De Beers Diamond Cartel_v2

7/29/2019 De Beers Diamond Cartel_v2

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1. Cartels: History and Meaning

1.1 Brief history of cartels

The term cartel originated for alliances of enterprises roughly around 1880 in Germany. The

name was imported into the Anglosphere during the 1930s. Before this, other, less precise

terms were common to denominate cartels, for instance: association, combination, combine

or pool . In the 1940s the name cartel got an Anti-German bias, being the economic system of

the enemy. Cartels were the economic structure the American antitrust campaign struggled to

ban globally.

Historically, cartels have been formed in markets characterized by excess production

capacity. At one time or another international cartels have attempted to control the world

market in such commodities as steel, oil, rubber, tin, and aluminum, and in chemical products

such as linoleum and rayon-involving patents.

In the early part of the 20th century the world aluminum industry was effectively controlled

by a cartel consisting of four companies from the United States, France, Germany, and Great

Britain. At the start of World War II it was estimated that more than 30 percent of international trade was controlled by international cartels.

More recently a large number of cartels appeared in Third World countries following the

short-lived success of OPEC in the 1970s. These Third World cartels were formed in order to

establish market prices for raw materials that they produced.



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1.2 Meaning of cartels

Merriam Webster defines cartels as ―a combination of independent commercial or industrial

enterprises designed to limit competition or fix prices‖.

A cartel is formed when a group of independently owned businesses agrees not to compete

with each other in areas such as prices, territories, and production.

A cartel agreement is considered a collusive agreement in that the different parties agree not

to allow market forces to determine their pricing, production, and other business practices.

Rather, the members of the cartel agree on such matters as what price to charge, how much to

produce, and which markets to serve.

A cartel is a formal agreement among competing firms. It is a formal organization where

there is a small number of sellers and usually involve homogeneous products.

Cartel members may agree on such matters as:

o Price fixing

o Total industry output

o Market shares

o Allocation of customers

o Allocation of territories

o Bid rigging

o Establishment of common sales agencies

o Division of profits

o Combination of above.

The aim of such collusion (also called the cartel agreement ) is to increase individual

members' profits by reducing competition.

Well-known examples of cartels include the Organization of Petroleum Exporting Countries

(OPEC), the Swiss banking cartel, International Air Transport Association (IATA) and the

International Tin Council. Cartels are particularly widespread in Japan and play a major role

in many different industries there.



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1.3 Public and private cartels

One can distinguish private cartels from public cartels. In the public cartel a government is

involved to enforce the cartel agreement, and the government's sovereignty shields such

cartels from legal actions. Private cartels are subject to legal liability under the antitrust laws

now found in nearly every nation of the world. Furthermore, the purpose of private cartels is

to benefit only those individuals who constitute it, public cartels, in theory, work to pass on

benefits to the populace as a whole.

There is no evidence that public cartels are less harmful to the general good, and being

government backed, they are much more effective and, hence, potentially harmful. In the case

of public cartels, the government may establish and enforce the rules relating to prices, outputand other such matters.

Export cartels and shipping conferences are examples of public cartels. In many countries,

depression cartels have been permitted in industries deemed to be requiring price and

production stability and/or to permit rationalization of industry structure and excess capacity.

In Japan for example, such arrangements have been permitted in the steel, aluminum

smelting, ship building and various chemical industries.

Public cartels were also permitted in the United States during the Great Depression in the

1930s and continued to exist for some time after World War II in industries such as coal

mining and oil production. Cartels also played an extensive role in the German economy

during the inter-war period. International commodity agreements covering products such as

coffee, sugar, tin and more recently oil (OPEC) are examples of international cartels with

publicly entailed agreements between different national governments. Crisis cartels have also

been organized by governments for various industries or products in different countries inorder to fix prices and ration production and distribution in periods of acute shortages.

Murray Rothbard considered the Federal Reserve as a public cartel of private banks.

In contrast, private cartels entail an agreement on terms and conditions that provide members

mutual advantage, but that are not known or likely to be detected by outside parties. Private

cartels in most jurisdictions are viewed as violating antitrust laws.

http://en.wikipedia.org/wiki/Export

http://en.wikipedia.org/wiki/Rationalization_(economics)

http://en.wikipedia.org/wiki/Excess_capacity

http://en.wikipedia.org/wiki/Japan

http://en.wikipedia.org/wiki/Steel

http://en.wikipedia.org/wiki/Aluminum

http://en.wikipedia.org/wiki/Ship_building

http://en.wikipedia.org/wiki/Chemical_industry

http://en.wikipedia.org/wiki/United_States

http://en.wikipedia.org/wiki/Great_Depression

http://en.wikipedia.org/wiki/World_War_II

http://en.wikipedia.org/wiki/Coal_mining


http://en.wikipedia.org/wiki/Petroleum_industry

http://en.wikipedia.org/wiki/German_economy

http://en.wikipedia.org/wiki/Commodity_markets

http://en.wikipedia.org/wiki/Coffee

http://en.wikipedia.org/wiki/Sugar

http://en.wikipedia.org/wiki/Tin

http://en.wikipedia.org/wiki/Oil

http://en.wikipedia.org/wiki/OPEC

http://en.wikipedia.org/wiki/Murray_Rothbard

http://en.wikipedia.org/wiki/Federal_reserve

http://en.wikipedia.org/wiki/Federal_reserve

http://en.wikipedia.org/wiki/Murray_Rothbard

http://en.wikipedia.org/wiki/OPEC

http://en.wikipedia.org/wiki/Oil

http://en.wikipedia.org/wiki/Tin

http://en.wikipedia.org/wiki/Sugar

http://en.wikipedia.org/wiki/Coffee

http://en.wikipedia.org/wiki/Commodity_markets

http://en.wikipedia.org/wiki/German_economy

http://en.wikipedia.org/wiki/Petroleum_industry



http://en.wikipedia.org/wiki/World_War_II

http://en.wikipedia.org/wiki/Great_Depression

http://en.wikipedia.org/wiki/United_States

http://en.wikipedia.org/wiki/Chemical_industry

http://en.wikipedia.org/wiki/Ship_building

http://en.wikipedia.org/wiki/Aluminum

http://en.wikipedia.org/wiki/Steel

http://en.wikipedia.org/wiki/Japan

http://en.wikipedia.org/wiki/Excess_capacity

http://en.wikipedia.org/wiki/Rationalization_(economics)

http://en.wikipedia.org/wiki/Export



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1.4 The theory of Oligopoly

Oligopoly is a market condition that exists when there are few sellers. It is a market situation

in which control over the supply of a commodity is held by a small number of producers each

of whom is able to influence prices and thus directly affect the position of competitors.

The conditions that give rise to an oligopolistic market are also conducive to the formation of

a cartel; in particular, cartels tend to arise in markets where there are few firms and each

firm has a significant share of the market .

A single entity that holds a monopoly cannot be a cartel, though it may be guilty of abusing

said monopoly in other ways. As such, it is inaccurate to describe (for example) Microsoft or

AT&T as cartels. Cartels usually occur in oligopolies, where there are a small number of

sellers.

Oligopolistic firms join a cartel to increase their market power, and members work together

to determine jointly the level of output that each member will produce and/or the price that

each member will charge. By working together, the cartel members are able to behave like a

monopolist.

For example, if each firm in an oligopoly sells an undifferentiated product like oil, the

demand curve that each firm faces will be horizontal at the market price. If, however, the oil-

producing firms form a cartel like OPEC to determine their output and price, they will jointly

face a downward-sloping market demand curve, just like a monopolist. In fact, the cartel's

profit-maximizing decision is the same as that of a monopolist, as Figure 1 reveals. The cartel

members choose their combined output at the level where their combined marginal revenue

equals their combined marginal cost. The cartel price is determined by market demand curve

at the level of output chosen by the cartel. The cartel's profits are equal to the area of the

rectangular box labeled abcd in Figure 1 . Note that a cartel, like a monopolist, will choose to

produce less output and charge a higher price than would be found in a perfectly competitive

market.

http://www.cliffsnotes.com/study_guide/Cartel-Theory-of-Oligopoly.topicArticleId-9789,articleId-9779.html#duffy3241c12-fig-0004






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Figure 1 Profit maximization by oligopolistic cartel

Cartels in an oligopolistic market

o Control over market supply and prices:

A cartel is a form of formal collusive behaviour by firms usually in an oligopolistic

market where there are only handful of businesses which sell a homogenous or

standardized product. It is a collaborative agreement where firms agree to control

market supply and prices in order to jointly maximise profits.

o Market sharing:

Cartels also agree to market sharing. They often do this by dividing up different

regions to different firms within the cartel, meaning that the firm has complete market

share in the region an so there is no competition.

o Allocation of customers:

Cartels also allocate different customers to different firms within the cartel to reduce

competition

.



