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A New Partnership: An Interview with Gary Ralfe
Jul 27, 2000 4:47 PM
By Martin Rapaport
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Martin Rapaport interviews De Beers Managing Director Gary Ralfe for an inside look at De Beers’ new strategic initiatives and future direction.
Martin Rapaport: What’s so important about the Supplier of Choice Program?
Gary Ralfe: The Supplier of Choice presents a new partnership for our industry as we enter the twenty-first century; a new partnership between the Diamond Trading Company (DTC) and its sightholders. The Supplier of Choice is important because it’s about growing diamond demand and growing the business between the DTC and its sightholders. The Supplier of Choice is also important because it represents a move away from the old style in which we did business, which was through managing the market through supplies, to a new style, which is to grow the business and demand for diamond jewelry.
MR: What kind of growth do you think this is going to bring us?
GR: We set ourselves the reasonable target of emulating, and perhaps surpassing, the growth rates of other luxury goods. Over the last ten to 15 years luxury goods have shown a phenomenal compound annual growth rate of 10 percent, well out-performing the diamond jewelry business. I cannot think of any good reason why we shouldn’t be doing at least as well as other luxury goods, which are, after all, the competitors of diamond jewelry.
MR: What do you expect of your Sightholders?
GR: We want to help unleash the extraordinary intelligence, entreprenuership, and creativity of our clients to drive demand. We want them to devote themselves to marketing diamonds, because that is what this is all about. I think in the past there was much more emphasis upon the manufacturer. The magic, or the mystique has gone out of manufacturing. The magic of business is now marketing. What we want to do together with our clients is to find ways in which we can help them to drive demand and grow our overall share of the luxury goods market.
MR: So, you’re looking for the sightholder in effect to assist in the marketing of diamonds?
GR: We’re looking for our sightholders to do the marketing of diamonds in the same way that we’re marketing diamonds. We’re not marketing directly to the public. Most of the sightholders are not marketing to the public either. But that doesn’t prevent us from finding our own ways to market diamonds which will penetrate all the way through to the end consumer.
MR: So you’re pushing B2B marketing initiaves.
GR: We’re pushing all sorts of initiatives. B2B is absolutely one of them. It could be on the Internet. It could be our clients going out and developing new lines with particular jewelers. It could be clever clients going to fashion houses and saying, "we want to provide diamond jewelery accessories, so when a lady steps in to buy one of your gowns, you might direct her towards your line of diamond jewelry." I would like to see some of the well established fashion brands have lines of diamond jewelry. I think Coco Chanel started this a long time ago and I would like to see more of it. When we talk about the proliferation of brands that we would like to see, we were thinking about new brands. But for heavens sake a fast way to the consumer is by exploiting existing brands. Houses such as Gucci have already started the process. So much of this is already on the way.
I think the other very important thing that we’re looking to from our sightholders is to sit down together and develop compatible and coordinated business plans. Building upon existing initiatives like Planned Production ProForma (PPP), we are introducing a more systematic and orderly overall business model. A partnership of how we see goods moving through the distribution channels to the end consumer.
What we’ve done in the past has worked well, but it’s been rather haphazard. The market has obviously been the major arbiter. We believe that by having a much better handle on how clients are running their individual marketing program, and by then in turn having a better idea of what their downstream clients are doing, we will be able to get more system and coherence into our overall marketing program. And I believe that, that in itself, will help to drive demand.
MR: If you want better marketers why don’t you just go to Madison Avenue, find the best marketing people in the world, hand them a bag of rough diamonds and say – "go market?" What makes you think that the Sightholders will be better at marketing, than the marketing experts will be at manufacturing?
GR: I am not ruling out the idea that our clients go to the Madison Avenue specialists and say, "we’ve got a brief, we want to better market these goods." Much better than the bag of rough diamonds is for us to say "we’ve got a bag of polished diamonds. How can we market them better?" I would be very happy for the best professionals to be brought in. Insofar as our business lacks certain expertise, it must bring in that expertise from the outside.
MR: Should the non-sightholders see this new De Beers initiative as a threat?
GR: I have not directly examined that closely myself. What I have been looking at is the benefit to our sightholder because our business is with our sightholders. I don’t believe that the initiative itself threatens non-sightholders. I heard their complaints, poignantly couched at the last conference in Tel Aviv. There seemed to be insufficient supplies of well-priced rough diamonds available in the market. This may be a passing phase, depending on whether the big demand and the premiums that we saw for diamonds early on this year are sustainable. I think there are signs that this trend has actually peaked. And it could well be that the pressures will actually lessen significantly in the second-half of the year.
