1.

Cartels: History and Meaning

1.1 Brief history of cartels The term cartel originated for alliances of enterprises roughly around 1880 in Germany. The name was imported into the Anglosphere during the 1930s. Before this, other, less precise terms were common to denominate cartels, for instance: association, combination, combine or pool. In the 1940s the name cartel got an Anti-German bias, being the economic system of the enemy. Cartels were the economic structure the American antitrust campaign struggled to ban globally. Historically, cartels have been formed in markets characterized by excess production capacity. At one time or another international cartels have attempted to control the world market in such commodities as steel, oil, rubber, tin, and aluminum, and in chemical products such as linoleum and rayon-involving patents. In the early part of the 20th century the world aluminum industry was effectively controlled by a cartel consisting of four companies from the United States, France, Germany, and Great Britain. At the start of World War II it was estimated that more than 30 percent of international trade was controlled by international cartels. More recently a large number of cartels appeared in Third World countries following the short-lived success of OPEC in the 1970s. These Third World cartels were formed in order to establish market prices for raw materials that they produced.

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1.2 Meaning of cartels Merriam Webster defines cartels as a combination of independent commercial or industrial enterprises designed to limit competition or fix prices. A cartel is formed when a group of independently owned businesses agrees not to compete with each other in areas such as prices, territories, and production. A cartel agreement is considered a collusive agreement in that the different parties agree not to allow market forces to determine their pricing, production, and other business practices. Rather, the members of the cartel agree on such matters as what price to charge, how much to produce, and which markets to serve. A cartel is a formal agreement among competing firms. It is a formal organization where there is a small number of sellers and usually involve homogeneous products. Cartel members may agree on such matters as: o Price fixing o Total industry output o Market shares o Allocation of customers o Allocation of territories o Bid rigging o Establishment of common sales agencies o Division of profits o Combination of above.

The aim of such collusion (also called the cartel agreement) is to increase individual members' profits by reducing competition. Well-known examples of cartels include the Organization of Petroleum Exporting Countries (OPEC), the Swiss banking cartel, International Air Transport Association (IATA) and the International Tin Council. Cartels are particularly widespread in Japan and play a major role in many different industries there.

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1.3 Public and private cartels One can distinguish private cartels from public cartels. In the public cartel a government is involved to enforce the cartel agreement, and the government's sovereignty shields such cartels from legal actions. Private cartels are subject to legal liability under the antitrust laws now found in nearly every nation of the world. Furthermore, the purpose of private cartels is to benefit only those individuals who constitute it, public cartels, in theory, work to pass on benefits to the populace as a whole. There is no evidence that public cartels are less harmful to the general good, and being government backed, they are much more effective and, hence, potentially harmful. In the case of public cartels, the government may establish and enforce the rules relating to prices, output and other such matters. Export cartels and shipping conferences are examples of public cartels. In many countries, depression cartels have been permitted in industries deemed to be requiring price and production stability and/or to permit rationalization of industry structure and excess capacity. In Japan for example, such arrangements have been permitted in the steel, aluminum smelting, ship building and various chemical industries. Public cartels were also permitted in the United States during the Great Depression in the 1930s and continued to exist for some time after World War II in industries such as coal mining and oil production. Cartels also played an extensive role in the German economy during the inter-war period. International commodity agreements covering products such as coffee, sugar, tin and more recently oil (OPEC) are examples of international cartels with publicly entailed agreements between different national governments. Crisis cartels have also been organized by governments for various industries or products in different countries in order to fix prices and ration production and distribution in periods of acute shortages. Murray Rothbard considered the Federal Reserve as a public cartel of private banks. In contrast, private cartels entail an agreement on terms and conditions that provide members mutual advantage, but that are not known or likely to be detected by outside parties. Private cartels in most jurisdictions are viewed as violating antitrust laws.

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1.4 The theory of Oligopoly Oligopoly is a market condition that exists when there are few sellers. It is a market situation in which control over the supply of a commodity is held by a small number of producers each of whom is able to influence prices and thus directly affect the position of competitors. The conditions that give rise to an oligopolistic market are also conducive to the formation of a cartel; in particular, cartels tend to arise in markets where there are few firms and each firm has a significant share of the market. A single entity that holds a monopoly cannot be a cartel, though it may be guilty of abusing said monopoly in other ways. As such, it is inaccurate to describe (for example) Microsoft or AT&T as cartels. Cartels usually occur in oligopolies, where there are a small number of sellers. Oligopolistic firms join a cartel to increase their market power, and members work together to determine jointly the level of output that each member will produce and/or the price that each member will charge. By working together, the cartel members are able to behave like a monopolist. For example, if each firm in an oligopoly sells an undifferentiated product like oil, the demand curve that each firm faces will be horizontal at the market price. If, however, the oilproducing firms form a cartel like OPEC to determine their output and price, they will jointly face a downward-sloping market demand curve, just like a monopolist. In fact, the cartel's profit-maximizing decision is the same as that of a monopolist, as Figure 1 reveals. The cartel members choose their combined output at the level where their combined marginal revenue equals their combined marginal cost. The cartel price is determined by market demand curve at the level of output chosen by the cartel. The cartel's profits are equal to the area of the rectangular box labeled abcd in Figure 1 . Note that a cartel, like a monopolist, will choose to produce less output and charge a higher price than would be found in a perfectly competitive market.

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Figure 1 Profit maximization by oligopolistic cartel

Cartels in an oligopolistic market o Control over market supply and prices: A cartel is a form of formal collusive behaviour by firms usually in an oligopolistic market where there are only handful of businesses which sell a homogenous or standardized product. It is a collaborative agreement where firms agree to control market supply and prices in order to jointly maximise profits. o Market sharing: Cartels also agree to market sharing. They often do this by dividing up different regions to different firms within the cartel, meaning that the firm has complete market share in the region an so there is no competition. o Allocation of customers: Cartels also allocate different customers to different firms within the cartel to reduce competition .

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Major reasons why firms in an oligopoly might enter into collusive behaviour o If firms within an industry are in an oligopoly and enter into collusive behaviour they act as a monopoly. o Acting as a cartel can also stop revenue and prices from being unstable in that industry. o Often firms in an oligopoly benefit from being in a cartel because it limits competitive responses that might reduce profits such as a price-war or attacking each others market share. o Working as a group ensures maximum benefit: When firms collude, it would be beneficial to any individual firm to expand output and undercut others in the cartel. This however would result in all firms following suit; supply would rise flooding the market and price would plummet bringing a negative result for all of the firms within the cartel. From this we can see that collusion can often be explained by a desire to achieve joint-profit maximisation or to try an stabilise the revenue or price in a market. As John Nash noticed, each individual acting solely in his/her own interests does not, as Adam Smith suggested, necessarily produce the maximum benefit.

In the case of a cartel, it would serve one firm to increase production, but, in the longrun, the break-down of trust between the cartel-members would have a negative effect on the industry profits as a whole. Essentially, working as a group guarantees longterm higher profits for all.

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1.5 Interdependence and the incentive to form a cartel As interdependence between firms is essential in an oligopoly, the field of game theory is relevant. In fact, the firms pricing strategies, when simplified, can be modelled as the game of prisoners dilemma. Let us look at the possible pricing strategies of two firms and let us assume that there are two prices which the firms can charge for their product. 1. If both charge a high price, each will get equal market share, but relatively high revenue due to the high price. 2. In contrast, if both charge the low price, each will get the same market share, but lower revenue due to the low price. 3. If one charges the high price while the other charges the low price, the latter will gain sufficient market share from the former, which is likely to generate the highest revenue

As can be seen, charging the low price is the dominant strategy, as it is always preferable to charging the high price, regardless of what the rival firm charges. However, due to the symmetry of the game, the Nash equilibrium becomes the (low; low) outcome, which is collectively worse than if both firms adopt the dominated strategy in order to reach a (high; high) outcome.