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Major reasons why firms in an oligopoly might enter into collusive behaviour

o If firms within an industry are in an oligopoly and enter into collusive behaviour they

act as a monopoly.

o Acting as a cartel can also stop revenue and prices from being unstable in that

industry.

o Often firms in an oligopoly benefit from being in a cartel because it limits competitive

responses that might reduce profits such as a price-war or attacking each other‘s

market share.

o Working as a group ensures maximum benefit:

When firms collude, it would be beneficial to any individual firm to expand output

and undercut others in the cartel. This however would result in all firms followingsuit; supply would rise flooding the market and price would plummet bringing a

negative result for all of the firms within the cartel.

From this we can see that collusion can often be explained by a desire to achieve

joint-profit maximisation or to try an stabilise the revenue or price in a market.

As John Nash noticed, each individual acting solely in his/her own interests does not,

as Adam Smith suggested, necessarily produce the maximum benefit.

In the case of a cartel, it would serve one firm to increase production, but, in the long-

run, the break-down of trust between the cartel-members would have a negative effect

on the industry profits as a whole. Essentially, working as a group guarantees long-

term higher profits for all.



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1.5 Interdependence and the incentive to form a cartel

As interdependence between firms is essential in an oligopoly, the field of game theory is

relevant. In fact, the firms‘ pricing strategies, when simplified, can be modelled as the game

of prisoners‘ dilemma. Let us look at the possible pricing strategies of two firms and let us

assume that there are two prices which the firms can charge for their product.

1. If both charge a high price, each will get equal market share, but relatively high

revenue due to the high price.

2. In contrast, if both charge the low price, each will get the same market share, but

lower revenue due to the low price.

3. If one charges the high price while the other charges the low price, the latter will gain

sufficient market share from the former, which is likely to generate the highestrevenue

As can be seen, charging the low price is the dominant strategy, as it is always preferable to

charging the high price, regardless of what the rival firm charges. However, due to the

symmetry of the game, the Nash equilibrium becomes the (low; low) outcome, which is

collectively worse than if both firms adopt the dominated strategy in order to reach a (high;

high) outcome.

Hence, just like how Thomas Hobbes argued that a strong state was needed to ensure

cooperation within the state of nature, a cartel is formed in order to ensure cooperation and

enforce punishment on those that will deviate from the ‗high price‘ option. Of course, if this

is successful, those that will be likely to lose out are the consumers.

Price fixing results in a situation where output is low to keep the price artificially high. This

results in a dead-weight loss of welfare for consumers because monopolies lose out on the

higher demand that exists at the lower price and consumers lose out due to the higher price.

Price fixing can be inequitable in particular for low income consumers as they may not be

able to afford these higher prices forcing them to leave the market.

This can be harmful if it occurs within an industry that provides a merit good.



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1.6 Economic and social benefits of cartels

There is a case for saying that a collusive oligopoly can bring about economic benefits toconsumers:

o Uniform market structure

Firstly, cartels results in a uniform market structure with one price and one level of

output produced. The result is greater consumer or business confidence, as

expenditure can be more easily planned.

One example of where prices were maintained relatively constant would be oil in the

1990s; where OPEC aimed to charge between $25 and $35 per barrel of oil. In doing

so, businesses requiring oil as a raw material had the confidence to make long-term

cost predictions. The ability to make such predictions often gives producers theconfidence to invest and boost the long-term profitability of the firm.

o Probable social benefits

Cartels may also provide social benefits in markets for demerit goods. In the cigarette

market for example, if firms were to collude on higher prices for tobacco, fewer

cigarettes would be ‗consumed‘ and welfare would be improved.

o Reduced costs of advertising and publicity

There is also no need for oligopolies to spend large amounts on publicity and

advertising since each firm is operating in the same way under a cartel. The result of

these higher profits mean there are more spare funds for investment and innovation,

which would ultimately benefit consumers in the long run.

o Availability of more funds for investment and research

Economist Baumol argued that oligopolies can improve their dynamic efficiency

more than other market structures. The interdependency of oligopolies under a cartel

also allows for the cooperation of research and development. There can also be joint

investment in capital and labour. The resulting decreased production costs provide

spare funds for product development.

It is possible however that there are some benefits for consumers. If firms have fixed

the price artificially high then it is likely they will see higher profits which could then





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1.7 Sustainability of cartels

In general, cartels are economically unstable in that there is a great incentive for members to

cheat and to sell more than the quotas set by the cartel. This has caused many cartels that

attempt to set product prices to be unsuccessful in the long term. Empirical studies of 20th

century cartels have determined that the mean duration of discovered cartels is from 5 to 8

years.

The problem is that cartel members will be tempted to cheat on their agreement to limit

production. By producing more output than it has agreed to produce, a cartel member can

increase its share of the cartel's profits. Hence, there is a built-in incentive for each cartel

member to cheat. Of course, if all members cheated, the cartel would cease to earn monopoly

profits, and there would no longer be any incentive for firms to remain in the cartel. The

cheating problem has plagued the OPEC cartel as well as other cartels and perhaps explains

why so few cartels exist.

For a cartel to work, members involved in the agreement must monitor other firms levels of

output. With firms not operating at their individual profit-maximising output, there is a

tendency to employ game-theoretical strategies within the cartel. If one or more firms

produce more than the agreed output in order to maximise their individual profits - which can

be done by increasing their output to where marginal cost is equal to marginal revenue - the

cartel is likely to break down, hence the almost inherent stability of these ventures

The collapse of international cartels usually follows a familiar pattern. Cartels generally

begin by establishing a price for their raw materials or other commodities that is somewhat

above their free-market value. In response to such price setting, consumers cut back on their

purchases and an oversupply of raw materials results. Soon supply exceeds demand,

especially when cartel members fail to agree to cut back production accordingly. As it

becomes clear the cartel has lost the power to enforce production quotas, it loses control and

prices fall drastically. Such a scenario occurred in the mid-1980s as oil prices plunged,

greatly reducing the power of OPEC.However, once a cartel is broken, the incentives to form

the cartel return and the cartel may be re-formed. Publicly-known cartels that do not follow

this cycle include the De Beers diamond cartel and the Organization of the Petroleum

Exporting Countries (OPEC).



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1.8 Legality of cartels worldwide

In the U.S., cartels are illegal; however, internationally, there are no restrictions on cartel

formation. The organization of petroleum-exporting countries (OPEC) is perhaps the best-

known example of an international cartel; OPEC members meet regularly to decide how

much oil each member of the cartel will be allowed to produce.

Such collusive agreements are illegal in the United States under antitrust laws contained in

the Sherman Antitrust Act of 1890, the Clayton Antitrust Act of 1914, and the Federal Trade

Commission Act of 1914. This body of legislation, known as the antitrust laws, made illegal

such practices as restraint of trade, price discrimination, tie-in contracts, acquisition of

competitors, and interlocking directorates. These practices were declared illegal only "where

their effect may be to substantially lessen competition or tend to create a monopoly."

In Japan formal and informal national cartels are accepted as part of doing business there.

Operating under a system of managed competition with a great deal of government guidance

and intervention, Japanese cartels enjoy acceptance in industries ranging from agriculture and

banking to beer manufacturing and barbering. One example is Nokyo, a national umbrella

group under which a huge agricultural cartel operates. Because of Nokyo, Japanese

consumers pay a much higher price for homegrown rice, for example, than rice sells for on

the world market. Nokyo serves to keep out imports, not only in rice but also in farm

equipment and supplies. In Japan, cartels are permitted by law, and many of them are

supervised by the government.

In Europe, national monopolies in industries such as telecommunications, postal service, air

transportation, and energy are in the process of being deregulated by the European Union.

With government support these European cartels flourished in a noncompetitive environment,

dividing up markets and agreeing not to compete with one another. Competitive pressures

from business and the globalized economy, however, have resulted in a European effort to

open these industries to outside competition.



