HOW much turmoil can the diamond industry sustain without shattering? On July 13th in an Ohio court De Beers, the world's largest producer of rough stones, finally pleaded guilty to charges of price-fixing of industrial diamonds and agreed to pay a $10m fine, thereby ending a 60-year-long impasse. De Beers executives are at last free to visit and work directly in the largest diamond market, America.
A few days earlier, on July 9th, the first case of successful industry self-regulation against trade in so-called “conflict diamonds” took place when Congo-Brazzaville was punished for failing to prove the source of its diamond exports. And on June 28th Lev Leviev, an arch-rival of De Beers, opened Africa's biggest diamond-polishing factory in Namibia.
Behind all these events lies sweeping change in an industry that sells $60-billion-worth of jewellery alone each year. For generations it has been run by De Beers as a cartel. The South African firm dominated the digging and trading of diamonds for most of the 20th century. Yet the system for distributing stones established decades ago by De Beers is curious and anomalous—no other such market exists, nor would anything similar be tolerated in a serious industry.
De Beers runs most of the diamond mines in South Africa, Namibia and Botswana that long produced the bulk of world supply of the best gemstones. It brings all of its rough stones to a clearing house in London and sorts them into thousands of grades, judged by colour, size, shape and value. For decades, if anyone had rough diamonds to sell on the side, De Beers bought these too, adding them to the mix. A huge stockpile helped it to maintain high prices while it successfully peddled the myth that supply was scarce.
De Beers has no interest in polishing stones, only in selling the sorted rough diamonds to invited clients (known in the trade as "sightholders") at non-negotiable prices. Sales take place ten times a year. The favoured clients then cut and polish the stones before selling them to retailers.
With its near monopoly as a trader of rough stones, De Beers has been able to maintain and increase the prices of diamonds by regulating their supply. It has never done much to create jobs or generate skills (beyond standard mining employment) in diamond-producing countries, but it delivered big and stable revenues for their governments. Botswana, Namibia, Tanzania and South Africa are four of Africa's richest and most stable countries, in part because of De Beers.
One family got extremely rich too. The Oppenheimers created the “single-channel marketing” system of shovelling all available stones to the clearing house. They came to dominate De Beers after Ernest Oppenheimer took control of most of Namibia's diamond mines nearly a century ago. He formed a mining conglomerate called Anglo American, before grabbing the chairmanship of De Beers. The family is thought to be worth around $4.5 billion today; Nicky Oppenheimer, Ernest's grandson, is Africa's richest man. The family still owns a more than 40% direct stake in De Beers, and its members—Nicky Oppenheimer and his son, Jonathan—run the firm. It may own more De Beers shares held indirectly through Anglo American's 45% stake.
But this stable, established and monopolistic system is now falling apart. Three things have happened. First, other big miners got hold of their own supplies of diamonds, far away from southern Africa and from De Beers's control. In Canada, Australia and Russia rival mining firms have found huge deposits of lucrative stones: BHP Billiton, Rio Tinto and Alrosa have been chipping away at De Beers's dominance for two decades.
De Beers once controlled (though did not mine directly) some 80% of the world supply of rough stones. As recently as 1998 it accounted for nearly two-thirds of supply. Today production from its own mines gives it a mere 45% share. Only a contract to sell Russian stones lifts its overall market share to around 55%.
That is a painful shift, but De Beers is still the biggest diamond producer. And rival mining firms do share one big interest with it: high prices for the stones they dig from the ground. That is why, although it is under pressure, the central clearing system that sustains high prices could yet survive a bit longer. Rather than controlling a pure monopoly, De Beers might be able to run a quasi-cartel that stops the market from opening fully. De Beers says the price of rough stones is still rising; the price of polished stones has risen by 10% this year, according to polishedprices.com, an independent diamond website that tries to track such things.
Worth fighting for
The next challenge might be manageable too. De Beers's system is highly secretive. Nobody knows the ultimate source of particular diamonds it sells, as all are mixed together in London. But De Beers faced extraordinary public-relations pressure after it emerged that rebel armies in Africa were funding their wars by selling what became known as conflict diamonds.
Since 2000 almost 70 countries and all of the big industry players (under the threat of consumer boycotts and activist campaigns by, among others, a London-based group called Global Witness) have adopted standards designed to prove the origins of their diamonds. The so-called Kimberley Process is now in force: governments must issue certificates of origin for the stones they export, and the stones can then be tracked.
