How the system operates – control production, dominate the trade, influence demand

    The Central Selling Organisation ,based in Switzerland and London, is the

collective name of companies controlled by De Beers and its associates. It buys

rough diamonds from the mines, valuing them and selling them to sightholders.

CSO sales peaked at $6.7 billion in 1997. By keeping rough prices at the highest

sustainable level, the cartel aims to achieve long-run profit maximisation over

the demand cycle rather than short-run market clearing at spot prices. The key

characteristics of the cartel are:

1. The system of producer quotas. Most significant producers have a long-term and

exclusive contract to supply a certain proportion of De Beers’ annual diamond

sales.

2. The cartel has created a strong antidote to any individual producer’s incentive to

cheat. De Beers backs up the carrot of higher prices with a powerful stick – its

ability to release from its stocks a supply of any type of diamond. Every

diamond mine has its own characteristic output. If De Beers chooses to release

more stones of this characteristic from its stockpile, the stockpile-supported

price can drop dramatically.

3. De Beers acts as a swing producer. In a buoyant market, De Beers benefits from

both higher prices and stock appreciation as goods are sold from the bufferstock.

But in a depressed market, it absorbs excess supply and reduces its own

production. It can play this role credibly since its mines are among the cheapest

sources of fine diamonds in the world and because of the company’s financial

strength. De Beers holds stocks worth US$4 billion .

4. The cartel pays careful attention to demand management. It spends over $150

million a year on advertising. Rather than ride out cyclical fluctuations

the company wants to drive incremental demand through targeted marketing

campaigns.

Threats to the system

    Any interference with the market system runs the danger of encouraging unintended countervailing and competing reactions. An official price ceiling gives an

incentive to sell diamonds outside the system while minimum prices

encourage over-supply. The diamond cartel is not exempt from these tendencies

and its operations are under periodic threat.

1. Advertising can influence demand, but its effects can easily be overwhelmed by

business cycles and by the ebb and flow of fashion. If De Beers expects a glut of

a certain type of diamond, it will stop putting it in boxes, but months can pass

before the effect of the move is felt in the market for polished stones.

2. De Beers’ sway over customers for rough diamonds is not matched by its influence on customers for polished diamonds – jewellers and their suppliers. This

makes it difficult for De Beers to control prices to the end-buyer.

3. New entrants add uncertainty to the diamond market. The new Ekati diamond

mine in Canada accounts for 6 per cent of world supply. Political instability in

Africa and Russia can also create problems by magnifying the incentive to

cheat and favouring short-term over long-term perspectives of national interest.

This explains why De Beers has embarked on a marketing campaign to

create a De Beers brand rather than to promote diamonds in general.

4. De Beers’ main concern is the confidence of its members. If they sense that the

cartel lacks the strength needed to fulfil its role as swing producer, cartel

members will be tempted to sell their diamonds before others do the same. The

main cement to this cartel, as to others, is the conviction that centralised

selling and buffer-stock management are in its collective interest.