An Essay on Diamonds,Trust,and Antitrust,Inspired by Barak D. Richman’s Stateless Commerce

I. Introduction

Warning: I bring to this article, inspired by Barak Richman’s recent book on the diamond industry as an example of “stateless commerce,” ¹ not only a professional career in the antitrust field but thirteen years of full-time employment in the diamond industry. Barak Richman, a personal friend, advisor to the American Antitrust Institute, and a professor of law and business administration at Duke University School of Law, has written a compelling account of the diamond network as an example of an industry where successful self-regulation has for a long period flourished, obviating the need for many of the state’s commercial laws and courts. Richman describes the cultural and economic conditions for a particular manifestation of commerce as exemplified by this tradition, whose dynamics are exposed by major changes that have occurred in the years since I rather joyfully departed the industry in 1995. The underlying question is how antitrust enforcement should look upon such industries.

Richman explores the relationship between trust within the diamond industry, which facilitates close cooperation among the participants at the price of somewhat constrained competition, and the industry’s structure. ² Historically, a high level of trust among diamond industry players resulted in a subdued competitive environment. The relatively recent decline of trust, caused primarily by sociological changes in the makeup of the industry, the arrival of new technologies, and diversification of diamond mining sources, has moved the diamond industry from one based on monopoly to a more diverse, oligopolized industry increasingly characterized by vertical integration. Left unanswered is whether consumers will be the beneficiaries of these changes, as the new winners and losers, like categories of rough diamonds, get sorted out.

II. The DeBeers Monopoly

My own experience in the industry supports Richman’s reporting, although—as will appear—my perspective comes more from the retail end of the industry than the upstream sector on which he primarily focuses. Essentially, during the relatively pure “stateless commerce” phase with which I was familiar, the diamond industry was dominated by the Oppenheimer family of South Africa, whose investments in DeBeers and its sister company, Anglo-American, created a supply monopoly. By owning diamond mines or, equally important, contracting with other mines for their output, DeBeers centralized and controlled something like 80 percent of the rough (i.e., uncut) diamonds of the world. It kept these in a depository at 17 Charterhouse Street in London where it sorted the rough into mixtures that could fit into shoebox-like containers. These boxes were then sold at a take-it-or-leave it monthly “sighting” to which approximately a hundred “sight holders” were invited. (Sight-holding was a valuable albeit extremely dependent position. Turning down a proffered box was taken as a request to never be invited back again.)

This arrangement gave DeBeers the crucial ability to control the output of diamonds into the market, involving both quantity and sizes of stones, and to set a base on price that would underlie a vast, global cutting, polishing, setting, and distribution network. This type of monopoly-cum-cartel established a throttle just downstream of the mining level. Such a control had been proven necessary early in the history of the diamond industry as new diamond fields would be discovered and rapidly exploited, creating dramatic fluctuations in the supply and hence the market value of diamonds. What prospective husband would want to invest in an expensive engagement ring if its resale value—affected by the price of new diamonds on the market—could virtually disappear overnight? What companies would want to invest in a network of manufacturing and distribution without the stable foundation that a DeBeers monopoly could provide?

Thus, the very foundation of the diamond industry lay in a monopoly that controlled the worldwide supply of diamonds. The system of a single buying and selling company worked well from 1929, when Ernest Oppenheimer took control of the DeBeers Consolidated Mines that had initially been cobbled together by Cecil Rhodes after huge mine fields were discovered in South Africa in 1867. ³

DeBeers could presumably have vertically integrated forward at that time from mining into manufacturing (sorting, cutting, polishing) and distribution (wholesaling and retailing). The fundamental choice of buying up diamonds and holding them in reserve when supply outmatched demand required very deep pockets and a long-term patience that was likely unique in the history of business, at least prior to the effectuation of the OPEC cartel in the late twentieth century.

