Looking Back At the Future
December 07, 06
A phone call in the middle of the week from a friend in London urged me to reread an article that we had written some three and a half years ago, which was around the time Supplier of Choice officially started. In this particular article, many things were predicted for the diamond industry, such as the lack of liquidity in the industry, bankruptcy of a major sightholder, the lack of success in the development and financing of branded diamonds, etc. My friend’s advice was to take a yellow marker and go over the article again.
We did, and I’d like to share it with you.
Have a nice weekend.
Looking Back From the Future
De Beers in 2019: Chairman Jonathan Oppenheimer looks back at Supplier of Choice and Remembers the “old days” in which diamond mining was still considered a De Beers core business.
By Chaim Even-Zohar
It is Monday, November 18, 2019. Jonathan Maximilian Ernest Oppenheimer, the chairman of the De Beers Luxury and Leisure Group (which in the 2010 reorganization became the Group’s principal holding company) is celebrating his 50th birthday. He just finished a transatlantic video call with his father Nicky, the “reluctant politician,” who had handed him the helm of the company some ten years earlier when his outstanding Parliamentary career was crowned with his election as Deputy President of South Africa. Nicky will be 75 years old next year. Now semi-retired, his parents still reside on the family’s Brenthurst Estate, in Parktown, Johannesburg. Jonathan and Jennifer live in New York which has now become the de-facto headquarters of the De Beers Luxury and Leisure Group (DB-LLG).
New York has been good to the Oppenheimer successor generation. Jonathan’s wife, Jennifer – always the more politically-minded of the two – serves as the U.N. Commissioner of Refugees and is responsible for the welfare of more people than the President of the United States. (Jonathan smiled remembering that a diamond trade newsletter once described his marriage as “Jonathan tying the knot with the equivalent of a full-fledged NGO – someone ensuring that all the family’s decisions are politically correct and socially responsible.”)
Jonathan pensively looks at the southern wall in his lavish 40th floor office in the De Beers Fifth Avenue Building. Upon touching a discrete button on his desk, it lights up a few dozen screens displaying real-time images of the company’s major retail houses, hotels, cruise ships, and remaining mines around the world. Business is bustling. The De Beers fashion division, which had re-introduced the old-fashioned green DBI-logo jeans a few years ago, is now the company’s main revenue stream.
Who would ever have imagined that De Beers would earn more from selling a bride’s wedding gown, handbag, shoes, watch and lingerie than from the diamond wedding band the bride is wearing on the occasion! Who would have imagined that wedding ceremonies would take place in up market De Beers Connoisseur Hotels and restaurants? Who had the foresight to expect a De Beers leisure travel division, specializing in honeymoon packages and senior citizens travel? Who would have expected the Oppenheimers to earn tens of billions in profits through the re-listing of some of their mining assets? Jonathan enjoys a few quiet minutes in his office to reflect about days long gone…preparing himself for the party which Jennifer is throwing for him at home.
Remembering the Penny Mantra and the Smell of Toast
With some nostalgia Jonathan was thinking of a strategic argument he enjoyed with the then newly appointed, incredibly ambitious, managing director,
Based on that premise, De Beers led a revolution. Within a few years the industry was turned upside-down: companies that didn’t go downstream fast enough or become closely associated with branded diamonds or branded diamond jewelry programs became “toast” – a euphemism for becoming redundant or superfluous. The smell of toast remained the prevailing scent in the cutting centers for many years, when the overproduction of polished was brought back in line with real demand. As hundreds of businesses closed their doors, the withdrawal of equity and exit of capital set off a major liquidity crisis in the already undercapitalized and over-indebted industry which the banks couldn’t cope with. Real havoc was caused when one of the mega-diamond firms went bust, in mid 2008. It was one of the larger DTC active clients: a severe blow to the DTC sightholder profile mechanism. (Basically, Sightholders could complete these questionnaires in any way, shape or form they wished. The DTC lacked the means to verify the data – especially of the mega-firms. The profiling mechanism was abandoned in 2007.)