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Examples of where cartels have been exposed and broken up by the competition authorities in

the UK and Europe

o Beer cartel

In 2007, Heineken, Grolsch and Bavaria were fined 273m Euros for operating a cartel in

the Netherlands. The European Competition Commission stated that the brewers had

exchanged ideas and ‗illegal agreements‘ artificially driving up prices for distributors of

the products, e.g. pubs, supermarkets and restaurants.

o Air Cargo Cartel

Following a three year investigation, British Airways was found guilty of participating in

an air cargo cartel. In consequence, the airline was fined £90 million by the European

Commission. The UK signature airline was found to have rigged fuel surcharges before

extending its ―co-operation by introducing a security surcharge‖. British Airways was one

of eleven airlines attracting charges amounting to €799 million.

o Recruitment Agency Fee Fixing

In September 2009, the Office of Fair Trading for price-fixing in the construction industry

fined six recruitment agencies a total of £39.3 million. The cartel was exposed by two

firms who were offered immunity in return. The recruiting agencies involved included the

likes of A Warwick Associates, Hays Specialist Recruitment (fined over £30 million) and

CDI AndersElite. Hays complained its fine was ―disproportionate‖ but its grounds for

appeal were unfavourable. The cartel was known as the Construction Recruitment Forum

and met five times between 2004 and 2006.

o Banking collusion

RBS was fined £28.6m for revealing its loan pricing plans to one of its biggest rivals,

Barclays. Regulators suggested that Barclays used the information to price its own loans,

acting against the interests of consumers.

o In Tokyo, four electric cable companies were fined 10.84 billion yen for working as a

cartel and fixing their prices breaching the antimonopoly law. It has been shown that the

five firms dominated the market for cables in Japan and had been fixing the price between

2005 and 2009.

o Pioneer foods in South Africa was a firm fined for participating in cartel activities. The

firm was fined 1 billion rand for fixing the price of bread, flour and poultry products



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Legality of Cartels in India

In India, the Competition Act 2002 was enacted with a view to:

1. Eliminate practices having adverse effect on competition;

2. Promote and sustain competition; and

3. Protect the interests of consumers and ensure freedom of trade carried on by other

participants, in markets in India.

The Competition Act empowers the Competition Commission of India, in case of cartel, to

impose upon each producer, seller, distributor, trader or service provider included in cartel,

a penalty equivalent to three times of the amount of profits made out of such agreement by

the cartel or 10% of the average of the turnover of the cartel for the last preceding three

financial years, whichever is higher.

Thus, penalty is linked with profits made, or turnover of cartel, whichever is higher, and

Commission does not have any discretion in respect of quantum of penalty to be imposed.

There will be no incentive to cartelize only if every cartel (be it domestic or international) is

detected, prosecuted and penalty is imposed and recovered which is almost unattainable as

per global experience.



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2. About DeBeers

2.1 The De Beers Group

De Beers Société Anonyme (the Company, or De Beers) was formally incorporated in the

Grand Duchy of Luxembourg in November 2000. It is the holding company of all De Beers

Group operations. The Company is managed and controlled from its head office in

Luxembourg where the board meets to attend to the business of the Group. Its commercial

activities are carried out by a number of subsidiaries, investments and joint ventures, which it

finances in different parts of the world. Together, these subsidiaries, investments and joint

ventures constitute the De Beers Family of Companies.



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3. The De Beers Cartel

3.1 The Birth of a Cartel – Creating an “illusion” of scarcity

For centuries, diamonds had been exceedingly rare and valuable: a luxury item largely

reserved for royalty. However, the sheer volume of diamonds flowing from the South

African mines and streaming into Europe in unprecedented numbers threatened to

destroy the very scarcity that had long defined the stones’ value.

Now, a sudden increase in their production had brought the stones, quite literally, into the

hands of the masses. But if diamonds became too prevalent, Rhodes realized, their

association with romance and luxury would be tarnished, and demand would fall.

Second, because diamonds are both a natural product and a highly variable one, South

Africa‘s individual miners were unable to control their production: they mined the stones

they found and tried to sell them all. Their buyers, by contrast, were pickier, preferring to

purchase only the largest and most beautiful stones.

Rhodes concluded that the only way to address these mutual concerns was to forge a unified,

vertically-integrated organization to manage — down to the carat — the flow of diamonds

from South Africa. Only cooperation, he reasoned, could keep supplies low and prices high.

And if ―excess‖ supply ever hovered on the market, DeBeers itself would acquire and

stockpile these stones, using its buying power to buffer the other producers and remind them

of cooperation‘s rewards.

In 1873, Rhodes signed a formal agreement with his buyers, the local diamond distributors,

to form the Diamond Syndicate. Under its terms, the distributors would buy diamonds

exclusively from Rhodes and sell them in agreed-upon numbers, at agreed-upon prices.

Rhodes postulated that ideally, the number of diamonds available each year to European

consumers should roughly equal the number of wedding engagements. By 1890, Rhodes

controlled all of South Africa‘s major mines, along with the distribution channels for their

output. These mechanisms remained in place until Rhodes‘s death in 1902.



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Then, Ernest Oppenheimer, a German who had risen to prominence in South Africa‘s

diamond industry, began to worry that the Diamond Syndicate was still too independent,

potentially capable of challenging the producers by shifting either supply or price. As

Oppenheimer advanced through the ranks of the diamond trade, he began to integrate the

channels of production and distribution even more tightly.

In 1925, Oppenheimer gained control of the Diamond Syndicate. In 1929, he also took

control of DeBeers, thus achieving near total integration of South Africa‘s diamond trade.

Sir Ernest Oppenheimer, the chairman of De Beers Group and leader of Anglo American,

came up with the idea of "single channel marketing" which he defined as "a producers' co-

operative including the major outside, or non-De Beers producers in accordance with the belief that only by limiting the quantity of diamonds put on the market, in accordance with

the demand, and by selling through one channel, can the stability of the diamond trade be

maintained."

This new single channel marketing structure eventually came to be known as the

Central Selling Organisation (CSO) that acted as the chief intermediary between the

stones mined in any given year and the consumers who would eventually purchase or

polish or wear them.

Oppenheimer now presided over a system that brought diamonds from the dirt practically to

the hands of brides-to-be.

Basically, Oppenheimer formed a cartel on the premise that he was operating a legitimate

enterprise. He stomped out all competition and kept a stranglehold on the supply of

diamonds, upping their value and rarity through a limited supply that De Beers doled out

carefully. It is safe to say that during this time De Beers Group owned and controlled about

90% of diamond production in the world; thus they could control the "rarity" and value and

keep a hold on the lucrative industry. Many of their dealings were shady, and they were

known for particular ruthlessness against their competitors.

Ten times a year, an elite group of dealers — handpicked by DeBeers — would gather at CSO

headquarters. There, the dealers, or ―sightholders,‖ would each be presented with an

individual parcel of stones, chosen by the CSO to reflect both what the sightholder was



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hoping to sell in the subsequent weeks and what DeBeers wanted to place into the market.

The sightholders were obliged either to take the entire contents of their parcel or none at all.

Through this ―orderly marketing‖ mechanism, DeBeers was able to determine not only the

precise size and quality of diamonds available each year, but also their price. Sightholders

were encouraged not to purchase diamonds from any sources outside the CSO, nor even to

repurchase a ―used‖ stone. This level of control was sufficient to sustain the cartel through

Oppenheimer‘s death in 1957.



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3.2 Cartelisation of the diamond trade beyond Africa

In the 1950s, South Africa‘s vast stock of diamonds began to diminish. More worryingly,

other countries — across Africa, in Australia and in the far north of the Soviet Union — were

beginning to discover new deposits of diamonds. For these countries, diamonds were a great,

glittering hope.

For DeBeers, however, each new entrant raised the spectre that had long haunted Rhodes and

Oppenheimer: the threat of diamonds flooding into the market, destroying their hard-won

―illusion of scarcity‖ and depressing prices.

Whenever diamonds were discovered, therefore, DeBeers moved swiftly to bring the new

producers into the fold. Operating without regard for political or economic tensions, the

South African company would sign long-term contracts with the diamond-producing

countries, guaranteeing to purchase a fixed proportion of the country‘s output at a fixed price.

In return, with minor exceptions, the country would agree not to sell its stones outside the

cartel. Clearly, any of these new producers could have entered the market on their own,

wrecking DeBeers (and hurting South Africa) in the process. Yet most of them

understood the basic logic of cooperation, the same logic that had struck Rhodes and

still defined DeBeers: if diamond supply grew too rapidly or too high, the allure of

diamonds would be shattered and prices would crash.

