Conjecturing About “Incredibly Hidden” Strategies Behind The Dropping Of So Many U.S. Sightholders
June 12, 03Some of the (many) New York DTC sightholders removed from the client list have the most amazing, exciting and successful marketing programs. The argument given in most instances to justify the removal is rough “availability”. However, sightholder appointments are not based on any short-term temporary inventory position of the DTC (as some public comments seem to suggest), but rather on the long-term intake models of present and expected mine production. Though some of the immediate growth in carat production of the De Beers mines is indeed cued towards lesser quality, there is no apparent reason to expect less availability of the better quality goods in the years ahead. Is it possible that the DTC has some “hidden reasons”, far beyond the established DTC sightholder criteria, for wanting to reduce the number of players in the larger and better goods? Is there a “hidden strategy” – an additional agenda – which, as a private company, the DTC is not bound to publicly share with anyone?
Quite a few people think there is. To avoid any misunderstanding: the DTC completely and unqualifiedly denies everything that is suggested in this article. As far as the DTC is concerned, this is simply “far-fetched fantasy”. The DTC insists that the New York client selection criteria (or the deselection decisions) are purely based on the sightholder criteria – and no other considerations were involved. As this article deals with strategies guiding De Beers, we respectfully suggest that those readers who do not want to waste time in reading an analysis which has been formally denied, stop reading here. Indeed, we want to stress that this is our conjecture – and is also largely based on perception in the market. De Beers ought to recognize that market perceptions are important, even if it considers some of these as being misguided. Many business decisions are based on perceptions. We hope they have quite a track record in hitting far more than they were missing…
Back to our story. It is reasonable to assume that De Beers closely watches the strategies of other producers. BHP-Billiton, which operates the Ekati mine, has publicly stressed and reiterated its desires to go downstream. At this moment in time, BHP-Billiton endeavors to sell 15% to 20% of its output as polished diamonds directly to retailers. The mining conglomerate, at this point, is involved in outsourcing the manufacturing (contract polishing) or manufacturing through joint ventures. In the future that 20% will grow – as BHP-Billiton makes more downstream revenues, depending on the rate of success. Other mining companies, noticeably Alrosa, follow – or plan to follow – similar routes.
Because of legal constraints which, unlike diamonds, may not last forever, De Beers is currently following a downstream strategy model in which it temporarily ceases title to the goods – it sells rough and buys polished. All very much on an arm’s length basis. It also has extremely ambitious objectives for its LVMH-De Beers joint venture. In its submissions to the European Commission it has indicated that “it expects the joint venture, Rapids World, to be able to obtain a 25% to 30% premium over unbranded jewelry sold by high-end independent diamond jewelry retailers.” It is extremely unlikely that in a very competitive market in large polished goods, De Beers will be able to procure the goods needed for the De Beers brand at prices which will enable generating such margins. The only way De Beers can succeed is maintaining some type of control over the higher end of the large goods market. To retain that control, the top end needs fewer players. There is so much at stake at the “top end” that it deserves a strategy on its own. Let’s look at the figures.
World production of diamonds is about $8.5 billion. Some 7% of that production (in carats) consist of goods of over >2 carats in all qualities (from industrial to the best of gems). By value this part of production represents some 44% of total value, i.e. $3.7 billion. The relevant goods, both for the New York market and for generating brand premiums would be I-color and up, clarity range VS1 and up, and size >2 carats. We estimate that these categories, by value, represent some 20% of annual world production, i.e. $1.7 billion at rough diamond mining sales values (i.e. the so called De Beers Standard Selling Values.) In terms of rough diamond intake, we further estimate that De Beers together with its contracted party Alrosa has about 60%-65% of this amount available for annual distribution. Though we are quite sure about that dollar figure, we are slightly less confident about the exact weight volume to associate with that figure, but expect it to be considerably less than 2 million carats per year, due to fluctuations in production.
It must be appreciated that precise data on the quality segmentation of the carat output is highly confidential, and commercially very valuable, proprietary data of the producers. In Russia even the overall carat output is considered a state secret and is not being released. In many countries there are special laws governing the disposal of the really large diamonds, the stones of >10.8 carats and up, stones to which the trade refers as “specials”. This category represents the expensive top of the line stones. A handful of such stones can affect the statistics and value of output. The law in South Africa requires all rough diamonds of >10.8 carats and higher which are mined in that country to be sold back to cutters in South Africa. This is a handicap for De Beers, and quite a few of the larger goods go to one or two local South African manufacturers who have a special relationship with De Beers. Another major producer of large (>10.8 carats) stones is Russia. By law, these stones cannot be exported as rough, but are either hoarded (by the government) or polished domestically. Therefore, the worldwide market for these stones is limited and also the number of manufacturers having the expertise to polish stones of sometimes 30, 100 or 200 carats apiece, are limited.