Jonathan recalls a particular negative yardstick in the SoC assessment: “No difference in consumers eyes between these products and other diamonds.” Sightholders MUST differentiate their products, otherwise they lost their sights. “How did we seriously think that a product in which 98% of all stones produced are less than 0.07 carats (seven points) could become fully branded; how unwise had it been to marginalize the generic diamond producers,” he thought.
By mid-2005, it had already become clear that the number of DTC Sightholders would soon decline to well below 45. The refusal by the EC competition authorities to allow the DTC to continue to market the Russian production dealt a severe blow to the DTC’s ability to ensure rough availability to accommodate a larger group of clients. And the aboriginals in Canada’s North West Territories had become a major pain-in-the-neck; Snap Lake’s development seemed then as elusive as ever. It was clear to Jonathan that the company needed to change course again: fast and decisively. What was needed was a review of fundamentals. Jonathan and Nicky imposed on the now legendary first managing director,
During Flare, management was, at every step, re-examining whether Supplier of Choice, and its supply commitment of very specific product categories to clients, would bring the company’s the greatest profits in the long term. Jonathan concluded at some time towards the end of the century’s first decade that SoC was not sustainable – but trying SoC was, in retrospect, essential – it determined the direction of the company. In a way – SoC didn’t go far enough, and therefore it failed. (Jonathan smiled. The business community believed that Rapaport’s multi-billion class action on behalf of non-Sightholders led to the demise of SoC. They were wrong. De Beers itself changed course, inspired by Flare and the post-Flare period, in which he already served as Chairman.)
The Gaps in the Opportunity Gap Theory
The key insight Bain & Co. produced in their strategic review of De Beers at the turn of the Millennium was the global under-performance of diamond jewelry sales in the 1990s, as compared to GDP and luxury goods. It’s Bain & Co. which gave birth to the Opportunity Gap theory. What is wrong with that premise? The cause and effect relationship doesn’t add up. It “sounds” good in speeches, but it doesn’t check out. In general, index numbers can easily become distorted if one item is much less or much more significant than the others. For example, in base-weighted indices demand tends to grow most rapidly for goods and services which increase least in price; one also should be wary of the illusory convergence on the base period where luxury goods, GDP, and diamonds all equaled 100. But the problem goes far deeper than methodology.
The De Beers theory was comparing apples to elephants. It ignored, at the time, that the growth of luxury goods sales and the growth of GDP are purely dependent on the economic activity in the markets. If there is a shortage of certain raw materials (cotton, or whatever) for luxury goods, there are plenty of substitutes. If there is a greater demand for handbags or scarves, the manufacturers simply produce more. However, in diamonds the supply is limited by the total output of the mines. There is hardly any elasticity on the supply side: even if there was a greater demand, the diamond market can never grow more than its output. Possible raw material “substitutes” (such as cubic zirconia, synthetic diamonds, etc.) have been thoroughly discredited and have been delegitimized through Best Diamond Practices incorporated in Supplier of Choice.
In the 1990s, De Beers itself reduced the supply of rough to the market because it could not sustain higher rough prices and thus its margins. Diamonds can always be sold; it’s just a matter of price. (De Beers proved that it in 2000 and 2001, when it sold at discounts to its Standard Selling Values (SSV) and was able to offload billions of excess inventories.) In the 1990s, it didn’t do that – by choice. It might have had valid reasons. To preserve its marked control position, it had intentionally dumped the price of the smaller goods (below three-grainers) in its war with Argyle. It desperately wanted to show (the Russians and others) that the single channel marketing system (i.e. the cartel) could force the prices of the larger goods upwards. That meant reducing supply: Imposition of quotas. This had little to do with the demand side or the way diamond jewelry was sold. How, in good faith, could De Beers withhold billions of diamonds from the market and then say that the market didn’t grow enough because of lack of brands?
There was less growth, because the diamonds were in the inventory of the producers, they were left in the ground. Each $1 billion in DTC inventory could have been converted into $7.5 billion worth of diamond jewelry sales. There was less marketing spent because the sales price of rough didn’t allow for the margins required to undertake ambitious promotion programs, including brands. Argyle couldn’t sell its diamonds fast enough.
