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Monopolist or Market Maker

Mar 3, 2000 9:21 AM   By Martin Rapaport
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By Martin Rapaport

The De Beers strategic review is probably the most important thing the company has done in the past 50 years. De Beers is undergoing a fundamental process of re-evaluation — a rethinking of what it does, what it is and what it should be in the years ahead. We are witnessing a sea-change in the way De Beers thinks about itself and its position in the diamond industry. This is much more than simply the introduction of new policies to improve profitability. De Beers is not merely changing its policies, it is changing its goals.

Obviously, as De Beers reinvents itself it will reinvent its role in the diamond industry. While change will be gradual it will be fundamental. Due to its size, strategic positioning and historic role, De Beers cannot move rapidly. However, these same factors assure us that any shift in direction by De Beers will have major ramifications on the rest of the diamond industry. As De Beers refocuses its activities on new goals there will be fundamental changes in the way the company impacts the diamond markets. Firms, be they sightholders, polished dealers or retailers will have to adapt to new market realities as De Beers changes the way it uses its market power.

While it is premature to provide a detailed analysis of all the ramifications of the strategic review, we can provide an initial report on some of the more obvious recommendations of the review and how they may be implemented. To their credit De Beers has been very open about the review process and recommendations. They have gone out of their way to communicate with the trade and insure a fair level of transparency. Readers are encouraged to review Gary Ralfe’s excellent interview in this issue (see page 35) as it provides insight into the thinking behind the new De Beers.

The Problem

The primary motivation for the strategic review is the very low market valuation assigned to De Beers by the financial sector. Simply put, De Beers share prices do not reflect the value of the company’s diamond business.

If one considers De Beers current market value (share price x number of shares: $23 x 400 million= $9.2 billion) and deducts the value of non-diamond investments ($7.25 billion) the balance is only $1.95 billon. This means that the financial markets are only paying $1.95 billion for $9.25 billion of De Beers diamond assets. That’s like 79 percent below list price. (see Table De Beers Diamond Assets.)

It’s crazy. The stock mavens on Wall Street are willing to pay retail prices for diamonds in jewelry stores but they are only willing to pay 21 cents on the dollar for diamonds owned by De Beers. They believe in the diamond dream, but they don’t believe in the diamond company.

Not surprisingly, De Beers mission statement and the driving force behind the strategic review is: The need to focus on creating and enhancing stakeholder value and especially shareholder value. Clearly the focus of the review is on the value of the company. Why is it so low and what can be done to increase it?

There are a number of reasons why De Beers shares are so undervalued. Some of the most important have nothing to do with the diamond business but rather with the financial structure of De Beers and the inability of De Beers to operate in the U.S. due to anti-trust laws. Before we take on these weighty issues let us consider how events in the diamond markets impacted De Beers diamond business and how this has limited De Beers market valuation.

The strategic review focused on the performance of De Beers in the 1990’s and noted that in comparison to the 80’s there were significant changes in the diamond markets. In the 80’s demand grew, the Far East boomed, the Yen surged, demand exceeded supply, single channel marketing was enforced, real diamond prices and inventory values increased. In the 90’s all these good things went bad. Demand was flat with the collapse of the Far East and the depreciation of the Yen, supply exceeded demand with leakages from Russia and Angola, Argyle left the CSO and Canada’s BHP began production limiting the effect of single channel marketing. Real diamond prices and inventory values decreased.

The poorer market conditions of the 90’s brought about two factors that hurt De Beers. First, De Beers diamond profits declined over the decade providing a miniscule return on assets. Second, De Beers diamond stockpile doubled in size from about $2.5 billion to over $5 billion.

Investor Perspectives

Investors looking at De Beers saw an old company doing things the old way in a rapidly changing business climate. They didn’t and don’t understand what De Beers is all about. Major questions surfaced in the mind of investors. Is De Beers in the business of maintaining the diamond industry, or is it in the business of making money by mining diamonds and selling them? What is De Beers doing with all that inventory? What is the value of all those great De Beers diamond assets if De Beers is sleeping on them? Why doesn’t De Beers know how to make a decent rate of return? If the diamond assets are not providing reasonable returns (i.e. profits) then perhaps the assets really aren’t worth very much?