If any of the new producers tried to destroy DeBeers, in other words, they would also destroy

themselves. Over the years, defections occurred. In 1981, for example, President Mobutu

Sese Seko of Zaire (now Congo) decided to stop selling his country‘s industrial-grade

diamonds to the syndicate. DeBeers responded by flooding the market with industrial

diamonds from its stockpile, bringing the price of Zairian diamonds down by 40 percent.

By 1983, Zaire agreed to renegotiate its contract with DeBeers on far less favorable terms

than before. Similarly, throughout the 1970s and 1980s, whenever the Soviet diamond

authorities wanted to sweeten their deal (and Russian diamonds are among the highest quality

in the world), they would quietly increase the number of diamonds they sold through their

own independent channels.



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3.3 Factors contributing to the cartel’s success

Economic theory and history both tell us that maintaining a cartel, for any length of time, is

almost impossible on the free market, as the firms who restrict their supply are challenged by

cartel members who secretly cut their prices in order to expand their share of the market as

well as by new producers who enter the fray enticed by their higher profits attained by the

cartelists. So, how could DeBeers maintain such a flourishing, century-long cartel on the free

market?

The answer is simple: the market has not been really free. In particular, in South Africa, the

major center of world diamond production, there has been no free enterprise in diamond

mining. The government long ago nationalized all diamond mines, and anyone who finds a

diamond mine on his property discovers that the mine immediately becomes government

property. The South African government then licenses mine operators who lease the mines

from the government and, it so happened, that lo and behold!, the only licensees turned out to

be either DeBeers itself or other firms who were willing to play ball with the DeBeers cartel.

In short: the international diamond cartel was only maintained and has only prospered

because it was enforced by the South African government.

And enforced to the hilt: for there were severe sanctions against any independent miners and

merchants who tried to produce "illegal" diamonds, even though they were mined on what

used to be private property. The South African government has invested considerable

resources in vessels that constantly patrol the coast, firing on and apprehending the

supposedly pernicious diamond "smugglers."

Back in the pre-Gorbachev era, it was announced that Russia had discovered considerable

diamond resources. For a while, there was fear among DeBeers and the cartelists that theRussians would break the international diamond cartel by selling in the open market abroad.

Never fear, however. The Soviet government, as a professional monopolist itself, was happy

to cut a deal with DeBeers and receive an allocation of their own quota of diamonds to sell to

the CSO.



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Other market characteristics that favoured cartelisation

o Small number of significant suppliers

o Rigorous barriers to entry

o Availability of few substituteso Durable, easy to store product

o Demand for diamonds is relatively price inelastic

Eight countries — Botswana, Russia, Canada, South Africa, Angola, Democratic

Republic of Congo, Namibia and Australia — produce the bulk of the world’s diamonds

and most of the producing entities within these countries conform to an explicit set of

rules.

They manage their production in line with expected demand, stockpile excess stones, and sell

the bulk of their rough diamonds to the Diamond Trading Company, a DeBeers-owned entity

based in London. This conformity is the product of over a century of careful planning and

negotiation, in which DeBeers has undertaken largely successful efforts to control

the diamond trade and maximize its long-term prospects.

And although the producing countries have shifted rank over the past decades and DeBeers

has adjusted its operating formula, the basic structures of the industry have barely budged.

Diamonds have enjoyed steady and rising prices in the last 20 years.

Key characteristics of the diamond cartel

o Currently, DeDe-Beers controls two two-thirds of the $7 billion yearly trade in uncut

diamonds and owns half the producing mines

o

The CSO processes over 80 of the world‘s diamonds. It regulates the supply of diamondsin the market to achieve price stability, earning DeBeers a high price price-cost margin

o Each year, DeBeers determines the total amount of diamonds it plans to sell in the

market; each producer is guaranteed a fixed percentage of total output

o Consequently, De Beers market those diamonds through the CSO

o Producers, are in turn, charged a handling and marketing fee, ranging between 10 and 20

percent



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3.5 Changes in the diamond industry

Not even this steadiest of cartels, however, has been wholly immune to change.

Over the past decade, the diamond trade — and DeBeers and the cartel — have faced the end of

apartheid in South Africa, the fall of communism in Russia, the opening of major mines in

Canada and the emergence of a worldwide movement against so-called ―blood‖ or ―conflict‖

diamonds.

All of these developments have pummelled the diamond industry and forced its central

players — most notably De- Beers — to change the nature of their trade viz:

o For the first time in the cartel‘s long history, producers have begun to brand their stones.

o They have started to integrate vertically in some cases and to break the barriers that have

long separated production and sales, or mining and jewelry, in this business.o They have adjusted the cooperative structures that bind the industry players to one

another and have brought new players, including the United Nations and a vocal group of

nongovernmental organizations, into the game.

Remarkably, these changes have not affected the core dynamic of the global diamond market.

It remains an industry dominated by a single firm and an industry in which, perhaps uniquely,

all of the major players understand the extent to which their long-term livelihood depends

on the fate and actions of the others.

In these cases, DeBeers couldn‘t quite play hardball: the Soviet stones were too good and too

plentiful. So instead the firm negotiated, making whatever concessions were necessary

to keep the Soviets inside the cartel and their excess diamonds off the market.

Managing Demand

Meanwhile, DeBeers matched its supply-side strategies with attempts to manage

demand. In 1948, the company debuted its famous slogan ―A diamond is forever,‖ later

hailed by Advertising Age as the slogan of the century.

Implicit in the slogan were all the notions that the cartel held dear. It told diamond customers

that their purchases were heirlooms, too valuable ever to be sold (which effectively killed the

resale market).



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It reminded them that diamonds equaled love, something not to be measured in terms of

price. And in the fine print and at the jewellers, DeBeers told its (mostly male) customers

how to buy these talismans of love: several months‘ salary was the recommended price, with

attention duly paid to the cartel‘s own criteria of color, cut, clarity and carat. Rarely has any

business been more specific in telling its customers what to buy and how.

On several occasions, DeBeers also moved to quell the subtle threat of

demand-side speculation.

In the 1970s, for example, Israeli diamond dealers began

converting their financial assets into diamonds, hoping to protect themselves from the

inflation then wracking Israel. Dealers in other trading centers soon followed suit, and

diamond prices began to rise. For DeBeers, this situation was a potentially dangerous

precedent. They didn‘t want diamonds to be seen, or purchased, as anything other than

precious, sentimental gifts, and they didn‘t want to risk the price decreases that would

inevitably follow a speculative rise. So rather than letting other players bid up the price of

diamonds, DeBeers imposed a drastic price increase on diamonds sold by the CSO — an

increase that all sightholders understood could be withdrawn at any moment. In other words,

DeBeers used its power to make diamond speculation a considerably riskier venture, because

the price to sightholders could suddenly decline. Then the company stripped hundreds of

dealers of their right to purchase diamonds from the CSO. The speculation ended almost at

once.

A different chain of events played out in 2004, when the global diamond industry was hit by

a surprising demand-side shock. Diamond jewelry sales rose by 6 percent, and producers, for

the first time in recent memory, could not keep up.

In other industries, of course, such a surge in demand would typically be considered good

news. But in diamonds, a shock to the system — even an apparently favorable one — is

perceived as a threat, because it challenges the stability that most firms in the market, and

particularly DeBeers, treasure. So rather than simply following the uptick in demand,

DeBeers responded to it. The CSO (which had been transformed by this point into a new

organization known as the Diamond Trading Company) raised its rough diamond prices 14

percent over the course of the year, and other major producers followed suit. DeBeers‘s own

stockpile, which had hit $4 billion in 1999, dwindled to nothing.



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For outsiders, the diamond industry‘s predilection for stability can be difficult to fathom. It is

not obvious that price volatility should be more dangerous for diamonds than for, say, oil or

coffee; nor that diamond producers should be that much more willing to sacrifice short-term

profits for long-term order.

But in the diamond market, unlike the markets for oil or coffee, sharp changes in price could

mean a longer-term shift in how consumers view diamonds, and how consumers think about

the price that they pay. Since Rhodes‘s time, the diamond cartel has managed to convince

consumers that diamonds are both valuable and scarce, that they should be purchased on

quality rather than price. But if either supply or demand were to change rapidly, this fragile

balance —the ―illusion of scarcity‖ in the industry‘s phrasing— could shatter.

