1 DeBeers and the Diamond Market A few years ago, DeBeers, the world’s main supplier of diamonds, ran an ad urging men to buy their wives diamond jewelry. “She married you for richer, for poorer,” read the ad, “Let her know how it’s going.” Crass? Yes. Effective? No question. For generations diamonds have been a symbol of luxury, valued not only for their appearance but also for their rarity. But geologists will tell you that diamonds aren’t all that rare. In fact, according to the Dow Jones-Irwin Guide to Fine Gems and Jewelry, diamonds are “more common than any other gem-quality colored stone. They only seem rarer…” Why do diamonds seem rarer than other gems? Part of the answer is a brilliant marketing campaign. But mainly diamonds seem rare because DeBeers makes them rare: the company controls most of the world’s diamond mines and limits the quantity of diamonds supplied to the market. DeBeers is a monopolist, the sole (or almost sole) producer of a good. (Krugman and Wells, 2005, p. 333) How does DeBeers do it? Background The international diamond cartel, which presides over the production side of the industry, may be the most successful and longest lasting cartel in the world. The dominant company in the cartel, DeBeers, has been around since 1880 and has been controlled by a single South African family, the Oppenheimers, since 1925. In 2004, DeBeers Societe Anonyme (now privately held and managed by Jonathan Oppenheimer, great-grandson of the firm’s founder) sold $5.7 billion worth of rough diamonds – or 48 percent of the world’s total – and reported earnings for the year of $652 million. Eight countries – Botswana, Russia, Canada, South Africa, Angola, Democratic Republic of Congo, Namibia, and Australia – produce most of the world’s gem diamonds, and their producers sell the bulk of their rough diamonds to the Diamond Trading Company, a DeBeers- owned entity based in London. This conformity is the result of over a century of careful planning and negotiation, in which DeBeers has undertaken largely successful efforts to control the diamond trade and maximize its long-term prospects. (Spar, 2006, pp. 195-196) 2 The upshot is that DeBeers’ virtual monopoly of diamond production and distribution, along with a very effective advertising strategy, has kept the price of diamonds high and remarkably stable, generating substantial and stable monopoly profits. The stability of diamond prices can be contrasted with the prices of other commodities. Figure 1 below shows that, while the prices of copper, aluminum, gold, and even oil have fluctuated continuously since 1980, the price of diamonds has been steady, even rising slightly over the period. Figure 1 Commodity Prices, 1980-1998 (Diamonds, platinum, gold, copper, aluminum, oil) Index Diamonds 100 Gold Oil 80 98 The Evolution of a Cartel: Control Over Production and Distribution (Go to www.debeersgroup.com for more information about the company) In 1867, the accidental discovery of diamonds in South Africa launched the modern diamond industry. Within months of the first discovery, prospectors from around the world rushed to pan the waters of the Vaal River. However, the bulk of the diamonds lay in deep volcanic pipes, rather than in the bed of the river. This made extracting them difficult and expensive, forcing the miners to pool their resources and cooperate. First, they joined land claims. Then, as the mine shafts grew into large pits, they came together to erect pathways, pulley systems, and eventually massive platforms and communal hauling machinery. By the early 1870’s, the shafts had tapped into underground aquifers, causing flooding throughout and bringing work to a standstill. Some miners tried to clear the flooding with hand-held pumps, but to no avail. 3 In 1874, an Englishman named Cecil Rhodes arrived at Kimberley Mine and began renting a far more effective, steam-powered pump to the miners. He soon installed pumps at other mines in the area and shortly thereafter began purchasing claims in the mines themselves. In 1880, Rhodes formed the DeBeers Mining Company to administer his holdings; seven years later, DeBeers controlled all the claims in the area. Cecil Rhodes Deduces the “Market Realities.” As Rhodes acquired his mines, he began to grapple with what he realized was a distinctly two-headed problem of the diamond trade, one that would haunt the industry for decades to come. First, the sheer volume of diamonds flowing from the South African mines and streaming into Europe in unprecedented amounts threatened to destroy the very scarcity that had long defined the stones’ value. For centuries, diamonds had been exceedingly rare and valuable: a luxury item largely reserved for royalty. Now, a sudden increase in their production had brought the stones, quite literally, into the hands of the masses. But if diamonds became too prevalent, Rhodes realized, their association with romance and luxury would be tarnished, and people would not be willing to pay as much for them; that is, demand for them would fall. Second, since diamonds are both a natural product and a highly variable one, South Africa’s individual miners were unable to control