Fundamentally, the investment community looks at De Beers and says: best case — your diamonds and your diamond mines are only worth what you can earn from them — and you haven’t been earning what you should or could. Furthermore, we can’t value your assets because you are not using them to make money, you are using them to maintain an artificial market for your product. Sure, we can buy into the mystique of diamonds as a gift of love — but we can’t buy into the mystique of diamonds as a controlled monopoly market. Simply put — we value the diamond monopoly business as zilch. Therefore, no money for diamond stockpile, no money for mines, perhaps no money at all because we don’t understand what you are doing with your assets.

So here we have it. Investors don’t want to put their money in De Beers because of the way De Beers is currently structured and the way De Beers runs its business. Ergo. De Beers has to change its structure and the way it does business if it is going to accomplish its important strategic goal of getting the valuation of its company up to reasonable levels.

The Big Issue

While the strategic review discusses almost every aspect of De Beers in great detail, it fails to focus on the one big issue from which everything else flows. The most important strategic issue facing De Beers is how to deal with the monopoly issue. To be a monopolist or not to be a monopolist? That is the question.

As evidenced by Gary Ralfe’s interview in this magazine, De Beers has taken the position that it no longer wants to be a monopolist. When asked. "Is De Beers moving away from being a monopolist?" Ralfe answered, "Yes, very clearly."

Let us consider Ralfe’s current position. Ralfe and De Beers are to be congratulated for finally taking the enlightened position that De Beers must turn away from monopolistic behavior. There is however a rider, De Beers is no longer a monopolist because it conflicts with increasing shareholder value. My understanding of De Beers position is this: If and only if, being a monopolist is getting in the way of increasing shareholder value, then and only then, does De Beers not want to be a monopolist.

This, of course, begs the question. What if at some time in the future Wall Street falls in love with monopolists and being a monopolist adds shareholder value? Will De Beers then change direction and go back to being a monopolist? How sure are we that over the long term being a monopolist is bad for De Beers earnings? After all if the diamond market heats up globally, the value of the stockpile may increase significantly over the long term. How serious are De Beers new strategic moves? Are they short-term fixes or are they serious long-term shifts in the direction of the company?

Hopefully, De Beers will go the last mile with this very important strategic move. It will once and for all and forever get out of the monopoly business. It is time to make peace with Washington.

The problem with the strategic review and the way De Beers management is implementing it is that it is too bottom up. By this we mean that De Beers is trying to heal itself by looking at and treating symptoms. The objective of the strategic review should not be to increase shareholder value. Low shareholder value is merely a symptom of larger problems elsewhere in the company. The objective should be to change the policies of the company that result in low shareholder value.

In other words, De Beers needs to decide on a firm long-term policy position. Yes monopolist or no monopolist? They need to make a clear decision. The new objective of the company should be to maximize profits as a non-monopolist company in a freely competitive market. Frankly, if they run the business right shareholder value will take care of itself.


Fortunately, the strategic review has quite a bit to say about how De Beers can run its business better. It has played a key role in helping management focus on new strategic initiatives. Let us consider some of the lessons learned from the strategic review.

Growth. There appears to be a strong correlation between sales growth and increasing shareholder value. Therefore, If De Beers wants to increase shareholder value it should push growth. This ties in very nicely with the fact that De Beers must reduce its stockpile to improve returns on assets. It also fits in with the preferred supplier concept whereby De Beers seeks a greater share of its clients rough diamond purchases. Most importantly, the idea that De Beers should be growing sales (i.e. selling more diamonds) is good because it changes the direction of the company from being a monopolist that tries to limit sales and increase prices to a competitive free market player that focuses on increasing sales at market prices.

Marketing. The fundamental lesson is that De Beers must be a demand driven company and therefore the best way for De Beers to improve its earning and shareholder value is by growing diamond demand. The fact that the diamond industry only spends 1percent of retail sales on advertising while other luxury product industries spend about 10 percent means that there is tremendous upward potential to increase diamond demand. Our industry is spending only $500 million a year on advertising when it should be spending close to $5 billion.

The problem is that De Beers cannot do the advertising all by itself. Worldwide retail diamond jewelry sales are $50 billion while De Beers diamond sales are $5.2 billion. The challenge for De Beers is to use its leadership position to encourage the rest of the diamond industry to drastically increase advertising.

Fortunately, De Beers is in a good position to promote trade advertising. It can leverage the $200 million it already spends on advertising to encourage others in the industry to spend equal or greater amounts in co-op advertising programs.