For example, if the Soviets had decided to break from the cartel and had flooded the world

market with their stones, not only would diamond prices have plummeted, but the sentimental

value of diamonds — the value that keeps brides demanding this particular stone and grooms

obligingly paying — would likely have plummeted as well. Conversely, excess demand could

lead to speculation, which might again alter the sentimental value that people place on

diamonds — and even encourage some of them to consider reselling their jewels.

Other industries can handle such fluctuations, because the underlying demand for their

product is less rooted in sentiment. If prices for coffee or oil soar and then fall back to

previous levels, the quantity demanded will fall accordingly and then return fairly closely to

previous levels. For diamonds, by contrast, demand was explicitly constructed, and the

potential for permanent substitution is very high. Rubies and other precious stones, after all,

make perfectly good rings. The challenge for the diamond industry, therefore, is to convince

consumers to separate the value they place on diamonds from the price they pay. For this,

they need to ensure that prices stay steady and commerce relatively unobtrusive.

For over a century, the diamond cartel flourished on a mixture of cooperation

and ruthlessness. Led by DeBeers, the major producers agreed to restrict the supply

of diamonds and sell only through a single channel. Through the operation of the

CSO, buyers followed a similarly strict code: no haggling, no repurchase, no outside

sources of supply. The millions of consumers who bought these symbols of love

implicitly agreed to play by the rules that the cartel had set. To be sure, this



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arrangement did experience the occasional wobble: DeBeers suffered minor losses

in 1915 and 1932, for example, and also in 1980 and 1981, when diamond sales

dropped and the firm was forced to spend hundreds of millions of dollars to

support diamond prices. But these few exceptions prove the general rule: in a world

of volatile commodity prices, diamonds were the stone whose value never declined,

and the international diamond industry remained consistently and robustly

profitable.



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3.6 Problems of the Cartel

o In recent years, the diamond cartel has lost control of diamonds produced in several

African countries (e.g. Angola & the Democratic Republic of Congo)

o Additionally, Australia's significant Argyle mine recently left the cartel

o DeBeers is also fighting to hold onto its monopoly rights to distribute diamonds produced

in Russia which holds 26% of known reserves

3.7 Future of the Cartel

o An Israeli named Lev LevievLeviev – who owns factories in Armenia, Ukraine, India,

Israel and elsewhere challenges the De Beers Central Selling Organization. He seeks to

channel stones directly to his own polishers at lower prices

o Inexpensive synthetic diamonds might in the future replace real diamonds and thus put an

end to the De Beers dominance in the diamond business

o A change in consumer sentiment

Any one of these developments could potentially destroy the history of stable high prices in

the diamond market.

Yet history suggests that change will not come all that rapidly, and that the diamond cartel

will find the means to drag its market back to ―orderly competition.‖ After all, despite the

many changes of recent decades, cooperation still reigns supreme in the diamond market,

backed by the measures of control that allow for ―orderly marketing‖— a cartel, in other

words —to triumph. Much of this cartel‘s success can be attributed to the vigor with which itsleading player, DeBeers, has enforced the rules for interaction and to its legendary ability to

bring new producers into the fold and convince them not to sell outside its confines. But the

cartel‘s success is also due to the happy complicity of diamond buyers: to the polishers,

cutters, jewelers and brides, all of whom are eager to believe that diamonds really should be

treated as if they were forever.



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3.8 Challenges facing the diamond industry

HOW much turmoil can the diamond industry sustain without shattering? An Ohio court

De Beers, the world's largest producer of rough stones, finally pleaded guilty to charges

of price-fixing of industrial diamonds and agreed to pay a $10m fine, thereby ending a

60-year-long impasse. De Beers executives are at last free to visit and work directly in the

largest diamond market, America.

The first case of successful industry self-regulation against trade in so-called ―conflict

diamonds‖ took place when Congo-Brazzaville was punished for failing to prove the

source of its diamond exports. And on June 28th Lev Leviev, an arch-rival of De Beers,

opened Africa's biggest diamond-polishing factory in Namibia.

Behind all these events lies sweeping change in an industry that sells $60-billion-worth of

jewellery alone each year. For generations it has been run by De Beers as a cartel. The

South African firm dominated the digging and trading of diamonds for most of the 20th

century. Yet the system for distributing stones established decades ago by De Beers is

curious and anomalous — no other such market exists, nor would anything similar be

tolerated in a serious industry.

De Beers runs most of the diamond mines in South Africa, Namibia and Botswana that

long produced the bulk of world supply of the best gemstones. It brings all of its rough

stones to a clearing house in London and sorts them into thousands of grades, judged by

colour, size, shape and value. For decades, if anyone had rough diamonds to sell on the

side, De Beers bought these too, adding them to the mix. A huge stockpile helped it to

maintain high prices while it successfully peddled the myth that supply was scarce. De

Beers has no interest in polishing stones, only in selling the sorted rough diamonds to

invited clients (known in the trade as "sightholders") at non-negotiable prices. Sales take

place ten times a year. The favoured clients then cut and polish the stones before selling

them to retailers.

With its near monopoly as a trader of rough stones, De Beers has been able to maintain

and increase the prices of diamonds by regulating their supply. It has never done much to

create jobs or generate skills (beyond standard mining employment) in diamond-

producing countries, but it delivered big and stable revenues for their governments.



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Botswana, Namibia, Tanzania and South Africa are four of Africa's richest and most

stable countries, in part because of De Beers.

One family got extremely rich too. The Oppenheimers created the ―single-channel

marketing‖ system of shovelling all available stones to the clearing house. They came to

dominate De Beers after Ernest Oppenheimer took control of most of Namibia's diamond

mines nearly a century ago. He formed a mining conglomerate called Anglo American,

before grabbing the chairmanship of De Beers. The family is thought to be worth around

$4.5 billion today; Nicky Oppenheimer, Ernest's grandson, is Africa's richest man. The

family still owns a more than 40% direct stake in De Beers, and its members — Nicky

Oppenheimer and his son, Jonathan — run the firm. It may own more De Beers shares held

indirectly through Anglo American's 45% stake.

But this stable, established and monopolistic system is now falling apart.

o Three things have happened. First, other big miners got hold of their own supplies of

diamonds, far away from southern Africa and from De Beers's control. In Canada,

Australia and Russia rival mining firms have found huge deposits of lucrative stones:

BHP Billiton, Rio Tinto and Alrosa have been chipping away at De Beers's

dominance for two decades.

o De Beers once controlled (though did not mine directly) some 80% of the world

supply of rough stones. As recently as 1998 it accounted for nearly two-thirds of

supply. Today production from its own mines gives it a mere 45% share. Only a

contract to sell Russian stones lifts its overall market share to around 55%.

o That is a painful shift, but De Beers is still the biggest diamond producer. And rival

mining firms do share one big interest with it: high prices for the stones they dig from

the ground. That is why, although it is under pressure, the central clearing system that

sustains high prices could yet survive a bit longer. Rather than controlling a pure

monopoly, De Beers might be able to run a quasi-cartel that stops the market fromopening fully. De Beers says the price of rough stones is still rising; the price of

polished stones has risen by 10% this year, according to polishedprices.com, an

independent diamond website that tries to track such things.

o The next challenge might be manageable too. De Beers's system is highly secretive.

