De Beers and Beyond: the History of the International Diamond Cartel∗

De Beers and Beyond: The History of the International Diamond Cartel∗

Diamonds are forever hold of them. The idea of making diamonds available to the general public seemed un- A gemstone is the ultimate luxury thinkable. When diamonds were first found product. It has no material use. Men in South Africa in 1867, however, supply in- and women desire to have diamonds creased rapidly, although the notion of dia- not for what they [diamonds] can do monds as a precious and rare commodity re- but for what they desire.1 mained to the present day. Similar to the gold miners in California, dia- To hear these words from a person who at- mond miners in South Africa tended to rush to tributes his entire wealth and power to the the latest findings.2 As a matter of principle, trade of diamonds illustrates the peculiar na- diamond miners preferred to work by them- ture of the diamond market: Jewelry dia- selves. However, the scarcity of resourceful monds are unjustifiably expensive, given they land and the need for a minimum of common are not actually scarce and would fetch a price infrastructure forced them to live together in of $2 to $30 if put to industrial use. Still, limited areas. In order to fight off latecom- by appealing to the customers’ sentiment, di- ers and to settle disputes, Diggers Committees amonds are one of the most precious lux- were formed and gave out claims in a region. ury items and enjoy almost global acceptance. Each digger would be allocated one claim, or, This fact is often attributed to the history at most, two. of one company. DeBeers, founded by Cecil Since digging diamonds on a larger scale Rhodes in 1870, has been a highly successful was virtually impossible for individuals, small and effective controller of the diamond mar- claimholders soon merged into larger ones. ket, having developed a unique purchasing and Moreover, equipment for digging, hauling the marketing cartel that has influenced prices in dirt up and pumping water out of the mines the market virtually undisturbed for almost a was purchased or rented by groups of min- century. Lately, however, there are signs that ers, thereby forced to cooperate even more more and more players seem ready to challenge intensively.3 Cecil Rhodes was one of the DeBeers’ dominance, and ever since, DeBeers first businessmen to rent out pumping equip- has struggled to keep the cartel intact. ment and soon realized that he had tapped a vast market potential. He reinvested the ini- tial proceeds from equipment rental in acquir- Diamonds and the Cartel ing claims. By 1880, he held a large enough share of diamond claims to justify a separate For centuries, the only two countries produc- company purely concerned with managing the ing diamonds were India and Brazil. Up to mines: thus DeBeers Mining Company was the middle of the 19th century, the world created. By 1887, the company was the sole supply of diamonds was so scarce that even owner of South African diamond mines. monarchs and noblemen found it hard to get Concurrently, Cecil Rhodes took control of ∗This case was written by Tobias Kretschmer un- the distribution channels through “The Di- der the supervision of Professor Lu´ısCabral. Finan- amond Syndicate,” an alliance of merchants cial Support by the Material or Research Fund from London Business School is gratefully acknowledged. 2In fact, most of the early diamond miners used c 1998, London Business School. to be gold diggers, attracted by the enormous riches 1Nicky Oppenheimer, DeBeers deputy chairman, at surrounding diamonds. a Foreign Correspondents Association Lunch. (Source: 3The diamonds were located in increasingly lower Reuters.) soils that contained underground water.