Hence, just like how Thomas Hobbes argued that a strong state was needed to ensure cooperation within the state of nature, a cartel is formed in order to ensure cooperation and enforce punishment on those that will deviate from the high price option. Of course, if this is successful, those that will be likely to lose out are the consumers.

Price fixing results in a situation where output is low to keep the price artificially high. This results in a dead-weight loss of welfare for consumers because monopolies lose out on the higher demand that exists at the lower price and consumers lose out due to the higher price.

Price fixing can be inequitable in particular for low income consumers as they may not be able to afford these higher prices forcing them to leave the market. This can be harmful if it occurs within an industry that provides a merit good.

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1.6 Economic and social benefits of cartels

There is a case for saying that a collusive oligopoly can bring about economic benefits to consumers: o Uniform market structure Firstly, cartels results in a uniform market structure with one price and one level of output produced. The result is greater consumer or business confidence, as expenditure can be more easily planned. One example of where prices were maintained relatively constant would be oil in the 1990s; where OPEC aimed to charge between $25 and $35 per barrel of oil. In doing so, businesses requiring oil as a raw material had the confidence to make long-term cost predictions. The ability to make such predictions often gives producers the confidence to invest and boost the long-term profitability of the firm. o Probable social benefits Cartels may also provide social benefits in markets for demerit goods. In the cigarette market for example, if firms were to collude on higher prices for tobacco, fewer cigarettes would be consumed and welfare would be improved. o Reduced costs of advertising and publicity There is also no need for oligopolies to spend large amounts on publicity and advertising since each firm is operating in the same way under a cartel. The result of these higher profits mean there are more spare funds for investment and innovation, which would ultimately benefit consumers in the long run. o Availability of more funds for investment and research Economist Baumol argued that oligopolies can improve their dynamic efficiency more than other market structures. The interdependency of oligopolies under a cartel also allows for the cooperation of research and development. There can also be joint investment in capital and labour. The resulting decreased production costs provide spare funds for product development.

It is possible however that there are some benefits for consumers. If firms have fixed the price artificially high then it is likely they will see higher profits which could then

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be reinvested in the form of R&D. This is especially likely if firms cannot compete within a market in the form of price and as such will have to compete in other areas such as quality. Having said this price fixing does remove, to a large extent, the incentive to lower costs in order to remain profitable. Without price competition firms do not have to keep costs low and it is likely that some of the extra profit that could be directed towards R&D will in fact be wasted away by the lack of cost incentive. o Greater returns for shareholders Shareholders will benefit from the higher profits gained from price fixing as these profits may be passed on to them in the form of dividends giving them a higher disposable income and more ability to consume.

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1.7 Sustainability of cartels

In general, cartels are economically unstable in that there is a great incentive for members to cheat and to sell more than the quotas set by the cartel. This has caused many cartels that attempt to set product prices to be unsuccessful in the long term. Empirical studies of 20th century cartels have determined that the mean duration of discovered cartels is from 5 to 8 years. The problem is that cartel members will be tempted to cheat on their agreement to limit production. By producing more output than it has agreed to produce, a cartel member can increase its share of the cartel's profits. Hence, there is a built-in incentive for each cartel member to cheat. Of course, if all members cheated, the cartel would cease to earn monopoly profits, and there would no longer be any incentive for firms to remain in the cartel. The cheating problem has plagued the OPEC cartel as well as other cartels and perhaps explains why so few cartels exist. For a cartel to work, members involved in the agreement must monitor other firms levels of output. With firms not operating at their individual profit-maximising output, there is a tendency to employ game-theoretical strategies within the cartel. If one or more firms produce more than the agreed output in order to maximise their individual profits - which can be done by increasing their output to where marginal cost is equal to marginal revenue - the cartel is likely to break down, hence the almost inherent stability of these ventures The collapse of international cartels usually follows a familiar pattern. Cartels generally begin by establishing a price for their raw materials or other commodities that is somewhat above their free-market value. In response to such price setting, consumers cut back on their purchases and an oversupply of raw materials results. Soon supply exceeds demand, especially when cartel members fail to agree to cut back production accordingly. As it becomes clear the cartel has lost the power to enforce production quotas, it loses control and prices fall drastically. Such a scenario occurred in the mid-1980s as oil prices plunged, greatly reducing the power of OPEC.However, once a cartel is broken, the incentives to form the cartel return and the cartel may be re-formed. Publicly-known cartels that do not follow this cycle include the De Beers diamond cartel and the Organization of the Petroleum Exporting Countries (OPEC).

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1.8 Legality of cartels worldwide

In the U.S., cartels are illegal; however, internationally, there are no restrictions on cartel formation. The organization of petroleum-exporting countries (OPEC) is perhaps the bestknown example of an international cartel; OPEC members meet regularly to decide how much oil each member of the cartel will be allowed to produce. Such collusive agreements are illegal in the United States under antitrust laws contained in the Sherman Antitrust Act of 1890, the Clayton Antitrust Act of 1914, and the Federal Trade Commission Act of 1914. This body of legislation, known as the antitrust laws, made illegal such practices as restraint of trade, price discrimination, tie-in contracts, acquisition of competitors, and interlocking directorates. These practices were declared illegal only "where their effect may be to substantially lessen competition or tend to create a monopoly." In Japan formal and informal national cartels are accepted as part of doing business there. Operating under a system of managed competition with a great deal of government guidance and intervention, Japanese cartels enjoy acceptance in industries ranging from agriculture and banking to beer manufacturing and barbering. One example is Nokyo, a national umbrella group under which a huge agricultural cartel operates. Because of Nokyo, Japanese consumers pay a much higher price for homegrown rice, for example, than rice sells for on the world market. Nokyo serves to keep out imports, not only in rice but also in farm equipment and supplies. In Japan, cartels are permitted by law, and many of them are supervised by the government. In Europe, national monopolies in industries such as telecommunications, postal service, air transportation, and energy are in the process of being deregulated by the European Union. With government support these European cartels flourished in a noncompetitive environment, dividing up markets and agreeing not to compete with one another. Competitive pressures from business and the globalized economy, however, have resulted in a European effort to open these industries to outside competition.

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Examples of where cartels have been exposed and broken up by the competition authorities in the UK and Europe o Beer cartel In 2007, Heineken, Grolsch and Bavaria were fined 273m Euros for operating a cartel in the Netherlands. The European Competition Commission stated that the brewers had exchanged ideas and illegal agreements artificially driving up prices for distributors of the products, e.g. pubs, supermarkets and restaurants. o Air Cargo Cartel Following a three year investigation, British Airways was found guilty of participating in an air cargo cartel. In consequence, the airline was fined 90 million by the European Commission. The UK signature airline was found to have rigged fuel surcharges before extending its co-operation by introducing a security surcharge. British Airways was one of eleven airlines attracting charges amounting to 799 million. o Recruitment Agency Fee Fixing In September 2009, the Office of Fair Trading for price-fixing in the construction industry fined six recruitment agencies a total of 39.3 million. The cartel was exposed by two firms who were offered immunity in return. The recruiting agencies involved included the likes of A Warwick Associates, Hays Specialist Recruitment (fined over 30 million) and CDI AndersElite. Hays complained its fine was disproportionate but its grounds for appeal were unfavourable. The cartel was known as the Construction Recruitment Forum and met five times between 2004 and 2006. o Banking collusion RBS was fined 28.6m for revealing its loan pricing plans to one of its biggest rivals, Barclays. Regulators suggested that Barclays used the information to price its own loans, acting against the interests of consumers. o In Tokyo, four electric cable companies were fined 10.84 billion yen for working as a cartel and fixing their prices breaching the antimonopoly law. It has been shown that the five firms dominated the market for cables in Japan and had been fixing the price between 2005 and 2009. o Pioneer foods in South Africa was a firm fined for participating in cartel activities. The firm was fined 1 billion rand for fixing the price of bread, flour and poultry products

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Legality of Cartels in India In India, the Competition Act 2002 was enacted with a view to: 1. Eliminate practices having adverse effect on competition; 2. Promote and sustain competition; and 3. Protect the interests of consumers and ensure freedom of trade carried on by other participants, in markets in India.

