Q1. The information in exhibit 1 shows that the inventory strategy remains constant regardless of CSO sales performance and overall profit from operations. This strategy helps De Beers effectively manage demand and prices. Furthermore, the exhibit highlights that during the bust in the 1980s, inventory levels were significantly higher than both OP and CSO sales, indicating a low point for De Beers.
Q2. Please give a brief summary of the recent cycle of boom and bust.
During the 1970s, the diamond market faced a period of volatility with inflation causing speculation and hoarding of rough diamonds. However, this bubble eventually burst due to high interest rates and declining retail demand leading to bankruptcy for many industry players. Consequently, producer countries reassessed their ties with De Beers’ CSO which resulted in the growth of the diamond market’s economic pie.
Q3. Please provide a brief discussion of De Beers and the issues that need to be resolved. Throughout the majority of the 20th century, De Beers managed to maintain control over the worldwide production of uncut diamonds through political tactics, coercion, and their substantial purchasing power. However, the CSO (Central Selling Organization) began to lose control over nations that were suppliers, such as Zaire, which chose not to renew their contract with De Beers in 1981. Additionally, competition has intensified since 1980 due to the increasing number of diamond suppliers in the market.
The entry of influential players such as BHB Billiton, Alrosa, and Rio Tinto has raised doubts about the long-term viability of DeBeers’ monopoly strategy. One major challenge they face is the extensive control they must maintain to sustain their current approach. They have two options: satisfying all stakeholders continuously or controversially incorporating new processes into De Beers through vertical integration. Q4. What is the information conveyed in Exhibit 4?
Exhibit 4 showcases the extensive involvement of De Beers in arrangements and purchases in 1982, particularly through CSO. This highlights the relationships between diamond suppliers across different countries. The exhibit reveals that CSO controls 67% of the global diamond supplies, affirming De Beers’ quasi-monopsony status. Given that De Beers controls 95% of the diamond industry, it has the power to effortlessly control market prices. Interestingly, each diamond sold by De Beers incurs a commission rate of approximately 13.75%. As a quasi-monopsony, De Beers employs the strategy of conducting ten “sight” sales per year to dictate the price and quantity of diamonds sold. During these sales, around 125 to 150 privileged members are invited to CSO, leaving them powerless and without the option to accept or reject the quality and prices of the diamonds.
Furthermore, members were disallowed from engaging in negotiations or sales with retailers and were required to supply De Beers with regular updates on market conditions and inventory levels. By monitoring the demand and supply of diamonds, De Beers could ensure that clients were not secretly hoarding diamonds. In addition, De Beers performed unannounced inspections of client factories to examine their financial records, inventories, machinery, and workforce in order to determine the quantity of cut diamonds produced by clients.
Q5. Could you please provide a brief discussion on the supply aspect of the diamond industry?
CSO, the global middle-man in the diamond industry, controls the supply of rough diamonds worldwide and acquires all other diamonds. They also oversee diamond demand and have complete control over the supply chain, enabling them to establish their own market prices. De Beers vigorously promoted diamonds, resulting in a high demand for these precious stones. More than 70% of American women possess at least one diamond, and “A Diamond is Forever” emerged as a renowned advertising slogan during the 20th century, implying that diamonds represent romance, love, and commitment. Exhibit 5 provides details on diamond quality from various countries, with gemstones comprising 25% of total production. The Soviet Union contributes to 26% of world production while De Beers holds a substantial share of 46% in gem production through its mines located in South Africa, Botswana, and Namibia.
Exhibit 6 shows the changes in the CSO’s average list price since 1949. It reveals that the real prices remained relatively consistent with the baseline level over the years, while nominal prices of diamonds experienced a significant increase starting from 1973. Q7. What is the significance of a “surprise on site audit”? A surprise on site audit is one method through which the CSO asserts control over sight holders. Sight holders play a crucial role in the evaluation of important aspects of the diamond industry for the CSO.