1 in Kimberley who abided to Rhodes’ terms (which represented about one half of total sup- of business, recognizing that their own inter- ply). Each year, DeBeers determines the to- ests and DeBeers were compatible in that both tal amount of diamonds it plans to sell in aimed for high prices and a notion of scarcity. the market. Each producer is guaranteed a In the following three decades, a German fixed percentage of total output, that is, De- immigrant named Ernest Oppenheimer estab- Beers commits to buy that amount and market lished himself as a prominent figure in the it through the CSO. Producers, in turn, are South African diamond and gold industry. Af- charged a handling and marketing fee, rang- ter some time as a diamond expert, he en- ing between 10 and 20 per cent, depending on tered the gold business by creating the Anglo- the amount purchased and the general demand American Corporation of South Africa, own- situation. ing a dominant share of South Africa’s gold mines. His greatest ambition, however, was The Central Selling Organization serves as to gain a place on the board of DeBeers, the a clearinghouse for the entire industry. It reg- company he felt would provide him with the ulates the quantity and price in the market. best opportunities to expand his knowledge Packages of diamonds are bought and sold at and power in the diamond industry. Op- sights, held ten times a year in London, on a penheimer sensed that the structure of the take-it-or-leave-it basis. As it remains a priv- syndicate would provide DeBeers with insuffi- ilege to attend sights by the CSO, few deal- cient power to control the distribution of di- ers dare to refuse a package offered to them. amonds in the long run. In particular, he The attempt to haggle over quantity and price was aware of the danger that the members of the offered package could well lead to the of the syndicate might be tempted to break sightholder not being invited again. Over 80 away in the expectation of greater quantities per cent of the world’s diamonds were traded and prices. DeBeers board members, however, through the CSO in its early days. Recent de- viewed Oppenheimer as an overambitious nou- velopments have caused a downward trend in veau riche, and blocked his way into the board this percentage; present estimates range be- for decades. Not to be discouraged, Oppen- tween 65 and 75 per cent. heimer gradually bought blocks of DeBeers shares whenever they came up for sale, un- The buyers from CSO are mainly diamond til finally he was one of the two most signifi- dealers who have the stones cut and polished cant single shareholders, the other being Solly and resell them at one of the world’s main di- Joel, his friend and business partner. At last, amond clearing centers: Antwerp, New York, Oppenheimer gained full control and owner- and Tel Aviv. ship of DeBeers in 1926. Soon after, he was named chairman. An even larger company, One of DeBeers’ main roles is to maintain the Diamond Corporation, was formed that the notion that diamonds are a scarce com- had subsidiaries dealing with producing and modity. This they do by means of advertising selling diamonds all over the world. Outside and by purchasing excess supplies when that is contracts were practically made impossible by needed to avoid price decreases: as a matter of an exclusivity requirement that each supplier principle, prices are never lowered by DeBeers. was forced to sign with the CSO. This tightly-knit organization has proven ben- Over time, new discoveries of diamond re- eficial for most in different ways: producers, serves in Australia, Siberia, and Western often state-run diamond mines in developing Africa became known and eroded the com- countries relying heavily on diamonds, are pro- pany’s monopoly position in diamond sup- vided with a stable inflow of foreign currency. ply. Harry Oppenheimer, Ernest’s son, quickly Dealers enjoy stable price increases which can realized the threat this implied and focused easily be passed on to consumers. DeBeers, his efforts on maintaining power in distribu- however, seems to be benefiting the most from tion through the Central Selling Organization the agreement, asking for what producers of- (CSO), the company’s marketing arm. ten perceive as inappropriately large fees and The structure of the DeBeers conglomer- in turn charging prices to merchants at their ate has remained widely unchanged ever since: own discretion. The temptation for both pro- A subsidiary of DeBeers buys diamonds from ducers and dealers to by-pass the CSO is there- all producers, including DeBeers’ own mines fore quite significant.