DeBeers chose to work through a huge network of independent large and small companies rather than incorporating these tasks internally. This has been explained in various ways that Richman explores. Perhaps most important were three:

First, diamonds have little intrinsic value beyond being rare and extremely hard minerals. Mining them is expensive and risky. Early diamontaires had to focus on how to build sustained demand in the face of fluctuating supply, a strategy that required large investments in public relations as well as mining and withholding diamonds from the market. Supply could be further affected by the fact that diamonds, once sold, endure—and can be sold back into the market. Sentiment would be needed not only for the initial sale to a consumer but to discourage resale. The DeBeers slogan that “diamonds are forever” captured the emphasis on creating a world culture that equated the gift of a diamond with the sentiment of love. ⁴ As Michael Roman, the then-chairman of Jewelers of America, once explained to me a little less sentimentally—and I hope I recall this verbatim—“As long as men have erections, there will be a strong diamond industry.” The development of a brand new and flourishing diamond-buying culture in Japan and China after the Second World War is perhaps the most remarkable tribute to the power of public relations and advertising. ⁵

Second, the value-erecting strategy required removing diamonds from the category of commodity by stressing the uniqueness of each diamond—a fact of nature, but not something that is obvious or meaningful to the nonexpert. This strategy entailed a complex challenge of matchmaking: how to get the “right” diamond into the hands of the “right” individual customer. Cutting, polishing, and sorting diamonds by their individual characteristics (the famous “4-C’s” of caret, clarity, color, and cut) requires expertise and judgment. It is also risky. Regularly investing in grades that turn out not to be in high demand by the time they reach the jewelry store is not forgiven by the market. Transaction costs could deter DeBeers, already loaded with huge carrying costs, from vertically integrating into downstream operations.

Third, as small but high-value products, only the most trusting relationships could control a global distribution system. As we used to observe, sadly, in my retail business, “diamonds have legs.” This metaphor was accurate at all levels of the industry, from individual miners who would try to sneak out of the mine with valuable minerals conveyed in unlighted body cavities, all the way to the retail level, where diamonds would inexplicably disappear from inventory on a regular basis. Perhaps most importantly, in Richman’s telling, trust was needed as a basis for credit. Because a diamond usually cannot be converted into immediate cash, it was normally necessary to hand over a diamond from one person to another, with the expectation that payment would have to come later.

III. The Trust-Based Model

Richman shows how trust was built up and in more recent years how it has begun to break down. A starting point was that courts were not particularly suitable for dealing with the kinds of issues that would most frequently arise in the diamond trade. Principal issues would include claims of breach of contract or fraud. Asymmetry of knowledge is a basic fact in the trade. Just as a putative husband (or even an anniversary-celebrating one) is at a disadvantage to a jewelry retailer, courts lacked the expertise of businesspeople with daily knowledge not only of the diamonds themselves, but of the reputations of the players. More importantly, courts could only deal with problems after the fact. A more efficient dispute resolution system would rest upon institutions within the diamond profession that could arbitrate disputes and use the leverage of reputation to assure a minimum of deviation from norms. A dealer who acted in bad faith could be effectively ostracized, that is, disabled from practicing the profession. The enlarged role of deterrence of this sort was thought to serve the industry—and the public—better than after-the-fact dispute resolution.

Such trust-supportive institutions developed in a small number of centralized communities where diamonds became a leading economic factor. The center of the diamond trade in the United States is 47th Street in Manhattan. Richman describes the leading role there of Orthodox Jews who know one another well, deal with one another repeatedly, seal a transaction with a blessing and a handshake, and belong to the Diamond Dealers Club (which not incidentally provides a room for daily prayer). “Club” may be the operative word. The Diamond Dealers wield a formidable arbitration system that can post negative information (not only in New York but also in key diamond centers such as Antwerp, Amsterdam, and Tel Aviv), with the practical effect of making it easy to toss a bad apple out of the global apple cart.

An additional institutional feature has been the passing down of diamond businesses within families, so that not merely the reputation of an individual but of the family business itself is constantly at stake. The result has been a remarkably stable industry in which the players display great trust in one another, minimizing the transaction costs.