The other thing about this, Martin, is that many of the people who are not our sightholders are supplied by our dealers. Our new initiative doesn’t preclude those channels of distribution. I know of some of our major dealers who not only have enormous businesses in rough dealing, but also have enormous polished dealing, buying polished back from the same guys to whom they sell the rough. I’m not saying that that is an inefficient system of distribution. I am absolutely certain that some of the business I looked at was extremely efficient. I am not saying that there is not a place for the little man. There is every indication that in certain distribution channels they play and will continue to play a vital role.
MR: Does De Beers have enough diamonds?
GR: Ah, a very interesting question. For the moment I can say emphatically, yes, we have enough diamonds. You know we started the Supply Demand committee, as part of our own internal re-organization. It is very important, because it is trying to align our production and purchases with our marketing. No doubt, the sort of thing we should have had a long time ago, but we’ve now got it, and we think that this is a very good tool. We have enough diamonds now, but only because we have a stockpile. We depleted that stockpile last year and will go on depleting it this year. The crucial question is, how much rough does one need to sustain the $56 billion that was sold in the retail marketplace last year?
Now, last year when we were running down our stocks, there was a stock build-up in the cutting centers. This year it appears that there is stock building among retailers. There has been a 30 percent increase of polished diamond imports into the U.S. while best estimates of retail demand indicate sales growth of no more than 8 percent to 9 percent. So inventory rebuilding is taking place also in the retail centers. There has been a shift of our stock over the last 18 months into pipeline stocks.
None of us can be certain of the actual amount of rough diamonds that are consumed in the $56 billion of annual retail demand. Is it the entire $7.5 to $8 billion of rough that was supplied to the cutting centers last year or was it a lesser figure? It must have been a lesser figure or they would not have been able to reflate their own inventories. But what we do know is that a pipeline that was singularly dry of stockpile by the end of 1998 has started now to increase inventory.
This is a long way of answering your question, but it is an important way because it comes down to this — none of us can be absolutely certain of the level of sales that are necessary to sustain consumer off-take, because inventory levels throughout the pipeline are volatile. Of vital importance is where stocks are sitting. Whether stocks are being built up or depleted at various levels of the distribution system is a function of confidence in the market.
De Beers can respond to demand from our own clients running ahead of our supplies in three ways. One, increase production. Two, shorten the pipeline from mine to our sales-boxes in London. Three, increase prices. None of these methods are exclusive and we would look at doing all three of them.
Increase Supplies. We have just significantly increased the size of the Orapa mine and we are building a new combined treatment plant in Kimberly which will increase production from that old source. We also have a feasibility study on extending and effectively building a new mine at Premier. We would obviously like to increase our production. De Beers is also exploring for new sources and it has launched a bid for Winspear a small but interesting project in Canada.
Shortening the pipeline. Over the last ten years while we have been building up stocks there hasn’t been any emphasis on shortening the pipeline because it hasn’t been necessary. Indeed it would have increased costs which we were not keen on doing. Now, because of the run down of our own stockpile our early warning system has been activated. There are good opportunities to shorten the half year it takes to move goods from the mine to a London sight because we have had a leisurely pipeline.
Price changes, we have already had two price changes this year. The first was pretty marginal. The second, two sights ago had significant positive price changes.
MR: Is your stockpile balanced? Why is there such a great shortage in 6/4 and larger polished? Why aren’t you releasing more larger size rough?
GR: We are selling what we can and cannot increase supplies in those areas. Consider the 5 to 10 carat box which is producing the sort of polished you are referring to. This box has a good premium on it, and our price went up as a result of the premium.
You must consider that at De Beers we are always looking ahead and strive to match sales with production. We don’t say, gosh, we have stock lets get rid of it now. Rather, we look at what we expect to be producing and buying-in over the next 18 months. We are looking to provide consistent supplies into the market because we are always thinking in the long-term. We also try to build up clients over the long-term. We don’t want to say — here take all these 5 to 10’s now because there is great demand for it — and then have clients sit around wringing their hands because we have now run out of stocks and cannot continue to supply at the same rate. Our system of marketing is all about providing consistency to our clients. So on the 5 to 10’s we have been looking to see what the supply profile looks like over the next 18 months and factor that into the allocations that we are making right now.
