DE BEERS AND BEYOND: AN UPDATE (1997 2003)*

CASE STUDY

PREPARED BY

MAX C. REICHEL
UNDER THE SUPERVISION OF

DR. TOBIAS KRETSCHMER

This case study is an update to the 1998 London Business School case De Beers and Beyond: The History of the International Diamond Cartel written previously by Tobias Kretschmer and Lu?s Cabral and focuses on the recent developments of the diamond industry. For further information please email m.c.reichel@lse.ac.uk or t.kretschmer@lse.ac.uk. Copyright 2004
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CASE STUDY DE BEERS AND B EYOND: A N U PDATE (1997 - 2003)

The Need for Change

[The radical and far reaching changes represent] De Beers response to the challenges of a competitive environment and a change from a supply to a demand-driven business 1 Nicky Oppenheimer

De Beers traditional role in the diamond market has been to take on the position of the custodian of the entire industry, protecting producers, dealers and cutters through its cartel from the vices of free markets. De Beers self-implied obligation to the stakeholders has been to shield the industry from volatility in prices and demand, to the consumers to secure diamonds as a prestigious and exclusive luxury item. In the last century, De Beers managed to do so, by safeguarding its cartel from competitors, by buying off excess supply, storing it in vast stockpiles to protect the prices, and by launching advertisement campaigns on behalf of the entire industry (e.g. A Diamond is Forever ). In the late 1990s, however, De Beers realized that the diamond market was getting increasingly competitive, especially with the opening of new diamond mines in Canada, resulting in a decline in market share of DeBeers from nearly 80 per cent in the old days to 65 per cent in 1999 and a general underperformance of its stock.2 The diamond market at that time was characterized by flat demand and excess supply, which caused De Beers to increase its diamond stockpiles from US$2.5 billions in 1990 to US$5 billions in 1998. It became obvious that in an industry where De Beers was no longer the sole supplier of diamonds, the traditional custodian role that De Beers had adopted over the past, could not be sustained as such.

Formal Strategic Review

De Beers decided that it had to change its conventional strategy of an all-embracing stronghold of the diamond industry to one of a highly aggressive competitor. With the announcement of its new chairman, Nicky Oppenheimer, and its new managing director, Gary Ralfe, De Beers seriously considered changing its overall strategy and decided to launch a formal strategic review of the industry, its operations and their future outlook in an increasingly competitive market. With the help of the Strategic Review Report, De Beers identified three main areas that had to be transformed, in order to assure De Beers success in the years to come.

Firstly, current operations had to be optimized. This included increasing efficiency and cutting costs by 15 per cent in its operations ( As is plus strategy), as well as the restructuring of the organization into transparent, customer-orientated business units.

Chairmans Statement, De Beers Annual Report 2000 Total percentage of diamonds distributed through the De Beers Diamond Trading Company De Beers share of worldwide production was 44 per cent in 2002
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CASE STUDY DE BEERS AND B EYOND: A N U PDATE (1997 - 2003)

Secondly, De Beers realized the protection of its market leader position demanded long-term measures. However, through it being a publicly listed company on the JSE and LSE, De Beers felt that it had to endure the quick-fix profit demand of its shareholders, instead of focussing on necessary long-term projects. It thus decided to go private in 2001 after its stock had been listed for over 100 years.

Lastly, De Beers alleged that there is unrealized potential in decreasing advertisement costs and increasing customer demand by promoting a more competitive environment at the downstream portion of the industry pipeline while binding them closer to their own upstream business (Supplier of Choice strategy).

The implementation of the first measure, to decrease costs and to restructure the company, was a fairly standard procedure in the light of the new competitive nature of the global economy. The other two aims, however, express a fundamental change within De Beers as a corporation and the diamond industry as a whole, intended to enable De Beers [to enter] the new century, fitter, leaner and streamlined for success 3.

Going Private
De Beers realized that a company such as itself could not solely be influenced by the short-termism of the stock market. Throughout history, De Beers had to decrease its profits to balance the market, to prevent excess supply and to sanction competitors. Trying to sustain the market position of the stronghold of the industry, De Beers recognized that it needed to maximize profits, not on an exclusive year-to-year basis, but rather on a long-term view. The only way to implement this was to go private, contradictory to the general trend in the global economy. Preceding the organizational restructuring of the De Beers Group instigated in 1999, De Beers separated its management ties from Anglo American Corporation in 1998, initiating an exclusive refocus on its diamond products. In 1999 De Beers acquired the minority interests in the DTC from Anglo American Corporation, sold most of its non-diamond businesses and two years later announced its proposal to acquire all of the outstanding shares of its shareholders. 4 Within less than half a year, 93 per cent o f the shareholders accepted the offer by De Beers Investments, comprised of the Oppenheimer Family through the Central Holdings Limited (45 per cent), Anglo American plc (45 per cent) and Debswana, the joint-venture between the Government