2 The cartel under threat lized. Israeli dealers disposed of their stock and conceded their price and quantity-setting Israel: Downstream Rebellion autonomy to DeBeers again. They paid a con- siderable price for their defection, however. In The huge profits in virtually every sector of the late 1970s, one in every four employees the industry finally turned out to be the major in the Israeli diamond industry lost his job. stumbling block for DeBeers in the mid-1970s. Moreover, many Israeli dealers lost their cher- In the 1970s, Israel was going through a pe- ished position in the CSO’s circle of proteges. riod of high inflation; diamonds were one of While DeBeers successfully managed to the few stable currencies and means for stor- whip the mutineers back into place, it suffered age of value; diamonds as collateral were the from the events in the late 1970s for some years best way of securing preferential loan rates. to come. Contrary to their previous policy of This induced merchants to hoard a signifi- controlled price increases and demand regula- cant amount of diamonds with a view at re- tion, DeBeers too was enticed to take advan- selling them later. As a result, the supply of tage of the bear market for diamonds. Prices diamonds was artificially reduced, driving up set at the CSO’s sightings went up rapidly, prices. soon reaching levels unimaginable only five DeBeers, while enjoying further increases in years before. This further fueled the specu- profits from such price increases, foresaw the lative bubble, which eventually burst, as dia- imminent catastrophe: Up to that time, diamond hoarders decided to dump their holding monds “were forever,” that is, not to be resold. in the market to realize their capital gains. At As soon as diamonds were held for investment this stage, all that DeBeers could do was to re- purposes, however, the exact quantity in the act buying the excess supply from the market market at a given time would be beyond De- and preventing too big a price crash. With the Beers’ control. In particular, if a significant quantities involved, however, this proved to be number of decided to dump their holdings in costly: DeBeers’ stocks in diamonds soared to the market at the same time, quantity could almost $2bn in 1984. increase and prices fall rapidly, thus hurting the image of diamonds as a rare product. Zaire DeBeers tried to soften the speculative waves through a variety of instruments. It A brief period of stable activity was soon dis- created a temporary surcharge levied on di- rupted by another attack on the cartel. Zaire amonds sold through the CSO. The surcharge felt that the terms they were given by the CSO could be withdrawn at any time without prior fell below their expectations. Zaire claimed notice. This measure was designed to dampen they were charged a 20 per cent handling fee the incentives for speculative transactions: a on their diamond sales, and that they could speculator stood to make large losses in case easily recover some of that on the free mar- the surcharge were withdrawn and the price ket for industrial diamonds while undercut- drop suddenly. In addition, a DeBeers repre- ting the cartel’s artificially high prices. And so sentative was sent to the defiant Israeli deal- they did. The timing of Zaire’s move proved ers to warn them that if they continued dis- rather unfortunate, however. Because the car- obeying DeBeers’ orders, the number of dia- tel had run up huge stockpiles of all kinds of monds allocated to them would be cut by 20 diamonds, DeBeers was quite prepared to re- per cent, only for DeBeers to observe the mer- lease some of it in the market at a price much chants clinging to their accumulated stocks below the prevailing market price. Zaire, who even more, further driving up the prices. Fi- contributed less than 3 per cent of world pro- nally, as if the previous measures did not suc- duction, was in no position to push prices up- ceed in stopping hoarding, Israeli sightholders wards, and had to suffer a dramatic drop in were dismissed from the Syndicate’s diamond its revenues. sightings-the highest penalty they could have Zaire relying heavily on diamond export rev- suffered. enues, it soon returned to DeBeers to ap- In combination, these measures proved an peal for readmission into the cartel. DeBeers effective way of disciplining the cartel: Inter- obliged and offered significantly worse terms est rates on diamond loans were back up to to Zaire than initially. Once again, the defect- normal levels, and diamond prices had stabi- ing party was severely punished for its refusal

