F.P.O. Is a new diamond market emerging?

Recent developments in the diamond industry are hinting that the diamond market may have seen the last of single-channel supply.

The shape of the new market may have broken the surface in July when De Beers Consolidated Mines (DBRSY-Q) announced it was developing a new strategy to market diamonds. De Beers, henceforth, would make itself the “supplier of choice” in the diamond industry, rather than attempting to control supply in the pattern that had developed since the Central Selling Organisation was established in 1934.

De Beers’ point-man for the changing times is the Diamond Trading Company, the CSO unit that sold gem and near-gem quality rough to the sightholders — the diamond traders and large cutters who then sold cut diamonds further downstream to polished-diamond dealers and jewellery manufacturers.

Sightholders had traditionally been expected to buy whatever was on offer from the DTC, which had the virtue of keeping the market in balance and profitable for everyone, but which alienated some customers and tarred the CSO as a cartel. It seems clear that the new DTC will be much friendlier to its sightholder customers than was the old one, whose policy might have been described as “take-it-or-leave-it,” or less charitably as “take-it-or-leave.”

The sightholders’ hearts and minds are to be won over with a new package of support services from the DTC, to include training, general business support, and market research. Access to market data may be the prime payoff for the sightholders, who could legitimately feel De Beers was now treating them more like a partner and less like a franchisee.

The sightholders also share in whatever success a revamped diamond marketing campaign may find. De Beers has a US$170-million budget for advertising in 2000 that brings the DTC’s name front and centre.

The company’s “Supplier of Choice” strategy has been widely seen as a concession that the 20th-century CSO can’t be maintained. Instead, De Beers is recognizing that other producers may have the muscle to bring stones to market as competitors, rather than junior partners in an old-style CSO.

With that has come an emphasis on keeping De Beers and other established diamond players out of producing areas like Sierra Leone, Liberia and Angola. The “conflict diamond” issue — as much as it deserved to be seen as a rejection of the African warlords and their violence — also positioned the CSO-linked traders and producers as the people who could sell you the better class of diamond. The issue meshed well with the branding strategy.

The Best Practice Principles, part of De Beers strategy for the DTC, is particularly strong on the ethics of diamond distribution, especially at the retail end of the pipeline. But it also distances the DTC from conflict diamonds, unsafe work practices and child labor, all of which are issues that might hurt a marketer at the retail level.

Three researchers, Menahem Sevdermish of the European Gemological Centre in Tel Aviv, and Alan Miciak and Al Levinson of the University of Calgary, published a study of the newly evolving “diamond pipeline” in the Geological Association of Canada’s review Geoscience Canada in 1998. They suggested the CSO’s control of the market has been fading since 1996, largely as a consequence of India’s rise as a cutting centre and Russia’s emergence as a diamond-trading power outside the CSO.

For these authors, one of the principal shifts in the diamond market came in the mid-1980s, when the Argyle mine in the northeastern corner of Western Australia came into production supplying large quantities of small diamonds of “near-gem” quality. The new supply of raw material needed labour and capital, and found it in India.

Indian cutters cannot match the skills of their counterparts in Antwerp or Tel Aviv, but can beat them handily on price. That has made the Indian cutting factories the leader in producing small, low-quality stones to make the mass-market goods that were sprung on the jewellery industry in the mid-80s: the pendants and earrings encrusted with sand-sized diamonds that go for under $100 in mass-market department stores.

The partnership of Argyle rough and Indian cutting gave Argyle’s owners, Rio Tinto (RTP-N) and Australian-based Ashton Mining the backing and nerve to pull out of the CSO in 1996.

At roughly the same time as the Argyle-India connection blossomed, the Russian diamond industry slipped out from under the old gentlemen’s agreements between the Soviet Union and De Beers that had governed that country’s production. Russian diamonds were believed to have flooded the markets by 1993, and the Russian industry renegotiated its arrangement with the CSO in 1997, for a four-year period.

In July, management of Alrosa, the Russian diamond production agency, openly mused about loosening the relationship with De Beers. Alrosa, whose current supply contract with the CSO expires in 2001, might try to renegotiate its marketing arrangement, under which Alrosa supplies up to 26% of the CSO’s sales; in the extreme, the agency might even start marketing its own stones.

Political pressures, which drive many of the prevailing winds in the new Russia, may be at the heart of the Alrosa moves. Some Russian politicians see the value added in the downstream phases of the diamond industry and — looking to the old model of self-sufficiency, as well as the possibility of more revenue in Russia — expect more of the cutting and polishing work to remain in the country.

The emerging Northwest Territories diamond mining industry appears to be bouncing on top of these waves, buoyed by some definite advantages like high-quality rough stones and a politically clean reputation. Under an agreement with De Beers, Broken Hill Proprietary (BHP-N) and Dia Met Minerals (DMM-T) are making 35% of production from their Ekati mine available to De Beers for three years. But they have also concluded their own agreements with cutting factories, including three in the Territories.

Similarly, the well-publicized deal between Aber Diamond (ABZ-T) and upmarket jeweller Tiffany suggests producers and downstream manufacturers may be looking to develop alliances that ensure some control over supply for the manufacturer and some assurance of sales for the miner.

It’s against this backdrop of an increasingly competitive market downstream that De Beers can be seen making a move to control the commercial high ground. Strenuous marketing, the identification of De Beers and the DTC as a diamond brand, and De Beers’ quick move to identify itself as a morally clean producer all suggest the company is looking at positioning itself for the most well-to-do market segment, for that is where they can expect to find the most discriminating buyers on the retail floor.

If a move to downstream control of a De Beers “brand” is to be the mainspring of the company’s strategy, then what is that likely to mean for the upstream assets?

One essential of the branding philosophy is to resist the idea of rough as a commodity. De Beers still has access to much of the really high-quality rough being produced — the Namibian marine and beach diamonds, and the good-quality material from hard-rock mines like Jwaneng in Botswana and Ekati. The company may see its upstream future in isolating these sources of high-quality rough, joining that with an upscale marketing pitch on cut and polished material.

But if the swing to a competitive commodity-style market can’t be resisted, then producing mines will likely be forced into being cost-efficient no matter what corporate umbrella they shelter under. Mines with high values per tonne of rock — especially with high-quality diamonds that contribute disproportionately to the ore value — will then probably be the ones in the best position to make a living.