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The End of a Monopoly

May 31, 2001 5:32 PM   By Martin Rapaport
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The diamond industry is undergoing a period of fundamental change and challenge. While the attention of the trade is naturally focused on the short term implications of the softening U.S. economy and resultant increase in inventory and debt levels, structural changes in De Beers’ supply side of the diamond equation and a repositioning of marketing and distribution strategy by De Beers sightholders are setting the stage for fundamental changes in the diamond industry. Many in the diamond trade are concerned about their future. We are being challenged by new developments that are highly complex and beyond our control.

The changing role of De Beers in the diamond industry is an area of primary concern to the trade. De Beers position as the primary supplier of 65 percent of the world’s rough diamonds is but one aspect of the company’s influence and importance. The development of a competing De Beers consumer brand and its new “Supplier of Choice” (SOC) program that will allocate rough diamonds to sightholders based on their ability to develop downstream target marketing channels that bypass the traditional diamond distribution system have alarmed many in the trade. The European Commision’s (EC) investigation of the De Beers branding and SOC initiatives have increased uncertainty about what the company can or will do in the future. Finally, Oppenhiemer’s takeover and privatization of De Beers today raise questions about the ability of De Beers to maintain stable rough pricing.

Obviously, the De Beers situation and its impact on the diamond industry is more than a bit complicated. Since De Beers’ specific programs have been well covered in previous Rapaport articles (available at Diamonds.Net — the New De Beers section) we will present a summary analysis of the new De Beers.

Today’s takeover and privatization of De Beers is a historic event in the 102- year history of the company. De Beers will be owned by a consortium (40 percent Oppenheimer family, 45 percent Anglo American and 15 percent Debswana — the joint venture between De Beers and the government of Botswana). Nicky Oppenheimer, who remains in control of De Beers management, has told RDR that the policies of the new privatized De Beers will be unchanged. De Beers will be going forward with its branding and

SOC initiatives.

No Money For Monopoly

The big story about the new De Beers is not its policy intent, but rather its financial muscle. In one fell swoop De Beers goes from a public company with over $11 billion in assets to a private company $3.6 billion in debt. Any thoughts that you have that De Beers is the custodian of the industry just went out the window. The simple fact is that De Beers no longer has the money to play monopoly. De Beers has just made an irrevocable move that supports the new policy they adopted over a year ago: the custodian of the market policy is being replaced with Supplier of Choice (SOC).

So where does that leave the trade? What is the new policy of De Beers? We believe that barring any extraordinary circumstances De Beers will stick to its sales projections of $4.8 billion this year. But what about the weak market conditions? Actually, it is really quite simple. If market conditions remain weak, De Beers has two choices. It can reduce the amount of goods it sells or it can lower prices. Guess what? At the beginning of last year De Beers did lower prices. In the opinion of this writer, De Beers will pursue a policy of selling relatively fixed amounts of rough over the year. If that means diamond prices go down, so be it.

The price of not being a monopolist, of not increasing your inventory, of selling through your production, of being a private company is that you no longer control prices. In other words, we expect rough diamond prices to fluctuate based on demand and supply with very little intervention by De Beers. Of course, if there is a threat of a major market collapse, De Beers would do what any commodity company in a leading position would do — reassess the situation and perhaps hold off on some sales for the short term. But make no mistake about it, the future of rough diamond pricing is demand driven.

Supplier of Choice

The De Beers SOC initiative is designed to help De Beers move its rough at better than market prices. It is also designed to rationalize and prioritize De Beers rough allocation policies. The impact of SOC on the diamond trade is quite extensive. Essentially SOC requires sightholders to sell their diamonds through well defined distribution channels that avoid placing polished diamonds in the open marketplace. This not only means that sightholders have to come up with innovative direct channel marketing programs, it also means that they can’t target their polished to open markets. If you happen to be a small dealer buying polished in the open market, too bad, you probably aren’t going to find the goods. On the flip side if you are a sightholder and have a great way to sell your polished to retailers then you are in. After all, why should sightholders trying to make “better” prices from retailers have to compete against open market competitors that do not “protect or defend” the diamond prices. Now come this July, De Beers is supposed to implement its new SOC program and publish a very nice directory listing exactly who is and by default who isn’t a sightholder. Clearly this has created quite a bit of anxiety among sightholders. De Beers will be publicly deciding who will be in and who will be out.

