Friday, October 23, 2009
The War Against Competitors Chapter Nineteen
On December 21, 1952, a small Austen Autocrat aircraft cut off its single engine and quietly glided to a landing on the diamond-strewn beach in the forbidden zone in Namibia. The plane taxied to a halt on the sand as the sun began to rise over the Namib Desert. It was Sunday, and except for the two men in the plane, the beach was entirely deserted. One of the men was a former geologist for De Beers who, while prospecting in the forbidden zone, had managed to hide a container of some 1400 diamonds; the other man was a South African pilot, hired the night before for this mission. The geologist got out of the plane and retrieved the cache of diamonds that he had squirreled away six months earlier. When he returned with the container, the pilot started the engine. The plan was to escape before the first dawn patrol. But the plane's landing gears were embedded in the sand, and it could not take off. A few hours later, security officers spotted the plane. Both men were arrested-and after a brief interrogation, the geologist confessed that he had planned to steal the diamonds he had found on the beach while in the employ of De Beers. (Their incident provided Ian Fleming with the opening scene of his James Bond novel, Diamonds Are Forever.)
When the two men were brought to court, their lawyer argued that the original concession for diamond prospecting extended only to the high water mark on the beach, and since the plane had landed on the seaward side of this demarcation line, the men had not violated the sanctity of the forbidden zone. The De Beers subsidiary holding the concession argued that its rights extended to the low water mark and that therefore the men were trespassers. To the surprise and dismay of De Beers, the judge accepted the defendant's contention. Not only were both men acquitted but, more far-reaching, De Beers was held not to control legally the rights to the submerged portion of the 200-mile long forbidden zone.
While De Beers attempted to redress this definition of the forbidden zone in the appellate courts, a brash, young, oil pipeline lawyer named Sammy Collins persuaded the authorities in Namibia to grant him a prospecting concession for the underwater portion on the diamond beach. He then, in 1961, sold shares in a company called the Marine Diamond Corporation, and with the proceeds, equipped a barge with giant suction hoses, pumps, and other dredging gear. By August of 1962, Barge 77, as it was called, began recovering small diamonds from the ocean floor. A few weeks later, Barge 77 sank in a storm, and Collins had to build second barge.
In 1964, Collins was back in full production. The pumps on his barges were sucking 30,000 carats of diamonds a month out of the sea. Although almost all these diamonds were of gem quality, most were extremely small, averaging about .45 carats apiece. Collins predicted that when the dredging system was perfected, it would yield much larger diamonds. He informed his financial advisors that he planned ultimately to have fourteen barges operating in the ocean off the Namibian coast, and that these ships would recover more than one million carats worth of gem diamonds a year. If realized, this production would in the mid-sixties be equivalent to nearly one-fifth of the world's gem diamonds.
De Beers obviously could not afford to have such a competitor working alongside its most lucrative mines in the forbidden zone. To succeed in his ambitious venture, Collins had to demonstrate to his financial backers that he could sell the diamonds at a profit as well as recover them. And De Beers still had some influence on the market for small diamonds. In 1964, most of the factories that could cut and polish diamonds less than a half carat in weight were located in Israel and were, directly or indirectly, clients of De Beers' Diamond Trading Company. Suddenly, these Israeli manufacturers found that the boxes they were receiving at the London sights were brimming over with the same categories of small diamonds that Collins was producing in Namibia. Moreover, it was made clear to at least one of Israel's leading manufacturers that if he bought any of Collins' diamonds, his supply from De Beers would be cut off.
Collins discovered that despite his enterprise in dredging diamonds from the ocean, there was no ready market for them. Despite the shortage of immediate revenue from the sale of diamonds, Collins was committed to an ambitious program of building and outfitting barges. By 1965, he found that the Marine Diamond Corporation was drained of all its cash resources and faced with bankruptcy. There was, moreover, little possibility of raising additional capital from outside banks, since it was clear to everyone concerned that the market for these diamonds was controlled by the diamond cartel. Under these conditions, Harry Oppenheimer offered to buy the Marine Diamond Corporation.
Collins had no choice but to accept, and within months, his company became a subsidiary of a De Beers subsidiary. De Beers then gradually reduced the dredging operation and closed it entirely in 1971. Collins, the would-be competitor, died in retirement in South Africa in 1978.
