The diamond supply chain

imagesSome retailers like to vertically integrate. For example, in clothing the two large players (Gap, Inditex/Zara) are vertically integrated into production (though not to fabric production). Other do not. For example, in athletic shoes (Nike/Adidas), the firms like to outsource production and do not reach all of the way back into the production of materials (such as cows for leather). The Internet giant, Amazon, doesn’t make the stuff it sells (I suspect it outsources production of the Kindle) and the physical world giant, Wal-Mart, also primarily sticks to retailing.

The supply chain for diamonds is special, in particular due to the existence of the “legal cartel”, De Beers. The WSJ yesterday (Diamond Industry Makeover Sends Fifth Avenue to Africa – 10/26/09) reported how Tiffany’s has invested in diamond cutting and polishing in Botswana. Why would they do this?

The technology for diamond cutting and polishing doesn’t seem to be particularly complex or proprietary (protected by patents, etc.). It isn’t a very capital-intensive step in the process(unlike mining), which is reason to get into it (i.e., it isn’t a big investment) and reason to let others get into it (there must be lots of competitors due to the low capital requirement). There doesn’t seem to be evidence of a cartel at that step in the process or substantial barriers to entry.

One theory is that controlling the diamond supply chain facilitates branding, and in particular avoiding the tarnish of “conflict diamonds” (see Blood Diamonds).  But, to quote a quote in the article:

“We really want the focus…to be on the quality of the diamond ring, not how it came to be,” said Mr. Kowalski, the CEO.

In other words, they are not investing in Botswana cutting and polishing to convince consumers that their diamonds are “clean”. In fact, they want to completely avoid the discussion of where their diamonds come from.

Hence, it must be that (i) the ROI on this investment is at least as high as opening up new stores and (ii) the ROI is high because vertical integration into this step creates efficiencies that cannot be had from buying cut and polished diamonds on the open market. (i) is plausible if they are running out of good places to put their stores, but they might not want to signal that to Wall Street. (ii) is plausible if the market is not sufficiently efficient to drive down margins.  Alas, the article doesn’t provide enough information to know if these theory holds water or not.

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One Response to The diamond supply chain

  1. Pushkar Bajpai says:

    The post was interesting to read. Diamond supply chain is a typical example of how political/ethical matters are intertwined with a supply chain. There are two parts to my comment.

    1. Here is a link about how Amazon’s Kindle is manufactured. http://blogs.harvardbusiness.org/hbr/restoring-american-competitiveness/2009/10/the-us-cant-manufacture-the-ki.html
    Interesting to read about its suppy chain.

    2. Unless a diamond company controls the source of diamonds (a mine etc) how can the consumer be certain about the origins of the diamond. It can be compared to Nike, Gap etc buying a sweatshop in Thailand/Malaysia to control the quality of production. Ultimately the sweatshop still exists and conditions haven’t changed for the workers. Maybe the interpretation of CEO’s words is wrong but the message it is giving in its present form is indifferent to the origins of a diamond.

    Thank you for your time to read my comment.

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