their production: they mined the stones they found and tried to sell them all no matter what their quality. Consequently, the supply of diamonds would be highly variable resulting in unstable prices. Rhodes realized that he had to control both the demand and supply of diamonds and concluded that the only way to do this was to forge a unified, vertically-integrated organization to manage – down to the carat – the flow of diamonds from South Africa. Only cooperation, he reasoned, could keep supplies low and prices high. Managing Supply. In 1883, Rhodes signed a formal agreement with his buyers, the local South African diamond distributors, to form the Diamond Syndicate. Under its terms, the distributors would buy diamonds exclusively from Rhodes and sell them in mutually agreed-upon numbers, at agreed-upon prices. As a result of this “collusive” agreement, by 1890, Rhodes controlled all of South Africa’s major mines, along with the distribution channels for their output. These mechanisms remained in place until Rhodes’ death in 1902. Then, Ernest Oppenheimer, a German who had risen to prominence in South Africa’s diamond industry, began to worry that the buyers in the Diamond Syndicate were still too independent, potentially capable of challenging the producers by shifting either supply or price. As Oppenheimer advanced through the ranks of the diamond trade, he began to integrate the channels of production and distribution even more tightly. In 1925, Oppenheimer gained control of the Diamond Syndicate. In 1929, he also took control of DeBeers, thus achieving near total integration of South Africa’s diamond trade. Oppenheimer now presided over a system that brought diamonds from the dirt practically to the hands of brides-to-be. At the core of this system was DeBeers’ Central Selling Organisation (CSO), a London-based group that acted as the chief intermediary between the stones mined in any given year and the consumers who would eventually purchase or polish or wear them. Ten times a year, an elite group of dealers – handpicked by DeBeers – would gather at CSO headquarters. There, the handpicked dealers, or “sightholders,” would each be presented with an individual parcel of stones chosen by DeBeers. The sightholders were obliged either to 4 take the entire contents of their parcel or none at all. In this way, DeBeers was able to control not only the total amount of diamonds on the market and their price, but the quality as well. Sightholders were encouraged not to purchase diamonds from any sources outside the CSO, nor even to repurchase a used stone. (Spar, 2006, pp. 197-199). This process allowed DeBeers to amass a large stockpile of unsold diamonds that it could use to manipulate the market when conditions unexpectedly turned against it. This level of control was sufficient to sustain the cartel through Oppenheimer’s death in 1957. But in the 1950’s, South Africa’s vast stock of diamonds began to diminish. More worryingly, other countries – across Africa, in Australia and in the far north of the Soviet Union – were beginning to discover new deposits of diamonds. For these countries, diamonds were a great, glittering hope. For DeBeers, however, each new entrant raised the specter that had long haunted Rhodes and Oppenheimer: the threat of diamonds flooding into the market, destroying their hard-won “illusion of scarcity” and depressing prices. Whenever diamonds were discovered, therefore, DeBeers moved swiftly to bring the new producers into the fold. Operating without regard for political or economic tensions, DeBeers would sign long-term contracts with the diamond-producing countries, guaranteeing to purchase a fixed proportion of the country’s output at a fixed price. In return, with minor exceptions, the country would agree not to sell its stones outside the cartel. Clearly, any of those new producers could have entered the market on their own, wrecking DeBeers (and hurting South Africa) in the process. Yet most of them understood the basic logic of cooperation, the same logic that had struck Rhodes and still defined DeBeers: if diamond supply grew too rapidly or too high, the allure of diamonds would be shattered and prices would crash. In other words, if any country tried to destroy DeBeers by independently selling as many diamonds as it could, demand and prices might fall to such an extent that the diamond trade would no longer be profitable for anyone. Over the years, to be sure, defections occurred. In 1981, for example, President Mobutu Sese Seko of Zaire (now Congo) decided to stop selling his country’s industrial-grade diamonds to the syndicate. DeBeers responded by flooding the market with industrial-grade diamonds from its stockpile, bringing the price of Zairian diamonds down by 40 percent. By 1983, Zaire agreed to renegotiate its contract with DeBeers on far less favorable terms than before. (Spar, 2006, pp. 199-200) The Evolution of a Cartel: Managing Demand Meanwhile, DeBeers matched its supply-side strategies with attempts to manage demand. In 1948, the company debuted its famous slogan “A diamond is forever,” later hailed by Advertising Age as the slogan of the century. Implicit