De Beers Case Study Conduct

De Beers Case Study

Conduct a value chain analysis for De Beers, including the new activities of jewelry making and retailing through its joint venture with LVMH.

In assessing the value chain analysis of De Beers, the transition of their business model from being a cartel with monopolistic pricing and demand management strategies to being more market-driven is evident. As is evident from the value chain analysis below, De Beers dominates the Inbound Logistics processes of the industry by controlling nearly all mined diamonds, and domination the Operations and Outbound Logistics functions of the industry value chain. Figure 1 illustrates the De Beers value chain, capturing the transition from being monopolistic in process and pricing to being more market driven.

Figure 1: De Beer's Value Chain Analysis

The value chain analysis identifies the issues that De Beers faces in transitioning from a cartel to a market-driven company that relies on its branding over just pricing. Specific issues include a re-alignment of their firm infrastructure, approach to Human Resources Management (HRM) to also be in compliance to more ethical and fair trade approaches to managing their workforce and supplier base. Another critical issue De Beers faces is the use of information technologies and more strategically, Technology Development to better streamline the processes they will need in order to successfully transition from being monopolistic to market customer- and market driven. The greatest issues in the short-term and intermediate timeframes however are the difficult tasks of creating joint venture (JV) for retailing with LVMH. This is the most difficult area of the value chain for De Beers to execute on as it forces a major cultural shift in how they view their own strengths, and secondly, how they relate to specific external partners. This JV is represented in the Outbound Logistics, Marketing & Sales and After-Sales Services of the value chain analysis shown in Figure 1. Between the processes, people and technologies that need to be drastically changed for De Beers to be more adept at competing for consumers vs. driving their competitors out the greatest challenge is going to be changing the internal De Beer's culture. Supporting Activities as shown in Figure 1 in the short- and medium-term that will undergo the greatest change will be the firm's infrastructure, approach to HRM, technology development and rapid adoption of Business Process Management (BPM) approaches to streamlining and making more customer-centric their most complex processes including order management. Procurement will need major re-vamping to be in compliance to fair trade guidelines and also to alleviate ethical lapses that have been happening in mining operations globally.

Part 2: How sustainable is the competitive advantage created by their new strategy?

The sustainability of the competitive strategy created by their new business model is predicated on how quickly they align all customer-facing and channel-facing strategies in the outbound logistics, marketing & sales and after-sales service areas of their value chain. These are entirely new areas of operations for De Beers. Symptomatic of the extend to change required in these processes is the reliance on distributed order management systems that can integrate at the process and information systems levels with LVMH for example. There is also the requirement of having a more synchronized yet auditable procurement and supply chain series of processes in place. Initiating an approach of focusing more on creating value through fulfilling the unmet needs of channel partners, including ensuring the success of the LVMH joint venture will require De Beers to re-define their pricing strategies to be more focused on process costing and cost controls than has been in the case. In addition, the Inbound Logistics and Operations areas of the value chain will need to be more focused on inventory turns and efficiency of supply chain responsiveness to the needs of the channel partnerships including LVMH and the new ventures aimed at penetrating the jewelry manufacturing market. With all these intermediate- and long-term modifications to their business model, the sustainability of their new competitive strategy is going to be very difficult in the short-term. it's entirely realistic to assume that De Beers is going to struggle for at least twelve months or more to get their processes, revised roles for its staff, and systems synchronized and in place to sustain the new strategy. The magnitude of these changes on a cultural basis will result in turnover and attrition as many of the long-time employees immersed in the culture will find the change too difficult to cope with over time and leave the company or retire as a result.

Part 3: Do you support De Beers' entry into the retail jewelry business or do you think they should focus exclusively on diamond mining, grading, sorting, wholesaling, cutting and polishing?