This points to an interesting conclusion: it was all a matter of price. The “persuasive power” of De Beers over its clients is so strong that the industry rarely questioned such arguments – or dared to argue. By artificially limiting output – thus having demand out-pace supply – rough prices will rise. That has been the time-honored proven policy followed by Jonathan’s father, grandfather, and great-grandfather. It had been amazingly successful in the past. It was also successful in the 1980s when, mostly through price increases, demand (consumption) grew in value (using an index on which 1980 equals 100) to 230 by 1989. (In the 1986 to1989 period alone, rough price changes grew by an average of almost 45 percent). But it failed terribly in the 1990s.
What failed in the 1990s was not the demand side --- but the policies on the supply side. Looking back with the benefit of hindsight, the De Beers diamond account (the ratio of net profits earned by De Beers to sales) registered a high peak of 28.4 percent in 1989, plunging to about half that figure to 14.6 percent in
It would have been interesting if Bain & Co. would have made a chart with indices of the growth in profit margins made in diamond mining and luxury brand marketing. It is not truly defensible to say that the lack of growth came from lack of branding; the lack of growth came from a resistance (a “glass ceiling”) to ever higher polished diamond prices. De Beers wasn’t able to break through that ceiling – and thus it stockpiled. Excessive rough prices had pushed the finished product out of the market.
The diamond industry would have embraced Supplier of Choice and the branding concept with much greater enthusiasm if a good case had been made why branding is good for the business: To show that branded consumer items (including diamond jewelry) may provide margins over generic items or that the industry benefits from branding. In 2005, the feeling prevailed that it was the producers and, especially, De Beers who benefited from the branding strategy -- and that the lack of diamond retail growth in the 1990s was totally wrongly blamed on the downstream industry. “It was almost hilarious,” thought Jonathan, “how we got away with withholding goods from the market and then simultaneously accusing the market players for not growing the market.”
All the downstream players in the diamond pipeline – from dealers, manufacturers and distributors, to jewelry manufacturers and retailers -- only make money on the value-added, the difference between their net buying and selling prices. A lower level of rough diamond prices will not necessarily reduce their margins; it might even raise the return on capital. (It will, of course, also cause temporary disruption as inventory loses value. But that would be recoverable over time. The jewelry industry has learned very well how to live with fluctuating gold prices.)
By mid-2005, it had become clear that the downstream pipeline had become far more efficient (for which credit is due to De Beers). Also, the downstream margins were severely eroded by the incessant increases in rough prices, totally out of sync with polished prices. (The relatively small branding premiums were neutralized by higher rough prices well before these premiums could be collected. The downstream players felt they had been “taken for a ride”. They were ready to rebel.)
The ultimate aim of brand proliferation was for the “downstream” to work harder to facilitate rough price increases by the producers. Rio Tinto, which had remained the only “true” rough mining company which didn’t exert downstream pressures on its clients became, de facto, the Preferred Supplier. Though Rio Tinto fully benefited from all the De Beers policies, it never was attributed with any of the “blame” on failures. BHP-Billiton was seen differently – it was seen as a company trying to emulate and out-De Beers the dominant producer’s policies. It was seen as a follower of the leader, not as an initiator. In any event, sometime around 2010 Rio Tinto bought BHP’s Ekati mine, after it had bought a 20 percent stake a few years earlier from geologists Chuck Fipke and Stu Blusson. De Beers had not tried to bid for Ekati – diamond mining had ceased to be its core business. But there was a more profound reason. It also remembered its fight to get 40 percent of the Argyle mine, when it launched its bid for Ashton Australia. It lost its bidding war with Rio, not because it hadn’t offered a lot, but Rio Tinto skillfully played out Australian and international competition authorities. It was the prospect of prolonged anti-trust investigations that frustrated the Ashton bid; De Beers wasn’t going to risk a repeat performance in Canada. It never challenged Rio’s bid for Ekati. (Jonathan wondered if that 2010 decision not to fight had been right; the Linklaters (i.e. the lawyers) had been adamant – and if lawyers forfeit an opportunity to make money, they must have had good reasons.)