The Competition Act empowers the Competition Commission of India, in case of cartel, to impose upon each producer, seller, distributor, trader or service provider included in cartel, a penalty equivalent to three times of the amount of profits made out of such agreement by the cartel or 10% of the average of the turnover of the cartel for the last preceding three financial years, whichever is higher. Thus, penalty is linked with profits made, or turnover of cartel, whichever is higher, and Commission does not have any discretion in respect of quantum of penalty to be imposed. There will be no incentive to cartelize only if every cartel (be it domestic or international) is detected, prosecuted and penalty is imposed and recovered which is almost unattainable as per global experience.

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2. About DeBeers
2.1 The De Beers Group

De Beers Socit Anonyme (the Company, or De Beers) was formally incorporated in the Grand Duchy of Luxembourg in November 2000. It is the holding company of all De Beers Group operations. The Company is managed and controlled from its head office in Luxembourg where the board meets to attend to the business of the Group. Its commercial activities are carried out by a number of subsidiaries, investments and joint ventures, which it finances in different parts of the world. Together, these subsidiaries, investments and joint ventures constitute the De Beers Family of Companies.

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3. The De Beers Cartel

3.1 The Birth of a Cartel Creating an illusion of scarcity

For centuries, diamonds had been exceedingly rare and valuable: a luxury item largely reserved for royalty. However, the sheer volume of diamonds flowing from the South African mines and streaming into Europe in unprecedented numbers threatened to destroy the very scarcity that had long defined the stones value. 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 demand would fall. Second, because diamonds are both a natural product and a highly variable one, South Africas individual miners were unable to control their production: they mined the stones they found and tried to sell them all. Their buyers, by contrast, were pickier, preferring to purchase only the largest and most beautiful stones. Rhodes concluded that the only way to address these mutual concerns was to forge a unified, vertically-integrated organization to manage down to the caratthe flow of diamonds from South Africa. Only cooperation, he reasoned, could keep supplies low and prices high. And if excess supply ever hovered on the market, DeBeers itself would acquire and stockpile these stones, using its buying power to buffer the other producers and remind them of cooperations rewards. In 1873, Rhodes signed a formal agreement with his buyers, the local diamond distributors, to form the Diamond Syndicate. Under its terms, the distributors would buy diamonds exclusively from Rhodes and sell them in agreed-upon numbers, at agreed-upon prices.

Rhodes postulated that ideally, the number of diamonds available each year to European consumers should roughly equal the number of wedding engagements. By 1890, Rhodes controlled all of South Africas major mines, along with the distribution channels for their output. These mechanisms remained in place until Rhodess death in 1902.

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Then, Ernest Oppenheimer, a German who had risen to prominence in South Africas diamond industry, began to worry that the Diamond Syndicate was still too independent, potentially capable of challenging the producers by shifting either supply or price. As Oppenheimer advanced through the ranks of the diamond trade, he began to integrate the channels of production and distribution even more tightly. In 1925, Oppenheimer gained control of the Diamond Syndicate. In 1929, he also took control of DeBeers, thus achieving near total integration of South Africas diamond trade. Sir Ernest Oppenheimer, the chairman of De Beers Group and leader of Anglo American, came up with the idea of "single channel marketing" which he defined as "a producers' cooperative including the major outside, or non-De Beers producers in accordance with the belief that only by limiting the quantity of diamonds put on the market, in accordance with the demand, and by selling through one channel, can the stability of the diamond trade be maintained." This new single channel marketing structure eventually came to be known as the Central Selling Organisation (CSO) that acted as the chief intermediary between the stones mined in any given year and the consumers who would eventually purchase or polish or wear them. Oppenheimer now presided over a system that brought diamonds from the dirt practically to the hands of brides-to-be. Basically, Oppenheimer formed a cartel on the premise that he was operating a legitimate enterprise. He stomped out all competition and kept a stranglehold on the supply of diamonds, upping their value and rarity through a limited supply that De Beers doled out carefully. It is safe to say that during this time De Beers Group owned and controlled about 90% of diamond production in the world; thus they could control the "rarity" and value and keep a hold on the lucrative industry. Many of their dealings were shady, and they were known for particular ruthlessness against their competitors. Ten times a year, an elite group of dealershandpicked by DeBeerswould gather at CSO headquarters. There, the dealers, or sightholders, would each be presented with an individual parcel of stones, chosen by the CSO to reflect both what the sightholder was

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hoping to sell in the subsequent weeks and what DeBeers wanted to place into the market. The sightholders were obliged either to take the entire contents of their parcel or none at all. Through this orderly marketing mechanism, DeBeers was able to determine not only the precise size and quality of diamonds available each year, but also their price. Sightholders were encouraged not to purchase diamonds from any sources outside the CSO, nor even to repurchase a used stone. This level of control was sufficient to sustain the cartel through Oppenheimers death in 1957.

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3.2 Cartelisation of the diamond trade beyond Africa

In the 1950s, South Africas vast stock of diamonds began to diminish. More worryingly, other countriesacross Africa, in Australia and in the far north of the Soviet Unionwere beginning to discover new deposits of diamonds. For these countries, diamonds were a great, glittering hope. For DeBeers, however, each new entrant raised the spectre that had long haunted Rhodes and Oppenheimer: the threat of diamonds flooding into the market, destroying their hard-won illusion of scarcity and depressing prices.

Whenever diamonds were discovered, therefore, DeBeers moved swiftly to bring the new producers into the fold. Operating without regard for political or economic tensions, the South African company would sign long-term contracts with the diamond-producing countries, guaranteeing to purchase a fixed proportion of the countrys output at a fixed price. In return, with minor exceptions, the country would agree not to sell its stones outside the cartel. Clearly, any of these new producers could have entered the market on their own, wrecking DeBeers (and hurting South Africa) in the process. Yet most of them understood the basic logic of cooperation, the same logic that had struck Rhodes and still defined DeBeers: if diamond supply grew too rapidly or too high, the allure of diamonds would be shattered and prices would crash.

If any of the new producers tried to destroy DeBeers, in other words, they would also destroy themselves. Over the years, defections occurred. In 1981, for example, President Mobutu Sese Seko of Zaire (now Congo) decided to stop selling his countrys industrial-grade diamonds to the syndicate. DeBeers responded by flooding the market with industrial diamonds from its stockpile, bringing the price of Zairian diamonds down by 40 percent.

By 1983, Zaire agreed to renegotiate its contract with DeBeers on far less favorable terms than before. Similarly, throughout the 1970s and 1980s, whenever the Soviet diamond authorities wanted to sweeten their deal (and Russian diamonds are among the highest quality in the world), they would quietly increase the number of diamonds they sold through their own independent channels.

