Q1. What does exhibit 1 tells us? First of all, it tells us that the inventory strategy is consistent regardless of how CSO sales and overall profit from operations perform. This strategy was launched so that the De Beers could control demand and prices. Evidently it also shows that the 1980’s bust is a low peaking point for De Beers, as inventory levels for the first time is significantly higher than OP and CSO SALES. Q2. Please briefly talk about the recent boom-and-bust
The 1970s were a turbulent time for the diamond market, which saw the growth of inflation that led to speculation and hoarding in the rough diamond market. Eventually, the drastic increase in interest rates to the diamond trade coupled with falling retail demand burst the diamond bubble, which led many industry players to go bankrupt. As a result, several producer countries were reconsidered their relationship with De Beers’ CSO, also leading to the expansion of the economic pie of the diamond market.
Q3. Please briefly talk about De Beers and the problems to be solved. For most of the 20th century, maintaining control of world rough diamond output was possible through political or coercive means, or through their raw buying power. However, the CSO eventually started losing control of supplier nations, for example Zaire, who in 1981 decided not to renew its contract with De Beers. Since 1980, competition also increased due to the growing number of diamond suppliers on the market.
The appearance of these powerful actors, including BHB Billiton, Alrosa and Rio Tinto eventually called into question the continued feasibility of DeBeers’ monopoly strategy. In general their biggest problem is the enormous amount of control that they have to assert in order to keep their current strategy. By aiming to, constantly satisfyieing all stakeholders or controversially begin to vertical integrate new processes into the De Beers. Q4. What does Exhibit 4 tell us?
Is De Beers a quasy-monopsony (single buyer)? When looking at exhibit 4, it illustrates the high intensity of arrangements and purchases that De Beers were involved in 1982 with CSO’s arrangements and purchases and the relationship between the diamond suppliers in different countries. When analyzing the exhibit, CSO controls 67% of the world’s diamond supplies and it could be said that De Beers is considered a quasy-monopsony because it controls 95% of the diamond industry, which enables them to effortlessly ontrol market prices. In addition, we learn the commission rate for each diamond sold by De Beers is around 13. 75%. As a quay-monopsony, De Beers’ control tactic of supply is by selling diamonds 10 times a year at ‘sight’ to determine at what price and how many diamonds are sold. Each time around 125 to 150 exclusive members were invited to CSO to purchase diamonds, where they were powerless and had no choice to accept or reject the grade of diamond and the prices.
Furthermore, members were not allowed to negotiate or sell to retailers, and were required to update De Beers with information on market and inventory levels. By auditing the demand and supply of diamonds, De Beers could make sure that clients are not secretly overstocking diamonds and made un-announced visits to client factories to check their financial records, inventories, machinery, and employees hired to calculate how many cut diamonds clients are producing. Q5. Please briefly talk about the supply-side of diamond industry.
When discussing the supply of the diamond industry, CSO is the global middle-man which controls rough diamond supplies and buys out all other diamonds found around the world. Apart from monitoring the demand of the world’s diamond, they also control the supply chain, which gives them full control to set their own equilibrium market prices. As for the demand of diamonds, they were very high due to the heavy advertising made by De Beers, which was advertised everywhere from movies, magazines, and over 70% of American women own at least one diamond. A Diamond is Forever’ was the best advertising slogan of the 20th century and it portrayed that diamond was a symbol of romance, love and commitment. Q6. What do Exhibit 5 and 6 tell us? Exhibit 5 portrays the different diamond production characteristics in terms of quality produced by different countries. Gems account for 25% of total diamond production. The Soviet Union demonstrates that they are a major producer by producing 26% of world production, but De Beer still has a significant amount of 46% of total gem production, where they own South Africa, Botswana and Namibia mines.
Exhibit 6 summarized the evolution of the CSO’s aver list price since 1949 and indicates that over the years, while real prices sustained a rate that was relatively close to the baseline level, but nominal prices of diamonds increased dramatically starting from 1973 and onwards. Q7. Why “surprise on site audit”? Surprise on site audit could be seen one of the many ways that CSO has full control of sight holders. • Sight holders play an important role for CSO to judge important aspect of diamond industry.