As the retailing business is one that encompasses entirely new skill sets, processes, systems, integration points, HRM practices and supply chain considerations, it's critical that De Beers take a realistic approach to their ability to re-align their business model while entering an entirely new business. Retailing is much faster moving, more attuned to analytics and interpolating market signals than is the case for cartels, which rely on pricing alone. Even down to the perspective of the market itself, De Beers will face a daunting task of re-orienting their approach to reading the market and interpreting market-driven needs and requirements. This is going to be even more exacerbated by the dual cultures of LVMH and De Beers, two companies who operate in vastly different processes, systems and practices. Secondly, the core competencies or strengths that De Beers has today are most efficiently transferred to the roles of Inbound Logistics, Operations, Manufacturing, and Outbound Logistics. Their existing approach of costing and pricing as a cartel are best aligned with mining, grading, sorting, wholesaling, cutting and polishing, all critical functions of process-driven costing. The transition to retailing requires an entirely new perception of time within the organization as well. Retailing is much more short-term while other areas of the De Beers value chain are more long-term in orientation. For all these reasons the move to retailing is going to be fraught with challenges and unexpected delays as the cultures of De Beers and LVMH collide in many of the areas defined.

Question 2 De Beers -- Human Resources Question - Describe some of the difficulties that De Beers may find in staffing senior international positions. Your answer should include the following areas: Which HR issues may cause particular difficulties? What might be some of the skills gaps for staff in these positions? How might newly-appointed staff be prepared for positions in parts of the world of which they have little experience?

Cartels and monopolistic companies, organizations and trading exchanges develop a highly unique and what many consider to be eccentric organizational cultures and structures as a result of their approach to competing. That's because these organizations, to survive as cartels, attract those that don't ethically find anything wrong with using pricing as a means of enforcing conformity to the cartel's specific methods of operating. A common strategy on the part of De Beers is to drive down prices to punish those companies who are defectors from their cartel. Another common strategy is to preserve the perception that diamonds are scare and therefore substantiate inflated prices, thereby supporting the pricing strategies of the De Beers cartel as well. A common third strategy is to continually control demand though the use of their CSO to give De Beers Corporate the opportunity to directly control the optimal price for the market.

These three common strategies that are engrained in the culture of De Beers require senior management candidates that are accustomed to navigating ethically complex decisions quickly. The role of new senior international positions will be made more complex by taking into account these challenges of ethically making the best decisions while taking De Beers into a more market-driven set of strategies over those that had been defined purely on price alone. At first glance it would appear that cognitive, theoretically-minded senior managers would be the best possible choice for assisting De Beers move from being one-dimensional in its planning, execution and selling strategies. Yet consider the fact that many of the primary activities as defined in the company's value chain, including Inbound Logistics, Operations and Outbound Logistics are intensively manual in scope. There has been no impetus for De Beers to improve these manual processes of mining, no impetus to change how to manage the 12-15% of employees in Africa who may be infected with the HIV / AIDS virus, and no reason to embrace any sort of Corporate Social Responsibility (CSR) coordination, as none of these factors have in the past impacted their brand. De Beers had successfully been able to keep a duality of their company from emerging to the buying public. As the Internet and social networking are continually making the world a much more transparent place, De beers can no longer allow this duality to exist. Senior managers in international positions will be forced to bridge this duality without appearing hypocritical in addition to navigating the company away from the three common strategies mentioned earlier. All of these factors then contribute to the complexity of hiring senior international positions, and underscore the HR issues that are going to cause difficulties in the hiring process.