Nobody knows the ultimate source of particular diamonds it sells, as all are mixed

together in London. But De Beers faced extraordinary public-relations pressure after it

emerged that rebel armies in Africa were funding their wars by selling what became

known as conflict diamonds.

http://www.polishedprices.com/

http://www.polishedprices.com/



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o Since 2000 almost 70 countries and all of the big industry players (under the threat of

consumer boycotts and activist campaigns by, among others, a London-based group

called Global Witness) have adopted standards designed to prove the origins of their

diamonds. The so-called Kimberley Process is now in force: governments must issue

certificates of origin for the stones they export, and the stones can then be tracked.

o It was under this agreement that Congo-Brazzaville was punished by being expelled

from the Process (the first country ever to be thus censured). As a result, legal trade in

its diamonds should cease. It is a test case for the industry.

o The introduction of the Process could have threatened De Beers, which wanted to

maintain the right to buy diamonds anywhere it pleased and to keep its purchases

secret. Eli Izhakoff of the World Diamond Council, an industry body based in New

York, says the new rules mean ―the industry is changing— it is nothing like it was four

or five years ago.‖

o But although the regulations make it easier to track the flow of rough diamonds, they

have not required De Beers to open all its books to public scrutiny. Most of those

diamond-fuelled African wars are over. And the firm has a declining interest in

buying up any rough stones that appear on the market. It knows that its ability to

control world supplies is dwindling.

o It is the third challenge that is much more troublesome. This is a threat to break up

entirely the way De Beers organises the industry. It can best be summed up in two

words: Lev Leviev.

o Like the Oppenheimers, Mr Leviev has made himself very rich over the past three

decades. An Israeli of Uzbek descent, he is reputedly worth around $2 billion. Though

he has interests in transport and property, his real love is diamonds. His Lev Leviev

Group is the world's largest cutter and polisher of them. He has mining interests too:

his fleet of clanking mining ships began operating off Namibia's coast earlier this

year, sucking up diamonds from the sea bed. He boasts it is the world's second-largest

fleet; only De Beers has a bigger one.

o And Mr Leviev recently moved into diamond retailing. He claims that he is the only

tycoon with interests in every stage of production from ―mine to mistress‖ (a canardin the industry holds that men buy more diamonds for their mistresses than for their

wives). But his real power lies in the cutting and polishing businesses.

He has factories in Armenia, Ukraine, India, Israel and elsewhere. These give him

power to challenge De Beers's central clearing house and seek instead to channel

stones directly, and at a lower price, to his own polishers. There is a more personal

explanation too. Mr Leviev long worked as one of those De Beers sightholders,

buying unseen parcels of stones at non-negotiable prices. Even as recently as last year

he was among De Beers's clients in South Africa. Being forced to take or leave the

stones granted by the diamond cartel infuriated him. He was eager to strike back.



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o His breakthrough came in Russia. Mr Leviev has cultivated close ties with Russian

politicians, including Vladimir Putin long before he became president. Already well

known as a cutter and polisher of diamonds in the 1980s, Mr Leviev was asked to

help the Soviet state-owned diamond firm set up local factories 15 years ago.

He agreed and formed a joint-venture with the state firm, now called Alrosa. But he

insisted that stones for the factories be supplied directly from Russian mines, rather

than diverted through De Beers's central system. De Beers was furious at the loss of

supply, but the factories got their local stones. When the factories were privatised, Mr

Leviev somehow emerged as the exclusive owner.

o What happened in Russia set a pattern for clashes elsewhere. Mr Leviev has found

that governments welcome factories that create jobs and add value to the diamonds

they export; it is a smart way to snipe at De Beers.

o Angola was next. Angola's diamonds are among the world's best when measured by

value per carat (see chart) and promise a lucrative return for anyone who can market

them. De Beers has had a long interest there. Mr Leviev first invested $60m in the

country in 1996, financing a mine at a time when civil war was raging. And just as he

cultivated Russia's governing elite, he struck up warm relations in Angola.

o It was a well-timed move. The Angolan government despised De Beers. In the days

when its monopoly was secure, De Beers regularly bought up any supply of rough

diamonds that appeared on the market. It was accused of helping, indirectly, to fund

UNITA, the rebel army in Angola, which sold huge quantities of diamonds. In 2001

De Beers ended a spat with the government by quitting the country. By then Mr

Leviev had already moved in, eager for another supply of good stones.

o By the time the government won Angola's war in 2002, thereby getting control of all

the country's diamond mines, the contracts it had struck with Mr Leviev (ie, those lost



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by De Beers) were worth $850m a year, a sum greater even than that lost by De Beers

in Russia.

o Mr Leviev has not had it all his own way. Last year Angola's government abruptly

cancelled three-quarters of his deal. Some observers accused Mr Leviev of using

underhand means (he is close to the daughter of José Eduardo dos Santos, Angola's

president) to win them in the first place. Yet, however he did it, Mr Leviev showed in

Angola that he could barge aside De Beers in a valuable area near its southern African

heartland.

o Mr Leviev has been inspired to take another swipe at his rival. On June 28th he took

the arm of Sam Nujoma, Namibia's president, and guided him around a sparkling new

diamond- polishing factory in Windhoek, Namibia's capital. ―For years we have been

told this could not be done,‖ commented various Namibian politicians.

o Now Mr Leviev, saviour-like, strode around his factory, showing off row upon row of

workers, who wore uniform green overalls and fiddled with chrome machines and

modern flat-screen computers. Mr Leviev boasts that, with its capacity for 550

workers, the factory is Africa's biggest.

o Jonathan Oppenheimer, affable heir to the Oppenheimer dynasty, says he does not

understand what Mr Leviev is up to in Namibia: ―And when we don't understand, we

worry.‖ He is right to be concerned. Mr Leviev's obvious next step in Namibia is to

challenge De Beers directly. De Beers's mines are run in a joint venture with the

government called Namdeb. A 1999 mining law lets the government force any miner

to supply stones locally. If Mr Leviev demands it, the government could tell De Beersto provide stones directly to Mr Leviev's new factory, a repeat of the Russian blow.

o More important, if Namibia is able to establish a viable cutting and polishing industry

using its own stones, then why not every other diamond-producing country too? That

would seriously threaten De Beers. Mr Nujoma all but dared his neighbours to follow

suit. ―To our brothers and sisters of neighbouring states, Angola, Botswana, South

Africa, I hope this gives you inspiration to try to imitate what we h ave here,‖ he said

at the factory opening.

o Mr Leviev is building another factory in Luanda, Angola, partly hoping to curryfavour with the government. More important, he is offering to build a factory in

Botswana, the jewel in the crown of De Beers's empire. De Beers has close ties with

the Botswana government: they share a joint venture, Debswana, that exclusively

mines the country's diamonds; Botswana gets a huge share of its foreign currency and

a large part of its national income from diamond revenues. It is a similar arrangement

to that in Namibia.

o In an interview, Mr Leviev said he had offered Botswana's government a factory to

employ ―tens of thousands‖ of people, a scale vastly larger than in Namibia. A senior

civil servant from Botswana toured the Windhoek factory with Mr Leviev. As Mr Oppenheimer concedes, this is a delicate time for Mr Leviev to be courting in



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southern Africa. De Beers is still renegotiating the terms of an 18-year lease on the

Jwaneng mine, in southern Botswana, which is due to expire at the end of this month.

The mine is thought to be worth $1.3 billion a year, producing stones of a quality that

would have Mr Leviev salivating.

o More broadly, De Beers must renegotiate the terms of all its marketing operations in

Botswana and in Namibia every five years. These talks are also due. While no-one

expects Mr Leviev to break up De Beers's relationships in these countries — Mr

Oppenheimer is confident that the government will not do anything to risk its big

revenues — his appearance on the scene puts pressure on De Beers.

o The obvious step for De Beers now would be to take on Mr Leviev at his own game.

In Botswana and Namibia there have been a few diamond-polishing factories backed

by De Beers. But De Beers does not want to be involved in that stage of diamond

production.

o It is first a miner and only belatedly a retailer of diamonds. But it is blocked from the

production steps in between as long as it remains the major supplier of stones to the

whole industry, says Mr Oppenheimer. Buyers of its stones would suspect De Beers

of holding back the best diamonds for its own manufacture and would revolt.

o Nor does Mr Oppenheimer think a polishing industry is viable in many diamond-

producing countries, whatever Mr Leviev says. In Namibia just a few hundred people

work as polishers and cutters. There are few skilled workers, the scale of production is

small and wage costs are roughly ten times that of India, which dominates the worldmarket and where 900,000 people work as basic polishers.

o Nor are small countries, such as Namibia, likely to develop the top-level skills needed

for the very highest-quality stones. Those skills are concentrated in a few cities, such

as Antwerp, Tel Aviv and New York. Within southern Africa, only South Africa has a

long-established cutting and polishing industry, to which De Beers supplies some

good-quality stones (―specials‖ in the language of the trade). But Mr Leviev probably

does not care. A few factories may be uneconomic, but if they allow him to get hold

of direct supplies of diamonds, then so be it.

o Mr Oppenheimer is worried that a more fragmented industry will not just damage De

Beers, but that the whole industry might collapse. Consumers believe diamonds are

valuable largely because of decades of clever marketing by De Beers and its clients.