IV. Antitrust and Trust

As anyone aware of antitrust can easily see, this trust-based model raises concerns about possible anticompetitive entry barriers and group boycotts, not to mention the underlying feature of price-fixing. Richman reviews cases that have made it to the court system, ⁶ for example when a nonmember of the club suffers economic harm by his (usually his) exclusion. His approach is to distinguish traditional antitrust analysis of collaborations that ask whether the collaboration generates economic outcomes that outperform unfettered competition, in other words, whether there has been a “market failure,” from an institutional antitrust analysis of the diamond industry that he says must ask whether the collaboration corrects a “court failure.” ⁷ Richman argues that per se illegality should not apply where “institutional economics can explain why the diamond industry’s coordinated boycotts are superior to state-sponsored courts and other governance mechanisms.” ⁸

His description of three cases where antitrust violations likely occurred illustrate the real inefficiencies and shortcomings that might be revealed in a Rule of Reason analysis. “An antitrust analysis [of concerted group boycotts] should…evaluate when a particular group boycott is designed to achieve procompetitive multilateral private ordering and when it aims to secure anticompetitive rents.” ⁹ This seems right, with the open question being how frequently antitrust enforcement will come upon networks similar to the diamond industry’s. Richman points the eye toward the concept of “court failure,” but others will have to do the empirical work to establish its frequency.

Most issues in the diamond trade have been resolved not in court but through the industry’s self-regulating arbitration system, keeping the dirty laundry out of general sight while applying the necessary degree of expertise and a strong tradition aimed both at maintaining deeply held theologically based ethical standards and at protecting the industry from the unenlightened interference of federal or state enforcers.

DeBeers, as a monopoly, was long subject to an antitrust order that effectively kept its employees from travelling to the United States for fear of arrest. To avoid prosecution while keeping in touch with the U.S. distribution network, DeBeers created the “24-Carat Club” and every other year would invite its U.S. members (of which I was one on three occasions) to travel to one or another international watering hole not located in the United States for several days of mutual discussion about the state of the industry and DeBeers’ plans for the near future. Topics that would raise antitrust eyebrows in the United States were not, to my awareness, discussed. To me, it was revealing to find how knowledgeable, intelligent, and globally strategic the DeBeers executives appeared to be. They did not seem to be a bunch of passive beneficiaries of monopoly status, resting on expectations that the future would resemble the past.

V. Transformations

The diamond network functioned well and still persists today, but Richman demonstrates that the business has changed dramatically since the 1990s, when I exited the industry. “The diamond value chain no longer reflects the long-term collaboration between DeBeers and its sightholders—between upstream suppliers and downstream distributors—and the company’s relationship with these intermediaries has turned from collaboration to competition.” ¹⁰ Why this strategic change?

First, new diamond fields were opening up in Canada and Australia. Would they join the monopoly or sell their diamonds outside of the DeBeers network? What would happen with the transitioning state of Russia, a very major factor in mining, already sitting on a state-owned depository said to be the equivalent of the one in London?

I can fill in part of the Russian story because I travelled over to Moscow twice in the late 1990s to see if my company’s buying group (another common form of cooperation in the retail industry) could purchase rough diamonds directly from Russia, bypassing DeBeers and its network. Yes, even the communist Soviet Union had bought into the value of capitalist monopoly, supplying its plentiful and high-quality diamonds (mined in Siberia) under a long-term contract with DeBeers—a contract that was about to expire toward the end of the twentieth century. The post-Soviet Yeltsin government, as part of the process of privatization then under way, invited various people in the industry to come in and explain how they would distribute Russian diamonds if the DeBeers contract were not extended.

On my first visit, I actually saw the state depository’s bags and bags of rough diamonds, looking like emergency sandbags awaiting a flood, in room after room of the heavily protected building’s basement. At least, that is what they told me I was seeing. In addition to meeting with the head of the depository, who later was reported to have gone to jail, I met with several Moscow-based conglomerate companies, one of which was centered on the concrete industry, that were seeking partners in their hope of gaining access to these diamonds as the state privatized.

We were most intrigued by a military-industrial conglomerate that was involved in space rocketry, fire-fighting equipment, and diverse other manufacturing, and whose company town on the outskirts of the capital had a vacant, ridiculously large, factory building that it hoped to fill with diamonds and Russian diamond cutters whom we would train. The training was deemed necessary by the government because under communism there had been no incentive to cut the rough diamonds in the most profitable, that is, efficient, ways. A lot of value was apparently being left on the table, but the diamond that entered the market was usually very beautiful. A uniformed army general was in charge of the conglomerate, and he later came to my office in Silver Spring, Maryland, to check things out. We entered negotiations that led me back to Moscow for a second visit.