It was under this agreement that Congo-Brazzaville was punished last week by being expelled from the Process (the first country ever to be thus censured). As a result, legal trade in its diamonds should cease. It is a test case for the industry.
The introduction of the Process could have threatened De Beers, which wanted to maintain the right to buy diamonds anywhere it pleased and to keep its purchases secret. Eli Izhakoff of the World Diamond Council, an industry body based in New York, says the new rules mean “the industry is changing—it is nothing like it was four or five years ago.”
But although the regulations make it easier to track the flow of rough diamonds, they have not required De Beers to open all its books to public scrutiny. Most of those diamond-fuelled African wars are over. And the firm has a declining interest in buying up any rough stones that appear on the market. It knows that its ability to control world supplies is dwindling.
It is the third challenge that is much more troublesome. This is a threat to break up entirely the way De Beers organises the industry. It can best be summed up in two words: Lev Leviev.
Like the Oppenheimers, Mr Leviev has made himself very rich over the past three decades. An Israeli of Uzbek descent, he is reputedly worth around $2 billion. Though he has interests in transport and property, his real love is diamonds. His Lev Leviev Group is the world's largest cutter and polisher of them. He has mining interests too: his fleet of clanking mining ships began operating off Namibia's coast earlier this year, sucking up diamonds from the sea bed. He boasts it is the world's second-largest fleet; only De Beers has a bigger one.
And Mr Leviev recently moved into diamond retailing. He claims that he is the only tycoon with interests in every stage of production from “mine to mistress” (a canard in the industry holds that men buy more diamonds for their mistresses than for their wives). But his real power lies in the cutting and polishing businesses.
Mr Leviev says he is the only tycoon with interests in every stage of production from “mine to mistress”
He has factories in Armenia, Ukraine, India, Israel and elsewhere. These give him power to challenge De Beers's central clearing house and seek instead to channel stones directly, and at a lower price, to his own polishers. There is a more personal explanation too. Mr Leviev long worked as one of those De Beers sightholders, buying unseen parcels of stones at non-negotiable prices. Even as recently as last year he was among De Beers's clients in South Africa. Being forced to take or leave the stones granted by the diamond cartel infuriated him. He was eager to strike back.
His breakthrough came in Russia. Mr Leviev has cultivated close ties with Russian politicians, including Vladimir Putin long before he became president. Already well known as a cutter and polisher of diamonds in the 1980s, Mr Leviev was asked to help the Soviet state-owned diamond firm set up local factories 15 years ago.
He agreed and formed a joint-venture with the state firm, now called Alrosa. But he insisted that stones for the factories be supplied directly from Russian mines, rather than diverted through De Beers's central system. De Beers was furious at the loss of supply, but the factories got their local stones. When the factories were privatised, Mr Leviev somehow emerged as the exclusive owner.
What happened in Russia set a pattern for clashes elsewhere. Mr Leviev has found that governments welcome factories that create jobs and add value to the diamonds they export; it is a smart way to snipe at De Beers.
Can Lev levitate?
Angola was next. Angola's diamonds are among the world's best when measured by value per carat (see chart) and promise a lucrative return for anyone who can market them. De Beers has had a long interest there. Mr Leviev first invested $60m in the country in 1996, financing a mine at a time when civil war was raging. And just as he cultivated Russia's governing elite, he struck up warm relations in Angola.
It was a well-timed move. The Angolan government despised De Beers. In the days when its monopoly was secure, De Beers regularly bought up any supply of rough diamonds that appeared on the market. It was accused of helping, indirectly, to fund UNITA, the rebel army in Angola, which sold huge quantities of diamonds. In 2001 De Beers ended a spat with the government by quitting the country. By then Mr Leviev had already moved in, eager for another supply of good stones.
By the time the government won Angola's war in 2002, thereby getting control of all the country's diamond mines, the contracts it had struck with Mr Leviev (ie, those lost by De Beers) were worth $850m a year, a sum greater even than that lost by De Beers in Russia.
Mr Leviev has not had it all his own way. Last year Angola's government abruptly cancelled three-quarters of his deal. Some observers accused Mr Leviev of using underhand means (he is close to the daughter of José Eduardo dos Santos, Angola's president) to win them in the first place. Yet, however he did it, Mr Leviev showed in Angola that he could barge aside De Beers in a valuable area near its southern African heartland.