De Beers itself spent $180m on advertising last year, its clients a further $270m. That

sort of spending could not be co-ordinated and sustained, he suggests, if the industry

were to fragment.

o That is a risk; but there are opportunities for De Beers too. As it has lost market share,

the old goliath has become nimbler. No longer focusing exclusively on defending a

cartel, De Beers is freer to make decisions according to commercial interest. For instance, it now buys fewer stones at uneconomic prices; profits matter more than



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market share. A trimmer De Beers, with a pared down list of clients, might even be

able to make bigger profits than the old giant. Last year it produced healthy profits of

$676m on sales of $5.5 billion.

o But its decision to settle American antitrust charges laid against it in 1994 points to

how much it is feeling the pressure. De Beers executives should now be free to travel

to America to conduct business without fear of arrest. That should make it easier to

promote De Beers LV, a hitherto disappointing partnership with the luxury-goods

firm LVMH to market De Beers-branded diamonds.

o That venture may prove essential for De Beers's long-term health, as more producers

bet on getting a presence in profitable diamond retailing. Already rivals are moving:

Canada's Ekati mine markets its stones directly to consumers; Mr Leviev's firm struck

a deal in May with Bulgari, an Italian jewellery maker, to market Leviev-branded

stones. De Beers's days of market dominance are clearly drawing to a close. But

consumers should not get too excited just yet. Whether a duopoly or oligopoly

emerges, diamond prices are not going to plummet. Mr Leviev will be among those

putting a stop to that.



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3.9 Evolution

In the 1990s, however, political and economic shifts ignited a new set of challenges for the

diamond trade. First came the end of apartheid in South Africa and the political ascendance,

after years of exile and opposition, of the African National Congress (ANC).

For decades, the ANC had been explicit in laying out its plans for the South African mining

sector. Upon his release from prison, for example, Nelson Mandela proclaimed that ―the

nationalization of the mines, banks and monopoly industry is the policy of the ANC and a

change or modification of our views in this regard is inconceivable‖ (Abdelal, Spar and

Cousins, 2003).

Yet once the ANC took office in 1994, no mines were nationalized, and the legal status of

privately-held mining resources did not change. Instead, the ANC-led government instituted a

widereaching program of black economic empowerment that, among other provisions,

encouraged South African firms to sell a portion of their assets and reserve a portion of their

jobs for ―historically disadvantaged‖ groups. Because the end of apartheid in South Africa

also meant the removal of international economic sanctions, South Africa experienced a flood

of interest from foreign investors, which in turn meant new pressures from global financial

and product markets.

By this time, South African diamonds had fallen to only about 14 percent of the world‘s

rough production, and DeBeers‘s own production (which included mines in Botswana,

Tanzania and Namibia) was down to 45 percent of the world total (Oomes and Vocke, 2003;

Anglo American PLC, 2001). New discoveries in Canada promised to reduce this percentage

even further, while political change in Russia threatened once again to remove that country‘s

production from DeBeers‘s grasp.

For DeBeers, the combined impact of these changes was subtle but vast. In 1990, DeBeers

restructured its already-complicated corporate structure, moving the bulk of its financial

assets out of South Africa and into a Swiss-based corporation named DeBeers Centenary AG.

Then in the mid-1990s, it hired an American consulting firm to review its entire strategy. The

consultants noted that DeBeers didn‘t run its operations like a typical firm. It held roughly $4

billion worth of stockpiles (at the end of 1999); it explicitly cooperated with its competitors;

and it had never focused on maximizing its share price, although a rising proportion of its

shares was held by foreign institutional investors. As Harry Oppenheimer (Ernest‘s son) told



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me at the time, ―I don‘t really care about the share price today. I care about the company that

my great grandson will inherit.‖ Moreover, DeBeers had never taken financial advantage of

its brand name.Once these concerns were laid out, however, DeBeers responded in a rather

unusual way. In June 2001, DeBeers Consolidated Mines delisted from the Johannesburg

Stock Exchange and sold all of its shares to three entities: 45 percent to Anglo-American

PLC, a major mining company with longstanding links to DeBeers and the Oppenheimer

family (Gregory, 1962, pp. 109 – 57); 45 percent to Central 202 Journal of Economic

Perspectives Holdings Limited, a private firm owned by the Oppenheimers; and 10 percent to

Debswana, a joint venture between DeBeers and the government of Botswana (Alfaro and

Spar, 2003). Effectively, DeBeers was now a privately-held, family-run company. It also

transformed the CSO into the Diamond Trading Company (DTC) and announced a new

policy, ambiguously entitled Supplier of Choice.

Under this program, the number of sightholders was slashed, and those who remained would

no longer be expected to take whatever stones DeBeers deemed most appropriate. Instead, the

buyers would now plot their own sales, implement their own marketing strategies, and

request a specific package of stones from DeBeers. Theoretically, this independence would

allow sightholders to choose their purchases to align with their customers‘ demands. In the

process, it would also pull more diamonds through the pipeline, reducing DeBeers‘s stockpile

and absorbing some of the projected supply increases.

DeBeers also began rearranging its own sources of supply. It purchased 100 percent of Snap

Lake, a mine in Canada‘s far north, and renewed its supply contracts in Botswana and

Namibia. It signed a five-year, $4 billion trade agreement with Russia‘s largest diamond

producer and expanded its exploration efforts around the world.

Yet competitive pressures continued to mount. In 2000, a diamond sightholder named Lev

Leviev convinced the Angolan government of Jose´ Eduardo Dos Santos to terminate the

country‘s relationship with DeBeers and instead sell all of its rough production through

Leviev‘s newly established firm.

After Leviev cornered the market for Angolan stones, his firm became the world‘s second-

largest producer of rough diamonds. Meanwhile, Alrosa, the newly configured Russian

diamond mining company, was also actively contemplating a break with DeBeers. Alrosa

already sold half of its rough production to local cutters, and several of its leaders — some



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with links to the highest levels of political power in Russia — were itching to sell more.

Canadian producers were likewise hinting at plans to polish, brand and market independently

the stones produced at their Diavik and Ekati mines, and batches of diamonds were also

seeping into the market from across the vast middle regions of Africa.

Acknowledging that its grasp on the upstream-side of the industry was slipping, DeBeers, for

the first time in its history, began to explore possible moves into the world of cut diamonds.

Until this point, DeBeers‘s only direct connection with the jewelry trade was its famous

―diamonds are forever‖ campaign, an industry-wide appeal sponsored solely by DeBeers. In

1999, however, the newly organized company heeded the consultants‘ advice and made the

brand its own. New advertisements touted a limited-edition ―millennium‖ diamond that

literally bore the DeBeers name: the stones were etched with microscopic versions of the

company‘s logo.

The Angolan government was also a partner in the new company, named Ascorp. So,

reportedly, were ―secret‖ shareholders, including Dos Santos‘s daughter.

In 2001, DeBeers moved another step further, signing a deal with LVMH Moe t Hennessy

Louis Vuitton, one of the world’s leading luxury goods companies. DeBeers agreed to

transfer all rights to the DeBeers brand in the retail market to a newly established, jointlyowned firm (while retaining rights to its brand in the rough diamond sector), and then agreed

to let this firm develop a DeBeersbranded line of premium diamond jewelry. This deal

brought together two of the world‘s most successful firms in a high-profile venture that

promised to revolutionize how consumers viewed and bought diamonds. DeBeers opened

cutting centers in Botswana, Namibia and South Africa, and retail operations (with LVMH)

in the United States and United Kingdom.

Compared with most other markets, diamonds still operated in an idiosyncratic fashion, with

supply and demand actively managed by a tiny group of very powerful players. Around the

edges, though, the rules of the diamond game had started to shift. Although DeBeers

remained the dominant player, the company had been forced to change its strategy to

maintain its control.

An even greater change in the diamond market, however, was let loose by an unlikely source:

two previously obscure activist groups called Partnership Africa Canada and Global Witness.

According to these groups‘ charges, brutal warlords in Sierra Leone, Liberia, Congo and



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elsewhere were funding their activities with diamonds — the same diamonds that eventually

graced the hands of brides-to-be across the Western world (Global Witness, 2000). To

prevent the heinous acts fuelled by the diamond trade, the activists argued, Western

consumers and governments had to stop purchasing ―blood‖ or ―conflict‖ gems. Remarkably,

Partnership Africa Canada and Global Witness managed eventually to embed their vision in a

major global initiative. Ironically, the implementation of this vision worked directly to

enhance the competitive position of DeBeers.