3 to follow the terms of the cartel. meanwhile, suffered from severe cutbacks in profits; quick action was called for. Eventually, the Soviet Union rejoined the Russia cartel, this time in an official way and at what As early as in 1957, large quantities of dia- industry participants believed to be substan- monds were discovered in Siberia. DeBeers tially improved conditions. In particular, De- quickly realized the latent threat posed by Beers guaranteed Russia a steady inflow of these supplies and allegedly negotiated an foreign currency by buying all of the latter’s agreement with the Soviet government to output, not a percentage of DeBeers’ deter- channel their diamonds through the CSO. Un- mined target output. This freed Russia from derstandably, the terms were never revealed, the task of finding buyers for the vast quanti- but industry sources were convinced that De- ties it was producing. For the remaining man- Beers made sure virtually no Siberian gems ufacturers, Russia’s outbreak implied a very would enter the market through other chan- welcome side effect: DeBeers’ position was so nels than the CSO.4 It was estimated that So- profoundly under threat that, in 1985, the viet production represented between 20 and 30 company was forced to offer its faithful sup- per cent of world production, or some 10 to 11 pliers a price increase of 7.5 per cent in order million carat. DeBeers, under the estimated to keep them from joining forces with Rus- terms of the deal, guaranteed the purchase of sia. For the first time, DeBeers did not punish 95 per cent of Soviet production, while allow- mutiny in its ranks, partly because Russia was ing the Soviet diamond industry to cut, pol- not formally part of their cartel, partly be- ish, and sell the remaining five per cent au- cause Russia was too strong a competitor to tonomously. This was seen as a concession play hardball with. In contrast, dealers who the cartel had to make in order to keep the had bought Russian gems during that period larger part of the Soviet diamonds under their were deprived of their sights and made to pay control. It is also believed that prices paid for their wrongdoings. The industry was puz- for Soviet diamonds exceeded the prevailing zled as to the Russians’ long term goals: If the cartel prices by up to 10 per cent. Until the government, who was overseeing the diamond early 1980s, the Soviets were satisfied with operations through Komdragmet, the Com- the preferable treatment they were offered and mittee for Precious Gemstones, was merely honored the agreements with DeBeers. in search for hard currency, the survival of The Soviet Union eventually realized that the cartel could be secured simply by offer- the profit potential from selling directly to the ing them favorable credit deals and guaran- market was enormous. Adding to this the need teed payments. If on the other hand they were for foreign currency and, more recently, the to abandon the cartel altogether and establish political turmoil following the breakdown of an alternative means of distribution, no con- the former Soviet Union, the cartel was once cession would be sufficient to make up for the again put to the line. In early 1984, Antwerp– enormous profits to be made by replacing De- Europe’s main clearing market for polished Beers. diamonds–was flooded by high-quality Rus- By the mid-1980s, an unsteady equilibrium sian diamonds at a low price. Diamond deal- had been achieved: The terms for diamond ers, who had only just restored their confi- manufacturers had been notably improved, dence in DeBeers’ ability to discipline the mar- the Russians were back under DeBeers’ um- ket, were thrown into a state of confusion: brella, and diamond dealers were expecting Should they continue purchasing from the car- the next move by either of the sides. tel? Should they buy polished Russian di- In October 1987, investing in diamonds be- amonds at a significant discount? Diamond came an attractive option again. The stock suppliers were subject to a similar dilemma: market crash decreased confidence in paper in- should they continue selling through DeBeers, vestments; accordingly, demand for tangible or should they follow the Russians? DeBeers, assets increased. DeBeers, in need of financial relief, took full advantage of this situation by 4Official relationships between the countries had repeatedly raising prices at its sightings, while just been stalled that year, so the existence of such at the same time discouraging the purchase agreements would have presented a major embarrass- ment for both parties, which is why they consistently of diamonds for investment purposes. Once denied deals of any such kind. again, dealers disregarded DeBeers’ warnings