The Price of Legality, Legitimacy, and Respectability
The ostensibly perennial disequilibrium between rough and polished prices worried Jonathan and colleagues for many years. In a competitive market – and even with Supplier of Choice in place – he recognized that there are limits on the pressures which could be exerted on the downstream players and clients. When the return on capital employed by the downstream business becomes incommensurate with the risks, downstream players will exit the industry – something which is detrimental to market growth. When De Beers – operating in a strictly competitive environment – becomes dependent upon a few large clients, the leverage between supplier and client will equalize. These large clients will not purchase rough at prices which don’t provide a reasonable return on the resultant polished or diamond jewelry sales.
“There is an irony here,” mused an observer in the year 2010, just before Jonathan became chairman of De Beers. “De Beers wanted to be legally compliant in every jurisdiction it operates. It wanted to be rid of, once and for all, the stigma of periodically standing accused of abuse of dominant power. It truly wanted to make the industry competitively and demand driven. One of the greatest failures of Bain & Co. was that they never (at least never publicly) quantified the “price of legitimacy.” Sir Ernest, Harry, and Nicky had very good reasons to prefer a monopoly, to operate a cartel. Nicky has frankly and publicly admitted that the company was committed to illegal price collusion, illegal supply controls, and illegal management of prices. Nicky Oppenheimer earned his place in history by, together with
Jonathan appreciated as early as 2005 that becoming a highly respected – and even a “loved”, “desired”, “prestigious”, “preferred brand” and internationally recognition as a responsible corporate player – demands a price. The “cartel margin” had to be relinquished.
For Jonathan and Jennifer to become frequent guests at the White House in Washington, to become intimate personal and social friends with the policy and opinion makers in the world’s leading economies, to have their parties attended by Secretaries of States, Attorneys General, Secretaries of the Treasury and others, they would have to pay a price.
In the early years of the Millennium, Jonathan’s father – preoccupied by paying back the debt incurred in the leveraged management buyout – continued the policy of continuously driving up rough prices, never showing too great a concern with the stagnant polished market or with the lack of real growth in these markets. The “inflationary growth” was invariably heralded as a success of policies; the fact that in volume terms and in per carat realization the market was declining, was never given much weight. And, in all fairness, Nicky was practicing the company’s post-custodian role: optimizing revenues for the company’s shareholders. If clients were willing to pay the higher prices, the company acted quite rightly in raising prices continuously. Apres nous le deluge. The price incongruity between rough and polished created a bubble that would burst – and Jonathan correctly expected this and ensured that it would not affect De Beers.
Nicky: Coming to the Rescue of his Country
Why Jonathan and not Nicky? In the history of De Beers, the years 2003 to 2005, presented a turning point in the lives of both father and son. It commenced with the Brenthurst Initiative launched by both Nicky and his son, Jonathan. Reminiscent of
They were also inspired by business realities. In 2003,
When Ernest Oppenheimer was first elected to the South African parliament as the representative of Kimberley, he said, in his maiden-speech “my presence here shows that I put country before business, and that I have only one desire, and that is to be able to render useful service to South Africa.” Ernest’s son, Harry, followed his father’s footsteps and served in parliament, where he was one of the first South African statespeople to call for constitutional reforms and equal rights among all Africans when the apartheid regime was at its peak. Harry had incredible guts and courage.
In 2003, Nicky truly didn’t see himself running for parliament some day. Nor did he see himself one day as deputy president of his country. But when he professed his conviction that he “has been troubled by the nervousness over South Africa’s risk and reward ratios which seems to inhibit investment decisions – both local and from abroad,” and expressed his ideas as to how government should accelerate black economic empowerment in ways which would strengthen investor confidence and thus “expand the South African economy for the benefit of all its people,” he certainly made a commitment to follow through.
Nicky proudly recalled, “It was my father’s belief that South Africa would only realize its true destiny when everyone could engage fully and irrespective of race in every strand and level of its economic life. In putting forward our ideas, Jonathan and I hope we are taking his legacy forward and closer to the day when his hopes are fulfilled; when everyone will enjoy his or her fair share not only of the existing cake, but in an ever-expanding and vigorous economy with more than enough for all.”