CSO performs surprise on-site audits to obtain a comprehensive understanding of sight holders’ background and information. The purpose of these audits is to establish a trustworthy relationship with sight holders, enabling CSO to grant further approval. The surprise on-site audits serve as a preventive measure against sight holders engaging in illegal activities such as smuggling. Additionally, these audits help maintain the quality and stability of diamond prices.
Surprise on-site audits have the power to create an atmosphere of exclusivity and competition. These audits ensure that sight holders behave in a compliant manner, thus stabilizing the price of diamond parcels. Furthermore, they allow CSOs to gain an understanding of the diamond channeling segment and potential end-side customers, as a significant percentage of sight holders are involved in the diamond cutting and polishing industry.
80% of sight holders will sell their diamonds into the pipeline, and the CSO can observe this process through surprise on-site audits. The remaining 20% of sight holders, who received the largest and most valuable parcels, will sell to independent cutters in Antwerp, Tel Aviv, New York, and Bombay. By conducting surprise on-site audits, the CSO can identify potential future customers from these four cities. Based on data from 1971, exhibit 7 displays that the IMF price index was 100. Despite almost doubling from 1971 to 1983, high inflation surprisingly stimulated diamond demand and led to increased prices. This suggests that consumers not only buy diamonds for personal use but also consider them as investment goods during periods of high inflation. Investors prefer holding diamonds instead of cash, especially in sluggish economies with high inflation rates. Moreover, the United States has emerged as one of the major markets for the diamond industry.
From 1979 to 1983, the price index increased by 43%, but the increase in polished carats was only 7%. This limited supply of diamonds, combined with a high inflation and slow growth economy, leads to higher demands. In the case of the USA market, demands continue to grow due to the reduced value of the local USD currency caused by inflation. Q9 requests a brief discussion of the demand-side of the diamond industry.
De Beers/CSO holds almost a monopoly over the entire diamond market. One way to increase demand is by temporarily restricting the supply of diamonds, for instance, by purchasing most rough diamonds from various mine sites worldwide. This strategy aims to prevent competitors from buying and flooding the marketplace.
If customers refuse to buy diamonds due to their increasingly exorbitant prices, De Beers/CSO will flood the market to create the illusion of high demand and cause the diamond price to decrease. De Beers/CSO is able to set high prices for diamonds because they purchase most rough diamonds from mines worldwide and even own their own mines. In fact, they control nearly 95% of the global diamond market. During periods of high inflation and slow economic growth, purchasing and stockpiling diamonds as assets can help stimulate the demand in the diamond industry.
During the great recession, evidence shows that the demand for diamonds will decrease. However, by engaging in heavy advertising campaigns like De Beers has done with their slogan “A diamond is forever,” customers are convinced that diamonds can be purchased as a symbol of eternal love, regardless of any economic hardships. This advertising will increase the demand for diamonds, regardless of their cost.
The CSO serves as a global intermediary in the diamond industry, performing various functions that help expand the economic pie. These functions include controlling supply and demand. The CSO controls a significant portion of the world’s rough diamond resources by owning mines and purchasing rough diamonds from major diamond-producing nations.
CSO, the diamond industry’s governing body, maintains high prices by strategically managing the availability and perception of diamonds. By controlling the flow and quality of diamonds on the market, CSO creates an image of exclusivity and rarity. Additionally, CSO successfully promotes diamonds as symbols of enduring love and romance, solidifying their importance in engagement and wedding ceremonies.
CSO exercises control over the sorting, grading, and pricing of rough diamonds. Using the four Cs criteria, rough diamonds are categorized into different grades. The CSO then assigns a value to each diamond based on its weight and grade, establishing a list price.
CSO’s distribution strategy involves a tightly regulated selling process known as “sight.” Through this process, all rough diamonds are sold to cutters and dealers who eventually sell them to consumers. CSO’s dominant market presence and ownership of the majority of rough diamond resources allows them to maintain a monopoly in the diamond industry. This ultimately enables CSO to expand its economic influence while also having control over diamond prices, which they can manipulate and determine to their advantage.