Eventually, it appeared that to get a deal with the state depository, our partners would have to include the Russian Orthodox Church and a special assistant to President Yeltsin. We also began to understand that further forms of bribery would be needed to bring the diamonds out of Russia. What really spooked me was that there would be huge security challenges involved during this “Wild West” phase of modern Russian history, a time when bankers were being shot on the street and the relative calm of Putin and his oligarchs had not yet prevailed. At this point, I lost interest in pursuing the negotiations and went home. ¹¹

Apparently others were more interested than I was, because Russia began to distribute its huge diamond resources outside of the DeBeers’ Central Selling Office (CSO) in 1996. Whereas the CSO had controlled over 80% of supply in 1989, by 2014, the share had shrunk to 34%. DeBeers recognized that its model was failing. In 2000, it reorganized internally, partially out of concern that the mining conditions for diamonds were attracting the negative designation as creating “blood diamonds.” Henceforth DeBeers would focus on diamonds in London, and Anglo-American in South Africa would focus on other mining interests.

Russia’s changing role was obviously important to DeBeers, but there were also other changes that were disrupting the market.

The homogeneity of the network itself began to break down. The lucrative opportunities of the industry attracted new ethnic networks and new family businesses that were able to manage the diamond value chain. The industry became more diverse. In particular, the rise of India as the world’s capital of diamond cutting, supported by government policies and spreading Asian participation in other segments of the diamond industry, caused margins throughout the value chain to decline. The prospect of bequeathing valuable reputations to the next generation was not as effective a force for good behavior. New sources of financing undermined the industry’s historical mechanism of securing credit and punishing defaulters.

Because Richman does not focus on the retail segment, let me mention several aspects of that perspective on change. In the United States, a kind of golden age of retail jewelry had opened when veterans, like my father, returned from World War II and built up businesses in a climate of growing prosperity. But as this generation retired or died out, there were not always heirs to take over the businesses. Ethnic groups had become better integrated into the overall society, and prosperity made it possible to send one’s children to university and on to careers like law (I am an example). If the business was sold, it was normally to an expanding chain operation.

Chains grew especially rapidly as the country experienced postwar prosperity, the suburbs exploded, shopping centers followed, and then large regional shopping malls sprung up, seemingly wherever two major highways (typically Interstates) intersected. At first this was a boon to the most successful local retailers, who could grow with the mall developers and become regional retailers. These changes in retailing geography had an enormous impact on where jewelry would be purchased. Gradually regional retail jewelry companies merged to become multiregional or multinational, seeking somewhat illusory economies of scale and practical leverage to rent prime retail locations. The largest chain, in those days, was Zale’s, and it had sight-holder status with DeBeers, presumably giving it some cost advantages over smaller rivals. Other retailers had to buy through the network that included sight holders, manufacturing firms, and brokers. Although many had Jewish owners, the retail level was much more diverse than the segment of the supply chain described by Richman, and it was not bound by the rules of the Diamond Dealers Club.

By the time I entered the jewelry business in the early 1980s, my father’s company was the familiar independent jeweler in the area that mall developers wanted to offset the national chains, and so we could negotiate center court locations, with two to four direct competitors, not counting department stores, which were seen as rather incompetent amateurs. By the time I made my exit thirteen years later, the absolute size of malls had grown and there were typically ten or twelve competitors, even more if we count the department stores that had made major new investments in their jewelry departments. I could no longer negotiate outstanding locations because my competitors were now much larger chains and the mall development companies had also consolidated. Consequently, my competitors would be negotiating for multiple locations with the same developer from whom I could lease only one location, so guess who got the center court locations? The rental rates went up even as the number of competitors increased and the competitive value of the offered location within a mall went down. One could read handwriting on the wall. There were now too many malls and too many retail jewelers operating below the most efficient levels.