De Beers' recruiting process is going to have to focus on those professionals in critical skill gap positions that are accustomed to being in an industry that has complex ethical trade-offs that need to be made, yet has the necessary initiative level to attack manual processes that need to be updated to me market-competitive instead of cartel-sustaining. This becomes more concrete when the considerations are taken into account of hiring a new general manager for one of the company's many diamond fields in Africa. Anyone from a manufacturing background will find the processes in these diamond fields archaic and nearly impossible to apply advanced Six Sigma planning techniques to, much less measure in any meaningful way. There are also no real information systems in place within these mining operations, or in any of the Inbound Logistics, Operations, or Outbound Logistics functions of the De Beers supply chain. Why all this is important in hiring senior staff to operate international operations, especially in manufacturing, is that these senior-level professionals are accustomed to running their business using dashboards and scorecards, yet in the De Beers existing organization there is no need for this level of detailing reporting and analysis. Paradoxically however De Beers will need to have the expertise of these senior managers to navigate the complexities of the three core strategic area mentioned earlier yet does not have the necessary infrastructure to allow them to excel in the positions they want them to fill. In essence they need an experienced, capable senior manager who has been literally in start-up situations that can manage to automate the most critical manual processes while also developing their own approach to evaluating how the operations they are responsible for running are performing. This recruitment challenge is made even more difficult when the lack of metrics and measurement inherent in a cartel-dominated culture is taken into account. As De Beers navigates its way from a supply control dominated business model to driving demand growth, all of these challenges will be the most acutely felt in hiring efforts and practices.

Skill gaps in staff positions necessary for the transformation of De Beers include supply chain, strategic sourcing, marketing, sales and managing the retailing joint venture with LVMH. These skill sets are crucial if De Beers is to be successful in transition from a supply control to driving demand growth company. Starting with supply chain and strategic sourcing, the skill gaps include the need for professionals who are familiar with Collaborative Planning Forecasting & Replenishing (CPFR) techniques so that demand generated in retail channels is quickly translated into forecasts and mining operations work schedules to ensure all sales can be fulfilled. The need for the skill sets of Vendor Managed Inventory (VMI) a crucial area of inventory management in supply chains that serve retailers as well. There is also the need for strategic sourcing expertise, which is the ability to create a high level of collaboration and shared risk across an entire series of suppliers, multiple tiers down in the procurement networks of companies. This is entirely new to De Beers which has extensively relied on its own captive supply chains in the past; there is complete ignorance of strategic sourcing in the company and it will take a senior level professional to initiate and keep this type of collaboration running smoothly. Additional skill gaps in supply chain and procurement include supplier quality management and supplier audits, and the need for advanced supply chain expertise in validating synthetic diamonds, an area De Beers is investigating during this time period. If all these challenges were not enough, there is also the need for managing to new ethical standards to alleviate "conflict" diamonds and adherence to fair trade practices. All of these requirements make the selection of senior managers for international operations all the more difficult.

In the staff positions of marketing, sales and after-sales service, the need for branding expertise is evident. The Right Hand Ring Campaign has significant potential as it gives women the opportunity to assert their individuality and enjoy celebrating their own achievements by purchasing a diamond ring for their right hand. Branding, marketing and after-sales service in Japan, India and China are also critical skills sets the company will have to actively recruit in order to be successful with the new strategic initiative of driving demand growth. The challenges of finding branding professionals in each of these geographies including the U.S.A., Japan, India and Chinas will also force De Beers HR to concentrate on cultural alignment of candidates with the unique aspects of each nation as well. In conjunction with the cultural biases of the company internally, finding candidates who can align with the specific cultural norms and values of these nations that De Beers must successfully market into also presents a unique set of recruitment challenges. In making recommendations regarding the recruitment and placement of senior-level professionals in the core areas of Inbound Logistics, Operations and Outbound Logistics including mining, manufacturing, and refinement De Beers must first work to change the internal company culture away from supply control to driving demand growth. Second, these areas require key performance indicators (KPIs) and metrics of performance to effectively be run and are often the basis by which senior managers and professionals manage these aspects of any business. Without this infrastructure in place, De Beers will find it difficult to hire the level of professional they need to run these businesses. Third, the redefining of key process areas including the development of Business Process Management (BPM) strategies to make each of these key areas as efficient as possible and autonomous is going to be critical to recruit the level of professionals needed to transform the company from a cartel into one driven to satisfy consumers' wants and needs - in short to be market driven. Recommendations for accomplishing this daunting series of tasks must start with finding experienced professionals in each area who are experience enough to deal with uncertainty but confident and resilient enough to look for a challenge. Using interviewing, recruiting, and screening techniques that look for the best possible combination of traits combined with a high tolerance for ambiguity yet strong initiative is going to be critical in the hiring processes for key senior and staff positions.