So, in any event, the market for these large goods is limited to begin with – but probably still too large for the objectives of the LVMH-De Beers joint venture, called Rapids World. Though it is somewhat speculative to assess Rapids World’s potential market share of this segment of the market, the joint venture partners have publicly stated that Rapids aims at securing (in 10 years time) about 1.4% of the market (by retail value). De Beers has, as recently as this week, stressed it aims at growing the diamond jewelry market by 50% in ten years, i.e. it wants to see a diamond jewelry market of close to $90 billion by 2012. The LVMH-De Beers share of this would be $1.25 billion – and here we simply use the figures supplied by the joint venture itself!
Assuming that the diamond value in the worldwide diamond jewelry annual market figure is $22.5 billion – this would require almost a tripling of mining production within the next decade, something which is definitely not going to happen. Thus this growth must come from price increases and price increases and price increases. That isn’t so easy in a competitive market. But it is certainly manageable in the better goods, if there are as few players as possible in that segment.
Let’s for a second move away from speculation. If Rapids World were today operating at its targeted level, it would hold 1.4% of the $59 billion worldwide market and have a turnover of $825 million at retail level. Assuming that the diamond content at wholesale prices would not be less than 55% of the final jewelry product (a very low and conservative estimate – in the better qualities the diamond value certainly represents more than 55% of the retail piece value), Rapids would consume up to $453 million at wholesale polished prices (with no brand-add on). Translated back to rough prices, this would come to about $400 million. Expressed in today’s terms this would represent 4.7% of total worldwide mining production and/or about 23% of the specific supply range from which we expect the polished suppliers to Rapids to draw their raw materials.
But that is only a “best case” scenario. When BHP-Billiton, Aber (through Tiffany’s) or Alrosa designate their best rough directly for their own downstream destinations, De Beers will – de facto – discover a much smaller market to find the polished for the world’s most exclusive diamond brand. By our estimates the LVMH-De Beers joint venture will find it increasingly difficult to secure the goods that it needs, to get the brand premiums it aims at, and to raise the price of the better goods appreciably to make it worth the exercise. With one store the problem is manageable. But with half a dozen or more stores, the problem may become mammoth size.
The industry did express to the European Commission its fears that the De Beers-LVMH joint venture would lead to some manipulation of the rough diamond market as a result of this merger. By volume the market of the high-end goods is sufficiently small that De Beers, through its allocation policies (or through withholding rough from the market), could stimulate demand for slow-moving LVMH goods – because other jewelers simply would not be able, or not without great difficulty, secure these goods. De Beers would be under pressure from its partner to perform. The anticipation of collecting considerable revenue from LVMH, coupled with the marketing strategy to make these diamonds the highest valued in the world, might become an incentive to De Beers to trigger considerable diamond price increases in this small segment of the market. It may also have a spillover effect on other categories. In adverse economic times, De Beers is expected by the industry to use its allocation policies to protect the LVMH venture. It seems practically impossible to avoid conflict of interests. The EC correctly argued that it cannot prevent the establishment of a business, just because of some hypothetical future scenarios.
There is no doubt that the new academically trained young management currently running the DTC marketing department are sincere in their desire to maintain an arm’s length approach. They are undoubtedly convinced, or have been made to believe by the company’s management consultants Bain & Company, that this retail joint venture is not only good for the business as a whole, but that it will give a welcome boost to the worldwide diamond jewelry branding business. The LVMH-De Beers venture constitutes a vital pillar to the strategy of the “New De Beers” and is, indeed, perceived as an integral part of the Supplier of Choice initiative. However, what is not publicly said is that De Beers cannot afford for the LVMH-De Beers joint venture to fail. Though it has only recently started, the early beginnings are not encouraging. De Beers MUST do everything to make that venture a success.
Oddly enough, De Beers has lately been “downplaying” the importance of the LVMH-De Beers joint venture. It was stressed to me, when discussing this article, that the joint venture is seen as a way to move the market into the direction of branding, not as a source for cash or revenues. It is stressed that it is, indeed, a part of the SoC strategy. We don’t fully buy these arguments. You don’t give your name (“De Beers”) away to an insignificant venture. You don’t risk a confrontation with your clients and the market unless the venture was an important part of your business. Downplaying the importance of the LVMH joint venture doesn’t change the fact that the market still can’t easily swallow the fact that the dominant rough supplier is competing with it on the retail side. However, this is a fact of life. Interestingly, we never heard any public outcry against BHP-Billiton. BHP-Billiton has structured its rough diamond marketing program in such a way that it basically competes with its own customers in the retail market. Why shouldn’t De Beers – within its self-imposed or EC-imposed limitations – enjoy a similar right to give considerations to its own downstream objectives in its rough marketing structure?
We think that is exactly what De Beers is doing. Moreover, De Beers would not act in the best interests of shareholders and joint venture partners if it wouldn’t be using its rough distribution system in the best interests of the company. This requires a different thinking about the distribution of its better goods. That’s what De Beers is doing – and that is what has seriously affected New York sightholders. As time progresses – we expect there will be more evidence of De Beers protecting all of its interests. And, we want to stress it again, De Beers says none of this is true.