Q11. Why has the CSO achieved greater success in the diamond industry compared to OPEC in the oil industry? Both organizations aim to provide stability and fair returns to their respective industries. However, the CSO has been more successful in the diamond industry because the price of diamonds from 1968 to 1982 (refer to exhibit 6 in the case) consistently rose compared to crude oil (as shown in the graph below). Q12.
How is the economic pie distributed among the players in the diamond industry? The players include mine operators in South Africa, Soviet Union, Zaire, Botswana, and Australia, among others. De Beers, the monopolistic producer in the diamond industry, sight holders, cutters, dealers, jewelry manufacturers, and retailers. The CSO, the key player in the diamond market that determines prices and supply, receives the largest portion of the economic pie along with De Beers. The monopolistic policy enables CSO to distribute the economic pie among the players.
The markup on diamonds varies among players. Cutters have a markup of 20%, dealers have a markup of 10%, jewelers have a markup of 50%, and retailers have a markup of 100%. The CSO also requires commissions to be paid. Soviets pay a commission of 10% due to the high quality and value of their diamonds, while Zaire and other players pay a commission of 20% because their diamonds are of lower grade. However, mine operators from Zaire and Australia opposed market regulations by the CSO and opted to sell rough diamonds on the open market in hopes of obtaining better prices and freedom from price and operational control.
Exhibit 8 reveals that the CSO list prices are consistently increasing, while prices for one-carat and half-carat polished diamonds are skyrocketing during the period when diamonds were being traded as a stable currency. However, when the bubble burst due to higher interest rates, numerous players faced bankruptcy, causing prices on the “secondary” diamond market to fall below the CSO list prices. This significantly harmed De Beers’ monopolistic strategy.
In 1981, the prices of half-carat diamonds were higher than those of one-carat diamonds. This can be attributed to people considering half-carat diamonds as a more affordable option and choosing to purchase them during economic downturns. Consequently, there was an increase in demand for half-carat diamonds, causing their prices to decline at a slower rate compared to one-carat diamonds and resulting in higher costs. Exhibit 9 clearly illustrates the significant impact of the downturn on De Beers’ balance sheet.
Under assets, there is a noticeable decrease in Cash levels, while other current and fixed assets are steadily increasing. Diamond inventory has nearly doubled every year from 1978 to 1980. Additionally, there is a clear correlation between the expanding inventory levels and the simultaneous increase in investments, indicating a stockpile strategy during the bust period. On the other hand, liabilities have also grown substantially. Although current liabilities and long-term debt have been managed to respectable levels by 1982, it has become necessary for the first time to increase short-term borrowings.
The equity of De Beers has significantly increased due to the expansion of their assets, namely inventory and investments. However, it is evident from the income statement that the company is facing challenges. Over a span of 5 years, CSO sales and operating profits have both declined. This has led to a decrease in PAT from 863 million USD in 1978 to 218 million USD in 1982, representing a decrease of approximately 75% since Q15 of 1978. Despite their advertising campaign, the price of diamonds continues to decrease. This raises the question of whether the advertising campaign is effective for De Beers.
No, De Beers cannot conclude that the advertising is ineffective. Market conditions, as seen during the bust, can create a secondary market. It is difficult to measure the impact of a campaign during a crisis because it requires comparing two identical markets – one with the campaign and one without. Q16. Why does De Beers continue purchasing something it can’t currently sell? As part of their monopolistic strategy, they need to maintain high diamond prices. This requires the CSO to keep buying diamonds in hopes of future payoff when the diamond market recovers.
In summary, CSO’s strategy of stockpiling serves as the foundation for manipulating prices through supply control. Discontinuing this approach would likely lead to long-term disadvantages. These drawbacks entail a rise in market participants, potentially causing an oversaturation of the market and subsequently driving down prices, reducing the value of De Beers’ current inventory. Corrective measures are necessary, such as collaborating with dealers to extend control and seeking new investors to obtain the cash required for inventory management.
