation considering the discontent with KP. Edahn Golan looks at what it offers and its shortcomings are.

It was only a month ago that we warned that governments might set regulations restricting diamond imports and trade. The issue was driven by a sense of frustration that Kimberley Process (KP) reform was not advancing and, as a result, alternative solutions might be produced to bypass the impasse. This was one of the conclusions drawn from an interview with the KP Chair, Ambassador Gillian Milovanovic.

We suggested that if traders did not want government intervention, but feared it was on its way, they could block it by setting up their own regulations and paying the associated costs. Last Friday, Jewelers of America (JA), Diamond Manufacturers & Importers Association of America (DMIA), Jewelers Vigilance Committee (JVC) and others did just that.

When we published the column, it raised concerns in some quarters of the industry that government restrictions are pending. They were quickly reassured (not by me) that no government would act against a multi-billion dollar industry. Apparently, the leadership of the industry in the U.S. felt differently.

To this end, this group of American retail, jewelry and diamond organizations presented the Diamond Source Warranty Protocol.

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The proposed Protocol is a voluntary system. It suggests that diamond suppliers make a commitment to buyers, to not sell them goods sourced from “undesirable” countries, Zimbabwe, for example or certain entities – people or organizations – and the buyer’s discretion. The mechanics of the new Protocol is an audited inventory control program at the seller’s part of the distribution chain.

The suggested Protocol immediately raised an uproar, and led to intense discussions in Mumbai where manufacturers and traders had gathered for the World Diamond Congress. Chaim Even-Zohar called it a “nightmare.”

That strong reaction is understandable. First, no one wants added supervision, but exception was also taken with a clause giving buyers a three-year period to sue sellers for damages.

Another issue is that of segregating goods by region. A De Beers executive once said to me “No way!”, when asked if the company would track goods by country. De Beers takes great pride in the consistency of its Boxes, the result of mixing goods from all over the world and sorting them into cohesive and consistent allocations. In other words, sometimes mixing goods is beneficial, and desirable by the buyers

The proposed tracking does not have to be of all goods. For example, buyers may select to have the Warranty applied only to diamonds of a certain size. The terms would need to be worked out between buyer and seller. The loose format gives it flexibility, but it could also be detrimental. Will a seller need to track all goods to meet the whim of many buyers?

This brings up the issue of cost. KP has a cost, a result of the paperwork, customs, etc. and it’s built into the cost of rough. Adding a new inventory control mechanism to a manufacturer’s system could be an expensive irritation, especially as about half of the global production is smaller than 0.10 carats. Another 45 percent is goods up to 2 carats. This is rough, which means that the polished coming out of 95 percent of global production is small goods. Gem labs only certify a fraction of these goods, so most of the rest is traded in parcels, with no individual tracking of each and every stone. The cost of starting to track every diamond is essentially prohibitive.

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On top of this, the proposed inventory controls need to be audited annually. Many are already complaining about the high cost of RJC’s auditing. As a result, the majority of traders and manufacturers, most all of which are mid- to small-size, have not joined RJC and, given the choice, will most likely not subscribe to this Protocol.

It’s a Matter of Choice and Cost

Choice is the name of the game. Retailers and buyers can choose to join the Protocol. Sellers can choose to accept it or not. But buyers, who take the decision to ask this from a supplier, should be ready to pay for it.

A manufacturer with a 3-7 percent margin will immediately add the cost of inventory tracking and auditing to his overhead costs, and then pass it on to buyers. Will buyers, already complaining of eroding margins and shrinking market share, be willing to pay more? This is an important point, possibly the most important point that needs resolving.

“Only those retailers willing to pay the extra cost, if any, would undertake the Protocol process,” says Robert Headley, COO of JA. “As with all other aspects of their business relationships, the practical implementation of the Protocol would take place over time, and must work to the benefit of both parties in order to be successful.”

Another insider was cautious about the future of the proposed Protocol, saying this was a way to start the conversation. “It’s about maintaining the integrity in the diamond industry,” the person said, adding that consumers are not demanding this – yet.

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The threat, however, blows from up high. The U.S. State Department constantly waves Dodd-Frank in front of the industry’s eyes, as if warning of the Boogie Man that may arrive when we are suffering from a nightmarish sleep and kidnap the trade from our feeble hands. Let’s brush this aside, it is a bluff.

It seems that those who drafted this document made a tactical error. They did not consult with a wide enough range of international industry players, resulting in the hullabaloo that hit them at the WDC.

Headley says the Protocol is needed “Since KP is a very unwieldy group.” Reaching consensus is indeed tough in KP, but avoiding far-reaching discussions has its own price – resistance. The need to build a coalition is essential, and that is the political mistake made by the proposers. Fixing it now, from a defensive position, won’t be easy.

So here it is, a voluntary protocol that both sides need to accept. But who will approve the auditors, how will a standard inventory control system be formed, by whom and at what cost? The suggested system has many flaws and weaknesses, but it may respond to a need that many in the industry – removed from the retail experience – don’t see or understand. Are you in favor or against? Do you feel something is needed, but should be different? This, my friends, is the time to speak up.

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