In a way, seen from a historic perspective, Nicky had “thrown away” the custodianship of the diamond industry and, instead, shown a willingness to accept responsibility to shape the future of South Africa. A custodian of a different kind, maybe, Nicky had grown from businessman to statesman. He may have even lost interest in managing the diamond business – after having privatized the business and, together with
And that left De Beers to Jonathan.
Jonathan: Leader in Diversification and Corporate Growth
In 2010, the young chairman understood that the growth of the diamond industry would always be limited by the forces of nature. He understood that the dismantling of the cartel structure and the full acceptance of free market forces would cause mining margins to be more reasonable and substantially lower. With consumer groups gazing over every conglomerate’s shoulders, society would come to tolerate only the earning of reasonable, economically justifiable, and responsible profits. “Excessive profits” – in itself a quite difficult concept to define – were not acceptable anymore. This hurt the mining margins.
Branding and Supplier of Choice certainly avoided – or delayed -- a stiffer erosion of profits, but the clients of De Beers resented that “their premium profits” had to be shared with the rough supplier. The limited worldwide mining output also greatly constrained the proliferation of brands. Many of the initiatives of the early 2000s failed – not because the marketing concepts were wrong, but because of a lack of money (liquidity) to finance many dozens of sustained branding programs and because the producers lacked the needed rough availability.
The Supplier of Choice strategy to grow the market worked – up to the moment the suppliers could supply the rough and the clients lacked the liquidity (and desire to invest) to maintain multiple brands.
But, most of all, the young chairman understood that globalization was a process of creating “global consumers.” If, around the turn of the century, the United States’ economy was seen as fully consumer-driven (a situation that led that country to become the 50 percent consumer of all polished diamonds), Jonathan understood that, eventually, the global village would be consumer-driven.
The real “big” money was in consumer items or in consumer spending. The “biggest” money was in luxury goods, fashions, and leisure products.
Jonathan found a complete and logical convergence among the family company’s best business interests, his father’s aspirations to fulfill the political legacies of the family, and the need to “reposition” the company’s corporate image once and for all. In a consumer driven society, there must be no potential blemish on a company product. No NGO – in the old days, they were called civil society – should be able to level any real or imaginary charge on any of the products.
Therefore, he executed the “Jonathan 2010 Program”. In a way, that program was a revised Rainbow strategy. First, he re-listed the South African De Beers Consolidated Mines on the flourishing Johannesburg stock market. His family’s Brenthurst Initiative had made South Africa one of the most attractive emerging markets in the world and investment companies and fund managers had a greater confidence in the JSE than in the NASDAQ. The De Beers South African assets – including the Venetia mine – were floated at a market value of $15 billion. Most of the shares were taken by investment funds controlled by previously disadvantaged South Africans. The board of directors closely resembled the make-up of the shareholders. Jonathan – whose family had kept a 26 percent share in the company – remained chairman. The move created a lot of positive excitement in South Africa and certainly added to the popularity of Nicky Oppenheimer and the rest of the family. And, in Washington, the Americans loved it! As this was another major step in the voluntary dismantling of the cartel – and a step with significant social and political implications – then U.S. President Hillary Clinton decided to reward the Oppenheimers. The last remaining indictments against De Beers were dropped, leaving De Beers to become as American as MacDonalds, Tiffany’s, and Coca Cola.