A third change factor was technological. The advent of online shopping on the Internet made it possible to buy and sell most diamonds without the intermediation of a retailer and the brokers who service retailers. At first, most jewelers scoffed at the idea that a person would actually buy a diamond online: would people spend a lot of money for an object they couldn’t see and touch, from a nonhuman computer?

You could probably trust the jeweler you had known or your cousin knew, and you could perhaps trust a trained employee of a local chain whose reputation was well-established in the community. But could you trust a company known only through your computer? Obviously, that underestimated the power of the Internet to invent its own methods of creating trust. While the dollar volume of Internet sales is not yet great, “the Internet retail’s emphasis on price comparisons is in tension with many forces that traditionally fueled the industry.” ¹² As Richman puts it, price transparency has obviated the valuable services that intermediaries historically provided. ¹³ Thus, the Internet contributed to a reduction in the importance of the network between DeBeers and the consuming public.

So, how did DeBeers react? According to Richman, it moved from being a monopolist to becoming an aggressive vertically integrated competitor in the crowded luxury goods market. ¹⁴ Its new slogan—as a retailer and seller of branded diamonds—would be “Less than 1% of the world’s diamonds are eligible to become a Forevermark diamond” instead of the seemingly ancient industry-expanding “diamonds are forever.” Today DeBeers produces 35% of the world’s rough diamonds by volume, Alrosa of Russia controls another 30%, and three other competitors produce 2% to 10% each. ¹⁵ Not only did DeBeers become vertically integrated, but so did some of the largest retail chains.

Somewhat surprisingly, price stability has apparently been maintained, even though the industry has been changed from a monopoly to an oligopoly and the leader is no longer run by a long-time family with a mission to provide stability to an entire industry. Vertical integration has gradually displaced the trust-based network, within DeBeers and the other production companies. This is not to say that the Diamond Dealers Club has shut down or that there is no longer a role for ethnic and family-based companies…but their role has greatly declined. ¹⁶

VI. Findings

Richman draws several lessons from his autopsy of the old industry. First, he says that descriptions of the industry that had relied on dispute resolution and cooperation were only powerful with respect to a temporary stage of the diamond business. “The cooperative frameworks…were dependent on a confluence of institutional and historical circumstances that did not sustain themselves in the long term.” ¹⁷

From this I generalize that the relationship between cooperation and competition within an industry is likely to be fragile and changeable, depending on many factors. This should be seen as something of a hypothesis. While Richman does allude to stateless commerce in industries other than the diamond network, none is explored in comparable depth, and the reader is unsure, as I noted previously, how frequently we will find comparably full models of stateless commerce, as opposed to aspects of industry-specific self-regulation.

Second, Richman observes that it was the loss of credible reputation structures along the supply chain that caused the distribution structure to change, ¹⁸ an observation that rejects the claim some had made that the network arrangement (as opposed to vertical integration) was triggered because measuring a diamond’s qualities had become too costly. I would add that a transaction costs argument has some possible merit, but only as a contributing factor to the decentralized network structure and not as a principal driving engine of structural change.

One of these driving factors was the role of trust, as Richman emphasized. By not including sufficient focus on what was happening in the retail segment of the diamond industry in the United States, however, Richman may have overstated the role of a breakdown in trust and understated the role of the changing locus of retail jewelry business—the development of large shopping malls and subsequent changes in the structure of the retailing segment.

I might also comment that the retail jewelry industry in the United States had long been split into two categories: the carriage trade, largely establishment Christian in makeup, on the one hand; and the credit trade, catering to a less wealthy clientele, and disproportionately Jewish, on the other. The two categories developed certain separate associations and educational institutions. For instance, the credit jewelers often considered themselves blocked from the Gemological Institute of America, which trained jewelers, and therefore they created the Diamond Council of America (of which I was once the president) to train jewelers who would work in credit-type retail stores. Over time, with mergers and acquisitions playing an important role along with changing sociological patterns and the growth of credit cards, the two categories lost much of their separate identity, but to some extent the ethnic homogeneity that Richman studied upstream was not as descriptive at the retail level and there was no private authority equivalent to the Diamond Dealers Club.