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3.3 Factors contributing to the cartels success Economic theory and history both tell us that maintaining a cartel, for any length of time, is almost impossible on the free market, as the firms who restrict their supply are challenged by cartel members who secretly cut their prices in order to expand their share of the market as well as by new producers who enter the fray enticed by their higher profits attained by the cartelists. So, how could DeBeers maintain such a flourishing, century-long cartel on the free market? The answer is simple: the market has not been really free. In particular, in South Africa, the major center of world diamond production, there has been no free enterprise in diamond mining. The government long ago nationalized all diamond mines, and anyone who finds a diamond mine on his property discovers that the mine immediately becomes government property. The South African government then licenses mine operators who lease the mines from the government and, it so happened, that lo and behold!, the only licensees turned out to be either DeBeers itself or other firms who were willing to play ball with the DeBeers cartel. In short: the international diamond cartel was only maintained and has only prospered because it was enforced by the South African government. And enforced to the hilt: for there were severe sanctions against any independent miners and merchants who tried to produce "illegal" diamonds, even though they were mined on what used to be private property. The South African government has invested considerable resources in vessels that constantly patrol the coast, firing on and apprehending the supposedly pernicious diamond "smugglers." Back in the pre-Gorbachev era, it was announced that Russia had discovered considerable diamond resources. For a while, there was fear among DeBeers and the cartelists that the Russians would break the international diamond cartel by selling in the open market abroad. Never fear, however. The Soviet government, as a professional monopolist itself, was happy to cut a deal with DeBeers and receive an allocation of their own quota of diamonds to sell to the CSO.

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Other market characteristics that favoured cartelisation o Small number of significant suppliers o Rigorous barriers to entry o Availability of few substitutes o Durable, easy to store product o Demand for diamonds is relatively price inelastic Eight countriesBotswana, Russia, Canada, South Africa, Angola, Democratic Republic of Congo, Namibia and Australiaproduce the bulk of the worlds diamonds and most of the producing entities within these countries conform to an explicit set of rules. They manage their production in line with expected demand, stockpile excess stones, and sell the bulk of their rough diamonds to the Diamond Trading Company, a DeBeers-owned entity based in London. This conformity is the product 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.

And although the producing countries have shifted rank over the past decades and DeBeers has adjusted its operating formula, the basic structures of the industry have barely budged. Diamonds have enjoyed steady and rising prices in the last 20 years.

Key characteristics of the diamond cartel o Currently, DeDe-Beers controls two two-thirds of the $7 billion yearly trade in uncut diamonds and owns half the producing mines o The CSO processes over 80 of the worlds diamonds. It regulates the supply of diamonds in the market to achieve price stability, earning DeBeers a high price price-cost margin o Each year, DeBeers determines the total amount of diamonds it plans to sell in the market; each producer is guaranteed a fixed percentage of total output o Consequently, De Beers market those diamonds through the CSO o Producers, are in turn, charged a handling and marketing fee, ranging between 10 and 20 percent

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3.5 Changes in the diamond industry Not even this steadiest of cartels, however, has been wholly immune to change. Over the past decade, the diamond tradeand DeBeers and the cartelhave faced the end of apartheid in South Africa, the fall of communism in Russia, the opening of major mines in Canada and the emergence of a worldwide movement against so-called blood or conflict diamonds. All of these developments have pummelled the diamond industry and forced its central playersmost notably De- Beersto change the nature of their trade viz: o For the first time in the cartels long history, producers have begun to brand their stones. o They have started to integrate vertically in some cases and to break the barriers that have long separated production and sales, or mining and jewelry, in this business. o They have adjusted the cooperative structures that bind the industry players to one another and have brought new players, including the United Nations and a vocal group of nongovernmental organizations, into the game.

Remarkably, these changes have not affected the core dynamic of the global diamond market. It remains an industry dominated by a single firm and an industry in which, perhaps uniquely, all of the major players understand the extent to which their long-term livelihood depends on the fate and actions of the others. In these cases, DeBeers couldnt quite play hardball: the Soviet stones were too good and too plentiful. So instead the firm negotiated, making whatever concessions were necessary to keep the Soviets inside the cartel and their excess diamonds off the market.

Managing Demand Meanwhile, DeBeers matched its supply-side strategies with attempts to manage demand. In 1948, the company debuted its famous slogan A diamond is forever, later hailed by Advertising Age as the slogan of the century.

Implicit in the slogan were all the notions that the cartel held dear. It told diamond customers that their purchases were heirlooms, too valuable ever to be sold (which effectively killed the resale market).

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It reminded them that diamonds equaled love, something not to be measured in terms of price. And in the fine print and at the jewellers, DeBeers told its (mostly male) customers how to buy these talismans of love: several months salary was the recommended price, with attention duly paid to the cartels own criteria of color, cut, clarity and carat. Rarely has any business been more specific in telling its customers what to buy and how.

On several occasions, DeBeers also moved to quell the subtle threat of demand-side speculation. In the 1970s, for example, Israeli diamond dealers began converting their financial assets into diamonds, hoping to protect themselves from the inflation then wracking Israel. Dealers in other trading centers soon followed suit, and diamond prices began to rise. For DeBeers, this situation was a potentially dangerous precedent. They didnt want diamonds to be seen, or purchased, as anything other than precious, sentimental gifts, and they didnt want to risk the price decreases that would inevitably follow a speculative rise. So rather than letting other players bid up the price of diamonds, DeBeers imposed a drastic price increase on diamonds sold by the CSOan increase that all sightholders understood could be withdrawn at any moment. In other words, DeBeers used its power to make diamond speculation a considerably riskier venture, because the price to sightholders could suddenly decline. Then the company stripped hundreds of dealers of their right to purchase diamonds from the CSO. The speculation ended almost at once.

A different chain of events played out in 2004, when the global diamond industry was hit by a surprising demand-side shock. Diamond jewelry sales rose by 6 percent, and producers, for the first time in recent memory, could not keep up. In other industries, of course, such a surge in demand would typically be considered good news. But in diamonds, a shock to the systemeven an apparently favorable oneis perceived as a threat, because it challenges the stability that most firms in the market, and particularly DeBeers, treasure. So rather than simply following the uptick in demand, DeBeers responded to it. The CSO (which had been transformed by this point into a new organization known as the Diamond Trading Company) raised its rough diamond prices 14 percent over the course of the year, and other major producers followed suit. DeBeerss own stockpile, which had hit $4 billion in 1999, dwindled to nothing.

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For outsiders, the diamond industrys predilection for stability can be difficult to fathom. It is not obvious that price volatility should be more dangerous for diamonds than for, say, oil or coffee; nor that diamond producers should be that much more willing to sacrifice short-term profits for long-term order.

But in the diamond market, unlike the markets for oil or coffee, sharp changes in price could mean a longer-term shift in how consumers view diamonds, and how consumers think about the price that they pay. Since Rhodess time, the diamond cartel has managed to convince consumers that diamonds are both valuable and scarce, that they should be purchased on quality rather than price. But if either supply or demand were to change rapidly, this fragile balancethe illusion of scarcity in the industrys phrasingcould shatter.

For example, if the Soviets had decided to break from the cartel and had flooded the world market with their stones, not only would diamond prices have plummeted, but the sentimental value of diamondsthe value that keeps brides demanding this particular stone and grooms obligingly payingwould likely have plummeted as well. Conversely, excess demand could lead to speculation, which might again alter the sentimental value that people place on diamondsand even encourage some of them to consider reselling their jewels.

Other industries can handle such fluctuations, because the underlying demand for their product is less rooted in sentiment. If prices for coffee or oil soar and then fall back to previous levels, the quantity demanded will fall accordingly and then return fairly closely to previous levels. For diamonds, by contrast, demand was explicitly constructed, and the potential for permanent substitution is very high. Rubies and other precious stones, after all, make perfectly good rings. The challenge for the diamond industry, therefore, is to convince consumers to separate the value they place on diamonds from the price they pay. For this, they need to ensure that prices stay steady and commerce relatively unobtrusive.