Mr Leviev has been inspired to take another swipe at his rival. On June 28th he took the arm of Sam Nujoma, Namibia's president, and guided him around a sparkling new diamond-polishing factory in Windhoek, Namibia's capital. “For years we have been told this could not be done,” commented various Namibian politicians.
Now Mr Leviev, saviour-like, strode around his factory, showing off row upon row of workers, who wore uniform green overalls and fiddled with chrome machines and modern flat-screen computers. Mr Leviev boasts that, with its capacity for 550 workers, the factory is Africa's biggest.
Jonathan Oppenheimer, affable heir to the Oppenheimer dynasty, says he does not understand what Mr Leviev is up to in Namibia: “And when we don't understand, we worry.” He is right to be concerned. Mr Leviev's obvious next step in Namibia is to challenge De Beers directly. De Beers's mines are run in a joint venture with the government called Namdeb. A 1999 mining law lets the government force any miner to supply stones locally. If Mr Leviev demands it, the government could tell De Beers to provide stones directly to Mr Leviev's new factory, a repeat of the Russian blow.
More important, if Namibia is able to establish a viable cutting and polishing industry using its own stones, then why not every other diamond-producing country too? That would seriously threaten De Beers. Mr Nujoma all but dared his neighbours to follow suit. “To our brothers and sisters of neighbouring states, Angola, Botswana, South Africa, I hope this gives you inspiration to try to imitate what we have here,” he said at the factory opening.
Mr Leviev is building another factory in Luanda, Angola, partly hoping to curry favour with the government. More important, he is offering to build a factory in Botswana, the jewel in the crown of De Beers's empire. De Beers has close ties with the Botswana government: they share a joint venture, Debswana, that exclusively mines the country's diamonds; Botswana gets a huge share of its foreign currency and a large part of its national income from diamond revenues. It is a similar arrangement to that in Namibia.
In an interview in Windhoek last month, Mr Leviev said he had offered Botswana's government a factory to employ “tens of thousands” of people, a scale vastly larger than in Namibia. A senior civil servant from Botswana toured the Windhoek factory with Mr Leviev. As Mr Oppenheimer concedes, this is a delicate time for Mr Leviev to be courting in southern Africa. De Beers is still renegotiating the terms of an 18-year lease on the Jwaneng mine, in southern Botswana, which is due to expire at the end of this month. The mine is thought to be worth $1.3 billion a year, producing stones of a quality that would have Mr Leviev salivating.
More broadly, De Beers must renegotiate the terms of all its marketing operations in Botswana and in Namibia every five years. These talks are also due. While no-one expects Mr Leviev to break up De Beers's relationships in these countries—Mr Oppenheimer is confident that the government will not do anything to risk its big revenues—his appearance on the scene puts pressure on De Beers.
The obvious step for De Beers now would be to take on Mr Leviev at his own game. In Botswana and Namibia there have been a few diamond-polishing factories backed by De Beers. But De Beers does not want to be involved in that stage of diamond production.
It is first a miner and only belatedly a retailer of diamonds. But it is blocked from the production steps in between as long as it remains the major supplier of stones to the whole industry, says Mr Oppenheimer. Buyers of its stones would suspect De Beers of holding back the best diamonds for its own manufacture and would revolt.
Nor does Mr Oppenheimer think a polishing industry is viable in many diamond-producing countries, whatever Mr Leviev says. In Namibia just a few hundred people work as polishers and cutters. There are few skilled workers, the scale of production is small and wage costs are roughly ten times that of India, which dominates the world market and where 900,000 people work as basic polishers.
Nor are small countries, such as Namibia, likely to develop the top-level skills needed for the very highest-quality stones. Those skills are concentrated in a few cities, such as Antwerp, Tel Aviv and New York. Within southern Africa, only South Africa has a long-established cutting and polishing industry, to which De Beers supplies some good-quality stones (“specials” in the language of the trade). But Mr Leviev probably does not care. A few factories may be uneconomic, but if they allow him to get hold of direct supplies of diamonds, then so be it.
A polished act
Mr Oppenheimer is worried that a more fragmented industry will not just damage De Beers, but that the whole industry might collapse. Consumers believe diamonds are valuable largely because of decades of clever marketing by De Beers and its clients. De Beers itself spent $180m on advertising last year, its clients a further $270m. That sort of spending could not be co-ordinated and sustained, he suggests, if the industry were to fragment.
