The strategic significance of the De Beers management decision to open a Diamdel office in Dubai is being downplayed by Diamdel Chief Executive Officer Neil Ventura (and by some of his astute public relations colleagues in London) as just a routine business decision, Chaim Even-Zohar writes in his analysis posted on www.israelidiamond.co.il by courtesy of Diamond Intelligence Briefs, Tacy Ltd. While I was told a few weeks ago that any attempt to seek a “broader interpretation” is simply speculation and conjecture, I couldn’t disagree more. The new Dubai office is part of a De Beers policy to move a larger part (if not all) of its rough sales through auctions, which could have near catastrophic ramifications on the diamond business.
For starters, the two main Antwerp diamond banks have already put the DTC on notice that they will not finance an industry that depends on auctions for its rough supplies. That failed to get the subject off the table. Behind the scenes, there is a fierce debate raging among senior executives within De Beers – especially among those with legal and financial backgrounds – about the fundamental issue of DTC sights versus Diamdel auctions.
Apparently, there is even a view that the DTC should be scrapped altogether and that De Beers would become far more profitable and efficient if it would simply auction off all of its rough. It is believed that this would provide huge profits during good times, which would provide a safety cushion during global economic downturns or crises. Things aren't that simple.
The Repositioning of Diamdel
It is not clear whether the Dubai office announcement was done as part of the creation of facts on the ground to make the auction direction a foregone conclusion, or whether a formal decision has already been made in advance of the CEO-designate, Philippe Mellier, taking the helm. If a decision has been made, then the next DTC sightholder contract will be the last – and we'll see a gradual move to rough auctions. If there is one distinct area in which interim joint-CEOs Stuart Brown and Bruce Cleaver have clearly left a major legacy it is the repositioning of Diamdel.
Diamdel, which only a few years ago had nearly been written off and followed a policy of major redundancies and office downsizing, has quite suddenly re-emerged as an integral part of De Beers' expansions, in importance maybe second only to the growth in the Forevermark department.
As already mentioned, the Diamdel CEO is downplaying the significance of his company's move to Dubai. Ventura stressed to us that “the purpose of Diamdel Dubai is simply to provide registered companies which enjoy easy access to Dubai, improved opportunities to view the products that we will be offering at auction."
Continues Ventura: "Just as we have done elsewhere in the world, Diamdel is trying to make our clients lives easier as our auctioning model evolves. Indian-based businesses, in particular, currently have to travel to our Antwerp, Tel Aviv or Hong Kong offices to do this and so we anticipate that Dubai will provide another option for these businesses to participate at our auctions, given its geographic proximity and convenient transport links."
An Evolving Diamdel Auction Model
Generations of diamantaires will recall that their first acquaintance and business ties with De Beers came via Diamdel – paving the way for some successful companies to get DTC sight privileges later. In the past decade, when De Beers adopted the Supplier of Choice marketing model, Diamdel sales hovered mostly below 8-10 percent of De Beers' overall rough diamond sales levels.
The auction system was developed only in recent years, partly as a reaction to some disturbing internal bad-governance issues requiring a partial personnel and system overhaul. The auction model not only optimizes Diamdel’s revenues, but it also facilitates a transparent, clean, proper good-governance model. It is probably the best thing that ever happened to Diamdel.
Virtually all major diamond producers today have adopted a business model in which part of the goods are marketed through long-term contracts and partly through auctions. Some (such as Alrosa) are watching what De Beers will be doing. A few minor producers have moved to a hundred percent auction model. De Beers seems keen to growing the role of Diamdel and channeling a greater part of the production through auctions. DTC Chief Executive Officer Varda Shine hinted at the increasing role of auctions at her presentation to DTC clients in Antwerp last week – although, some participants weren’t clear if her message referred to the diamond industry in general or De Beers in particular. Probably both.
What Does De Beers Really Want?
When Philippe Mellier assumes the reigns at De Beers, it is crucial that he realizes that the issue is not one of revenue optimization. Auctions will commoditize the diamond product in the value chain. It will cause pipeline fragmentation. It will dry up downstream finance. There will be fewer, or no, players committed to promoting the diamond dream.
Does De Beers want to sell a commodity or a luxury product? Does it want to use its leverage over its clients (through Supplier of Choice) by ensuring the creation of added value through the value chain or does it wants to collect maximum money? As a matter of policy, will De Beers encourage DTC clients to take their boxes and sell their goods through an auction, as one Indian player is doing at the moment? If so, that would spell the end of the Supplier of Choice philosophy. African producer governments would have all their national output auctioned.
Auctions Lead to Industry Fragmentation
Today, the auctions are driven by speculative demand. Prices are ridiculous. The question is: will auctions continue to provide a better return in the long term under normal conditions? We asked various diamond manufacturers and traders this question. It is believed that the first immediate result of auctions will be industry fragmentation. That's a major step back to the past when De Beers had many hundreds of clients and the industry consisted of thousands of small, competing entities.