For over a century, the diamond cartel flourished on a mixture of cooperation and ruthlessness. Led by DeBeers, the major producers agreed to restrict the supply of diamonds and sell only through a single channel. Through the operation of the CSO, buyers followed a similarly strict code: no haggling, no repurchase, no outside sources of supply. The millions of consumers who bought these symbols of love implicitly agreed to play by the rules that the cartel had set. To be sure, this
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arrangement did experience the occasional wobble: DeBeers suffered minor losses in 1915 and 1932, for example, and also in 1980 and 1981, when diamond sales dropped and the firm was forced to spend hundreds of millions of dollars to support diamond prices. But these few exceptions prove the general rule: in a world of volatile commodity prices, diamonds were the stone whose value never declined, and the international diamond industry remained consistently and robustly profitable.

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3.6 Problems of the Cartel o In recent years, the diamond cartel has lost control of diamonds produced in several African countries (e.g. Angola & the Democratic Republic of Congo) o Additionally, Australia's significant Argyle mine recently left the cartel o DeBeers is also fighting to hold onto its monopoly rights to distribute diamonds produced in Russia which holds 26% of known reserves

3.7 Future of the Cartel o An Israeli named Lev LevievLeviev who owns factories in Armenia, Ukraine, India, Israel and elsewhere challenges the De Beers Central Selling Organization. He seeks to channel stones directly to his own polishers at lower prices o Inexpensive synthetic diamonds might in the future replace real diamonds and thus put an end to the De Beers dominance in the diamond business o A change in consumer sentiment

Any one of these developments could potentially destroy the history of stable high prices in the diamond market. Yet history suggests that change will not come all that rapidly, and that the diamond cartel will find the means to drag its market back to orderly competition. After all, despite the many changes of recent decades, cooperation still reigns supreme in the diamond market, backed by the measures of control that allow for orderly marketing a cartel, in other wordsto triumph. Much of this cartels success can be attributed to the vigor with which its leading player, DeBeers, has enforced the rules for interaction and to its legendary ability to bring new producers into the fold and convince them not to sell outside its confines. But the cartels success is also due to the happy complicity of diamond buyers: to the polishers, cutters, jewelers and brides, all of whom are eager to believe that diamonds really should be treated as if they were forever.

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3.8 Challenges facing the diamond industry HOW much turmoil can the diamond industry sustain without shattering? An Ohio court De Beers, the world's largest producer of rough stones, finally pleaded guilty to charges of price-fixing of industrial diamonds and agreed to pay a $10m fine, thereby ending a 60-year-long impasse. De Beers executives are at last free to visit and work directly in the largest diamond market, America. The first case of successful industry self-regulation against trade in so-called conflict diamonds took place when Congo-Brazzaville was punished for failing to prove the source of its diamond exports. And on June 28th Lev Leviev, an arch-rival of De Beers, opened Africa's biggest diamond-polishing factory in Namibia. Behind all these events lies sweeping change in an industry that sells $60-billion-worth of jewellery alone each year. For generations it has been run by De Beers as a cartel. The South African firm dominated the digging and trading of diamonds for most of the 20th century. Yet the system for distributing stones established decades ago by De Beers is curious and anomalousno other such market exists, nor would anything similar be tolerated in a serious industry. De Beers runs most of the diamond mines in South Africa, Namibia and Botswana that long produced the bulk of world supply of the best gemstones. It brings all of its rough stones to a clearing house in London and sorts them into thousands of grades, judged by colour, size, shape and value. For decades, if anyone had rough diamonds to sell on the side, De Beers bought these too, adding them to the mix. A huge stockpile helped it to maintain high prices while it successfully peddled the myth that supply was scarce. De Beers has no interest in polishing stones, only in selling the sorted rough diamonds to invited clients (known in the trade as "sightholders") at non-negotiable prices. Sales take place ten times a year. The favoured clients then cut and polish the stones before selling them to retailers. With its near monopoly as a trader of rough stones, De Beers has been able to maintain and increase the prices of diamonds by regulating their supply. It has never done much to create jobs or generate skills (beyond standard mining employment) in diamondproducing countries, but it delivered big and stable revenues for their governments.

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Botswana, Namibia, Tanzania and South Africa are four of Africa's richest and most stable countries, in part because of De Beers. One family got extremely rich too. The Oppenheimers created the single-channel marketing system of shovelling all available stones to the clearing house. They came to dominate De Beers after Ernest Oppenheimer took control of most of Namibia's diamond mines nearly a century ago. He formed a mining conglomerate called Anglo American, before grabbing the chairmanship of De Beers. The family is thought to be worth around $4.5 billion today; Nicky Oppenheimer, Ernest's grandson, is Africa's richest man. The family still owns a more than 40% direct stake in De Beers, and its membersNicky Oppenheimer and his son, Jonathanrun the firm. It may own more De Beers shares held indirectly through Anglo American's 45% stake. But this stable, established and monopolistic system is now falling apart. o Three things have happened. First, other big miners got hold of their own supplies of diamonds, far away from southern Africa and from De Beers's control. In Canada, Australia and Russia rival mining firms have found huge deposits of lucrative stones: BHP Billiton, Rio Tinto and Alrosa have been chipping away at De Beers's dominance for two decades. o De Beers once controlled (though did not mine directly) some 80% of the world supply of rough stones. As recently as 1998 it accounted for nearly two-thirds of supply. Today production from its own mines gives it a mere 45% share. Only a contract to sell Russian stones lifts its overall market share to around 55%. o That is a painful shift, but De Beers is still the biggest diamond producer. And rival mining firms do share one big interest with it: high prices for the stones they dig from the ground. That is why, although it is under pressure, the central clearing system that sustains high prices could yet survive a bit longer. Rather than controlling a pure monopoly, De Beers might be able to run a quasi-cartel that stops the market from opening fully. De Beers says the price of rough stones is still rising; the price of polished stones has risen by 10% this year, according to polishedprices.com, an independent diamond website that tries to track such things. o The next challenge might be manageable too. De Beers's system is highly secretive. Nobody knows the ultimate source of particular diamonds it sells, as all are mixed together in London. But De Beers faced extraordinary public-relations pressure after it emerged that rebel armies in Africa were funding their wars by selling what became known as conflict diamonds.

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o Since 2000 almost 70 countries and all of the big industry players (under the threat of consumer boycotts and activist campaigns by, among others, a London-based group called Global Witness) have adopted standards designed to prove the origins of their diamonds. The so-called Kimberley Process is now in force: governments must issue certificates of origin for the stones they export, and the stones can then be tracked. o It was under this agreement that Congo-Brazzaville was punished by being expelled from the Process (the first country ever to be thus censured). As a result, legal trade in its diamonds should cease. It is a test case for the industry. o The introduction of the Process could have threatened De Beers, which wanted to maintain the right to buy diamonds anywhere it pleased and to keep its purchases secret. Eli Izhakoff of the World Diamond Council, an industry body based in New York, says the new rules mean the industry is changingit is nothing like it was four or five years ago. o But although the regulations make it easier to track the flow of rough diamonds, they have not required De Beers to open all its books to public scrutiny. Most of those diamond-fuelled African wars are over. And the firm has a declining interest in buying up any rough stones that appear on the market. It knows that its ability to control world supplies is dwindling. o It is the third challenge that is much more troublesome. This is a threat to break up entirely the way De Beers organises the industry. It can best be summed up in two words: Lev Leviev. o Like the Oppenheimers, Mr Leviev has made himself very rich over the past three decades. An Israeli of Uzbek descent, he is reputedly worth around $2 billion. Though he has interests in transport and property, his real love is diamonds. His Lev Leviev Group is the world's largest cutter and polisher of them. He has mining interests too: his fleet of clanking mining ships began operating off Namibia's coast earlier this year, sucking up diamonds from the sea bed. He boasts it is the world's second-largest fleet; only De Beers has a bigger one. o And Mr Leviev recently moved into diamond retailing. He claims that he is the only tycoon with interests in every stage of production from mine to mistress (a canard in the industry holds that men buy more diamonds for their mistresses than for their wives). But his real power lies in the cutting and polishing businesses. He has factories in Armenia, Ukraine, India, Israel and elsewhere. These give him power to challenge De Beers's central clearing house and seek instead to channel stones directly, and at a lower price, to his own polishers. There is a more personal explanation too. Mr Leviev long worked as one of those De Beers sightholders, buying unseen parcels of stones at non-negotiable prices. Even as recently as last year he was among De Beers's clients in South Africa. Being forced to take or leave the stones granted by the diamond cartel infuriated him. He was eager to strike back.