De Beers was confronted with another potential competitor in the mid-1970s, Albert Jolis. Jolis, a resourceful American, who had served in the OSS during World War 11, headed an international diamond firm called Diamond Distributors, Inc., or DDI. His father, Jac Jolis, had once worked for De Beers, and for three generations the Jolis family had a close business relationship with the Oppenheimers. Indeed, in the late 1940s, Sir Ernest had encouraged Jolis's father to establish a diamond-cutting factory in Los Angeles, and he had promised him a supply of uncut diamonds for the venture. Then, without any prior warning, Oppenheimer decided against the Californian venture and refused to provide any diamonds for it. No explanation was ever tendered, and the Jolis family was expected to take the loss without asking any questions. From that point on, Albert Jolis was eager to break the dependence his family had on De Beers. He negotiated a deal in the French territory of Ubangi, which became the Central African Empire, and set up diamond-buying offices in Venezuela and Brazil. These countries provided only a small fraction of the diamonds his firm sold, and thus he still had to rely on De Beers' sights in London for the lion's share of his diamonds.
In 1975, however, Jolis saw a golden opportunity to acquire a major diamond concession in Angola. Until then, Angola had been a Portuguese colony, and its diamond fields, which produced 1.5 million carats of diamonds a year, had been under control of a Portuguese-based company, Diamondco, which was partially controlled by De Beers' stockholders. Diamondco sold all of its diamonds under long-term contract to the Diamond Trading Company in London. When Portugal decided to withdraw from Africa in 1975 after more than 200 years of colonial rule, the diamond concession was again up for bidding. Angola itself was at the time on the brink of civil war.
Three rival factions shared the positions in the transition government. Each was determined to seize power for itself; and each was secretly receiving arms and mercenary assistance from foreign intelligence services. The MPLA, which had spearheaded the guerrilla war of independence against Portugal, was backed by the Soviet Union and Cuba. The FLNA, whose forces had been given sanctuary and training in neighboring Zaire, was supported by the United States, North Korea, China, and Zaire. And UNITA, which was allied to the dominant Ovambo tribes in southern Angola, had even a more curious medley of sponsors, Zambia, Tanzania and South Africa. (A fourth faction, FLEC, not represented in the government, advocated the secession of the oil-rich enclave of Cabinda and was backed by French oil interests.) In this maelstrom of international intrigue, even De Beers, with all its resources, could not immediately exert influence over the diamond fields. It was first necessary to pick the eventual winner in the power struggle.
Jolis saw the possibility of obtaining the Angolan concession-and dealing with the cartel from a position of strength. Flying to the Angolan capital of Luanda, Jolis made contact with Jeremias Kalandala Chipanda, Minister of Natural Resources in the transitional government. A mining engineer by training, Chipanda turned out to be extremely well-informed about the diamond business. He had personally inspected the diamond fields, and he suspected that the De Beers cartel had deliberately retarded the development new riverbed mining in order to hold down the world supply of diamonds. He reasoned that if these riverbeds were more aggressively mined, diamonds could earn more foreign exchange for his country.
In their negotiations, Jolis managed to persuade the Angolan minister that his company, unlike De Beers, would have a competitive incentive to develop the fields as rapidly as possible. Moreover, he promised to train black technicians (De Beers had trained only eight in all of Angola). Jolis also flew in a geologist, who prepared a comprehensive report on Angola's mineral wealth.
After weeks of wining, dining, and briefing the minister and his staff in Luanda, an agreement was finally reached. Jolis's firm would be given a large portion of the concession formerly held by a De Beers subsidiary on the condition that it would accelerate the development of the diamond fields. Jolis returned to New York that spring and began making arrangements to hire personnel and to market the Angolan diamonds. Although he realized that the final outcome of his venture in Angola would depend on how the political crisis there was resolved, he had high hopes of success.
That summer, however, the political situation changed radically. The Soviet-backed MPLA faction seized Luanda in July, initiating a full-scale civil war. The transitional government was quickly deposed-with Minister Chipanda, a supporter of the UNITA faction, fleeing into the jungle. With the assistance of Soviet rockets and Cuban troops, the MPLA forces quickly routed the other two rival factions (despite aid to them from the CIA). By the year's end, the MPLA was in almost complete control of Angola.
Early in 1976 Jolis learned that his diamond concession had been canceled by the new MPLA regime. Moreover, his geologist and staff had been denied visas. When he attempted to make contact with government officials his calls went unreturned.