Now to most folks the idea of someone deciding who is in and who is out might seem unfair, particularly if they control 65 percent of the distribution. Add to that the notion that they will be reducing the availability of diamonds on the open, free and fair competitive markets. The simple fact is that if SOC goes through, the little guys who depended on De Beers rough, or resultant polished, will be history. And so the big question of fairness enters the equation. Is De Beers’ new SOC initiative unfair? Anti-competitive? Illegal?

EC Me

To De Beers’ credit, it decided to find out. De Beers asked the European Commission (EC) to issue a ruling on whether its new SOC program was in compliance with EC laws. Not surprisingly, the EC decided to investigate the matter. Essentially, De Beers will be going ahead with SOC subject to the guidelines that will be provided by the EC. De Beers has found itself a rabbi in the form of the EC. The EC will tell De Beers how to do SOC in a legal and hopefully fair manner.

The key to understanding all this is to recognize that SOC is not a fete accomplis; it is a work in progress. July is not the end of the SOC process but rather the beginning of a new long term De Beers initiative.

Incorporated into this process are many factors, one of which happens to be an EC investigation that will help define the process. Those who think the EC investigation will delay SOC long term are mistaken. De Beers might delay SOC until August when results of another EC investigation into the De Beers consumer brand are made available. Unless the EC asks it to, De Beers is unlikely to delay it much longer. The EC process may take years during which De Beers will be operating in compliance of the law and may be getting guidelines as to how to legitimize and legalize the SOC process.

While SOC is the boogeyman of the wholesale trade, the new De Beers consumer brand is the boogeyman of the retail sector of our industry. Many retailers are afraid that they will not be able to compete successfully against a De Beers consumer brand. Since the De Beers brand is a joint venture with another large company LVMH, EC approval was required. After an initial investigation the EC decided upon a stage two investigation into the matter. The deadline for the EC’s decision on the matter is August 28. It is hoped that the EC decision regarding the De Beers brand will ensure that the legitimate interests of the diamond trade and consumers are well protected. As the decision will reflect on the role of De Beers in the diamond trade it is reasonable to expect that De Beers might delay implementation of the SOC initiative until September.

Undoubtedly, the fact that the EC will rule on De Beers plans with regard to SOC and the De Beers brand is good news, for it introduces an element of control by an independent third party into what is essentially a public policy issue. The industry is entitled to fair play from De Beers and De Beers is entitled to grow without unreasonable constraints. For all too many years decisions about what De Beers could and could not do were swept under the rug by governments more interested in big business than fair play. While the diamond industry in general and sightholders in particular often benefited from De Beers market control they also paid a high price when De Beers exploited the trade by taking away profits.

A New Beginning

Now that De Beers has entered upon the slippery slope of legal legitimization, a new process of competitive market prioritization will take place. EC compliance regarding branding will bring about EC compliance regarding SOC. A strategic review designed to deal with low share prices has evolved into a strategy that has taken De Beers out of the monopoly business. The issue isn’t how fair or good De Beers is today but rather the direction De Beers is heading in.

The privatization of De Beers, introduction of the SOC initiative, and De Beers requests for EC compliance seem contradictory and problematic. In fact, they mark a new beginning not just for De Beers, but for the diamond trade. A new non-monopolistic De Beers that pursues pro-competitive marketing initiatives subject to the control of independent government agencies might be just the thing that the diamond industry needs to grow and prosper.

Today marks the end of the De Beers monopoly. Let us hope that it also marks the beginning of a new more enlightened De Beers that uses its size and importance to promote its own interests and the interests of the diamond industry through the expansion of free and fair competitive trade practices.
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Tags: Anglo American, Compliance, Consumers, De Beers, Debswana, Economy, Government, LVMH, Production, Sightholders
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