HOW TO OPERATE A DIAMOND CARTEL: EXPLORING DE BEERS' DOMINANCE

By Andrew GuichetThe De Beers Diamond Cartel is arguably the most successful cartel in history both in terms of profit and longevity. For nearly 130 years, the cartel has managed to maintain a firm hold on diamond production while at the same time weathering significant changes in the diamond market. With every firm within the cartel constantly incentivized to break free from the collusive agreement and reap tremendous short-term profits, why is it that the diamond cartel has been able to withstand the test of time? There is no single answer to this difficult empirical question, but a number of key variables point to the reasons behind the seemingly perpetual success of the De Beers Diamond Cartel. These variables include: the number of firms and concentration of the diamond market, characteristics of the market, and the ability of the cartel to deter entry. Analysis of these fundamental factors sheds light on the underlying reasons behind the continued success of the De Beers Diamond Cartel.The number of firms within and concentration of the diamond market is a huge factor behind the success of the De Beers Cartel. Since the world’s diamond deposits are spread throughout only a handful of countries, the diamond market is very concentrated with relatively few countries producing most of the world’s supply. In 2003 for example, only Australia, Botswana, the Democratic Republic of Congo, and Russia accounted for 75% of the world’s total rough diamond production¹.The small numbers of firms and high market concentration have empirically been shown to improve chances of cartel success. With fewer firms, monitoring and coordination costs for the cartel remain relatively low while at the same time making it easier to detect, punish and deter cheating². Additionally, the success of the De Beers Diamond Cartel provides additional support for the theory that fewer decision makers within the cartel increases its chances of success. Unlike cartels where decisions are made democratically between firms³, pricing and supply decisions regarding the diamond cartel flow from one source – De Beers.The De Beers Cartel has also benefited greatly from some of the unique characteristics of the diamond market. First, it has been shown that increasing homogeneity of a cartel’s product contributes significantly to the cartel’s success⁴. Diamonds are not as homogeneous as products like steel and sugar, but an efficient quality rating system has ensured that prices can be efficiently set throughout the industry for various product. The differentiation between diamonds that does exist, however, reduces the opportunity for cheating because no specific products are perfect substitutes. Second, because De Beers is able to manage supply and thus industry demand so effectively, it can best position itself to limit the bargaining power of consumers and increase profits. Third, increasing levels of inter-market contact between firms has also been shown to result in increasing levels of cartel success⁵. As inter-market contact between firms increases, the penalties for defecting firms rise as well. De Beers’ continuing attempts to vertically integrate as well as the induction of the Kimberly Process have made it increasingly difficult for defecting firms to avoid market contact with De Beers. Since the induction of the Kimberly Process, De Beers has worked to develop the infrastructure for the tracking and certification of stones produced within the cartel ⁶. Clearly, any firm thinking about defecting from the cartel is less incentivized to do so when infrastructure for mandatory tracking and certification is unavailable. Along with the characteristics of the diamond market, the cartel’s own ability to deter market entry has had a huge impact on its ability to succeed in the long-run.The chances for a cartels success increase with its ability to deter outside firms from entering the market as well as its ability to prevent firms within the cartel from defecting. If a collusive agreement exists between a set number of firms with respect to market share and price levels, the contract must be renegotiated in the event of entry by another firm. Entry usually results in diminished market share for firms within the cartel resulting in increased strain on the collusive agreement. This can often lead to the breakdown of a cartel. De Beers has historically shown that it has the power to effectively deter entry into the diamond market. Its massive stockpile of excess diamonds, totaling near $4 billion, allows De Beers to control market supply and influence the price of diamonds. It is this ability to manage supply and impact prices which makes De Beers so effective at ensuring that firms within the cartel remain obedient and new market entrants are willing to cooperate. Additionally, the Kimberly Process has placed new cost on the industry making it even more difficult for smaller firms to enter the market⁷. However, in recent years De Beers ability to effectively deter market entry has begun to weaken. Recent discoveries of Canadian and especially Russian diamonds have forced De Beers to make increased concessions in order to keep the two nations within the cartel ⁸. The pressure of the Russian diamond industry to overproduce and De Beers willingness to conform illustrates the weakening power of the cartel.There is no singular factor that can be said to determine the success of a cartel, however the 3 variables examined above have been empirically shown to be important in their long-run success. When examining the De Beers Cartel with respect to these three variables, it becomes clear that the cartel is incredibly well positioned for success. However, recent discovery of high quality diamonds in diamonds in Russia and Canada is placing increased strain on the cartel and is a signal that the cartel’s success is weakening.References.Photo courtesy of cameronconner, mafic