Jolis finally arranged for someone in Angola with connections to the MPLA Angola to investigate the loss of this concession. In Luanda, his intermediary made inquiries at the Ministry of Natural Resources and eventually obtained an internal staff report that cleared up the mystery. According to this document, the Soviet Union had specifically instructed its MPLA allies to cancel all agreements and negotiations with Jolis's Diamond Distributors, Inc. Adding insult to injury, the Soviets had further advised the Angolans that Diamond Distributors, Inc., was an established front for De Beers. Since the MPLA had strictly forbidden Angolans from trading with South African companies, this piece of misinformation linking Diamond Distributors, Inc., to De Beers effectively precluded the former from doing any business in Angola.
When Jolis read the contents of this report, he realized that he had been cleverly maneuvered out of Angola and bested by De Beers. The only remaining question was what would happen to the Angolan output of diamonds, which, though severely diminished by the chaos of civil war, still had to be disposed of.
Under Soviet guidance, the MPLA arranged to sell the entire production of its diamond fields to a supposedly independent firm in London named the Diamond Development Corporation. The Angolan diamonds actually went to the offices of the Diamond Development Corporation in Chichester House, near Holbein Circus on the fringes of London's financial district. The Diamond Development Corporation, putatively in the business of sorting and selling African diamonds, was in turn owned by the Chichester Corporation, which itself is controlled by subsidiaries of De Beers. Both corporations were established by De Beers to provide a double-cover for its dealing with African nationalists. As one former De Beers executive explained, "If the Angolans ever demanded an interest in the Diamond Development Corporation, the assets and profits could be shifted to Chichester." The shipments of Angolan diamonds were driven around Holbein Circus to Number 2 Charterhouse Street, headquarters of the Diamond Trading Company. Through this circuitous route Angola's diamonds again entered the De Beers stockpile. Then, with the assistance of Cuban troops, the Angolans also managed to close down the smuggling routes between the diamond fields and the Congo border.
Of all the competitive threats to De Beers, the potentially most dangerous came from Harry Winston in New York. A short, determined man, Winston had made his own fortune in the diamond business. He had been born in 1900 in a walk-up tenement apartment in New York City, and by the age of fourteen had quit school to join his father in the jewelry business. He quickly discovered a diamond "mine" in estate jewelry. Buying up diamonds from estates, with financing from the banks, he found he could re-cut and sell them at a profit. He arranged to mass-merchandise these diamonds through chain stores. By 1940, he was America's largest diamond dealer. Consequently, he received the largest consignment of uncut diamonds from De Beers.
After World War 11, Winston rapidly expanded his American business. He opened up his own diamond factories in New York City, Puerto Rico and Israel. He also became the dominant wholesaler in America, supplying the major department stores and chain stores with their diamonds. Indeed, by 1951, he was distributing more than one-quarter of all the engagement diamonds in the United States. He even discussed plans of acquiring his own diamond mine and bypassing the diamond cartel entirely.
He first negotiated with Colonel Williamson for his concession in Tanganyika, but he realized that the British colonial authorities would never allow him to jeopardize De Beers' control of the diamond trade. Tanganyika (now Tanzania) was then a British colony.
In 1953 Winston saw a more promising opportunity in Angola. De Beers, attempting to renegotiate its contract with the Portuguese for the diamonds, had run into a snag over foreign exchange. The conflict concerned whether the Portuguese would be paid in dollars for their diamonds, as they preferred, or in British pounds, which De Beers preferred.
Winston flew to Lisbon to make his offer. There he made contact with Spiros Assantos, a well-connected banker who was influential in the Salazar government that ruled Portugal, and worked out with him a detailed plan to outbid De Beers for the diamonds. Since he could provide for Portugal a guaranteed market in the United States, which accounted for the sale of three-quarters of all gem diamonds in 1953, and could also pay in dollars, which Portugal desperately needed to balance its foreign exchange deficit, Spiros Assantos was confident that his bid would prevail.
Unfortunately, at a critical point in the negotiations, Spiros Assantos died on the operating table in a Lisbon hospital. Winston was left without a contact in the Salazar government. Soon afterward, he received a telephone call from Sir Ernest Oppenheimer warning him that if he persisted in his efforts to interfere in the negotiations, he would be entirely cut off from De Beers' diamonds. On the other hand, Sir Ernest suggested, if he withdrew from the negotiations, his consignment in London would be substantially increased at the sights. While he was still mulling over this offer, he received an ultimatum from the Foreign Ministry. He had forty-eight hours to leave Portugal. He then decided, as he later explained to his son Ronald, that "he had a business to run in New York," and boarded the next plane to the United States.