Jonathan glances at a picture on his desk. President Hillary Clinton and vice-president Arnold Schwarzenegger had invited Nicky and Jonathan Oppenheimer to a glamorous White House dinner, attended by some 200 guests including the nation’s chief anti-trust busters, to show that, once and for all, almost three quarters of a century of hostility towards the company were wiped out and forgotten.[2] In the picture, Jennifer is seen making a gesture which earned her a cover on both Newsweek and Time magazines. Just before the dinner’s second course, Jennifer stood up and asked permission to say a few words. Jonathan still remembers the puzzled looks on his father’s face, who had no idea about what was about to happen. “It gives me great pleasure,” she said “to present to the United Nations, and thus to the people of the world, with one of the world’s most spectacular treasures, the 203.04-carat Millennium Star. Let its shining beauty, its clarity, its individual uniqueness and splendor resemble the best of what we hope mankind represents.” Ever since that dinner, nobody would ever remember Ted Turner’s $1 billion donation to the UN – Jennifer and De Beers had made their mark in world history. “Next time you do something like this,” said Nicky to his daughter-in-law, “just give me a few minutes advance notice. My heart, you know.” (Jonathan never publicly admitted that he wasn’t consulted; marrying a strong-willed wife certainly brings moments of excitement)
Parts of the proceeds of the sale of the South African mining assets were used to make a public bid on their “difficult” joint venture partner LVMH. As De Beers had become a much leaner and non-dominant miner, it didn’t face any legal obstacles anymore. Jonathan was successful in getting close to 50 percent of the LVMH’s shares – and there was neither a need nor desire to privatize. Jonathan renamed LVMH, De Beers Luxury and Leisure Group (DB-LLG) and, not surprisingly, the first major transactions of DB-LLG was a friendly bid to acquire the De Beers Namibian, Tanzanian, and Canadian diamond assets.
The DTC was kept separate, more as a service then as a profit center. It fulfilled a brokerage function. In a very transparent way, the DTC bought the production of DB-LLG and marketed it in the traditional Supplier of Choice method. Occasionally, DB-LLG would sell directly to major market players or to other mining companies.
Through DB-LLG, Jonathan embarked on a massive program of mergers and acquisitions. One of the world’s largest cruise ships companies was acquired in 2012;
One thing never changed: the partnership between Debswana and De Beers remained as firm in 2019 as in 2003. The tremendous contribution the Oppenheimers were making to South African society had a spillover effect in southern Africa – especially Botswana. It certainly helped to cement the relationship with Debswana even more.
Anglo-American Corporation exchanged its shares in De Beers for shares in DB-LLG. This had changed the interest of Anglo-American in the diamond business. Debswana began producing a range of diamond and diamond jewelry products, marketed worldwide through DB-LLG. Debswana had become one of its leading brands – but it took still quite a few years after the retirement of
Nicky and Jonathan had also done some cherry-picking: some of Anglo-American’s excellent vineyards in the Capetown areas and their prized wines had become flagship items in DB-LLG. Looking at his De Beers “Diamond” watch, Jonathan has second thoughts. Maybe it is too early to retire. His main objective of changing the core business of De Beers towards products in which markets will never be saturated and where growth is never dependant on a limited (if not scarcely) available natural resources has been successful. By selling off most of the diamond assets, the family company, Central Holdings, has become one of the world’s cash-richest entities. (CH’s managing director, Clifford Elphick’s recommendation to make Jonathan chairman in 2010, was, with the benefit of hindsight, an excellent decision. Elphick’s memoirs will show that the choice wasn’t without opposition. Those who felt Jonathan was too young or too inexperienced have become quiet since.)
In 2019, DB-LLG would record a $180 billion turnover – about equal the size of Ford Motors back in 2000. World diamond mining output had risen to $15 billion by 2010, but since then declined steadily – not by volume, but by value. Jonathan had rightly foreseen the declining producer margins. The DTC has now only 15 customers – and Jonathan has long ago dispensed with all the ceremonial profile presentations, sightholder criteria and the cumbersome labor-intensive client selection process. The DB-LLG consumer products are manufactured by millions of workers in Africa, China, India, Vietnam and other developing countries. Each product sold by any of the DB-LLG retail units carries a tag indicating how this product contributed truly to the development and welfare of so many people. Jonathan looks at his watch. Jennifer and the children must be waiting already at the ‘surprise’ birthday party at home in their mansion “Marion’s Court” – a ten-minute helicopter flight away from Manhattan. Generations come and go, but some family habits never change.
[1] Comparison made with platinum, gold, copper, aluminum, and oil. Data: Deutsche Morgan Grenfell.
[2] In 2008 the U.S. Congress adopted an Amendment to the Constitution allowing non-native born Americans to run for president, in recognition of the reality that some 40% of Americans would have been born outside of the country by 2020.