Who controls the Polished Market?
November 25, 04The European Commission’s Competition Authorities, in their renewed investigation into the Supplier of Choice marketing strategy of De Beers, pose remarkably intriguing questions in their various questionnaires to stakeholders. In several instances there may not be one right answer – and the EC will have to evaluate the soundness of the argument supporting the response. One question that has given a variety of answers reads, in reference to specific years: “Estimate the total world market size of polished diamonds” which is then followed by “estimate what proportion of the total polished market has been supplied by DTC Sightholders”.
The easy answer, given by those Sightholders who are acutely aware of the fact that, at some point, De Beers will gain access to the answers and fear (rightly or wrongly) repercussions on the London front, is: “As we don’t know the total polished sales volume of the 84 Sightholders, we cannot estimate the part supplied by DTC clients.” That’s a nice way out of it. The truth is that the only company that can give an authoritative and accurate reply is the DTC itself. Its insistence that Sightholders have “visibility” on the polished destination of their sales, its desire to make the pipeline efficient, and its analysis of the cumulative client profiles enables the creation of a U.S. presidential election results type of map of the polished world: with red geographic areas supplied mostly by Sightholders and blue regions for the others. The EC isn’t looking for such detail. Such a map, however, would mostly be red.
The EC wants the data for specific years, such as 2002 and 2003. These were the years in which De Beers was still in the process of offloading its buffer stocks to the market and thus the market was oversupplied with rough. In other words, it is not correct to equate “polished supply” (and “polished supply” meaning the resultant polished of all rough supplied to the market) with “polished demand”, (which is actually the polished that is sold by the retailer to the consumer.) The EC is looking for “polished markets”, which will also include polished inventory build-ups or reductions.
We would tackle such a question as follows. As we have a fairly good idea about the volume and value of rough diamonds coming out of the ground – and their size categories – we can translate the rough diamond supplies to the market into resultant polished. We would estimate that in 2002 the total supplies of rough diamonds to the market from the DTC and other sources would total some $8.3 billion. This would translate into $15.3 billion worth of resultant polished. From other data we would estimate total polished demand in 2002 to be $14.5 billion, measured in polished wholesale prices (pwp). The diamond content in world diamond jewelry sales of some $58 billion would come to $14.5 billion. Therefore (in 2002) polished supply exceeded demand by at least some $800 million.
Doing the same exercise in 2003, we can rely on recent data released by De Beers itself. De Beers estimates that 2003 global rough diamond production totals $9.3 billion. Because of inventory withdrawals, the rough supply to the market was $10.1 billion. This figure translates into a polished equivalent of $16.1 billion. We would estimate polished demand at $15.5 billion, thus again showing a growth of polished inventories of at least $600 million.
Thus it is fair to estimate the combined size of the polished market in 2002 and 2003 together to come to $31.4 billion. To be precise: that’s the “new polished” that came into the market in those two years, or about $15.7 billion at an average. Let’s concentrate on 2003, as both years are fairly similar.
In terms of value, De Beers supplied in 2003 some $5.6 billion worth of rough to the market, which represents 55% of the total rough supplies of $10.1 billion. The resultant polished from these De Beers sales come to $8.85 billion. As DTC Sightholders secure at least some 35%-45% of their rough diamond needs from other (non-De Beers open market) sources it is fair to estimate that DTC Sightholders will also purchase some 40% of the outside rough, which comes to 18%-20% of global rough supplies. So the rough that ends up in the hands of DTC Sightholders is at least some 73%-75% of the new annual rough supplies.
Now, we all know that a large part of DTC sight boxes are traded in the market. We all know that a diamond may pass hands four or five times (if not more) before it reaches its final destination -- somewhere in jewelry adorning some happy and fortunate lady. But that is not relevant. These amounts of rough pass at least once through the hands of the sightholder and they control their destiny. Selling DTC boxes is a prerogative that comes with the purchase of the box.