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o His breakthrough came in Russia. Mr Leviev has cultivated close ties with Russian politicians, including Vladimir Putin long before he became president. Already well known as a cutter and polisher of diamonds in the 1980s, Mr Leviev was asked to help the Soviet state-owned diamond firm set up local factories 15 years ago. He agreed and formed a joint-venture with the state firm, now called Alrosa. But he insisted that stones for the factories be supplied directly from Russian mines, rather than diverted through De Beers's central system. De Beers was furious at the loss of supply, but the factories got their local stones. When the factories were privatised, Mr Leviev somehow emerged as the exclusive owner. o What happened in Russia set a pattern for clashes elsewhere. Mr Leviev has found that governments welcome factories that create jobs and add value to the diamonds they export; it is a smart way to snipe at De Beers.

o Angola was next. Angola's diamonds are among the world's best when measured by value per carat (see chart) and promise a lucrative return for anyone who can market them. De Beers has had a long interest there. Mr Leviev first invested $60m in the country in 1996, financing a mine at a time when civil war was raging. And just as he cultivated Russia's governing elite, he struck up warm relations in Angola. o It was a well-timed move. The Angolan government despised De Beers. In the days when its monopoly was secure, De Beers regularly bought up any supply of rough diamonds that appeared on the market. It was accused of helping, indirectly, to fund UNITA, the rebel army in Angola, which sold huge quantities of diamonds. In 2001 De Beers ended a spat with the government by quitting the country. By then Mr Leviev had already moved in, eager for another supply of good stones. o By the time the government won Angola's war in 2002, thereby getting control of all the country's diamond mines, the contracts it had struck with Mr Leviev (ie, those lost

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by De Beers) were worth $850m a year, a sum greater even than that lost by De Beers in Russia. o Mr Leviev has not had it all his own way. Last year Angola's government abruptly cancelled three-quarters of his deal. Some observers accused Mr Leviev of using underhand means (he is close to the daughter of Jos Eduardo dos Santos, Angola's president) to win them in the first place. Yet, however he did it, Mr Leviev showed in Angola that he could barge aside De Beers in a valuable area near its southern African heartland. o Mr Leviev has been inspired to take another swipe at his rival. On June 28th he took the arm of Sam Nujoma, Namibia's president, and guided him around a sparkling new diamond-polishing factory in Windhoek, Namibia's capital. For years we have been told this could not be done, commented various Namibian politicians. o Now Mr Leviev, saviour-like, strode around his factory, showing off row upon row of workers, who wore uniform green overalls and fiddled with chrome machines and modern flat-screen computers. Mr Leviev boasts that, with its capacity for 550 workers, the factory is Africa's biggest. o Jonathan Oppenheimer, affable heir to the Oppenheimer dynasty, says he does not understand what Mr Leviev is up to in Namibia: And when we don't understand, we worry. He is right to be concerned. Mr Leviev's obvious next step in Namibia is to challenge De Beers directly. De Beers's mines are run in a joint venture with the government called Namdeb. A 1999 mining law lets the government force any miner to supply stones locally. If Mr Leviev demands it, the government could tell De Beers to provide stones directly to Mr Leviev's new factory, a repeat of the Russian blow. o More important, if Namibia is able to establish a viable cutting and polishing industry using its own stones, then why not every other diamond-producing country too? That would seriously threaten De Beers. Mr Nujoma all but dared his neighbours to follow suit. To our brothers and sisters of neighbouring states, Angola, Botswana, South Africa, I hope this gives you inspiration to try to imitate what we have here, he said at the factory opening. o Mr Leviev is building another factory in Luanda, Angola, partly hoping to curry favour with the government. More important, he is offering to build a factory in Botswana, the jewel in the crown of De Beers's empire. De Beers has close ties with the Botswana government: they share a joint venture, Debswana, that exclusively mines the country's diamonds; Botswana gets a huge share of its foreign currency and a large part of its national income from diamond revenues. It is a similar arrangement to that in Namibia. o In an interview, Mr Leviev said he had offered Botswana's government a factory to employ tens of thousands of people, a scale vastly larger than in Namibia. A senior civil servant from Botswana toured the Windhoek factory with Mr Leviev. As Mr Oppenheimer concedes, this is a delicate time for Mr Leviev to be courting in

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southern Africa. De Beers is still renegotiating the terms of an 18-year lease on the Jwaneng mine, in southern Botswana, which is due to expire at the end of this month. The mine is thought to be worth $1.3 billion a year, producing stones of a quality that would have Mr Leviev salivating. o More broadly, De Beers must renegotiate the terms of all its marketing operations in Botswana and in Namibia every five years. These talks are also due. While no-one expects Mr Leviev to break up De Beers's relationships in these countriesMr Oppenheimer is confident that the government will not do anything to risk its big revenueshis appearance on the scene puts pressure on De Beers. o The obvious step for De Beers now would be to take on Mr Leviev at his own game. In Botswana and Namibia there have been a few diamond-polishing factories backed by De Beers. But De Beers does not want to be involved in that stage of diamond production. o It is first a miner and only belatedly a retailer of diamonds. But it is blocked from the production steps in between as long as it remains the major supplier of stones to the whole industry, says Mr Oppenheimer. Buyers of its stones would suspect De Beers of holding back the best diamonds for its own manufacture and would revolt. o Nor does Mr Oppenheimer think a polishing industry is viable in many diamondproducing countries, whatever Mr Leviev says. In Namibia just a few hundred people work as polishers and cutters. There are few skilled workers, the scale of production is small and wage costs are roughly ten times that of India, which dominates the world market and where 900,000 people work as basic polishers. o Nor are small countries, such as Namibia, likely to develop the top-level skills needed for the very highest-quality stones. Those skills are concentrated in a few cities, such as Antwerp, Tel Aviv and New York. Within southern Africa, only South Africa has a long-established cutting and polishing industry, to which De Beers supplies some good-quality stones (specials in the language of the trade). But Mr Leviev probably does not care. A few factories may be uneconomic, but if they allow him to get hold of direct supplies of diamonds, then so be it. o Mr Oppenheimer is worried that a more fragmented industry will not just damage De Beers, but that the whole industry might collapse. Consumers believe diamonds are valuable largely because of decades of clever marketing by De Beers and its clients. De Beers itself spent $180m on advertising last year, its clients a further $270m. That sort of spending could not be co-ordinated and sustained, he suggests, if the industry were to fragment. o That is a risk; but there are opportunities for De Beers too. As it has lost market share, the old goliath has become nimbler. No longer focusing exclusively on defending a cartel, De Beers is freer to make decisions according to commercial interest. For instance, it now buys fewer stones at uneconomic prices; profits matter more than