In making their claims, Partnership Africa Canada and Global Witness were echoing what

had become a newly powerful logic of activism. Rather than protesting to the wrongdoers or

to other governments, the DeBeers – LVMH joint venture did face a nagging legal problem. In

1994, DeBeers had been indicted in a U.S. court for price-fixing in the industrial diamond

market.

Although the case had been dismissed, DeBeers (whose executives never appeared in court to

defend themselves) formally remained under standing indictment, meaning that the company

could not legally operate in the United States. Accordingly, between 2001 and 2004,

DeBeers‘s U.S. lawyers stepped up their ongoing efforts to remove the indictment. They were

also aided by an emerging interest on the part of other U.S. agencies — including the U.S.

Departments of State and Treasury — to involve DeBeers in their own African initiatives. In

July 2004, DeBeers pleaded guilty to its ten-year-old charge of price fixing and paid the U.S.

government a fine of $10 million. Legally, the corporation could now do business in the

United States.

Activists charged that DeBeers and the diamond industry were effectively both funding the

atrocities of Africa‘s warlords and covering their tracks. The only way to stop the terror, they

urged, was to bring the diamond trade to a halt. Activists were instead bringing corporations

into the mix, lobbying them to take action and to take responsibility for ameliorating crimes

that weren‘t directly theirs.

In the diamond trade, these claims had a particular resonance, because — due to the inherent

difficulty of identifying or marking a particular stone —even ―clean‖ producers could well

find themselves handling ―conflict‖ stones.

If consumers had ever truly shunned African diamonds, or if governments in the United

States and Europe had forbidden their import, African producers would have been completely



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cut off from their largest and most lucrative markets. Given the politics of the time,

moreover, such an outcome was not entirely farfetched.

The United States was waging a war against terror; it had few major security interests in

Africa; and boycotting conflict diamonds would have been politically rather painless. Indeed,

as the campaign against these diamonds unfolded, the U.S. government, led by the

departments of State and Treasury, signed on to the activists‘ agenda and began exploring

ways of restricting the diamond trade.

These efforts culminated in the Kimberley Process, a vast international program launched in

2002 and supported by an array of strange bedfellows: producing countries, importing

countries, nongovernmental organizations, the jewelry trade and the United Nations.

The Kimberley Process is an extraordinary enterprise. It includes a complex certification

system for all diamonds and a commitment by all participants to adhere to the rules

embedded in this system. Every individual who handles a diamond — from the miner to the

jeweler — is responsible for maintaining an identity tag affixed to the stone at the time of

extraction. If a tiny half-carat stone is found by an alluvial digger in Angola, for instance, it

must be tagged as an Angolan stone by the broker who buys it from the digger; by the trader

who buys it from the broker; by the firm that cuts and polishes the stone; by the jeweler who sets it into a ring; and by the retailer. With such a system, theoretically at least, no warlord

in Liberia or Sierra Leone can slip diamonds into the pipeline. And no husband-to-be has to

worry about purchasing tainted goods for his bride. What is even more extraordinary about

the Kimberley Process is that DeBeers is a central proponent. DeBeers executives campaign

with Global Witness in support of the system; they sing its praises to analysts and reporters;

and, through the Supplier of Choice program, they formally impose Kimberley‘s provisions

on all DeBeers sightholders. The source of such enthusiasm is not obvious. Why, after all,

would the firm embrace a protester with a vision that was initially directed at smearing its

own image? Why would it join forces with those that reviled its trade? Why would a

company that prized secrecy welcome so many interlopers into its business?

The answer, as it turns out, is that the Kimberley Process is exceedingly good for DeBeers.

Recall that DeBeers has been devoted throughout its history to keeping excess supply off the

market and preventing new suppliers from entering the business. This is precisely what

Kimberley accomplishes. Like the cartel itself, this new international system restricts supplyand enhances the power of big, established players. It keeps the warlords and the small



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diggers and the shady traders out of the acceptable stream of commerce. It also imposes

costs (for tagging, monitoring and auditing) that make it even more difficult for new or

smaller players to enter the global market.

For DeBeers, then, the timing of Kimberley could not have been more propitious. Just as the

company was facing a serious decline in its ability to control supply, and just as it was

launching an unprecedented move into the retail sector, the campaign against conflict

diamonds helped to move the entire diamond market in DeBeers‘s direction. As a result of

the campaign and the Kimberley Process, new suppliers were crowded out of the market (as

DeBeers would have desired) and consumer preferences were directed to those producers

who (like DeBeers) could guarantee the integrity and ―cleanliness‖ of their brand. The other

major winners were the Canadians, whose homegrown diamonds — now branded and etched

with tiny polar bears — were also easily certified as conflict-free.

There is no evidence to suggest that DeBeers (or the Canadians) instigated the campaign

against conflict diamonds, or even that any of the major producers initially understood the

opportunity provided by their attackers. There is also no reason to believe that DeBeers

executives don‘t share the activists‘ moral outrage or their determination to prevent thugs and

criminals from funding their actions with diamonds. However, the fact remains that DeBeers

and the diamond cartel have managed to turn a potential attack on their business into a

substantial windfall.



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4. Conclusion

For more than a century, DeBeers has managed the diamond market by working with other

producers, restricting supply, squashing speculation and resisting excess profits. The ironic

proof of the strategy‘s success is the extent to which new entrants have mimicked it. Leviev,

for example, is challenging DeBeers but not departing from its approach; the Canadians are

selling their polar bear diamonds just as DeBeers sells its millenniums. DeBeers, meanwhile,

has no intention of loosening its own reins.

In 2004, the company discovered 39 new diamond deposits and signed marketing alliances

with producers in Canada, Botswana, India, Democratic Republic of the Congo, the Central

African Republic, Russia, Australia, Brazil and Madagascar.

In 2005, it joined with leading nongovernmental organizations to launch a Diamond

Development Initiative dedicated to ―optimiz[ing] the beneficial development impact of

artisanal [small-scale, or independent] diamond mining‖ (Diamond Development Initiative,

2005).

Quietly, the company was also positioning itself to oversee a massive system for tracking

diamond trades among some of Africa‘s smallest miners, which, if implemented, would

further help DeBeers to regulate the flow of diamonds, keeping rogue supply off the market

and power in its own hands.

De Beers undoubtedly, has proved to be the most successful cartel arrangement in the annals

of modern commerce.

The diamond invention is far more than a monopoly for fixing diamond prices; it is a

mechanism for converting tiny crystals of carbon into universally recognized tokens of

wealth, power, and romance.



References

―DeBeers and Beyond: The History of the International Diamond Cartel‖, Tobias

Kretschmer, New York University

―Have you ever tried to sell a diamond‖, Edward Jay Epstein, The Atlantic Magazine,

February 1982

―Are diamonds really forever?‖ , Making economic sense by Murray Rothbard,

Chapter 91

The history behind the DeBeers Diamond Cartel, http://voices.yahoo.com/the-history-

, 3 Jan, 2006 behind-debeers-diamond-cartel-12119.html?cat=46

De Beers UK Limited., http://www.debeersgroup.com/en/About-Us/The-family-of-

, 15 Sep, 2012 Companies/

Wikipedia, , 15 Aug,http://en.wikipedia.org/wiki/Cartel#Private_vs_public_cartel

2012

Wikipedia, , 17 Sep, 2012 http://en.wikipedia.org/wiki/De_Beers

―Diamond cartel meltdown‖, John Helmer, Asia Times Online,

, 6 Jan, 2009 http://www.atimes.com/atimes/Central_Asia/KA06Ag01.html

―The Diamond cartel is finally broken‖, Dr. Steve Sjuggerud, Daily Wealth,

, 3 Apr,http://www.dailywealth.com/838/The-Diamond-Cartel-is-Finally-Broken

2007

―Combating cartels in markets – Issues and Challenges‖, G. R. Bhatia, Competition

Commission of India

http://voices.yahoo.com/the-history-behind-debeers-diamond-cartel-12119.html?cat=46




http://www.debeersgroup.com/en/About-Us/The-family-of-Companies/




http://en.wikipedia.org/wiki/Cartel#Private_vs_public_cartel


http://en.wikipedia.org/wiki/De_Beers


http://www.atimes.com/atimes/Central_Asia/KA06Ag01.html


http://www.dailywealth.com/838/The-Diamond-Cartel-is-Finally-Broken










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