The fragmentation is clear from Diamdel’s results, though it is perceived as a virtue. Diamdel has already proudly stated that it presently has a customer base of some 350 companies. A Dubai presence might easily double that. In its most recent (May/June) auction, some 157 companies participated. Most interestingly, 46 percent of the lots sold at this auction were sold to DTC sightholders. That's exactly what the policy tries to achieve: the DTC client base is getting used to getting a mix of DTC sights and Diamdel parcels. Auction models will allow hundreds, even thousands, of small companies to compete for goods. But what will happen at the next levels? Will the Tiffanys, the Cartiers and the Sterlings of the world need to source their polished requirements from hundreds of sources?
Commoditization Destroys Product Differentiation…
One Indian sightholder pondered whether retailers would be able to maintain brands. “The trusted diamond brands need consistency and reliable supply sources to protect their credibility. In absence of scale players, these retailers will be compelled to deal with numerous people which will lead to no audit – pipeline controls, source due diligence, etc.,” said the DTC client. “The clients of De Beers will ‘lose identity’ as the De Beers goods will end up with hundreds, if not thousands, of small players.” It destroys the value of the producer brand.
De Beers may still advance its own Forevermark on the polished retail markets, but the trustworthiness of that brand will also be undermined, as it will face the very same sourcing impediments as other retailers in securing the polished. “If large retailers find it difficult to find a steady source of diamonds, this will lead them to use less diamonds and they will invest less in promotion,” said another diamantaire. The end result of a commoditized product is the total lack of meaningful differentiation in the manufactured goods.
…and Also Destroys Value
Commoditization changes the nature of the diamond since commoditization, by definition, represents a process by which a good, thought to be unique or superior, becomes like other, similar goods and services in the eyes of the market. Commoditization is the movement toward undifferentiated competition between two or more companies offering the same good or service. This leads to lower prices, say economists.
If we look at commodities in this world, it is fair to say that commoditized products have thin margins and are sold on the basis of price and not brand. This situation is characterized by standardized, ever cheaper, and common technology such as internet auctions that invite more suppliers who then lower the prices even further. Of course, rough diamond producers count on the fact that the number of rough suppliers (and the volumes of rough supplies) are limited and dwindling. But a commoditized diamond product will also affect the behavior on the demand side: it may reduce demand and create other opportunities. It will open the door to substitutes, such as synthetic diamonds.
Indeed, one of the manufacturers interviewed for this editorial made a fascinating remark: “Mass retailers who advertise the [diamond] product will face the same [problematic sourcing] fate and perhaps look to sell synthetics.” One might be cynical and say, “Hey, that’s what De Beers really wants,” but that is not a road of argument that I wish to pursue. Synthetic producers can assure the continuity of supply and steady prices.
Auctions Decrease Willingness to Invest
Those who have been in the business for many decades may hold some preconceived notions against auctions, but they also have the benefit of years of experience. In an auction-based supply situation, many manufacturers and other downstream players will simply refuse to invest in the business. It becomes too risky. Said one current mega-player: “Why would I stay in diamonds? There are at least 500 more interesting business opportunities in the real world.”
De Beers' new CEO will come in from the outside. In Mellier's professional experience, he has served as CEO of a company that was on the verge of bankruptcy but remarkably recovered. Surely, he will need to do a SWOT-analysis on De Beers and ask the perennial question whether the revenue side of the business should be focused on short-term (high) prices or longer term stable rough prices. Mellier must ask the hypothetical question of whether De Beers would have gone bankrupt in the past crisis if, at the time, it had an auction model. Could De Beers have afforded the volatility?
As it stands today, the auction part of De Beers' sales is minimal. But, clearly, the percentage of goods marketed through Diamdel (or auctions) is set to increase. The US$6 billion question is: where is the balance, where will the line be drawn?
Pipeline Re-Engineering
If indeed most of De Beers' rough would be channeled through auctions, the commoditization of the product will become inevitable. The resultant fragmentation will turn smaller and medium-size manufacturers into subcontractors as they themselves couldn’t guarantee having continuous rough supplies or have access to the money needed to play in a volatile market.
In a protracted downturn, there might be a chance that three or four large companies will corner the market, being able to pay a better rough price as they would create a new oligopoly on polished manufacturing. This will bring the producers back to square one since an oligopolistic situation in the polishing industry would mean that rough prices would be pushed lower as fragmented suppliers will lose their pricing power.
The new De Beers CEO should realize that the company he joins isn’t just “another producer” but rather the dominant supplier to the market. It considers itself as the Market Leader – and, as such, its policies reverberate throughout the diamond pipeline. A fresh look from the outside may well be what is needed – as long as any decision is accompanied by careful simulations mapping the ramifications. Auctions are not just about money and prices – they fundamentally alter the fabric of the industry.
