Co-Opetition - Adam M. Brandenburger [60]
There’s a one-word explanation: DeBeers. This South African company has a monopoly on the world’s diamond market. Nearly all of the world’s diamonds are sold through DeBeers’s distribution system, known as the Central Selling Organization. Even Russia is committed to selling 95 percent of its diamonds through DeBeers.
There’s more. DeBeers holds back the supply. Recall how Nintendo didn’t fill all of its retailers’ orders in 1988. With DeBeers, every year is that way. It holds ten sales a year—“sights” in industry parlance—to which only a select 150 diamond merchants are invited. DeBeers decides on the appropriate supply. Each invitee then gets an allotment of stones in a plain brown shoe box. It’s take it or leave it, and the dealers usually take it. Dealers who try to circumvent DeBeers—by hoarding, speculating, or dealing with the black market—shouldn’t count on being invited back to the next sight. There’s no shortage of dealers who would be glad to take their place.13
As well as controlling supply, DeBeers has made sure to manage demand. People value diamonds highly because they perceive them to be scarce. They’re not, but that’s beside the point; it’s the perception of scarcity that counts. The perceived scarcity has made diamonds an ideal choice for engagement rings, but not without some help from a long-running DeBeers advertising campaign. In fact, the diamond engagement ring is a newly created “tradition” in Japan. In 1967 only one in twenty Japanese brides had a diamond ring. Now it’s almost compulsory.
DeBeers uses advertising to shape the game in other ways, too. It wants people who buy diamonds to keep them forever. This limits competition from the secondhand market. So, to discourage people from selling their diamonds, DeBeers created its “Diamonds Are Forever” campaign. In response to an unwelcome upsurge in Russian exports of medium-grade diamonds, DeBeers popularized the “eternity ring,” an anniversary ring studded with these medium-grade stones.
But despite all its efforts, DeBeers has been unable to keep demand ahead of the rapidly growing supply. So, to maintain the scarcity of diamonds, it’s stockpiling more and more stones. While DeBeers sold a record $2.5 billion worth of diamonds in the first half of 1994, by June of that year, its inventories reached $4 billion—double the levels of a decade earlier.
The Russian Treasury has its own growing hoard of diamonds, estimated to be worth at least another $4 billion.14 With the recent political instability in Russia, this inventory makes a very tempting cookie jar, and unauthorized stones have been getting onto the market. In response, DeBeers has had to further cut back its own supply just to keep prices flat. Not for the first time in its history, DeBeers faces a serious challenge.
DeBeers and the Russians have a mutual interest in regaining control of supply. This time they may succeed. But it’s getting harder and harder to maintain a scarcity of diamonds in the face of the growing natural abundance. Diamonds may be forever, but how much longer will Adam Smith’s paradox persist?
The explanation of the modern water-diamond paradox goes beyond supply and demand. It’s about one player owning the supply and being able to control it. To see the significance of ownership and control, imagine for a moment that all the water in the world is owned and controlled by one person, a DeBeers of water. Next to this, the DeBeers of diamonds would look like a mere drop in the ocean.
Limiting Supply?
Let’s apply the lesson of the Nintendo, NFL, and DeBeers stories to a more familiar business situation. You face growing demand for your product. It’s clear that more capacity is needed, but how much more? Management science textbooks frame this as a balancing problem: expand too little and you risk losing sales; expand too much and you’ll end up having paid for unused capacity. The