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market share. A trimmer De Beers, with a pared down list of clients, might even be able to make bigger profits than the old giant. Last year it produced healthy profits of $676m on sales of $5.5 billion. o But its decision to settle American antitrust charges laid against it in 1994 points to how much it is feeling the pressure. De Beers executives should now be free to travel to America to conduct business without fear of arrest. That should make it easier to promote De Beers LV, a hitherto disappointing partnership with the luxury-goods firm LVMH to market De Beers-branded diamonds. o That venture may prove essential for De Beers's long-term health, as more producers bet on getting a presence in profitable diamond retailing. Already rivals are moving: Canada's Ekati mine markets its stones directly to consumers; Mr Leviev's firm struck a deal in May with Bulgari, an Italian jewellery maker, to market Leviev-branded stones. De Beers's days of market dominance are clearly drawing to a close. But consumers should not get too excited just yet. Whether a duopoly or oligopoly emerges, diamond prices are not going to plummet. Mr Leviev will be among those putting a stop to that.

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3.9 Evolution In the 1990s, however, political and economic shifts ignited a new set of challenges for the diamond trade. First came the end of apartheid in South Africa and the political ascendance, after years of exile and opposition, of the African National Congress (ANC). For decades, the ANC had been explicit in laying out its plans for the South African mining sector. Upon his release from prison, for example, Nelson Mandela proclaimed that the nationalization of the mines, banks and monopoly industry is the policy of the ANC and a change or modification of our views in this regard is inconceivable (Abdelal, Spar and Cousins, 2003). Yet once the ANC took office in 1994, no mines were nationalized, and the legal status of privately-held mining resources did not change. Instead, the ANC-led government instituted a widereaching program of black economic empowerment that, among other provisions, encouraged South African firms to sell a portion of their assets and reserve a portion of their jobs for historically disadvantaged groups. Because the end of apartheid in South Africa also meant the removal of international economic sanctions, South Africa experienced a flood of interest from foreign investors, which in turn meant new pressures from global financial and product markets. By this time, South African diamonds had fallen to only about 14 percent of the worlds rough production, and DeBeerss own production (which included mines in Botswana, Tanzania and Namibia) was down to 45 percent of the world total (Oomes and Vocke, 2003; Anglo American PLC, 2001). New discoveries in Canada promised to reduce this percentage even further, while political change in Russia threatened once again to remove that countrys production from DeBeerss grasp. For DeBeers, the combined impact of these changes was subtle but vast. In 1990, DeBeers restructured its already-complicated corporate structure, moving the bulk of its financial assets out of South Africa and into a Swiss-based corporation named DeBeers Centenary AG. Then in the mid-1990s, it hired an American consulting firm to review its entire strategy. The consultants noted that DeBeers didnt run its operations like a typical firm. It held roughly $4 billion worth of stockpiles (at the end of 1999); it explicitly cooperated with its competitors; and it had never focused on maximizing its share price, although a rising proportion of its shares was held by foreign institutional investors. As Harry Oppenheimer (Ernests son) told

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me at the time, I dont really care about the share price today. I care about the company that my great grandson will inherit. Moreover, DeBeers had never taken financial advantage of its brand name.Once these concerns were laid out, however, DeBeers responded in a rather unusual way. In June 2001, DeBeers Consolidated Mines delisted from the Johannesburg Stock Exchange and sold all of its shares to three entities: 45 percent to Anglo-American PLC, a major mining company with longstanding links to DeBeers and the Oppenheimer family (Gregory, 1962, pp. 10957); 45 percent to Central 202 Journal of Economic Perspectives Holdings Limited, a private firm owned by the Oppenheimers; and 10 percent to Debswana, a joint venture between DeBeers and the government of Botswana (Alfaro and Spar, 2003). Effectively, DeBeers was now a privately-held, family-run company. It also transformed the CSO into the Diamond Trading Company (DTC) and announced a new policy, ambiguously entitled Supplier of Choice. Under this program, the number of sightholders was slashed, and those who remained would no longer be expected to take whatever stones DeBeers deemed most appropriate. Instead, the buyers would now plot their own sales, implement their own marketing strategies, and request a specific package of stones from DeBeers. Theoretically, this independence would allow sightholders to choose their purchases to align with their customers demands. In the process, it would also pull more diamonds through the pipeline, reducing DeBeerss stockpile and absorbing some of the projected supply increases. DeBeers also began rearranging its own sources of supply. It purchased 100 percent of Snap Lake, a mine in Canadas far north, and renewed its supply contracts in Botswana and Namibia. It signed a five-year, $4 billion trade agreement with Russias largest diamond producer and expanded its exploration efforts around the world. Yet competitive pressures continued to mount. In 2000, a diamond sightholder named Lev Leviev convinced the Angolan government of Jose Eduardo Dos Santos to terminate the countrys relationship with DeBeers and instead sell all of its rough production through Levievs newly established firm. After Leviev cornered the market for Angolan stones, his firm became the worlds secondlargest producer of rough diamonds. Meanwhile, Alrosa, the newly configured Russian diamond mining company, was also actively contemplating a break with DeBeers. Alrosa already sold half of its rough production to local cutters, and several of its leaderssome

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with links to the highest levels of political power in Russiawere itching to sell more. Canadian producers were likewise hinting at plans to polish, brand and market independently the stones produced at their Diavik and Ekati mines, and batches of diamonds were also seeping into the market from across the vast middle regions of Africa. Acknowledging that its grasp on the upstream-side of the industry was slipping, DeBeers, for the first time in its history, began to explore possible moves into the world of cut diamonds. Until this point, DeBeerss only direct connection with the jewelry trade was its famous diamonds are forever campaign, an industry-wide appeal sponsored solely by DeBeers. In 1999, however, the newly organized company heeded the consultants advice and made the brand its own. New advertisements touted a limited-edition millennium diamond that literally bore the DeBeers name: the stones were etched with microscopic versions of the companys logo. The Angolan government was also a partner in the new company, named Ascorp. So, reportedly, were secret shareholders, including Dos Santoss daughter. In 2001, DeBeers moved another step further, signing a deal with LVMH Moet Hennessy Louis Vuitton, one of the worlds leading luxury goods companies. DeBeers agreed to transfer all rights to the DeBeers brand in the retail market to a newly established, jointly owned firm (while retaining rights to its brand in the rough diamond sector), and then agreed to let this firm develop a DeBeersbranded line of premium diamond jewelry. This deal brought together two of the worlds most successful firms in a high-profile venture that promised to revolutionize how consumers viewed and bought diamonds. DeBeers opened cutting centers in Botswana, Namibia and South Africa, and retail operations (with LVMH) in the United States and United Kingdom. Compared with most other markets, diamonds still operated in an idiosyncratic fashion, with supply and demand actively managed by a tiny group of very powerful players. Around the edges, though, the rules of the diamond game had started to shift. Although DeBeers remained the dominant player, the company had been forced to change its strategy to maintain its control. An even greater change in the diamond market, however, was let loose by an unlikely source: two previously obscure activist groups called Partnership Africa Canada and Global Witness. According to these groups charges, brutal warlords in Sierra Leone, Liberia, Congo and

