Session 23 (De Beers) Flashcards
(30 cards)
How much of the global supply did De Beers historically control?
Historically controlled ~90% of global diamond supply managed via Central Selling Organization.
Why are diamonds expensive?
Natural Scarcity
Manufactured Scarcity
- “A degree of control is necessary for the well-being of the
industry … because wide fluctuations in price … have been
accepted as normal in the case of most raw materials”
Marketing & Advertising
Illustrates how a single firm can create common value for
all firms in industry
Details of De Beer’s Marketing/Advertising
Convinced consumers that diamonds are a psychological
necessity and symbols of eternal love
Increase willingness-to-pay
- Advertisements told buyers how much they should spend on
engagement rings
Wildly Successful: Fraction of US brides w/ diamond ring
rose from 0% to 80% in 20th century (similar pattern in
other countries)
Diamonds became “universally recognized tokens of
wealth and power”; featured in movies, celebrity events
Why are diamond prices low in the secondary market?
Buyer motivation
- Seen as a one-time transaction rather than a longer-term jewelry
sales relationships (buy low sell high)
Limited number of buyers
- Few professional buyers, difficult to get offers
Newly minted diamonds aren’t overly expensive for
jewelers (50% of retail price)
Seller motivation
- E.g. distress, divorce, death, disinterest
Buyers don’t know history
Sellers don’t know quality
Why is Tom Montgomery so concerned about the
reselling market?
De Beers is an upstream supplier of rough diamonds not a downstream seller of polished
diamonds.
Why do Firms Need to Grow?
To increase profits and shareholder returns
To lower costs and achieve economies of scale
To increase market power
To reduce risk through diversification
To motivate management
Three Dimensions of Corporate Strategy
- Vertical integration
- Diversification
- Geographic scope
Underlying concepts that guide these:
- Core Competencies
- Economies of Scale
- Economies of Scope
- Transaction Costs
- Cost effectiveness of vertical integration vs. diversification
Considerations when choosing to expand?
Vision, mission statement, values of the firm
What are transaction costs?
Costs associated with an economic exchange
External transaction costs
Searching for contractors
Negotiating, monitoring, enforcing contracts
Internal transaction costs
Recruiting and retaining employees
Setting up a shop floor
When to make or buy?
If in-house costs < market costs
- the firm should vertically integrate
- own production of the inputs or own output distribution channels
If in-house costs > market costs
- the firm should consider purchasing instead
Strategic Alliances
Alternatives on the make or buy continuum
See slide 39 of Session 23 deck
What is vertical integration?
The ownership of inputs or distribution channels
Backward Vertical Integration
Owning inputs of the value chain
Forward Vertical Integration
Owning activities closer to the customer
Diamond Value Chain
Upstream Segment
- Most concentrated
- Involves the exploration, production, and sorting of rough
diamonds
Midstream Segment
- Most complex; highly technical process
- Cutting and polishing of rough diamonds to produce finished
product
Downstream Segment
- Jewelry designing and selling of finished product
Benefits of Vertical Integration
Lowers costs
Improves quality
Facilitates scheduling and planning
Facilitates investments in specialized assets
- Co-located assets, unique equipment, human capital
Secures critical supplies and distribution channels
Risks of Vertical Integration
Increase in costs
Reduction in quality
Reduction in flexibility
Increase in the potential for legal repercussions
When does vertical integration make sense?
When there are issues with raw materials
To enhance the customer experience
- Eliminate annoyances and poor interfaces
Vertical market failure
- When transactions are too risky or costly
Why change scope? (Porter)
Improve performance: add to shareholder value
- This means current businesses in different industries do not add value to shareholders and potential businesses will add greater value to shareholders
Tests:
- Industry Attractiveness
- Cost of Entry
- Better off Test
Industry Attractiveness Test
Threat from suppliers.
Threat from buyers.
Threat entrants.
Threat from substitutes.
Intensity of competition
Cost of Entry Test
Does the cost of entry capitalize all future earnings?
Two modes of entry into new areas:
- Acquisitions: Cost of acquisition can be substantial and more than what is the market price
Start up: The very factors that make the industry attractive can make it
very costly to enter
Better off Test
Will the business that has been acquired or started be
better off due to entry by the corporation?
Questions to ask:
- Is it a one-time benefit?
- Can the shareholders diversify on their own?
Is company size a ‘red herring’ for value?
