DeBeers and the Diamond MarketA few years ago, DeBeers, the world’s main supplier of diamonds, ran an ad urging men to buy their wives diamond jewelry. “She married you for richer, for poorer,” read the ad, “Let her know how it’s going.”Crass? Yes. Effective? No question. For generations diamonds have been a symbol of luxury, valued not only for their appearance but also for their rarity.But geologists will tell you that diamonds aren’t all that rare. In fact, according to the Dow Jones-Irwin Guide to Fine Gems and Jewelry, diamonds are “more common than any other gem-quality colored stone. They only seem rarer…”Why do diamonds seem rarer than other gems? Part of the answer is a brilliant marketingcampaign. But mainly diamonds seem rare because DeBeers makes them rare: the company controls most of the world’s diamond mines and limits the quantity of diamonds supplied to the market. DeBeers is a monopolist, the sole (or almost sole) producer of a good. (Krugman and Wells, 2005, p. 333) How does DeBeers do it?Background The international diamond cartel, which presides over the production side of the industry,may be the most successful and longest lasting cartel in the world. The dominant company in thecartel, DeBeers, has been around since 1880 and has been controlled by a single South African family, the Oppenheimers, since 1925. In 2004, DeBeers Societe Anonyme (now privately held and managed by Jonathan Oppenheimer, great-grandson of the firm’s founder) sold $5.7 billion worth of rough diamonds – or 48 percent of the world’s total – and reported earnings for the yearof $652 million.Eight countries – Botswana, Russia, Canada, South Africa, Angola, Democratic Republic of Congo, Namibia, and Australia – produce most of the world’s gem diamonds, and their producers sell the bulk of their rough diamonds to the Diamond Trading Company, a DeBeers-owned entity based in London. This conformity is the result of over a century of careful planning and negotiation, in which DeBeers has undertaken largely successful efforts to control the diamond trade and maximize its long-term prospects. (Spar, 2006, pp. 195-196)1The upshot is that DeBeers’ virtual monopoly of diamond production and distribution, along with a very effective advertising strategy, has kept the price of diamonds high and remarkably stable, generating substantial and stable monopoly profits. The stability of diamond prices can be contrasted with the prices of other commodities. Figure 1 below shows that, while the prices of copper, aluminum, gold, and even oil have fluctuated continuously since 1980, the price of diamonds has been steady, even rising slightly over the period.Figure 1Commodity Prices, 1980-1998 (Diamonds, platinum, gold, copper, aluminum, oil) Index Diamonds 100 Gold Oil 80 98The Evolution of a Cartel: Control Over Production and Distribution (Go to www.debeersgroup.com for more information about the company)In 1867, the accidental discovery of diamonds in South Africa launched the modern diamond industry. Within months of the first discovery, prospectors from around the world rushed to pan the waters of the Vaal River. However, the bulk of the diamonds lay in deep volcanic pipes, rather than in the bed of the river. This made extracting them difficult and expensive, forcing the miners to pool their resources and cooperate. First, they joined land claims. Then, as the mine shafts grew into large pits, they came together to erect pathways, pulley systems, and eventually massive platforms and communal hauling machinery. By the early 1870’s, the shafts had tapped into underground aquifers, causing flooding throughout and bringing work to a standstill. Some miners tried to clear the flooding with hand-held pumps, but to no avail.2In 1874, an Englishman named Cecil Rhodes arrived at Kimberley Mine and began renting a far more effective, steam-powered pump to the miners. He soon installed pumps at other mines in the area and shortly thereafter began purchasing claims in the mines themselves. In 1880, Rhodes formed the DeBeers Mining Company to administer his holdings; seven years later, DeBeers controlled all the claims in the area.Cecil Rhodes Deduces the “Market Realities.” As Rhodes acquired his mines, he began to grapple with what he realized was a distinctly two-headed problem of the diamond trade, one that would haunt the industry for decades to come. First, the sheer volume of diamonds flowing from the South African mines and streaming into Europe in unprecedented amounts threatened todestroy the very scarcity that had long defined the stones’ value. For centuries, diamonds had been exceedingly rare and valuable: a luxury item largely reserved for royalty. Now, a sudden increase in their production had brought the stones, quite literally, into the hands of the masses. But if diamonds became too prevalent, Rhodes realized, their association with romance and luxury would be tarnished, and people would not be willing to pay as much for them; that is, demand for them would fall. Second, since diamonds are both a natural product and a highly variable one, South Africa’s individual miners were unable to control their production: they mined the stones they found and tried to sell them all no matter what their quality. Consequently,the supply of diamonds would be highly variable resulting in unstable prices. Rhodes realized that he had to control both the demand and supply of diamonds and concluded that the only way to do this was to forge a unified, vertically-integrated organization to manage – down to the carat– the flow of diamonds from South Africa. Only cooperation, he reasoned, could keep supplies low and prices high. Managing Supply. In 1883, Rhodes signed a formal agreement with his buyers, the local South African diamond distributors, to form the Diamond Syndicate. Under its terms, the distributors would buy diamonds exclusively from Rhodes and sell them in mutually agreed-upon numbers, at agreed-upon prices. As a result of this “collusive” agreement, by 1890, Rhodes controlled all of South Africa’s major mines, along with the distribution channels for their output.These mechanisms remained in place until Rhodes’ death in 1902. Then, Ernest Oppenheimer, a German who had risen to prominence in South Africa’s