Question 2 De Beers -- Finance Questions

Part 1: Using the information provided in the case, analyze the financial performance of De Beers highlighting the areas of significant strength or weaknesses. This should include an analysis of the apparent sources and uses of cash. Tie the results of your analysis to the De Beers' activities and events from the case.

In analyzing the financial performance of De Beers from the case study, the company is growing despite a reduction in working capital and increased costs of depreciation on fixed assets. Starting with Earnings before Interest, Taxes, Depreciation and Amortization (EBITDA) growing 8% between 2003 and 2004, and the 23.3% cash flow return, De Beers also attained a Return on Capital Employed (ROCE) of approximately 14% from 2003 to 2004. Return on Equity (ROE) has consistently been at 16%, and operating cash flow for the years covered in the case study is staying constant at $1.5B (U.S.). Debt has declined steadily from $2.57B in 2002 to $1.76B in December, 2003. Net working capital has also steadily declined during the time period of the case study as well, sliding from approximately $2.5B in 2003 to approximately $1.3B a year later. The increase in Debt and the reduction in Working Capital are mainly due to significant spending on production costs which according to the case have been marginally effective in finding higher quality, larger carat diamonds. The majority of cash is being spent on increasing carat production which is resulting in more tonnage of wastes produced from the four mines that De beers relies on and mentioned in the case study. The rapid reduction in Net Working Capital is directly related to the inefficiencies in searching for larger carat diamonds. This strategy has not worked well for De Beers, yet their yields have been sufficient in terms of lesser grade diamonds to provide a positive ROCE, which this specific ratio being influenced by the low wage rates in Africa and throughout mining regions the company operates in. The Weighted Average Cost of Capital (WACC) for De Beers for 2003 is 9.4% and 9.8% at the end of 2004.

When the financial analysis completed is applied to the analysis of De Beer's activities and events in the case, the need for risk management and governance is made clear. The WACC is one example that shows how critical it is for the company to get a better grasp of the risks of transitioning its business model from supply control to demand growth. This is the cost of capital for the company to continually fund new business development, and needs to be heading down, not up. It should be in the 6% range or less to be competitive to market rates. Second, the reduction in working capital illustrates a fundamental point of the case study, and that is the company still has not become as efficient as it needs to be to compete in a market-driven business model. Significant process re-engineering is needed for the company to be able to more effectively compete with its new strategy. The company's strength in branding and the success of the Right Hand Ring Campaign are going to continually drive top-line revenue growth, yet will not solve the more fundamental underlying lack of process synchronization that is driving down working capital and making the company more expensive to operate over time.

Part 2: Identify the factors that are critical to De Beers' success prior to the mid-1980s. List in point form the financial and non-financial information and performance measures that management would consider to be critical for its success. Now consider its new strategy and identify the factors that are now critical to De Beers' success. Again, list in point form the financial and non-financial information and performance measures that management would consider to be critical for its success. Be very specific! Discuss whether the critical success factors, performance measures, and related management information needs changed and the reason(s) why. You may want to consider using tables for parts of this question.

Prior and during the 1980s, De Beers operated as an independent cartel and prematurely began to commoditize the diamond market as a result. This period of time for the company was notable in its lack of performance measurements, with the concentration being on pricing as a means to control the industry value chain. The factors and performance measures that were critical for the company during that time period were as follows:

Factors: Mid-1980s

Gaining access to diamond fields throughout Africa by brokering deals with governments, including rights to mine and manufacture within their nations.

Continually reducing labor and variable costs to increase Return on Assets and Return on Sales.

The profitability of De Beers was partially influenced by the ability to artificially deflate the perceived supply of diamonds to drive up their price.

Reliance on price as a means to reward suppliers and distribution channel partners, and financially harm detractors to their cartel.