MR: So there are real shortages in larger better quality rough?
GR: Yes.
MR: Are you holding goods back to get an increase in prices?
GR: The one thing I can say absolutely and emphatically is that we are not in the business of ramping prices by holding back goods. That would be dangerous and is absolutely counter to the way that we are now doing business.
MR: How large is your inventory and how large would you like it to be?
GR: Having depleted the stockpiles of Debswana and Namdeb we had just under $4 billion on our balance sheet, including substantial stocks belonging to De Beers Consolidated Mines which are held at cost of production. So that means that the overall sales value of the stockpile was between $4 to $5 billion at sales price levels. We would like to bring our stockpile down to working stock levels which would depend on sales levels. If our sustainable sales are at $5 billion a year then working stocks of one half year of about 2.5 billion would be reasonable. If we could get it down to three or four sights then we could go as low as $2 billion. That is the range.
MR: I imagine you would be very resistant to increasing stockpiles once you got them down.
GR: Yes, absolutely. Inventory consumes capital.
MR: So you are not manipulating inventories?
GR: No we are absolutely not in the business of manipulation.
MR: Over the past year banking credit to the industry has increased about 34 percent to over $6.5 billion. How do you feel about that?
GR: I look to the banks on this. When I last talked to the major banks three months ago they said that they were comfortable. I think that they are less comfortable now. They had talked about good rotation which has since slowed and the debt level has continued to increase. As usual, during the seasonal lull in our business people start to get a bit anxious and impatient waiting for polished demand to pick up again. There isn’t any panic in the banks but everybody is aware that there has been this significant increase in credit over the last 12 months. No doubt, if polished purchases pick up nicely in the next couple of months current concerns will relax.
MR: Is there a problem in India?
GR: I am told that there are certain problems in India. Again they come at a time when people are anxious about inventory levels and their ability to move their polished stocks through the pipeline. The problem with the Angardia’s and one or two bankruptcies obviously disturb people. Again, I am certain that if there is a good off-take of polished from India in the next few months then current concerns will be quickly forgotten.
MR: Do you expect prices for rough diamonds to increase significantly over the next year?
GR: No, I do not expect significant rough price increases in the near future. I think that we are still in the business of getting there — of building demand to support higher prices. In any case, prices turn on factors that are beyond our control. Like the American economy. Nor do I have a better guess than anybody else about whether we will still have a millennium effect in 2001.
I come back to what our new strategy is. We want to reduce the volatility and unpredictability of our business. We want a more programmed and systematic business. Of course one can’t take the volatility out all together. Demand for a luxury product like diamond jewelry depends on consumer confidence and the level of disposable income available for luxuries and that is subject to economic cycles.
MR: Why are De Beers share prices so low?
GR: The share prices are absolutely pathetic. The investment analysts tell us the major inhibitor for our share price is our holding of Anglo American. What drives De Beers share prices up and down is the movement of Anglo American. Our interest in Anglo American represents 75 percent of our total market cap.
Other factors limiting our share price valuation is the country risk associated with South Africa, the complex structure of De Beers which separates ownership of South African and non-South African holdings, concern that we may have a predilection to grow stockpiles and limits on our ability to operate in the U.S.
MR: So why don’t you get rid of your Anglo shares?
GR: It is a core investment in a major mining group that we believe is necessary for us to maintain our muscle in the diamond business. When times have been bad it has been something that gives our banks comfort when we borrow from them. I can’t argue the same reason when we start to be cash positive as we are at the moment. But I know that this business can turn with extreme rapidity and suddenly we may need lots of money again. Not money to run up the stockpile, but rather funds available to invest in our core product of diamonds for commercial reasons so that we can make money on the diamonds when we sell them.
MR: Is De Beers a monopolist?
GR: I assume when you say that, you speak from an American legal perspective and it is not entirely clear who the US law considers to be a monopolist or not a monopolist. We have always strived to be a consistent and reliable supplier to our clients. Our market share has declined and we have launched initiatives signalling significant change in the way we do business. We want to create a sustainable increase in the demand for rough diamonds and to improve our customer focus. We all need to bear in mind the requirements and expectations of consumers.
MR: Are you willing to reform so as to comply with U.S. anti-trust laws?