Furthermore, De Beers can leverage prioritized access to rough to encourage greater co-op advertising and marketing activity by sightholders and its clients (see Preferred Supplier section). De Beers can also use its significant marketing and advertising expertise to help improve the efficiency of advertising and promotional activities by other firms farther down the distribution pipeline.

Finally, it can use its research resources and leadership position to identify optimal generic advertising campaigns that are likely to succeed because they are well researched. Consider the success of the diamond solitaire program and how once the product category was well established other firms focused advertising on that product category. The same thing is about to happen with the three stone ring program.

While discussion of the strategic initiative regarding branding is premature because De Beers has not yet completed its review, we should point out that De Beers’ branding has the potential to unleash tremendous advertising and promotional resources industry-wide. Consider what would happen if De Beers pushed its diamond brand reallyl hard. Obviously, other diamond firms that did not have the De Beers’ brand would be compelled to introduce and support their own brands with significant advertising. The competition among brands would significantly increase overall diamond advertising. While some firms might think that they are wasting advertising dollars on unnecessary competitive advertising, in fact the net effect of all the “extra” advertising is that diamond market share would grow and everybody would be a winner.

There is a lot to be said for De Beers use of its brand not only to sell more De Beers diamonds but also to promote brand competition within the diamond industry. In fact, we are already seeing the beginning of brand wars within the diamond industry as highly capitalized internet startups do battle to gain market share.

Preferred Suppliers. The underlying concept is that clients are valued customers who need to be dealt with as buyers in a competitive market. Customers that must be assured a reasonable level of profits. Customers that deserve to be serviced. Customers that are entitled to enjoy enhanced value from their relationship with De Beers because they are stakeholders.

Since De Beers is now being so nice to its sightholders, or should we call them stakeholders, it is only natural that it will want something back in return. Here’s the deal. In the new demand driven world of the CSO, sightholders are not merely efficient manufacturers that are able to use the qualities of diamonds that the CSO has available for sale. Sightholders, are now “distribution partners” charged with the task of driving significant additional demand for CSO goods. You are not only going to have to know how to cut the diamonds, you are going to have to become experts in finding and promoting sophisticated and innovative ways to sell the goods. You will be expected to increase demand for the diamonds you cut by creating your own “distribution partnerships” with your polished customers.

De Beers wants its sightholders to hit home runs. Not singles and doubles that leave the polished out in the field. De Beers doesn’t want diamonds floating around in the marketplace putting downward pressure on prices. De Beers wants every stone to have a home. The CSO wants to shorten the diamond pipeline.

In return for hitting home runs, sightholders will get improved purchasing and sorting arrangements. They will be able to sign up for Planned Production Performers (PPP) programs that provide guaranteed supplies of select qualities of rough whenever they want them over the year. No more wondering what the next sight will bring, you can plan your production and marketing. You can use the added value that comes from consistent supplies to grow demand for diamonds. The CSO will also try to sell you more of the goods you need. No more running around the market desperately searching for goods because the people at the CSO say they will only sell you half of what you need. And guess what, the CSO won’t even charge you higher prices for all the extra value they are giving you in terms of guaranteed availability. If you have the right kind of polished customers that “drive demand,” buying rough diamonds from the CSO may be a very pleasant experience.

The Preferred Supplier and the PPP programs are good because they allow diamond manufacturers to optimize their diamond purchasing methods while limiting the ability of the CSO to micromanage the markets through the manipulation of the quantity and quality of rough they sell at select sights. These programs distribute more power to the participants in the competitive markets.

There are, however, a few problems. The CSO might be introducing inefficiencies into the marketplace by forcing less than optimal levels of vertical integration. It might be asking its manufacturing sightholders to do too much. After all why should a firm that is a world-class expert in diamond manufacturing also be expected to be a world-class expert in diamond marketing? Would it be efficient for the CSO to select a few marketing experts from Madison Avenue and expect them to become expert diamond cutters?

It is likely that a certain level of specialized expertise is necessary for the optimization of polished diamond distribution and pricing. While it is admirable that the CSO is now enlightened enough to address the legitimate needs of its clients, this should not come at the cost of the CSO using its market power to enforce a less than desirable level of vertical integration onto the markets. One would expect that efficient and competitive markets for polished diamonds would provide optimal merchandising and distribution facilities.