in the slogan were all the notions that the cartel held dear. It told diamond customers that their purchases were heirlooms, too valuable ever to be sold (which effectively killed the resale market). It reminded them that diamonds equaled love, something not to be measured in terms of price. And in the fine print and at the jewelers, DeBeers told its (mostly male) customers how to buy these talismans of love: several months’ salary was the recommended price, with attention duly paid to the cartel’s own criteria 5 of color, cut, clarity, and carat. Rarely has any business been more specific in telling its customers what to buy and how. (Spar, 2006, p. 200) DeBeers Adjusts to New Market Realities In the 1990’s, political and economic shifts ignited a new set of challenges for the diamond trade. By the time apartheid ended in South Africa, raw diamonds mined in South Africa constituted only about 14 percent of the world’s production, and DeBeers’ own production (including those from its holdings outside South Africa) was down to 45 percent of the world total. DeBeers began purchasing holdings and entering into agreements with producers all around the world, including some in Canada and Russia, to ensure that it would continue to be a major supplier of raw diamonds for years to come. However competitive pressures remained. In 2000, a diamond sightholder named Lev Leviev convinced the Angolan government of Jose Eduardo Dos Santos to terminate the county’s relationship with DeBeers and instead sell all of its rough production through Leviev’s newly established firm. After Leviev cornered the market on Angolan stones, his firm became the world’s second-largest producer of rough diamonds. Russian and Canadian producers were also exploring new marketing channels for their diamonds. Acknowledging that its grasp on production and marketing of raw diamonds was slipping, DeBeers decided to reduce its control of the marketing of diamonds in an effort to cuts costs. It transformed the CSO into the Diamond Trading Company and announced a new policy. The number of sightholders was slashed, and those that remained would no longer be expected to take whatever stones DeBeers deemed most appropriate. Instead, the buyers would now decide on their own how many and what type of diamonds they wanted to buy. After being limited in how many diamonds they could buy from DeBeers for years, the buyers could now request as many as they wanted and DeBeers would comply. This meant that DeBeers would sell diamonds out of its stockpile (estimated at $4 billion at the end of 1999). Thus, it could earn substantial revenues from these sales in the short-term and no longer would have to bear the costs of maintaining the stockpile and controlling the marketing of diamonds. In addition, for the first time in its history, it began to explore possible moves into the world of cut diamonds. Until this point, DeBeers’ only direct connection with the jewelry trade had been its famous “diamonds are forever” advertising campaign, an industry-wide appeal sponsored solely by DeBeers. In 1999, however, DeBeers advertisements began to tout a limited-edition “millennium” diamond that literally bore the DeBeers name: the stones were etched with microscopic versions of the company’s logo. (Go to www.debeers.com for current jewelry collections) Today, there are many new small firms trying to gain a piece of the diamond market. They send prospectors to troll through Africa and other places trying to uncover deposits of diamonds. Through mid-2007, however, they had made no major discoveries. Instead, demand for diamonds has continued to rise (partly because of growing incomes in China and India) and prices have continued upward (Barta, 2007). Nevertheless, if any major new sources of diamonds are found in the future, DeBeers could face even more competition, further eroding its control of the industry. 6 In an unlikely turn of events, the human rights movement became partners with DeBeers in helping it maintain a fair amount of control over the diamond market. In the late 1990’s, two previously obscure activist groups called Partnership Africa-Canada and Global Witness began to mount a campaign against diamonds being used to fund the activities of brutal warlords in Sierra Leone, Liberia, Congo, and elsewhere. To prevent the heinous acts fueled by the diamond trade, the activists argued, Western consumers and governments had to stop purchasing “blood” or “conflict” gems. Rather than protesting to the wrongdoers or to other governments, the activists began bringing corporations into the mix, lobbying them to take action and to take responsibility for ameliorating crimes that were not directly theirs. Eventually, the U.S. government, led by the departments of State and Treasury, signed on to the activists’ agenda and began exploring ways of restricting the diamond trade. These efforts culminated in the Kimberley Process, a vast international program launched in 2002 and supported by an array of strange bedfellows: producing countries, importing countries, nongovernmental organizations, the jewelry trade and the United Nations. The Kimberley Process