Sat, 27 Nov 2004

Just imagine

Your first day, getting to know the product

This morning, you flew into an area in the Arctic,
seeing a huge pit from your helicopter. On the ground, enormous trucks
pass by carrying tonnes of earth. Your first question to the engineer,
guiding you around: how many kilos of diamonds in such a truck?

He
explains that you are now mining a very rich area and that each tonne
of earth contains about 2 carats of diamonds. Not bad, you think,
imagining a nice 2 Ct-round brilliant.

What
a surprise, when you walk into the processing area, where the diamonds
are recovered from the earth. You see tiny baubles, sometimes a nice
crystal-shape, sometimes a bigger stone, a lot of colours, mostly brown
and faint yellow, and on the odd occasion that you have a transparent
stone, you always see these ugly black spots inside.

Your
engineer explains that the biggest part of your mine’s production is
diamonds for industrial use. With more and more synthetic diamonds
being produced for industrial purposes, the value of these is
constantly going down.

Of
the smaller part, which can be used for jewellery, most is quite small
in size, and rather heavily included. In the end, they will end up in
cheap jewellery under 100$, mostly sold through TV-shopping channels
and in mall stores. Luckily, some thirty years ago, some Indian diamond
cutters have specialised in cutting these stones, and they have created
a new market for your rough diamonds.

Fortunately,
a small portion of your production is of a very high quality and rather
big size, and within months, this will be sold as high quality
diamonds, exactly the ones you dreamed about last night.

That
evening, you think about the problem of having all kind of diamonds,
industrial ones, cheap and small gem-quality and some nice
high-quality. You realise that your complete production needs to be
sold at the highest possible price, for you to make a profit.

 

Day number two, meeting with the government

The
next day, you receive a delegation of the government. They explain that
mining in this country is done under certain clear government
regulations. When you export your rough diamonds (as you are doing for
100%), the government levies a small export tax of 5%.

Lately
however, the government is under increased pressure to create more
jobs, and they are considering the idea of promoting a local cutting
industry. In order to achieve this, they need your “co-operation”.

The
new policy will be that the export tax on rough diamonds will be
increased to 10%. On the other hand, there will be no tax on rough
diamonds, supplied to local cutters, and no export tax on the finished
product, which they export.

You
try to explain that this comes down to selling to local cutters at a
10% lower price, and they make you understand that this is exactly the
point. By selling to local cutters cheaper than to the foreign ones,
they can compensate their lack of experience and compete. This
reduction of 10% in your overall earnings is exactly the co-operation
that they have forced you to give.

On
top of that, in the new government regulations, you will have to offer
goods to local cutters first, before you are allowed to export them.
Your assistant explains that, in this way, your loyal foreign customers
will be disadvantaged, because the most interesting rough stones will
be picked out by the local cutters.

Well, says the representative of the government, that is exactly the point: we are supporting a new local cutting industry.

Again,
that evening, you have trouble finding your sleep. Percentages keep
racing through your mind. But the end-result is always the same. If
your foreign customers used to pay 100, of which 5 were the old export
tax, that would leave you 95 net. With the new regulation, the local
cutters buy the best rough at 90. And if you are lucky enough that the
foreign cutters still want to pay 100 (even though the best rough is
not included anymore), with the new export tax of 10, you will only
have 90 left. All in all, with the same investment, work and output,
the government has just taken away 5% of your turnover.

 

Day number three, meeting with De Beers

Your
great-uncle had a contract with De Beers’, which arranged for them to
purchase your whole production and for them to market it. As soon as
rough was mined, it would be sorted into hundreds of different
qualities and sizes, each with his own price-level, at which De Beers’
would sell that quality. You received 85% of that total price.

By
the end of the year, you have to decide whether to renew this contract.
Your assistants quickly briefed you about the situation:

Lately, De Beers’ is selling too cheap to the market, in order to bring down their excess stock. If sold directly in Antwerp, you could make a lot more for your production.

Also,
any new contract with De Beers’ will need to be monitored by the
European anti-trust-authorities. It could well be that a simple renewal
of the contract will be deemed anti-competitive and illegal.

On
the other hand, your great-uncle has borrowed a considerable amount in
the bonds-market, and in two years from now, this bond needs to be
renewed. The contract with De Beers’ is a guarantee that such a renewal
of the loan is not difficult. If however, you decide to start selling
on your own, there is a risk that you cannot renew the loan.

Today,
you had a first meeting with the representatives of De Beers’. It was
quite pleasant. At the end, you realise that nobody is discussing
anything essential, and that it feels more like a drink in your country
club. Then, you just point out that you do not consider a renewal of
the contract as something automatic, and that you clearly want to
consider whether it is the best option for your company.

With
a rather stiff upperlip, they react to your remark, saying that this
needs to be checked carefully, of course. Later that day, you receive
the news that a more senior delegation will come and meet you next
month.

 

Day number four, back home, warm and cosy

Back home, you try to summarize what you have learnt.

The
good thing, probably, is that you have inherited a diamond mine.
Unfortunately, to cover the mining and prospecting investment, your
great-uncle had borrowed a large sum on the bonds-market. If you do not
renew your contract with De Beers’, you risk not being able to repay
that loan.

On
the other hand, the government has just taken away 5% of your turnover,
by raising export taxes and trying to create a local cutting industry.

 

Finally,
the product-mix that you mine, is not all beautiful big gem-diamonds.
The majority is of industrial, or really low-price-quality, and you
have to make sure that all keeps getting sold, in order to remain
profitable.

Then,
you realise that you have to step away from your dream of super-wealthy
Scrooge McDuck. You have just entered a business, that you still need
to learn, but that is essentially like any other business. If you make
sure to take good and wise decisions, and if you are lucky, your
business will be profitable. If however, you take it for granted, you
will loose enormously.

 

discuss on the forum

 

Article Series
This article is part 1 of a 3 part series. Other articles in this series are shown below:

  1. Just imagine
  2. The Diamond Industry in 2005
  3. The diamond industry in 2005 – halfway review