There is also concern that if the CSO pushes vertical integration too hard it will have a detrimental impact on the overall efficiencies of the polished markets. We would not want to see De Beers setting up a scenario where they have obtained undue market power over the polished markets. While there is nothing wrong with a diamond manufacturer selling direct to retailers or even consumers, it is not likely that such vertical market integration will increase the overall level of diamond demand or even diamond pricing. Vertical market efficiencies are often constrained by the need for specialized service, merchandising and marketing expertise.

Fortunately, there are solutions. The CSO should indeed promote downstream advertising and marketing initiatives to grow diamond demand. This is a natural and highly beneficial function. There is nothing wrong with providing better terms to sightholders that are able to increase demand due to enhanced consistency of supply. However, the CSO in its new-found role as competitive market maker, should be extremely careful not to use its sizeable market power in the rough markets in a way that disrupts the flow of diamonds through the polished markets. The idea is to push marketing without controlling how clients distribute their polished.

Core Assets

When De Beers set out to develop its strategic plan they defined a number of “core assets” that were to be maintained or enhanced under any strategic scenario. These core assets included;

• The mystique, image, and perception of diamonds as a store of value;

• Leadership position of De Beers and relationships with sightholders;

• Southern Africa production and government partnerships;

• De Beers diamond knowledge and expertise potential;

• Latent potential of the De Beers Brand.

At this stage we would suggest adding: the potential to establish De Beers as a free market competitive player in the diamond industry.

Market Maker

Assuming De Beers has decided the “to be or not to be a monopolist?” question in an affirmative manner, the next critical question is how can De Beers become“not a monopolist?” After all, De Beers is a major economic force in the rough diamond industry. How can it go about its business of optimizing legitimate free market profits without disturbing competitive market forces?

Let us consider a quote from Gary Ralfe’s interview "We are seeing a transition in the business of De Beers and the CSO. We are moving away from a supply control business to a demand driven business."

There are a few important ideas in this quote. The first idea is that De Beers is exiting the “supply control” business. This means that De Beers will no longer be buying up diamonds from the open markets with the intention of controlling the availability or price levels of diamonds that are sold on the open market. It also means that De Beers will not be selling diamonds into the diamond market with the intention of controlling other competitive sellers. In other words De Beers could conceivably take a neutral non-interventionist stance regarding the supply and pricing of diamonds in the open market. Perhaps, De Beers could agree not to buy any outside diamonds at all. Theoretically these markets could then do their own thing

The second idea is that De Beers will be “demand driven.” This implies that De Beers will set the quantities and prices for the diamonds it sells based on demand. Such demand being influenced by other sellers of diamonds. Perhaps De Beers would also agree not to use its market power to force buyers to buy its diamonds. In other words, sightholders could choose not to buy without losing the opportunity to buy again.

The third idea is that Ralfe used the phrase “demand driven” and not “demand controlled” business. This implies that De Beers will not seek to control the demand for diamonds. It would, of course, promote and encourage demand but it would not use its market force to control the flow of polished diamond in the open markets.


The picture one gets is that De Beers is well on its way to becoming an acceptable free market player. The implementation of its strategic review presents opportunities for the company to reshape its future role in the diamond industry. Many of the changes suggested by the strategic review are consistent with the adoption of policies that could help establish De Beers as a competitive free market company. At this time it is clearly in De Beers overall strategic interest to fully explore the possibility of adopting a competitive market model.

Overall, the implementation of the De Beers strategic review will have a beneficial impact on the diamond industry. De Beers shift away from “supply control” will enable easier access to rough diamonds by open market buyers. Furthermore, over the medium term, rough diamond prices will be more in-line with polished diamond prices as De Beers seeks to ensure reasonable profit margins for its clients and outside market forces are allowed to compete in the markets without intervention by De Beers.

De Beers shift towards “demand driven business” will help the diamond industry by increasing the overall level of diamond demand. It will stimulate and empower the diamond and jewelry trade by encouraging them to take on a more proactive role in the advertising, marketing and promotion of polished diamonds.

As De Beers eases up on its control of the diamond markets the diamond industry is entering a new era of prosperity and opportunity. Increasingly, the state of our industry will rest upon the free competitive markets and the ability of the trade to innovate and meet competitive market challenges head on. While De Beers has had, and will continue to have significant impact on our industry, it is becoming increasingly obvious that the future of the diamond industry is open and free.
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Tags: Angola, Argyle, Consumers, De Beers, Government, Jewelry, Manufacturing, Production, Russia, Sightholders, Sights
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