CSO conducts surprise on site audit in order to understand the full background/information of sight holders. In this case CSO can give further approval to these sight holders based on trustable relationship built up from surprise on site audit. • To prevent sight holders from acting with illegal activity. Surprise on site audit can ensure that sight holders themselves are running regular business activity instead of further opportunities of crime, such as smuggling. • Maintain the quality and stability of diamond prices.
Surprise on site audit, this kind of activity can create a atmosphere of “elite and competitive selection”. By doing Surprise on site audit, CSO can make sure sight holders they have chosen will behave with higher degree of compliant. Due to price of diamond parcels is not negotiable by sight holders, this will further stabilize the diamond price. • Understand the diamond channeling segment and further potential end-side customers. Due to almost 80% of sight holders are in diamond cutting/polishing industry.
These 80% of sight holders will then sell their diamonds into pipeline. Surprise on site audit can enable CSO to witness the process of above. The remaining 20% of sight holders, who were given the largest, most valuable parcels, will sell to independent cutter from Antwerp, Tel Aviv, New York, and Bombay. By conducting surprise on site audit, CSO can peek what are future potential customers are from these 4 cities. Q8. What does exhibit7 tells us? Take year 1971 as reference data, IMF price index is exactly 100. From year 1971~1983, even though price index keeps increasing almost twice, high inflation surprisingly stimulate the demand of diamond to soar even the price goes up. This shows consumers may not only purchase diamonds for own usage, but also treat diamonds as investment goods and hold them as asset inventory whenever high inflation occurs. Investors rather to hold diamonds than cash especially during high inflation, slow growth economy. • USA becomes one of the most demanding countries for diamond industry.
• During year 1979~1983, price index increase 43%, however, polished carats only increase 7. %. During high inflation, slow growth economy, limited supply of diamond will result in higher demands, as we can see that for USA market, demands keep growing, since inflation already result in less value of local USD currency. Q9. Please briefly talk about demand-side of diamond industry. • De Beers/CSO almost has monopoly of control over entire diamond market. Demands can be raise up by temporarily limit the supply of diamond, such as buying/purchasing most rough diamonds from mine sites all over the world. To prevent the other competitors from buying and flooding the marketplace.
If customers refuse buying diamonds due to increasingly reticules price, and then De Beers/CSO will flood the market place to simulate the demands, and diamond price will drop. • Because De Beers/CSO keep buying/purchasing most rough diamonds from mine sites all over the world, and further more invest/self-own mine site, De Beers/CSO can arrange high diamond list price. To sum it up, De Beers/CSO has controlled almost 95% of world-wide diamond demands. • During high inflation, slow growth economy, purchase diamonds and keep as assets inventory will stimulate the demands of diamond industry.
However, evidences show during great recession economy, demands of diamonds will slump. • By heavily advertising, such as what De Beers has done, “A diamond is forever” will give a image to customers that no matter what happen, diamond could be purchased for your love ones as symbol of being forever sign. Advertisement above will stimulate the demands of diamonds no matter how much diamonds cost. Q10. What functions does the CSO perform as a global intermediary? How do these functions help expand the economic pie in the diamond industry? As a global intermediary, CSO performs following functions: Control supply and demand: CSO controls the majority of rough diamond resource in the world through owing mines and buying rough diamond from several major diamond-producing nations.
By adjusting the quantity and mix of diamonds flowing to the market, CSO creates a “rare goods” image for diamond and maintains the price at high level. In addition, by advertising diamond as the symbol of romance and everlasting love, CSO successfully shapes diamond as a necessity in engagement and wedding. • Control sorting, grading, and pricing of rough diamond: CSO sorts rough diamond into ifferent grade on the basis of the four Cs criteria. After sorting and grading, the diamond is then valued, based on its weight and grade, by the CSO list price. • Distribution: CSO built a highly controlled selling routine called “sight” which sells all the rough diamonds to cutters and dealers further down on the road toward the consumer. CSO creates a monopoly power in the diamond industry while it owned virtually all rough diamond resource in the world. Furthermore, CSO expand its economics pie to the greatest extent while diamond price can be maintained or even manipulated and determined by CSO.