That is a risk; but there are opportunities for De Beers too. As it has lost market share, the old goliath has become nimbler. No longer focusing exclusively on defending a cartel, De Beers is freer to make decisions according to commercial interest. For instance, it now buys fewer stones at uneconomic prices; profits matter more than market share. A trimmer De Beers, with a pared down list of clients, might even be able to make bigger profits than the old giant. Last year it produced healthy profits of $676m on sales of $5.5 billion.
But its decision to settle American antitrust charges laid against it in 1994 points to how much it is feeling the pressure. De Beers executives should now be free to travel to America to conduct business without fear of arrest. That should make it easier to promote De Beers LV, a hitherto disappointing partnership with the luxury-goods firm LVMH to market De Beers-branded diamonds.
That venture may prove essential for De Beers's long-term health, as more producers bet on getting a presence in profitable diamond retailing. Already rivals are moving: Canada's Ekati mine markets its stones directly to consumers; Mr Leviev's firm struck a deal in May with Bulgari, an Italian jewellery maker, to market Leviev-branded stones. De Beers's days of market dominance are clearly drawing to a close. But consumers should not get too excited just yet. Whether a duopoly or oligopoly emerges, diamond prices are not going to plummet. Mr Leviev will be among those putting a stop to that.
This article appeared in the Special report section of the print edition
Few names are more famous or notorious in the diamond business than De Beers. Few companies in any industry have cornered the global market in their space than De Beers.
Their reputation for bullying and unethical business practices is well documented. Partnering with brutal regimes to supply their diamonds was common place for De Beers. As market pressures have finally caught up, De Beers has had to face a number of obstacles to maintain their large share of the diamond market.
Progress has been made in parity and in providing the diamond buyer with an extensive education in the production practices of diamonds. It is satisfying to many to see De Beer’s face strong competition and have to overcome market pressures to their standard operating practices.
External environmental analysis
P—political factors that can influence the decisions and behavior of the firm. De Beers faced a number of global political factors over the decades as they sought to retain their market share. They controlled a monopoly on diamonds for decades. They would use punitive measures against other countries who stood in their way. After Zaire decided to stop selling its industrial grade diamonds to the De Beers syndicate in 1981, De Beers flooded the market bringing down the price of the Zairian diamonds by 40%. The supply of diamonds was influenced by political factors. For many years, DeBeers was prohibited from conducting business in the USA due to violating the Sherman Antitrust Act. Seven countries—Angola, Australia, Botswana, Canada, the Democratic Republic of the Congo, Russia, and South Africa—represented 88% of the value of diamond production and 96% of global production volume. India dominated the $19 billion processing industry of diamonds. Government conflicts and restrictions played an active part. In 1999, Namibia sought to win control of the processing industry by inserting a new law permitting the government to force miners to sell a percentage of their diamonds to local polishers instead of sending them to India. Israel opened their first cutting and polishing factory in 2004. Governments played an active role in influencing the decisions and behavior of De Beers. Focused on protecting De Beers, South Africa passed the Diamond Amendment Act in 2005 establishing duties on diamond producers who exported rough diamonds out of the country. The goal was to prevent exporting diamonds to India for polishing. When the Soviet system collapsed, there was turmoil in the diamond industry as contracts which De Beers had with countries who now no longer existed. Russian diamonds were then traded extensively on the black market and not through De Beers. The United States penalized De Beers for having a monopoly on the diamond market.
E—the economic factors in the external environment. One of the largest factors upon the natural diamond industry was the invention and development of synthetic diamonds. Synthetic diamonds created in a lab were chemically identical to naturally mined diamonds. The synthetic diamonds were dramatically lower in price than the natural diamonds which De Beers specialized in selling. A one-carat natural pink diamond could sell for upwards of $100,000 while an identical synthetic diamond would retail for around $4,000. Synthetic diamonds were growing rapidly and cutting into the natural diamond markets. Nearly $50 million synthetic diamonds were sold each year with expected growth of upward to 45% by 2015 and $2 billion in sales. Synthetic diamonds have now expanded into industrial uses and growing at a rate of 10% to 15% per year (90% were of industrial diamonds were synthetic diamonds). An excellent market developed for synthetic diamonds in a number of critical areas: semiconductor industry; the thermal conductivity; next generation optics; and digital data storage.