3 4

Chairmans Statement, De Beers Annual Report 1999 Previously, Anglo owned 32.2 per cent of De Beers, while De Beers owned 35 per cent of Anglo

CASE STUDY DE BEERS AND B EYOND: A N U PDATE (1997 - 2003)

of Botswana and De Beers (10 per cent).5 In June 2001 the trading of De Beers shares on the JSE and LSE was thus terminated and De Beers went private.

Supplier of Choice
The rough diamond market is becoming a competitive one and individual producers have to build up a loyal supportive base if they want to be able to sell their output under less buoyant market conditions6 De Beers Supplier of Choice (SoC) marketing strategy, which was finally cleared by the European Commission in 2002, is the attempt to closely bind downstream customers to the upstream business and to foster advertising and branding efforts of the downstream firms, thus growing and encouraging consumer demand and total sales. As part of the Supplier of Choice strategy, De Beers (re)-evaluates current and potential sightholders through a set of rigid criteria, such as financial standing, market position, distributional and marketing strengths etc., inviting the most promising of them to benefit from the formalized and closer relationship with De Beers. De Beers guarantees a steady supply of diamonds and the support of marketing activities of its sightholders through its Added Value Services. From its habitual 120 sightholders, many of them with long-established relationships with De Beers, 25 per cent were disposed of at the end of 2003, creating significant uncertainty in the diamond industry.7 Because of the criteria applied by De Beers, which nobody really seems to understand, [the Antwerp manufacturing] companies have seen their viability come under real threat 8

Closure of the Opportunity Gap

The primary goal of SoC is to initiate growth in the diamond market through downstream advertisement campaigns, driving the consumer demand while allowing De Beers to transfer its advertisement efforts. De Beers aimed to instigate a market where retail firms advertise and establish their own brands, creating more effective, customer-near marketing campaigns. Ultimately, De Beers is seeking to increase total diamond jewellery sales by 4 per cent per year, compounding to a total growth of 50 per cent over 10 years. In the 1990s the diamond market was not growing proportional to worldwide GDPs, compared to sales of similar luxury goods, it was underperforming. The growing divergence between the rate of

See Appendix 1: De Beers Ownership Structure Chaim Even-Zohar, Tacy Diamond Intelligence, 01.09.2000 7 See Appendix 2: Official DTC Sightholder List 2004 8 Peter Meeus, HRDs Managing Director, Antwerp Focus, September 2003
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CASE STUDY DE BEERS AND B EYOND: A N U PDATE (1997 - 2003)

increase of luxury goods sales and the rather flat rate of increase of the diamond sales is depicted as the Opportunity Gap below:

Exhibit I: Supplier of Choice, Opportunity Gap, www.debeersgroup.com Comparing the amount of money that was spent on advertisement in similar industries, the diamond industry was spending only 1 to 2 per cent of total sales in advertisement, whereas the watch industry was spending 6 per cent and the general luxury industry was spending even up to 10 per cent of total sales. De Beers itself spent the industrys lion share, allocating about 4 per cent of total sales to advertising. It appeared that the downstream diamond jewellery market and even other upstream competitors were mainly relying (free-riding ) on the industry-conducive marketing campaigns launched by De Beers (A Diamond is forever ). Determined to end this inadequacy, De Beers decided to introduce a new marketing strategy Supplier of Choice, choosing only the best retailers as its sightholders and training them in marketing and advertising. At the official launch of its Supplier of Choice strategy in July 2000, De Beers renamed its Central Selling Organization to Diamond Trading Company (DTC) and introduced the DTCs new logo the Forevermark , which is inscribed into its stones to ensure its quality. In addition to the Supplier of Choice, De Beers also introduced the Miner of Choice and the Employer of Choice schemes, promoting company culture, equal employment opportunities and such.