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elsewhere were funding their activities with diamondsthe same diamonds that eventually graced the hands of brides-to-be across the Western world (Global Witness, 2000). To prevent the heinous acts fuelled by the diamond trade, the activists argued, Western consumers and governments had to stop purchasing blood or conflict gems. Remarkably, Partnership Africa Canada and Global Witness managed eventually to embed their vision in a major global initiative. Ironically, the implementation of this vision worked directly to enhance the competitive position of DeBeers. In making their claims, Partnership Africa Canada and Global Witness were echoing what had become a newly powerful logic of activism. Rather than protesting to the wrongdoers or to other governments, the DeBeersLVMH joint venture did face a nagging legal problem. In 1994, DeBeers had been indicted in a U.S. court for price-fixing in the industrial diamond market. Although the case had been dismissed, DeBeers (whose executives never appeared in court to defend themselves) formally remained under standing indictment, meaning that the company could not legally operate in the United States. Accordingly, between 2001 and 2004, DeBeerss U.S. lawyers stepped up their ongoing efforts to remove the indictment. They were also aided by an emerging interest on the part of other U.S. agencies including the U.S. Departments of State and Treasuryto involve DeBeers in their own African initiatives. In July 2004, DeBeers pleaded guilty to its ten-year-old charge of price fixing and paid the U.S. government a fine of $10 million. Legally, the corporation could now do business in the United States. Activists charged that DeBeers and the diamond industry were effectively both funding the atrocities of Africas warlords and covering their tracks. The only way to stop the terror, they urged, was to bring the diamond trade to a halt. Activists were instead bringing corporations into the mix, lobbying them to take action and to take responsibility for ameliorating crimes that werent directly theirs. In the diamond trade, these claims had a particular resonance, becausedue to the inherent difficulty of identifying or marking a particular stoneeven clean producers could well find themselves handling conflict stones. If consumers had ever truly shunned African diamonds, or if governments in the United States and Europe had forbidden their import, African producers would have been completely

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cut off from their largest and most lucrative markets. Given the politics of the time, moreover, such an outcome was not entirely farfetched. The United States was waging a war against terror; it had few major security interests in Africa; and boycotting conflict diamonds would have been politically rather painless. Indeed, as the campaign against these diamonds unfolded, the U.S. government, led by the departments of State and Treasury, signed on to the activists agenda and began exploring ways of restricting the diamond trade. These efforts culminated in the Kimberley Process, a vast international program launched in 2002 and supported by an array of strange bedfellows: producing countries, importing countries, nongovernmental organizations, the jewelry trade and the United Nations. The Kimberley Process is an extraordinary enterprise. It includes a complex certification system for all diamonds and a commitment by all participants to adhere to the rules embedded in this system. Every individual who handles a diamondfrom the miner to the jeweleris responsible for maintaining an identity tag affixed to the stone at the time of extraction. If a tiny half-carat stone is found by an alluvial digger in Angola, for instance, it must be tagged as an Angolan stone by the broker who buys it from the digger; by the trader who buys it from the broker; by the firm that cuts and polishes the stone; by the jeweler who sets it into a ring; and by the retailer. With such a system, theoretically at least, no warlord in Liberia or Sierra Leone can slip diamonds into the pipeline. And no husband-to-be has to worry about purchasing tainted goods for his bride. What is even more extraordinary about the Kimberley Process is that DeBeers is a central proponent. DeBeers executives campaign with Global Witness in support of the system; they sing its praises to analysts and reporters; and, through the Supplier of Choice program, they formally impose Kimberleys provisions on all DeBeers sightholders. The source of such enthusiasm is not obvious. Why, after all, would the firm embrace a protester with a vision that was initially directed at smearing its own image? Why would it join forces with those that reviled its trade? Why would a company that prized secrecy welcome so many interlopers into its business? The answer, as it turns out, is that the Kimberley Process is exceedingly good for DeBeers. Recall that DeBeers has been devoted throughout its history to keeping excess supply off the market and preventing new suppliers from entering the business. This is precisely what Kimberley accomplishes. Like the cartel itself, this new international system restricts supply and enhances the power of big, established players. It keeps the warlords and the small
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diggers and the shady traders out of the acceptable stream of commerce. It also imposes costs (for tagging, monitoring and auditing) that make it even more difficult for new or smaller players to enter the global market. For DeBeers, then, the timing of Kimberley could not have been more propitious. Just as the company was facing a serious decline in its ability to control supply, and just as it was launching an unprecedented move into the retail sector, the campaign against conflict diamonds helped to move the entire diamond market in DeBeerss direction. As a result of the campaign and the Kimberley Process, new suppliers were crowded out of the market (as DeBeers would have desired) and consumer preferences were directed to those producers who (like DeBeers) could guarantee the integrity and cleanliness of their brand. The other major winners were the Canadians, whose homegrown diamondsnow branded and etched with tiny polar bearswere also easily certified as conflict-free. There is no evidence to suggest that DeBeers (or the Canadians) instigated the campaign against conflict diamonds, or even that any of the major producers initially understood the opportunity provided by their attackers. There is also no reason to believe that DeBeers executives dont share the activists moral outrage or their determination to prevent thugs and criminals from funding their actions with diamonds. However, the fact remains that DeBeers and the diamond cartel have managed to turn a potential attack on their business into a substantial windfall.

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4. Conclusion
For more than a century, DeBeers has managed the diamond market by working with other producers, restricting supply, squashing speculation and resisting excess profits. The ironic proof of the strategys success is the extent to which new entrants have mimicked it. Leviev, for example, is challenging DeBeers but not departing from its approach; the Canadians are selling their polar bear diamonds just as DeBeers sells its millenniums. DeBeers, meanwhile, has no intention of loosening its own reins. In 2004, the company discovered 39 new diamond deposits and signed marketing alliances with producers in Canada, Botswana, India, Democratic Republic of the Congo, the Central African Republic, Russia, Australia, Brazil and Madagascar. In 2005, it joined with leading nongovernmental organizations to launch a Diamond Development Initiative dedicated to optimiz[ing] the beneficial development impact of artisanal [small-scale, or independent] diamond mining (Diamond Development Initiative, 2005). Quietly, the company was also positioning itself to oversee a massive system for tracking diamond trades among some of Africas smallest miners, which, if implemented, would further help DeBeers to regulate the flow of diamonds, keeping rogue supply off the market and power in its own hands. De Beers undoubtedly, has proved to be the most successful cartel arrangement in the annals of modern commerce. The diamond invention is far more than a monopoly for fixing diamond prices; it is a mechanism for converting tiny crystals of carbon into universally recognized tokens of wealth, power, and romance.

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References
DeBeers and Beyond: The History of the International Diamond Cartel, Tobias Kretschmer, New York University Have you ever tried to sell a diamond, Edward Jay Epstein, The Atlantic Magazine, February 1982 Are diamonds really forever? , Making economic sense by Murray Rothbard, Chapter 91 The history behind the DeBeers Diamond Cartel, http://voices.yahoo.com/the-historybehind-debeers-diamond-cartel-12119.html?cat=46, 3 Jan, 2006 De Beers UK Limited., http://www.debeersgroup.com/en/About-Us/The-family-ofCompanies/, 15 Sep, 2012 Wikipedia, http://en.wikipedia.org/wiki/Cartel#Private_vs_public_cartel, 15 Aug, 2012 Wikipedia, http://en.wikipedia.org/wiki/De_Beers, 17 Sep, 2012 Diamond cartel meltdown, John Helmer, Asia Times Online, http://www.atimes.com/atimes/Central_Asia/KA06Ag01.html, 6 Jan, 2009 The Diamond cartel is finally broken, Dr. Steve Sjuggerud, Daily Wealth, http://www.dailywealth.com/838/The-Diamond-Cartel-is-Finally-Broken, 3 Apr, 2007 Combating cartels in markets Issues and Challenges, G. R. Bhatia, Competition Commission of India

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