Winston learned several months later from his financial associates in Lisbon why the government had issued this ultimatum. They told him that the British ambassador had intervened directly with the Salazar government, warning that the entire diamond system would collapse if Portugal bypassed De Beers and sold diamonds directly to Winston. The British government threatened that unless the Salazar government ended the negotiations with Winston and restored its contract to De Beers, it would place an embargo on all port wine imports. Since port was a crucially important export for Portugal, and England was its main market, the Salazar government ordered Winston to leave the country.
Winston, still seeking a diamond concession, next went to the West African country of Sierra Leone, also a producer of diamonds. He again tried to undercut the existing arrangement De Beers had with the British mining company that held the concession. This time, however, Oppenheimer made Winston an irresistible offer. Aside from his regular consignment of diamonds, Oppenheimer promised Winston 22 percent of all the diamonds produced from mines along the Atlantic Ocean beaches of Namibia, the richest single source of gem diamonds in the world. By guaranteeing, himself 22 percent of these highly prized diamonds, Winston would have a virtually unassailable position in the American diamond market. Moreover, Oppenheimer offered to give Winston the right to choose the diamonds he wanted from the West African fields. In return for granting him these advantages, Oppenheimer expected Winston to abandon his search for his own diamond mines. Winston agreed to these terms.
The uneasy truce between De Beers and Winston prevalled for almost a decade. De Beers, however, saw the arrangement as only a temporary expedient; and Winston still sought to sever his dependence on Dc Beers. In the early seventies Winston saw yet another possible source of diamonds: Siberia. He quietly opened up negotiations, through the Soviet trade delegation in London, to acquire a major share of the uncut diamonds coming from Siberian mines. He had, after all, his own cutting factories and the main distibution network for diamonds in the United States. Despite these assets, Winston underestimated the strength of the silent partnership between the Soviet Union and De Beers. In 1975, his overtures were flatly turned down.
De Beers, meanwhile, began a maneuver that would severely curtail the ambitions of Harry Winston. It began providing a large number of diamonds at its sights to Star Diamonds, owned by Sal Klagsbrun, a close friend and golfing partner of Monty Charles. Star Diamonds began to sell its diamonds in direct competition with Winston. In 1978, Harry Oppenheimer told Winston on the telephone that he would no longer receive the consignment of diamonds from Namibia that his father had arranged for him to receive at each sight. Winston reportedly became furious, and told Oppenheimer that Sir Ernest would never have gone back on his word.
Winston died soon afterward. Star Diamonds rapidly expanded its market share in America, and hired in 1979 some thirty additional salesmen in California. It then made an offer to Ronald Winston, who had succeeded his father, to buy his business. Ronald Winston refused to sell.
Afterwards, Ronald Winston found his allotment progressively smaller at each sight. Whereas his father had once received the largest single sight— some $20 million in a single box— Ronald now was receiving only a small fraction of his firm's needs, less than $2 million in 1980. Winston's pleas to Monty Charles to increase his allotment fell on deaf cars. Meanwhile, Star got more than $20 million in its box at a single sight. On an annual basis, Star was getting nearly ten percent of De Beers' total allocation. So Winston was forced to buy most of his diamonds on the secondary markets in Antwerp and Tel Aviv. Although he managed to keep a large share of the American wholesale business, he found it increasingly difficult to compete with the cartel. His profits were tightly squeezed.
Despite De Beers' success in suppressing individual competitors, major refinements in the design of the diamond invention were necessary to preempt challenges from the Soviet Union and other producing nations. The diamond cartel could no longer sustain the value of diamonds merely by controlling the production of the mines in southern Africa; it now needed to extend its reach "downstream" to the cutting, distributing, wholesale and even retail elements of the diamond trade to prevent the Soviet Union and others from establishing their own sales network. De Beers, in effect, had to compete with its own clients.
In 1975, De Beers opened up a small cutting factory in Lisbon. To allay the fears of clients, Dc Beers spokesmen stressed that the purpose of this factory was to monitor market conditions and keep track of smuggled diamonds that were arriving in Lisbon from Angola. They stressed that they had no intention of using the Lisbon factory to compete with clients. The following year, De Beers organized and financed Lens Diamond Industries in Antwerp (though the ownership remained in the hands of De Beers' shareholders rather than with De Beers itself). Lens built a huge factory, initially employing 545 workers, who sawed De Beers' rough diamonds into basic shapes then distributed them to the cutting factories in Antwerp for faceting and polishing. It was the largest such facility in the world, and with it, De Beers had the potential for completely dominating the cutting industry in Antwerp. When a number of Antwerp manufacturers voiced their concern that De Beers was taking over an important part of their trade with this factory, De Beers' head of public relations, David Nell-Gallagher, answered that De Beers' sole purpose in building this factory was to give stable employment to Belgian sawers who might otherwise be tempted to leave Antwerp's diamond industry for more lucrative opportunities in the automotive industry.