Vertical Integration
Many diamond-producing companies have started to build vertically integrated structures, a trend that will strengthen within the next three to five years when we will see quite a different structure of the world diamond market. 9 The Supplier of Choice strategy will undoubtedly result in a highly competitive, growth-orientated retailer market, as the removal of De Beers industry-wide cloak of protection would force retailers to
9

Alrosa Vice President Serguei Oulin, Interview with Rapaport Diamond Report, 09.04.2003

CASE STUDY DE BEERS AND B EYOND: A N U PDATE (1997 - 2003)

establish their own differentiated brands. As other diamond suppliers, such as BHP-Billiton and Alrosa, had announced before, De Beers saw a chance to gain from the downstream branding development. It decided to collaborate with the luxury producer LVMH to set up the joint venture Rapids World Ltd. The resulting new retail stores, named De Beers LV, targets the very high-end element of the jewellery market, attempting to obtain a 25 to 30 per cent premium over unbranded jewellery. Its first store opened in London at the end of 2002, three more in Tokyo in September 2003. The US launch will take place at the end of 2004 with locations in both New York and Los Angeles. Very recently, Aber Diamond Corporation announced that it would acquire the luxury jeweller Harry Winston Inc., following the trend of vertical integration set out by De Beers partnership with LVMH. Aber, however, felt that it did not have the name recognition and thus was bound to link up with a well-know brand, such as Harry Winston. Matthew Manson, Aber's vice president of marketing, explained the New York Times: We wanted to link up with a well-known brand. The very best brands like Tiffany and Cartier are already out there. You can't create those overnight. We want to be a more vertically integrated company, not just a producer and a seller. We are looking to attract investors. 10 De Beers had the advantage that it already had established its own name, and thus could rely on sufficient consumer confidence to make De Beers LV a successful brand name. Interestingly, the cartel is effectively profiting from an identical strategy to Intels Intel Inside campaign. In each case the companies had already established sufficient brand awareness with the consumer through its upstream activities. Both used their existing reputation to expand downstream and thus to benefit from its own name on various levels of the diamond pipeline. This of course, is intended not simply as a means of obtaining a greater overall return but should be seen as a stark diversification within De Beers' usual operations. De Beers further expects that the partnership with LVMH will allow the cartel to access the US retail market, a market so far closed to them due to US anti-trust allegations. It should be noted that Rapids World is set up as a completely independent company from the rest of De Beers operations. De Beers has repeatedly asserted that it would not directly supply Rapids World with stones. However, this would mean that Rapids will have to buy polished stones from the market at regular prices, while De Beers would sell them beforehand to polishers. Cynics argue that this is going to lead inevitably to a conflict of interest. De Beers needs to make certain that the new Rapids World is lucrative, as it would otherwise severely harm De Beers reputation as a whole. Thus,

10

Antwerp Facets News Service, 02.12.2003

CASE STUDY DE BEERS AND B EYOND: A N U PDATE (1997 - 2003)

one has to explore what options, besides providing cheaper diamonds, De Beers has to ensure the success of its joint venture over other downstream competitors.11

Developments in Operations and Exploration

Canada
Following the increase in competition through the split of Argyle from the cartel, De Beers faced a new challenge to its market power. So far three diamond deposits were discovered in Canada: Snap Lake, Diavik and Etaki. In 2000, De Beers was able to acquire Winspear and is expected to start mining at Snap Lake by 2005, expecting to produce 1.5 million carats per year over 22 years. De Beers competitors Rio Tinto and Aber Diamond mines secured ownership of the Diavik Mines, producing 6 million carats per year over 20 years. Another mine, Etaki, is owned by Dia Met along with BHP-Billiton. De Beers has signed a contract to distribute 35 per cent of Diaviks diamonds from 2000 to 2003. It is expected that Canada will be the third largest diamond producer, worth 17 per cent of the total market. To De Beers misfortune, it seems that they are having increasingly difficulties to establish themselves in this new market.

Botswana and Namibia

De Beers has continued to increase ties with Botswana and Namibia, through the joint ventures Debswana and Nambed, held equally between De Beers and the respective governments of both countries. A new mine in each of the countries was opened in 2002; Debswana will have increased its production to 30 million carats per year by the end of 2003 and Namdeb is aspiring to double its value from 2000 by 2005 (as set out in Big Hairy Audacious Goal 12 announced in 2001).