GR: We are always willing to consider changing our practices to comply with any legal and regulatory requirements.
MR: Regarding conflict diamonds, why did De Beers stop outside buying in Africa? Was it because they didn’t want to increase stockpiles or was it because they felt it was wrong to be dealing with these diamonds?
GR: It was a confluence of factors. Ethical considerations were of primary importance. This is not just a cynical reaction. When we speak about ethics in our new "Best Practices Principles" we are absolutely sincere. At the same time, since we are no longer managing the business through controlling supply it becomes less important to go and buy up all the marginal production we can find everywhere. A third reason is that there is quite a lot of competition in the places where we were operating and so the margins were getting narrower. And a fourth and very important reason is the security of our staff. We had several nasty experiences in Angola and do not want to put our personnel into any danger. All of these things added up and influenced our decision to pull out.
Undoubtedly, the most important thing and what really drove us out were important ethical considerations. Furthermore, De Beers as a company could not afford to even indirectly come anywhere near diamonds which can be termed conflict diamonds. Like Caeser’s wife we have to be above reproach.
MR: Are you expecting any new sightholders this year due to the new Supplier of Choice Program?
GR: I think that at the moment while we work out what the program means in real terms, we are not rushing out looking for new sightholders. But certainly in the future I see renewal. Our sightholders are characterized by being family firms. And these family firms on a historical basis tend to come and go. I believe it highly desirable that the same sort of people who have made it in the diamond business, artisans who often started on the wheel, built up capital and became the employers of other men are the sort of entrepreneurs that one wants to encourage in our business. We want to have the world’s best diamantaires as our customers. So, if I look towards the years ahead I am sure that there are going to be a great number of changes in our sightholder list.
MR: How about this year. Should we expect any new sightholders?
GR: I think it would be wrong for me to say no. Nobody has made any recommendations to me about it yet. I think that we have a lot on our plate at the moment, working out the new objective criteria for sight holders. There is a good argument to just call for a moratorium on new sightholders, but our minds are not made up on the matter.
MR: Could you provide a profile of the new Supplier of Choice Sightholder?
GR: Let me say that there are many of them around already and thank goodness we’ve already got them on our books. They are people of good financial standing. That doesn’t mean that they have to be big, but they must have good reserves in relation to their business and the right debt to equity ratio’s. They must be competent at their business, and able to develop marketing strategies. They should have open minds with the ability to learn and develop new ideas and be able to move with the times. They must have good business practices and be able to systematically organize their business so as to extract maximum value from their diamonds. Finally they have to subscribe in full sincerity to the best practice principles which we have outlined.
MR: De Beers has taken the position that they are not going to be selling their customer’s customers. Should sightholders be selling direct to retailers and cutting out middlemen?
GR: There are many ways to establish good distribution channels. I don’t think sightholders have to be like that. I do note however, that we have a broad range of sightholders. Some are retailers, others sell directly to retailers, and others do not sell to retailers. We are not being prescriptive in saying that you must shorten the pipeline so that you are selling direct to a retailer. We are not saying that at all. I think that some diamantaires go around flogging to retailers. That to my mind is not what we are looking for. We are looking for people who have proper systematic and consistent marketing programs.
MR: Do you consider it unethical for a sightholder to sell direct to a consumer and cut out the retailer?
GR: No, I don’t consider that unethical.
MR: Will the new program encourage the elimination of levels of distribution in the diamond pipeline. Is that what this is all about?
GR: It’s partially about that. Yes, we say that we want a more efficient and effective distribution system.
MR: What does that mean efficient and effective?
GR: I don’t know yet. We are trying to work that out for ourselves. I am looking for demand that is repeatable and sustainable. I am looking for system and order so that we can plan a business much better than we do at the moment. We work in a business that is very difficult to plan because volatility is so often the order of the day.
MR: What message do you have to the general diamond trade? The non-sightholders.
GR: Supplier of Choice is not against anyone’s interest. It is certainly not designed that way. What Supplier of Choice is all about is growing our business and maximizing returns. We believe therefore, that although it is directed at the partnership between DTC and it’s sightholders, there will be a positive impact going well beyond these two parties and it will include many others in the industry as well.
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Tags:
Anglo American, Angola, Banks, Conflict Diamonds, Consumers, De Beers, Debswana, DTC, Economy, India, Jewelry, Manufacturing, Namdeb, Production, Sightholders, Sights, South Africa
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