4 and either resold their packs at a premium and profit. DeBeers continued to point out or built up supplies for themselves. Instead that “even if the Australians drop away from of reacting through the purchase of excess di- the CSO, it would not have a great impact.”6 amonds or severely punishing defectors, De- However, their subtle (or not so subtle) ways Beers started a marketing offensive to raise of influencing the quantities offered in the mar- consumer demand by tapping into new po- ket indicated that they would not let such be- tential markets (such as Japan) and consumer havior go unpunished. Despite all of the dif- groups (such as male consumers); and by re- ficulties experienced as a consequence of this peatedly emphasizing that “diamonds are for- move, Argyle has continued to market inde- ever” (that is, not to be resold). pendently, desperately avoiding the fate Zaire suffered when it opted to rejoin the cartel. Australia Angola Over time, new threats to the cartel mate- In the midst of a civil war and in need of fast rialized: In Australia, massive findings have cash inflows, Angola followed in 1992 the Rus- been made that, if sold outside of the cartel, sian’s move of a few years earlier: while main- could represent a threat to its stability simi- taining its agreement with DeBeers, Angolan lar to the Russians’ defection (if not quite as producers increased the supply of rough dia- unpredictable). Argyle Diamond Mines PLC, monds by selling them directly in the market. who was operating Australia’s most profitable Angola was not quite big enough to destabi- mine, opted for a less aggressive strategy: In- lize the cartel on its own, but having to sweep stead of confronting DeBeers with another $500m worth of Angolan gems off the mar- threat to their dominance, a strategy that ket did not help DeBeers’ situation (especially might have sent the cartel into eventual obliv- in light of diminishing demand and increasing ion, Argyle opted to operate in niche mar- stocks). However, the Angola problem was kets, such as rare, high-priced gems or colored never perceived as a long-term threat to the gems. Coloured gems are not an important CSO but rather as a product of the political part of DeBeers marketing plan; selling them turmoil in country at that time. Differently through the CSO would have been particularly from previous cases, DeBeers did not inflict unattractive for Argyle. By creating an image any harsh punishment and let the Angolan di- of its own for coloured gems, Argyle entered amond producers largely alone. into a highly profitable situation without nec- essarily provoking the industry leader. In late 1995 and early 1996, however, the Canada CSO imposed price cuts for most of Ar- Adding to the woes of the cartel, another ma- gyle’s gems of industrial and near-gem qual- jor producer came into existence: Near Koala, ity. Moreover, it decreased the fraction of in Northwest Canada, a sizeable source of di- Argyle’s production that DeBeers agreed to amonds was discovered in 1991. Output es- purchase to 85%. Argyle was outraged and timates of $1.1bn indicated that if DeBeers threatened not to renew its marketing contract failed to secure distribution of these gems, the with the CSO. DeBeers’ inflexibility eventu- cartel might once again be doomed to extinc- ally led Argyle to break away from the cartel in tion. Not surprisingly, DeBeers, RTZ Corp. 1996. Since then, the Australians have worked (the world’s biggest mining corporation) and in close cooperation with the Indian diamond Australia’s Broken Hill Proprietary (BHP) Co. cutting industry, which now processes about scrambled for the right to explore the new 95% of Argyle’s rough diamonds output. A mines. It was not only a matter of tapping DeBeers spokesman declared that “[DeBeers] into a rich source of revenues to be made, but are not surprised. Argyle has been fairly vo- also of maintaining (or acquiring) a dominant 5 cal about its position in the last month.” position in production and distribution. Nonetheless, DeBeers response was immedi- Control over the Ekati mine, the largest ate: prices for the type of stones marketed by mine in Canada’s Northwest Territory was Argyle fell sharply in 1996, and in the first half won by BHP Co., which also had substantial year of 1997 Argyle reported a setback in sales US-based business interests in steel, copper,

5Daily Telegraph, June 8, 1996, p. 3. 6South China Morning Post, February 5, 1997.