Congo and Angola

Problem areas such as Angola and the Congo, still torn up by the consequences of civil war, pose another challenge to the cartel. Because of past civil unrests in Angola, De Beers had cut all operations there. At the moment they are engaged in discussions aiming to organise reconstruction and development in Angola. De Beers plans to return to the Democratic Republic of Congo, as it has regained stability, though being still extremely fragile. The United Nations, however, commenced

For a thorough and extremely interesting discussion of De Beers potential strategic motives behind the Supply of Choice , please see Tacy Ltd. Diamond Industry Consultants Viewpoint articles: Conjecturing about Incredibly Hidden Strategies behind dropping of so many U.S. Sightholders , June 12, 2003, as well as: DTC Strategies: A View from the Top, June 19, 2003, both written by Chaim Even-Zohar, published on www.diamondintelligence.com 12 The goal of growing the value of the diamond business owned by De Beers to US$10 billion by the year 2004 was indeed titled BHAG. The reasons for this curious naming are unknown.
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CASE STUDY DE BEERS AND B EYOND: A N U PDATE (1997 - 2003)

with an investigation against De Beers for allegedly exploiting the natural resources of Congo during the civil war.

Russia
Russia has since the fall of communism been a concern for De Beers. Only a part of Russias diamonds is traded through the DTC, while the rest is sold directly to cutters. De Beers had traditionally bought its Russian diamonds through the state owned supplier Alrosa; however, at the end of 2001 the official contract between Alrosa and De Beers ended. The European Commission has since been reviewing the renewal of the contract, an agreement to sell up to US$4 billion worth of rough diamonds over five years, as it fears that "by entering into the agreement, De Beers has abused its dominant position in the rough diamonds market 13. At the moment, De Beers and Alrosa are trading diamonds on a willing buyer/willing seller basis, selling US$634 in 2003 25 per cent lower than the laid-out contract would provide for. The question is: Does Russia gain from a fixed contract with De Beers or is it better off on willing-buyer/willing-seller basis allowing them to explore other opportunities simultaneously?

Challenges to the Diamond Market

Following De Beers forecasts, the value of diamonds will grow by 4 per cent per year to US$90 billion in ten years. A greater demand for diamonds, through the prospect of an accessible US market and expanding developing markets, notably India and China, are likely to result in a shortage of available rough diamonds in the years to come. Industry experts believe that the 50 per cent value increase in the diamond industry will be achieved through vigorous price increases, instead of higher diamonds sales. Despite sluggish economies and uncertain stock markets there is already a shortage of ongoing rough supplies which have only been met from stock.14 In the light of this, De Beers' shift in strategy, targeting a demand-driven rather than a supply-driven diamond market, might have severe consequences on the diamond trade. Industry experts predict that the combination of rising prices and the novel costs of intensified advertisement and branding efforts of the downstream market will lead to a complete re-organisation of the industry. Many retail downstream firms will be forced to consolidate with competitors or at least form joint ventures to avoid bankruptcy.

European Commission, January 2003 James Picton for UK stockbrokers W.H.Ireland, A Review of the Worlds Rough Diamond Market, www.minesite.com, 18.07.2003
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CASE STUDY DE BEERS AND B EYOND: A N U PDATE (1997 - 2003)

First, there is no guarantee that sufficient rough will be available to support all of these initiatives. Second, the market cannot support 130 different diamond brands. So we are likely to see many companies bankrupted by high costs.15 At present, the retailer market has incurred an extremely high debt of US$8,66 billion in 2002, from US$6,88 the year before. This was a result of the general de-stocking activities of the rough suppliers, specifically De Beers, in the last few years. Much of the extra supply was taken up by the extra demand in 2002. The anticipation of a steep rise in prices and the current low interest rates caused many downstream firms to buy off a great deal of diamonds, stockpiling them for the future. In 2003 the prices of rough diamonds increased by ca. 10 per cent, whilst the price of polished stones continued diluting. Inferential, retailers are speculating that the inflationary return of their inventory will exceed the cost of holding the diamond stockpiles. However, the transfer of non-debt-financed stockpiles of De Beers to highly debt-financed stockpiles of the retailers is clearly increasing the risk of firms in the downstream market and promoting the expected consolidation trend. These factors will lead inevitably to a shakeout in the market, leaving only the strongest, or better, the ones with the best strategy in the market. Experts predict a major and increasing trend to vertical integration of companies, similar to oil firms, where a small number of firms control the whole of the supply chain (industry pipeline) from mining to cutting to retail.

Conclusion
It is certain that the diamond market has changed from a tightly-controlled market, in the hands of the market-custodian De Beers, to a increasingly competitive industry, directing De Beers to fundamentally reshape its business proposition. Once upon a time, the key to success in the diamond business was skill [] In this new era, skill is still important, but strategy is more important.16 The question is whether the radical change of strategy will allow De Beers to hold on to its market share, and whether the Supplier of Choice strategy can defend the De Beers Group from further challenges in the future. Also is there another underlying plan hidden in the Supplier of Choice strategy or is De Beers only optimizing its distribution system? Diamonds are forever, but is the De Beers cartel?

