This is a case study detailing the worldwide network of middlemen diamond dealers who bring together the De Beers monopoly and retail jewelers. From 1929 through the end of the century, De Beers controlled between 80-90% of global diamond production. De Beers also took the lead in most diamond marketing campaigns, so they were preeminently influential in generating both supply and demand in the industry. They sold their diamonds together in bundles called sights that “sightholders” had to accept or reject as a set, with no negotiation. Each sight contains several hundred million dollars worth of rough diamonds, but even if one has the money, to become a “sightholder" one must be vetted by De Beers to ensure that you have the connections to create additional value for the stones. De Beers sells its stones in such sights so that the middlemen do not have to engage time and money in evaluating and grading each individual diamond pre-sale. De Beers passes on some of the monopoly rents to these middlemen, creating value downstream.
Most rough stones travel from Antwerp to India for polishing. “The total value of polished diamonds is approximately 50 to 75 percent more than the value of mined stones.” Credit is an essential part of the system. “30-40 percent of all U.S. retail sales occur in November and December.” It is important that dealers know and trust each other. “In the early twentieth century, 80 percent of all of Amsterdam’s thirty thousand cutters were Jewish and one-third of Antwerp’s cutters and three-fourths of its brokers were Jewish. Similar percentages have been maintained in today’s diamond centers of New York, Antwerp, and, more obviously, Israel.” Jews have a long history in the industry, helping to finance the Dutch East India Company and thus controlling Europe’s only source of diamonds for several centuries, before the discoveries in South Africa and Brazil. Today, “no agreement between diamond dealers, regardless of heritage or language, is official or enforceable if it is not sealed with a “Mazel.”” The diamond industry relies on its own arbitration and enforcement mechanisms instead of government courts. This requires a more intimate relationship between dealers. “When public courts are unavailable, inaccessible, unreliable, or too costly to support impersonal exchange, merchants might find personal exchange to be a viable alternative.” The New York Diamond Dealers Club formally began in 1931. It has around 2,000 members and is 85 percent Jewish. “Any member who does attempt to adjudicate in state courts will be fined or suspended from the club…. Arbitrators may question parties, rely on either secular or Jewish law or mere common sense to reach rulings, and are not bound to adhere to previous rulings or any form of precedent…. Its power is limited only to cooperating parties who hope to remain members of the diamond community, and its remedies- the ability to expel, to fine, or to order damages- are meaningful only against merchants hoping to maintain long-term, profitable diamond business. Merchants therefore only cooperate with the DDC arbitration board, and cooperate with each other, to preserve good reputations and protect the opportunity to engage in future diamond transactions…. The DDC fulfills this role by serving primarily as an information device, publicizing individual wrongdoing and thereby serving as a guardian to individual reputations…. Maintaining DDC membership in good standing signals to potential trading partners a clean past and the absence of an outstanding judgment.”
There are two types of individuals typically involved in the diamond industry- family business members and Orthodox Jews. The long-term family businesses are concerned with passing down their reputations and their profits to their next of kin. Not only are merchants in bad standing boycotted, but secondary boycotting for those doing business with those in bad standing is expected among the diamond community. Family members currently at the bottom of the rung are disincentivized to steal or cheat by the knowledge that one day they might lead the family chain. Orthodox Jews often engage in the low level jobs of cutting and brokerage. They are often in possession of millions of dollars of stones that they do not own. However, it is rare that stones are ever stolen or swapped, despite the lack of collateral. The workers are entrenched personally and culturally in the Orthodox community and see any possible excommunication as life ending. It is important to remember that these rules and norms for the community were not designed with the diamond trade in mind. The norms came first and enabled later business success at lower costs in this particular enterprise. “Reputation mechanisms do not arise easily and do not persist for long without institutional support.” It is the insular nature of the relationships that have allowed the diamond industry to thrive. “Diamond dealers are quite untrusting. They strongly favor familiar business partners, investigate backgrounds of potential new partners with fastidiousness and skepticism, and are very hesitant to outsiders…. They ultimately do trust- or show confidence in- the institutions that support the trade.”
Private regulation and enforcement within the diamond industry works because arbitration employs experts to act swiftly and at lower costs than public courts. They can impose uniquely tailored penalties where as “public courts are largely restrained by substantive contract law to impose remedial awards only equal to the damage done by the breaching party, which frequently are inadequate to credibly induce compliance.” Most importantly, “ethnic groups can mobilize social and community networks, in addition to the merchants themselves, to affect sectors of a merchant’s life that public courts cannot reach.” The downside of these homogenous networks are that they limit threats to legitimate competitors. They shelter incumbents from lower costs, superior skills, and new technologies. “Their community gives them a comparative advantage over other would-be dealers.” These ethnic group distribution networks also have been able to limit transaction costs to the point where vertical integration has not been seen as necessary. One benefit over a more vertically integrated firm is that “value creation is driven by the efficient dissemination and collection of information, a process best organized within a market structure.” Gossip and neighborly stigma are cheap enough and norms easily agreed to and enforced to allow for these decentralized middlemen.
These same communal ethnic factors have recently allowed for the entry of Indians into the diamond trade, further up the value chain. “Eighty-five percent of all diamonds (60 percent by value) are now polished in India.” The Palanpuri Jains from Gujarat started with industrial diamonds too small for jewels and, employing low wage labor, gradually moved up to more profitable stones. Community again plays a role, albeit slightly different than with Jewish merchants. “Jain success relies on consensus, whereas Jewish success relies on the acceptance of authority; Jain success relies on conciliation and rehabilitation, whereas Jewish success relies on adherence to legal codes.” The similarity between Jains and Jews is their insularity, their minority status, and their willingness to ostracize as a last resort. Today Kathiawari Indians, once employed by the Jains as cutters and managers, are supplanting Jains for control in the Indian diamond trade. “Kathiawari families now control over 50 percent of the diamond trade in Surat.” With modernity, an even larger rise of globalization, and the necessity of impersonal business relations, trust has begun to become perilous even within the insular diamond community. As a result, De Beers has begun shifting to a vertical strategy, controlling its jewels from mining, through polishing, all the way to retail. “Trust-based relationships and vertical integration are substitutes for each other.” As trust breaks down across the network, even with just a small percentage of bad apples, De Beers has been forced to adapt. The mystery is not that these worldwide ethnic distribution networks are now breaking down, but that they lasted as long as they have.
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