5 petroleum and minerals. While DeBeers has CSO’s sales, higher prices, and a seat on CSO’s urged BHP to sell its output through the CSO, board. DeBeers felt that these demands were BHP fears that this might trigger an investiga- absolutely unjustified for a diamond producing tion by the US anti-trust authorities. In fact, nation that, despite its large stocks, was be- the latter have for many years attempted to lieved to be running out of diamonds and was take on the CSO’s near-monopoly. However, in great need of foreign cash. Consequently, the fact that DeBeers’ operations are all lo- DeBeers was in no mood to yield, in part cated outside of US territory makes them im- also because the competencies on the Rus- mune to anti-trust legislation. Negotiations sian side were not clearly defined. Komdrag- between BHP and DeBeers are still underway; met and Almazy-Rossi-Sakha (ARS) are the production is scheduled to start in 1999. major players in the Russian diamond industry: Komdragmet owns the stockpile, while Russia, Part II ARS own the mines and controls diamond production. Each player pursues a different The early 1990s forced DeBeers and the Rus- goal: Komdragmet represents State interests sian diamond industry into an uneasy alliance: and is interested in securing foreign cash in- DeBeers was aware that Russia was the sin- flows sooner rather than later; ARS, in turn, gle most powerful outside member of the car- has an interest in keeping diamond prices high tel and would therefore have to be courted to and supplies limited. The three parties could be kept in the cartel. Russia, on the other not reconcile, and finally, in 1996 –for the first hand, was in dire need of credit and hard cur- time since 1957–, Russian diamond producers rency, with their only credible security being and the CSO did not have a joint marketing their vast supply of diamonds. By destabi- agreement. lizing the industry, the Russians would have The previous agreement was maintained on hurt themselves. In June 1993, in prepara- an informal basis for another year, during tion of a loan proposal to western banks, the which Russia remained uncommitted to the Russians disclosed, albeit unofficially, the size CSO and continued selling much more than of their diamond stockpile as being about 200 the agreed 5 per cent of their output in the million carats, which would be the largest di- open market. DeBeers lost its patience and amond treasure in the world. This disclo- announced the end of the agreement in Decem- sure, together with CSO-like sightings held by ber 1996. Russia sought to resume talks with the Russians, signalled to DeBeers that Russia DeBeers, realizing that its foreign reserves are had the potential to form a distribution cartel highly dependent on stable revenues from di- similar to the CSO. On the other hand, it is amond sales. An Antwerp dealer, expressing not clear the Russians would manage to stand the general sentiment of the unsettled down- on their own: “without a guarantee from De- stream merchants, said: “If everyone sticks to Beers to buy the stones, Russia can find no the deal then everyone wins. But if anyone is lender willing to take the risk.”7 stupid enough to break the agreement, then The 1990 agreement between Russia and everyone loses.”9 DeBeers was to expire in December 1995. Rumors of declining production at ARS’ Russia, after hinting that their stocks would mine in Sakha emerged. DeBeers and the Rus- enable them to run a parallel distribution sians, following high-level negotiations, finally channel, further demonstrated their power by reached an agreement, essentially on DeBeers’ “leaking” a large fraction of their own stones terms. Not content with this, DeBeers be- into the market. Unofficial sales through gan to undermine ARS’ authority and the gov- channels other than the CSO were estimated ernment’s tight grip on the Russian diamond at $800m, as compared to $1bn sold to the industry. In their customarily discreet style, CSO. Understandably, Russia expected an- DeBeers started buying a controlling share other improvement in the terms it is offered of the Lomonosov and Verkhotina diamond before it stopped from further “demoralizing fields, believed to be “two of the world’s rich- the industry;”8 accordingly, it formulated its est undeveloped diamond deposits,”10 much new demands: An increase in the share of to the dismay of the cash-strapped ARS and

7Diamond-backed loan proposal, East European 9Financial Times, October 16, 1997, p. 28. Markets, February 4, 1994, p. 10. 10Economist Intelligence Unit Country Alert, March 8Sunday Times, December 10, 1995. 12, 1998.

6 Komdragmet. At least for now, DeBeers seems to have re-gained the upper hand on the Rus- sian diamond industry, this time by undermin- ing it from the inside.

Attempts by major producers to defect from the cartel seem to repeat themselves at shorter and shorter time intervals. While it has been possible to force Zaire and Angola back into the cartel, Canada, Australia and Russia do not seem to accept such simple, uncompro- mising behavior by DeBeers: persuasion and incentives will play an increasingly important role in the future. Ultimately, however, the question that needs to be addressed is whether the “system we [DeBeers] propose is the best one in the long term.”11

11George Burne, director of DeBeers and the CSO, at an information session for diamond producers in Canada. Source: Financial Post, November 11, 1996.