Yet, even as De Beers rationalized its entry into the sawing business in Antwerp, it began construction of a second sawing factory in Tel Aviv. Clearly, a part of the new design was to take over the task of sawing uncut diamonds into their basic shapes.
In South Africa, De Beers provided financial assistance to small and supposedly independent diamond-cutting factories in and around Capetown. It sent a large number of Pieromatic automatic diamond-cutting machines to these factories, and by 1980 Some 20 percent of the world's diamond cutting machines were operating in Capetown. It also trained workers of racially mixed origins, classified under South Africa's apartheid laws as "coloreds," to polish the diamonds, which provided the Capetown factories with the cheapest labor force outside of India.
As the Capetown factories went into production, De Beers made arrangements for them to contract to sell their entire production to major Hong Kong dealers. Ho Pak Tao, one of Hong Kong's leading diamond dealers, told an American trade journal in 1979, "We used to depend on Israel for small goods but now we are using 'coloreds' and automatic machines to cut small goods in our South Africa factory ." Aside from the Hong Kong-to-Capetown connection, De Beers initiated a program of supplying selected Hong Kong manufacturers with pre-sawed diamonds from its Lens factory in Antwerp.
The developments in Capetown and Hong Kong were viewed with consternation by Israeli manufacturers who had previously considered the $300 million Hong Kong polishing market their private preserve. With these embryonic cutting factories, De Beers now had considerable leverage over the Chinese dealers, and through them, access to the entire Southeast Asian market for polished gems.
In India, De Beers also sought to expand its sphere of influence over the manufacturing of diamond chips. In October of 1979, it set up the Hindustan Diamond Corporation, in India, as a partner. Since the Indian government preferred not to be openly associated with a South African corporation, De Beers accommodatingly arranged that two Bermuda corporations, in which it owned substantial shares, be nominal owners of the De Beers interests in the Hindustan Diamond Corporation. Under this arrangement, the Hindustan Diamond Corporation became a distributor of De Beers' diamonds in India. It contracted to buy large quantities of diamonds, most of them less than a tenth of a carat, and allocated them among manufacturers in the Bombay area. The Indian manufacturers, in turn, farmed these minute diamonds out to a cottage industry of some 300,000 workers, mainly women. With the support of the government in this venture, De Beers established a modicum of quasi-official control over this segment of the polishing industry.
De Beers also became a major dealer in polished diamonds through an Antwerp subsidiary called Diatrada. Diatrada had buying agents for Diatrada buy large quantities of polished diamonds from manufacturers and resell them to wholesalers. A similar operation was opened in Tel Aviv, which by 1979 became the single largest purchaser of diamonds in Israel. Among other things, De Beers uses these buying offices to maintain the price of polished diamonds during periods of recession and glut. When a certain size or quality diamond becomes excessive and can not be easily disposed of on the trading bourses of Antwerp and Tel Aviv, Diatrada steps in and buys up the surplus. At the same time, De Beers deletes or heavily reduces the category of uncut diamonds that yielded this particular type of polished diamond at its sights in London. The net effect of these coordinated actions is to create an artificial shortage of this type of diamond and drive up the price. Diatrada gradually resells its inventory of polished diamonds at the higher price.
To further solidify its position in polished diamonds, De Beers began holding regular sights for major dealers in polished diamonds in Lucerne, Switzerland. In 1978, De Beers pressed these clients into doubling their annual purchases of polished diamonds, and most of them agreed to the larger consignment. The following year, De Beers distributed over $ 300 million worth of finished gems at these sights.
Despite the fact that De Beers captured nearly one-quarter of the entire polished diamond business, its executives continue to minimize its role in this area. Harry Oppenheimer, for example, said, in an interview in Jewelers' Circular Keystone in September 1979: "Our polished dealing operations were begun some years ago, principally to give us a better insight into the functioning of the market, they act as a market listening-post, if you like." In Antwerp, De Beers' move into the polished diamond business was seen as a fait accompli. "They are already competing with their own clients in polished goods," a governor of the Antwerp Diamond Club stoically observed. "They have the diamonds, the capital and the connections. Those are the facts of life." Independent dealers saw the handwriting on the wall. Ben Bonas, one of De Beers leading brokers explained " De Beers will run the entire polished diamond show, just as it runs the uncut diamond trade now. It has to, if only to keep the Russians out."