15 16

Moshe Leviev, Leviev International Diamond Group, Gemological Institute of America Newsletter Excerpt from discussion: The Past, Present and Future at Rapaport International Diamond Conference 2003, 20.10.2003

CASE STUDY DE BEERS AND B EYOND: A N U PDATE (1997 - 2003)

Appendix 1
De Beers Ownership Structure (Abridged) 17 - following the January 2002 restructuring

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Group Ownership Structure, www.debeersgroup.com

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CASE STUDY DE BEERS AND B EYOND: A N U PDATE (1997 - 2003)

Appendix 2
Official DTC Sightholder List 2004 18 - January 13, 2004
A. DALUMI DIAMONDS LTD. A. SCHWARTZ & SONS DIAMONDS LTD. A.M.C. BVBA ARJAV DIAMONDS NV ASIAN STAR COMPANY LIMITED ASTRA DIAMOND MANUFACTURERS LTD. B. VIJAYKUMAR & CO. BHAVANI GEMS BLUE STAR BORNSTEIN NV C MAHENDRA EXPORTS CHOW TAI FOOK JEWELLERY CO. LTD. CLASSIC DIAMONDS (INDIA) LIMITED D. NAVINCHANDRA & CO. DD MANUFACTURING NV DALI DIAMOND COMPANY NV DE TOLEDO DIAMONDS LTD. DIACOR INTERNATIONAL LTD. DIAMANTHANDEL A.SPIRA BVBA DIAROUGH NV DIGICO HOLDINGS LTD. DILIPKUMAR V. LAKHI DIMEXON DIAMONDS LTD. DYNAMIC DIAMOND CORP. E.F.D. LTD. EMA DIAMOND MANUFACTURING LTD. EUROSTAR DIAMOND HOLDINGS SA FABRIKANT & SALANT GROUP FESTDIAM CUTTING WORKS (PTY) LTD. FRUCHTER GAD DIAMONDS LTD. GEFFENS DIAMOND CUTTING WORKS (PTY) LTD. GEMBEL EUROPEAN SALES NV HASENFELD-STEIN INC. INTER GEMS-CLAES NV J.B. DIAMONDS JAYAM NV JULIUS KLEIN DIAMONDS LLC K. GIRDHARLAL K.P. SANGHVI & SONS KARP IMPEX LIMITED KGK ENTERPRISES KROCHMAL & COHEN DCW( PTY) LTD. L.I.D. LTD. LAXMI DIAMOND LAZARE KAPLAN INTERNATIONAL INC. LILI DIAMONDS In addition DTC supplies goods to the following industrial clients: HENRI POLAK DIAMOND CORP. LIEBER AND SOLOW LTD. SAINT -GOBAIN ABRASIVES LIMITED-L M VAN MOPPES AND SONS LIVINGSTONES LOUIS GLICK AND COMPANY M. SURESH & CO. MAHENDRA BROTHERS MICHAEL WERDIGER INC. MOHIT DIAMONDS IMPEX PRIVATE LTD. MOTI GANZ NAVIN GEMS OVERSEAS DIAMONDS NV P D KOTHARI & CO. PLUCZENIK DIAMOND COMPANY NV PREMIER DIAMOND CUTTING LTD. PREMIER GEM CORPORATION R.T. DIAMOND PVT. LTD RAND PRECISION CUT DIAMONDS (PTY) LIMITED RATILAL BECHARLAL & SONS RICHOLD SA ROSY BLUE (INDIA) PVT. LTD. ROSY BLUE NV S VINODKUMAR & CO. SANGHAVI EXPORTS SCHACHTER & NAMDAR POLISHING WORKS, LTD. SHEETAL MANUFACTURING CO. SHREE RAMKRISHNA EXPORT SHRENUJ & COMPANY LIMITED SMOLENSK STATE UNITARY COMPANY KRISTALL PRODUCTION CORPORATION STAR DIAMOND GROUP (SDG) BV SUASHISH DIAMONDS LTD. SUNDIAMOND BVBA SUPERGEMS HOLDINGS LTD SURESH BROTHERS TACHE COMPANY NV TASAKI SHINJU CO. LTD. TRAU BROS NV VENUS JEWEL VIJAYDIMON BVBA YAHALOMEI ESPEKA INTERNATIONAL LTD. YERUSHALMI BROTHERS DIAMOND LTD.

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Media Releases , www.debeersgroup.com

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