S—sociocultural factors capture a society’s cultures, norms, and values. The phrase “blood diamonds” played a key role in the public relations nightmare for the image of diamond producers. “Blood Diamonds” was a phase developed from rebel forces overthrowing the government of Angola, the world’s third largest producer of rough diamonds. The rebels then flooded the market with up to $1.2 billion worth of rough diamonds. These funds then underwrote their respective armed conflicts in Sierra Leone, Liberia, and the Congo. As news of these armed conflicts spread and word of the mistreatment of workers became well-known, customers wanted to know where their diamonds originated and if they were tainted with money from armed conflicts.
T—technological factors to create new processes and products. The greatest technological development in the diamond industry was the creation of synthetic diamonds. Lab grown diamonds had been around since 1955 and it had been a very laborious process using high pressure high temperature. It usually took 4 days to grow a 2.5 carat diamond. Technology grew and by 1996 a patent had been award for a chemical vapor deposition process for producing flawless diamonds. These synthetic diamonds also came in colors which truly cut into the natural diamond market. Due to the development in laboratory technology, synthetic diamonds were able to be used for industrial purposes. Purposes such as use in semiconductors, thermal conductivity, next-generation optics, and digital data storage. All of these technological factors truly had an adverse impact about the financial growth of De Beers.
E—Ecological factors. Natural diamonds were damaging to the environment to extract. It required several hundred tons of earth for each carat of natural diamonds. Diamond extractions caused destruction to fish habitats, land-based wildlife habitats, and caused caribou and grizzly bears to flee. The machines to operate the extraction of natural diamonds used diesel fuel which added to the production of greenhouse gases.
L—legal environment and regulations. In 2004 De Beers pleaded guilty to charges of price-fixing of industrial diamonds and agreed to pay $10 million fine. The next year, De Beers agreed to settle a class action suit for monopolizing the international diamond business for $250 million.
Porter’s Five forces—Threat of entry; power of suppliers; power of buyers; threat of substitutes; rivalry among existing competitors. The entry of synthetic diamonds into the market has had a profound impact upon natural diamond industry leader De Beers. Suppliers of synthetic diamonds in the US has grown dramatically and cutting into the natural diamond market. US synthetic diamond producers such as Adia Diamonds, Gemesis, Apollo, Chatham, and Life Gem. Due to changes in the natural diamond market, De Beers signed an agreement with the Botswana government to establish the Diamond Trading Company Botswana and with the Namibian government to form Namdeb. Resulting from the deal, Botswana moved up the value chain from mining and sorting to sales and marketing (taking London’s place). De Beers was reorganizing to better compete with the synthetic diamond market. The threat of a substitute diamond in the form of synthetics diamonds was very real. De Beers spent money on educating the public and working with the Federal Trade Commission in determining the terminology. A rivalry among existing competitors was the emergence of Russia after the fall of the Soviet Union. Alrosa began to take the market share from DeBeers after their Soviet contracts became void. Diamonds began to be cut in Russia instead of India. Australia’s diamond mind terminated their contract with DeBeers causing a major upheaval. Australia’s Argyle mine sold 42 million carats directly to polishers. Canada then became a threat to DeBeers. The majority of the country’s natural diamond production fell outside of DeBeers control.
VRIO framework–Due to De Beer’s focus on vertical integration through acquisitions and their alliances, their dominance in the natural diamond production and supply chain was valuable; rare (extent of their knowledge & global alliances); costly to imitate; and organized to capture value (global structure of smart infrastructure). Their expertise was built through acquisitions of small companies and mines throughout the world Their most valuable asset could be described as their global partnerships.
Current business level & corporate level strategies
The volume and value of natural diamonds has grown tremendously since 2002. The value has grown from $7.3 billion to $12.7 billion in just three years.
The USA has always provided the largest market for customers and retail buyers of the natural diamonds.
The changes De Beers made in partnering with Botswana and Nambia have proven very successful. The value of Botswana has exploded. Price has also worked in DeBeers favor as it has grown through 2005.
Making the diagnosis
De Beers would be wise to continue to educate the public on the origination of their natural diamonds and how natural diamonds are much more precious than synthetic. They own this unique niche and if they decided to enter the synthetic diamond market, it would hurt their branding. They would be wise to continue to develop a vertical integration of the diamond market and cut into the Indian polishing market. As they see their main competitors in Australia and Canada, they can seek to growth their markets in Botswana and Nabia. Continue to emphasize they are not producing “blood diamonds” and showing customers the origination is key.