Q11. Why has the CSO been more successful than, say, OPEC in the oil industry? OPEC is dedicated to providing a stable petroleum market, with steady supplies to consumers, reasonable prices and fair returns to investors in the oil industry. CSO has the same aims in the diamond industry. The CSO is more successful than the OPEC in the oil industry because the price (real and nominal) of diamond in the year 1968-1982 (see exhibit 6 in the case) had been steadily increased as compared to the crude oil. (see below graph). Q12.
How does the expanded economic pie end up getting divided among the various players in the diamond industry? Players in diamond industry are as following: • Mines operators in South Africa, Soviet Union, Zaire, Botswana and Australia, etc. -De Beers, the single producer having monopoly in diamond industry – Sight holders – Cutters – Dealers – Jewelry Manufacturers – Retailers CSO is the key player in the diamond market, the one that sets the price and supply parameters. Therefore, biggest piece from the economic pie goes to CSO and De Beers. Monopolistic policy allows CSO to divide economic pie among players.
The rest of players have a certain range of markup on the diamonds. (Cutters Markup = 20%, Dealers markup = 10%, Jewelers markup = 50%, Retailers markup = 100%) In addition, CSO commands that Soviets paid 10% commission due to high quality and high value diamonds, and Zaire and other players paid 20% commission due to lower grade of diamonds. However, the mine operators from Zaire and Australia fought to market rough diamond on their own in the hope that they could do better for themselves on the open market without being regulated on price and operation by CSO.
Q13. What does Exhibit 8 tell us? It shows us that the CSO list prices are steadily growing, meanwhile prices on polished prices: one-carats and half-carats are exploding during the years where diamonds were speculated in as a source of stable currency. When the bubble suddenly cracked due to higher interest rates, many players went bankrupt and made the prices on the “secondary” market of diamonds fall below the CSO list prices, damaging the monopolistic strategy of De Beers significantly.
What is also noticeable is that the prices on half-carat exceeds the one-carat prices in 1981. This might be because that it is perceived as a cheaper item, and in the years of slowdown in the global economy bought as a cheaper substitute. This increasing demand did made the prices fall slower than the one-carat and consequently made it more expensive. Q14. What does exhibit 9 tell us? Exhibit 9 shows us that the bust is greatly affecting the balance sheet of De Beers.
Under assets it is seen that Cash is running very low, other current- and fixed assets are steadily growing, diamond inventory almost doubled up every year from 1978 through 1980, lastly the investments has increased rather simultaneously with the expanding inventory levels which gives us a clear association with the stockpile strategy during the bust period. Liabilities has also grown significantly, current liabilities and long-term debt is being managed back to respectable levels in 1982, however for the first time it has been necessary to increase short-term borrowings.
Equity has also increased significantly due to the huge expanding in assets: inventory and investments. It also becomes clear when looking at the income statement that De Beers are suffering. In 5 years CSO sales and operating profits have fallen from 2552 million USD to 1257 and from 1100 million USD to 265 respectively. This is affecting PAT from being 863 million in 1978 to 218 million in 1982. Approximately 75% decrease since the 1978’s Q15. The price of diamond keeps decreasing in spite of her advertising campaign, can De Beers conclude that the advertising campaign is not effective?
No, De Beers cannot conclude that the advertising does not work. As market conditions, as seen during the bust is a factor that allows a secondary market to emerge. It is in fact extremely hard to measure the effect of a campaign during a crisis, as it would require two exact similar markets to compare with- and without. Q16. Why does De Beers keep buying something it cannot sell now? As part of their monopolistic strategy, the price of diamonds must remain high, implying the necessity for CSO to continue buy diamonds, and hope that it in the long run will pay off, when the market for diamonds have recovered.
In conclusion, CSO’s stockpiling strategy is the basis for price manipulation (by controlling supply), and pulling the plug would probably cause disadvantages in the long run. These disadvantages include an increase in the number of players in the market that would likely result in the flooding of the market, and the driving down prices that would render De Beers’ existing inventory less valuable. Correctional efforts are required, such as downward expansion (collusion with dealers) and finding new investors to acquire the necessary cash for inventory control.