is a complex certification system for all diamonds and a commitment by all participants to adhere to the rules embedded in this system. Every individual who handles a diamond – from miner to the jeweler – is responsible for maintaining an identity tag affixed to the stone at the time of extraction. If a tiny half-carat stone is found by an alluvial digger in Angola, for instance, it must be tagged as an Angolan stone by the broker who buys it from the digger; by the firm that cuts and polishes the stone; by the jeweler who sets it into a ring; and by the retailer. With such a system, theoretically at least, no warlord in Congo or Sierra Leone can slip diamonds into the pipeline. And no husband-to-be has to worry about purchasing tainted goods for his bride. What is extraordinary about the Kimberley Process is that DeBeers is a proponent of it. DeBeers executives campaign with Global Witness in support of the system; they sing its praises to analysts and reporters; and, through the Supplier of Choice program, they formally impose Kimberley’s provisions on all DeBeers sightholders. The source of such enthusiasm is not obvious. Why, after all, would the firm embrace a protester with a vision that was initially directed at smearing its own image? Why would it join forces with those that reviled its trade? Why would a company that prized secrecy welcome so many interlopers into its business? The answer, as it turns out, is that the Kimberley Process is exceedingly good for DeBeers. Recall that DeBeers has been devoted throughout its history to keeping excess supply off the market and preventing new suppliers from entering the business. This is precisely what the Kimberley Process accomplishes. Like the cartel itself, this new international system restricts supply and enhances the power of big, established players. It keeps the warlords and the small diggers and the shady traders out of the acceptable stream of commerce. It also imposes costs (for tagging, monitoring, and auditing) that make it even more difficult for new or smaller players to enter the global market. Analysts and diamond market participants believe that, despite its flaws, the Kimberley Process has in fact reduced the number of conflict diamonds on the market. (Barta, 2007). For DeBeers, then, the timing of Kimberley could not have been more propitious. Just as the company was facing a serious decline in its ability to control supply, and just as it was 7 launching an unprecedented move into the retail sector, the campaign against conflict diamonds helped to move the entire diamond market in DeBeers’ direction. As a result of the campaign and the Kimberley Process, new suppliers were crowded out of the market (as DeBeers would have desired) and consumer preferences were directed to those producers who (like DeBeers) could guarantee the integrity and “cleanliness” of their brand. There is no evidence to suggest that DeBeers instigated the campaign against conflict diamonds, or even that any of the major producers initially understood the opportunity provided by their attackers. There is also no reason to believe that DeBeers executives do not share the activists’ moral outrage or their determination to prevent thugs and criminals from funding their actions with diamonds. However, the fact remains that DeBeers and the diamond cartel have managed to turn a potential attack on their business into a substantial windfall. (Spar, 2006, pp. 202-206) Conclusion For more than a century, DeBeers has managed the diamond market by working with other producers and traders. While DeBeers does not control diamond production and trade today as completely as it did in the first half of the twentieth century, it is still by far the most influential player. The ironic proof of its success is the extent to which new entrants have mimicked its approach. Leviev, for example (see above), is challenging DeBeers but not departing from its approach. Indeed, DeBeers still has the ability to manipulate the diamond market. With the demand for diamonds falling during the world recession of 2008-09, DeBeers closed two of its African mines to reduce supply and keep prices up. (NBC News, 2009) Over the next decade, DeBeers and the diamond industry will face a new wave of challenges – from synthetic diamonds, for instance, from small-scale producers, and from a possible turn in consumer sentiment. Any one of these developments could potentially destroy the history of stable high prices in the diamond market. There is no reason to believe, based on its past, that DeBeers will not weather the storm and continue to exert its will on the industry. (Spar, 2006, pp. 206-207) Perhaps DeBeers should change its advertising slogan to “DeBeers is forever.” References Barta, Patrick. 2007. “The New Diamond Hunters.” The Wall Street Journal, May 12-13, pp. B1-B2. NBC News. 2009. “Diamonds No Longer a Girl’s Best Friend?” Sunday Night News, April 19. www.msnbc.msn.com Krugman, Paul and Robin Wells. 2005. Microeconomics. New York: Worth Publishers. Spar, Debora L. 2006. “Continuity and Change in the International Diamond Market.” Journal of Economic Perspectives. 20:3, pp. 195 – 208.