Diamonds Are Forever...and Quite Profitable Thanks to the De Beers Cartel
Over the weekend, I watched the blockbuster Leo DiCaprio movie “Blood Diamond.” The film’s back drop involves the sale of blood diamonds (diamonds mined in war zones sold to fund an insurgent’s military). While most moviegoers were engrossed in Leo’s romance with a beautiful reporter and hoping the resolute father would find his long lost family, not surprisingly...I found myself wondering about how diamond prices are set.
Many of us associate diamond prices with the notion of a cartel being run by the De Beers Group. But did you every wonder how this company operates? If so, you’ve come to the right place. De Beers has two primary business units: (1) Production and (2) Marketing and Wholesale Sales through its Diamond Trading Company (DTC) arm.
On the production front, De Beers owns several diamond mines and is a joint venture partner with several diamond producing countries including Tanzania, Namibia, and Botswana (largest producer of diamonds in the world). Every year, De Beers decides how many diamonds it wants to sell. Each producer associated with De Beers is then allocated a fixed percentage of this target goal that the DTC subsidiary will purchase. This supply “target” influences the market price for diamonds.
De Beers’ DTC unit focuses on influencing demand and manipulating supply. To stimulate demand, a few greatest hits of its marketing efforts include the concepts of “Diamonds are Forever” and spending “Two Months of Your Salary” on a diamond. To influence supply, when supply is plentiful, the DTC restricts sales and hordes excess diamonds in its vaults. Conversely, when supply is short, it releases diamonds from its excess inventory. At one point, over 80% of the world’s diamonds were sold through the DTC. Today, approximately half of the world’s diamonds are sold through this exchange.
With market share shrinking from over 80% to 50%, its share price dropping from $16 (in 1989) to $12 (1999), what’s a cartel in distress to do? Call in the Bain & Co. strategy consulting firm! In addition to its advice to measure high level employees’ performances by “key performance indicators” (an oldie but goodie in management consulting), the results of Bain’s “strategic review” are interesting. Bain advised De Beers to stop worrying about controlling the world’s diamond supply. Instead, it counseled De Beers to focus on marketing diamonds to end consumers (you and me) and solidifying relationships with the 93 customers (sightholders) who buy its rough diamonds.
Bain’s advice coupled with favorable market conditions has made life good for De Beers. The company’s stockpiles that it had accumulated from controlling prices – more than a year’s supply of diamonds – have been exhausted (according to Patrick Barta’s May 12 Wall Street Journal article titled “The New Diamond Hunters”). And while De Beers’ stock is not publicly traded, 45% of the company is owned by Anglo American, which is publicly traded. Anglo American’s stock (symbol AAUK) has risen by 54.4% in the last year (and 228.2% in the last 3 years)…pretty nice returns!
Readers' Comments on This Blog Entry
I think I understand what's happened. As De Beers lost control of supply, they used marketing to make up the difference. I wonder how the "artificial" diamond market is influencing their thoughts. There's an ad for them every month in Scientific American - prices are only 10-20% of "real" diamonds.