The EC is aware that Supplier of Choice, in a real sense, has replaced De Beers’ traditional controls at the supply side of the diamond pipeline with an enhanced involvement (visibility, guidance, control, etc.) of the diamond pipeline itself. De Beers has a greater say in the distribution rather than the supply of the rough. Through Supplier of Choice it is restructuring the pipeline (trying to make it more efficient) by making the marketing behavior (policies, strategies, objectives, results) of its clients a prerequisite to rough allocation. Indeed, it may well be the “beauty” of Supplier of Choice that De Beers now also impacts the marketing strategies and programs of non De Beers goods in the hands of DTC Sightholders. It’s quite clever, if one thinks about it.
Eliminating any “double accounting” of all the rough supplied to the market, 73%-75% (by value) will pass at least once through the hands of the 84 DTC Sightholders. [And for this analytical purpose, clients of Diamdel are also viewed as clients of De Beers, though, for all practical purposes, their purchases from other sources would be far greater. They are not included in the 84 figure. Virtually all DTC rough dealers have become manufacturers of polished, so no deduction was made to exclude dealers from the calculation.]
So if we had to reply to the EC’s Competition Authorities’ questions, we would argue that theoretically, the DTC Sightholders at one time or another will handle the rough equivalent or the resultant polished of some 75% of all the polished diamonds in the world, close to $12 billion (out of total polished value in the range of $15-$16 billion). This 75% is a conservative estimate which can be higher; it is very unlikely to be lower.
After writing these lines, we made phone-calls to a number of major players in the market. There was a general agreement with these figures. One source, however, took issue saying that the “weight” of the DTC Sightholders is “heavier” than suggested by the figures, because they have access to the larger goods. This got me back to the drawing board. Indeed, one may not ignore that diamonds are not a homogeneous product and that, when analyzed solely by sizes, some 7% of the world’s rough output (rough exceeding 2 carats) accounts for at least 45% of the total value.
After having estimated what part of the polished market is in the hands of the DTC Sightholders, we might further analyze the categories of rough supplied by the DTC to the market and create a size distribution of the resulting polished. The outcome of that exercise doesn’t change the arithmetic – but it will illustrate that the DTC Sightholders definitely hold a “qualitative edge” in the market.
We estimate the total annual production of polished diamonds worldwide to be close to one billion stones (!) at a total weight of some 30 million carats. Annual production of polished diamonds in excess of one carat each represents only approximately 1.2 million carats (i.e. 4% of the volume of the total polished production) and less than 1 million stones. The price trends in each size and/or quality category may move at rather different paces and even in contrary directions (just look at the huge price rises of D-flawless goods of over 1 carat.)
In terms of supply to the market of the types of rough which produce polished diamonds in excess of 1 carat, the DTC is fortunate that its intake of rough in that category represents some two thirds of the worldwide availability of larger goods. This is certainly relevant in the context of the questions asked by the EC. Though we have said that the DTC directly controls 55% of the rough supply to the market (in 2003), this is by value. And that value is reached because of the dominancy of De Beers in the larger goods (rough that results in polished above 1 carat). Actually, in all other size categories De Beers is “under represented” – i.e. measured in carats there is more non-DTC than DTC supplied rough in the market.
A few warned that “you are asking for trouble in respect to your relations with London if you write that De Beers, or its clients, hold dominancy in the market”. These Sightholders fail to grasp the essence of the exercise. There is nothing wrong with being dominant, or holding a dominant market share. There is nothing wrong with having clients who almost totally control the market. Dominance is not a “disease” – it is an achievement. It is something to be proud of and to strive for. De Beers has never argued the point – to the contrary, it presently owns (together with government partners) some 40%-42% of the world production and would like to come closer to 50%. Chairman Nicky Oppenheimer has expressed that wish more than once.
The EC Competition Authorities have no problem with dominancy per se. Their investigation centers solely on the question whether there is an infringement of specific legal provisions (articles 81, 82 etc.) – it is the “abuse” of a dominant position that worries authorities. If the EC determines that there is no infringement – nothing will stop De Beers and the DTC from growing even more. Some may not like that, but that’s a different argument all together. One cannot deny that one of the most treasured business objectives in the diamond world is still becoming a DTC sightholder – basically, to become part and parcel of the dominant structure. It’s definitely perceived as “being worth it” - being part of the dominant group is certainly considered more desirable than being left on the outside.
And let there be no mistake: De Beers is dominant in the diamond world and – as far as it is concerned – it will strive to perpetuate that situation to last forever.