Trust may have been a factor in the creation of many cooperative associations within the U.S. diamond industry. Some of these were normal trade associations. Others were less formal. For instance, my company was part of a buying group but also of a group of large regional chain companies, each operating in a separate region of the country. We would meet twice a year but would share virtually all of our operating data in the cooperative spirit that we could really help ourselves by helping each other. We were all credit jewelers, all (or primarily) Jewish, many were in a second generation of chain store expansion. But as our regional chains grew in size and saw the desirability of further expansion, one member began making moves into an adjacent region. Once competition of this sort had broken out, the essential data we were sharing could not be shared without business and antitrust risk, and this very helpful cooperative venture consequently came to an end. It was another one of those informal nonstate institutions that was of necessity a temporary phase. ¹⁹

Trust was important at the retail level in several other ways. For one thing, as the industry became more competitive, various forms of cheating came to light. Certain appraisal services would provide customers (through the jeweler) with invented guarantees of the value of their purchase, dramatically overstating the value but undermining trust that prices were related to value. Even more important was the advent of widespread “high/low” pricing, so that prices were jacked up and then the jewelry was advertised as being “on sale”—more or less always. In time most stores were only selling items when they were marked as discounted. This phoniness was not policed by the Federal Trade Commission, which was fearful of chilling price competition. The government’s failure to intervene undermined some portion of the trust within the industry, not to mention the trust of the customer for the industry.

Technology, too, undermined the trust that customers should have had in the jeweler, in part because the jeweler in the store could not always tell whether a diamond was real or synthetic or whether it had been “improved” by the removal of inclusions with the help of a laser. Handheld diamond testers were unreliable.

One of Richman’s most promising observations is that trust-based relationships and vertical integration are substitutes for each other. His description of the transformation of DeBeers and the oligopoly it now heads seems to support this generalization, but the role of trust probably varies over time and place and the decision for a company to go vertical likely rests on a variety of conditions and circumstances beyond trust considerations. The advent of blockchain technology and what appears to be its rapid commercialization, initially through the finance industry, can be projected to replace large numbers of intermediate sectors of the economy whose justification was to create trust. This will further illustrate some of the trade-offs between trust and industry structure.

Richman also generalizes that the rise and fall of trust illustrates both the possibilities and the fragilities of trust-based exchange. Applying this to the future of stateless commerce, he notes that reputation mechanisms do not emerge by themselves and are not sustainable without the requisite institutional support. Despite the fragilities, stateless commerce remains in force on many fronts, he says, and it can be especially vital to lower-income nations.

I offer the following concluding thoughts stimulated by this interesting and provocative book. First, Richman has his finger on a useful concept—that some industries perform commercial functions with only minimum dependence on the institutions of a state and that before we automatically apply antitrust to increase competition, we should understand how and why cooperation works in these situations. The implication is that the rule of reason rather than per se presumptions ought to be applied. This is sometimes at odds with the per se tradition that has been applied, for example, to the learned professions and to codes of professional ethics. Our efforts to streamline litigation over restraints of trade were highlighted by the Supreme Court’s announcement in National Society of Professional Engineers ²⁰ that our laws have already decided that competition is to be given priority over competing values. I am not sure we haven’t gone too far in ignoring the possible values of a bit more cooperation and a bit less competition in certain circumstances, but identifying such circumstances narrowly will be important if businesses are to be able to predict when their interactions will lead to legal jeopardy.

Second, industries vary in the role that trust plays, so that the appropriate relationship of cooperation and competition should not be assumed to be the same in every industry or at every point in time.

Third, trust is a valuable asset for an industry, making efficient forms of cooperation possible. If it breaks down, industrial structures may change, not necessarily for the better. Once trust is destroyed, it is very difficult to reconstruct.

And, finally, the breaking down of trust in the economy and politics of a nation could be expected to lead to changes in the structures of our major institutions, just as it has affected changes in the diamond industry. Richman doesn’t make this point, but it occurred to this reader, at least, that the attacks of President Donald Trump on trusted institutions such as the Justice Department, the judiciary, civil liberties, and the media, and his substitution of personal instinct for science and expertise and trompe-l’oeil for reality, imply that our society may be in the process, intentionally or not, of fundamental structural change. If diamonds are no longer forever, it would seem that all is changeable.