Rio Tinto Drops Some Long-Time Clients, Changes Business Model

It always seemed logical that Rio Tinto – the only major diamond mining company that sells solely to long-time customers and has no effective “market price” discovery system through tenders or otherwise – would sooner or later change its business model. It has done so now. In a letter to clients, Rio Tinto Diamonds general manager Jean-Marc Lieberherr writes that, “today we have to put on hold some of the well-established partnerships we have built over two decades, and we do not take this step lightly. These decisions however respond to what we see as business imperatives which the management team has a professional obligation to consider.”

By way of background, Lieberherr explains that the diamond team has “just concluded the review of our customer portfolio and allocations for the coming couple of years. I realize that this has been a long and protracted exercise which has created stress and uncertainty for your businesses and yourselves personally.” He goes on to ensure that the decision making process to reduce the clients list “was designed to ensure that all circumstances were considered, that no decisions were made in haste or with insufficient information, realizing what the potential implications could be for your companies.”

Basically, Rio Tinto Diamonds announced two separate decisions: it is changing its business model by decreasing its dependency solely on long-term clients, and it will market part of its output through different channels. Without specifying what these different channels are, clients believe Rio Tinto will opt for tenders. Rio Tinto has a long experience with polished pink tenders and that mechanism has served the company well.

The company presents two reasons for its decisions – the expected decline in mining output and the need for alternative marketing channels.

Expected Production Declines

In respect to declining production, Rio Tinto stresses that both Diavik and Argyle will reduce production as they move towards the underground phase of their lives. “This will be most marked during the coming three years as we transition from the open pit to the underground. It is not yet certain when Murowa [in Zimbabwe] will be expanded and Bunder [in India] developed.”

The rather steep reduction in expected output leaves the company with little choice. Just look at the numbers: By our estimates, Diavik’s 2009 production will come to some 5.6 million carats, which is down from 9 million carats in 2008. In 2007, Diavik produced 12 million carats. Thus in a short time span its production almost halved. The same story is true for Argyle: it went down from 30 million carats in 2006 to 15 million carats last year. In 2008, the company’s diamond output was worth some $1.1 billion.

However, Rio Tinto Diamonds is heading for major capital expenditures to finance the underground developments in Argyle and in Diavik. At the same time, the more expensive mining methods will negatively impact its margins. There must have been enormous pressure on the diamond marketing executives to find ways to optimize the company’s revenues. Having said that, the company has not been doing so badly on that score – its rough prices have always been considered being on the higher side of the market range. That might explain why the company didn’t make a move to other marketing methods earlier.

The Development of Alternative Sales Channels

Lieberherr gives a different reasoning. “We believe that the recent market volatility will remain a feature of the rough market over the next few years. This makes it a real challenge to manage effectively a business model solely based on stable pricing and predictable supply. While we want to reinforce that it remains Rio Tinto Diamonds’ core business model to provide long term partners with stable pricing and predictable supply so as to create an effective supply chain, it has become necessary to further inform and complement this model with other sales mechanisms.”

According to Lieberherr, “The mechanical result of this decision is that volumes available for longer term supply agreements will be further reduced.”

Just as with De Beers’ Supplier of Choice model, at the end it comes down to basic arithmetic. If you encourage your clients to develop marketing programs or enter into long-term agreements with jewelers or retailers, the mining company must make the rough needed for these programs. Moreover, you need to let the client to grow his business with you. The outcome of this is that one may have to drop more clients than would be necessary today.

Lieberherr touches on that dilemma rather frankly. “It is our objective to build a meaningful partnership with every Select Diamantaire. To do this, we must be able to provide a meaningful allocation to each business, which further reduces our ability to enter into a regular supply relationship with a wide base of clients.”

Impact on the Market

Rio Tinto has always been able to secure high diamond prices because of its loyal long-term clients. Old-timers will remember that when Argyle broke away from De Beers’ DTC marketing mechanism in 1996, many clients, facing the wrath of De Beers, had to make a choice between the companies with those who stayed with Argyle forfeiting their DTC Sightholder status. Rio Tinto subsequently rewarded these customers by allocating a large part of the good quality Diavik goods to them when that mine opened in 2003.

The question to be asked is whether Rio Tinto will materially fare better through a tender system. One may also ponder if the decisions will trigger a loss of goodwill among clients, or, in a larger sense, some loss of market appreciation. The announcement doesn’t indicate how many clients were removed from the list. In reply to my question, Lieberherr explained, “the large majority of our goods will continue to be allocated to our regular partners. We just can't afford supplying them all.”

The official announcement was made on Tuesday, November 10, and it would not be fair to conjecture on how the market will respond – we’ll know within a few days. Undoubtedly, this must have been an enormously difficult decision for the company, as it says that their core business principle of building long-term partnerships remains intact.

Another Rough Market Benchmark?

The tenders of BHP Billiton have become some kind of market price benchmarks. If Rio Tinto follows the same road, there will be an addition price barometer on the market. That can only be helpful.

However, don’t hold your breath. A source within Rio Tinto confided that, “the alternative sales mechanism prices will not be communicated.”

Then, as always, there is the issue of De Beers. It is marketing part of its output through its Diamdel subsidiaries and through various arrangements with southern African governments to enhance beneficiation. Diamdel is having considerable success with online tenders. Will the shift at Rio also impact the thinking in London?

It’s quite telling to see that all the erstwhile committed cartel members are now increasingly moving away from having just a long-term steady clientele to some form of tender system. All of these things occurred in a relatively short timeframe.

It will certainly affect manufacturers who may have to scramble – and pay more – for rough. It eventually will impact long-term relationships between jewelers and their suppliers. Rio Tinto’s is not so significant in terms of the volumes of supplies but rather because of the message it is giving to the market.

The Antwerp Diamond Symposium will start in a few days. The timing of Jean-Marc Lieberherr’s letter will provide for some lively debate at the conference sessions. As moderator of the Symposium, I am grateful to him. Everyone has his or her little angle to look at events. Rio Tinto’s letter has at least made one person happy. Let’s hope for Rio Tinto that I am not the only one.