Branding and marketing efforts were minimal and often relied on for gaining distribution vs. generating pull-through demand.

Intensive focus on the demand curve for diamonds and the defining of the optimal price to ensure continued success of the cartel

Performance Measures: Mid-1980s

The following measures were critical during this time period for De Beers to quantify the percentage control their cartel had on world diamond manufacturing and sales. These metrics provided a rough approximation of the global diamond supply chain:

World Production of Rough Diamonds

World Supply of Rough Demands

Polished Equivalent of Rough Diamonds

Global Sales of Diamond Jewelry

Key performance measures used during this time period focused on the more fundamental metrics needed to run a business. The company during this period had not invested in information technologies (it) to gain insights into operations, so the majority of their reporting systems were manually operated, yielding a lag time in the reporting of these key measures. The measures used during this period included:

Basic Financial Accounting - De Beers would generate a set of financial statements including balance sheets, income statements, statements of changes in financial position, Cash Flow Analysis in addition to Accounts Receivable and Accounts Payable. Pricing analysis and pricing studies were periodically done to also align pricing strategies to specific profitability and margin targets as well.

Yields by Manufacturing Location - During this period De Beers would have also captured the performance of specific manufacturing locations, including an assessment of their Return on Investment (ROI) and overall productivity relative to other plants. Most likely the company also used cost accounting to measure individualized contributions to revenue of each manufacturing center, creating Profit and Loss Statements for each location.

Price/Volume Analyses - as De Beers concentrated on defining an optimal price point based on interpreting the demand curve for the diamond market, the company invested heavily in price/volume analyses in an attempt to gain greater control over global markets through the use of pricing alone.

Critical Factors for new strategy

In contrast to the supply control approach taken by De Beers during the mid-1980s and before, the new strategy is centered on driving demand growth, and as a result requires a more broadly defined series of critical factors that take into account market and competitive intelligence, retailing, marketing, branding and distribution channel dynamics, and assessments of competitive pricing as well. The following are critical factors for De Beer's new strategy going forward:

Competitive intelligence of emerging value chains in 3rd world nations, many if which have superior costing and pricing structures, and leaner, more agile processes for working with retailers.

Greater intelligence with regard to retailing trends and the tendency of the world's most profitable retailers including Tiffany & Company to concentrate on vertical integration as a strategy to retain profitability long-term.

To understand how compliance initiatives including Free Trade and reducing dependence on conflict diamonds has direct and measurable implications on the De Beers brand.

Branding's effectiveness is measurable and more directly attributable to De Beer's social, economic, moral and ethical decisions in the nations they manufacturer in than ever before. It is an age of transparency that De Beers must contend with and make sure all company's activities, anywhere in the world, support the claims made as part of the branding promises.

Compliance to ethical and moral commitments to shareholders and indirectly to customers through branding and the assurance of ethicacy is critical for the company to gain and sustain retailing joint ventures globally.

Greater level of insights into how currency exchange rates and currency valuations affect demand for their diamonds and jewelry product lines in China, India, Japan and the U.S. Marketing intelligence in each of these markets is also essential for the company to continue to grow.

Greater process-centric knowledge of how to contribute to the growth of its channels partners and Joint Venture partners globally is also critical. Turning process-centric knowledge into an asset is critical for De Beers to compete in the chosen global markets it has entered.

Key performance measures for the new strategy are more attuned to financially measuring the performance of marketing strategies while at the same time staying fundamentally focused on the demand curve for the industry. The following key performance measures are now used in De Beers to assist in accomplishing the new strategy:

As was the case in the mid-1980s De Beers also quantifies the industry value chain today as well, and the following measures of performance are used to do that:

World Production of Rough Diamonds

World Supply of Rough Demands

Polished Equivalent of Rough Diamonds

Global Sales of Diamond Jewelry

Return on Marketing Investments - Measures how investments in marketing programs to promote retailing, Joint Ventures with LVMH and others are performing over time. This is also a metric that takes into account spending on Internet-based advertising including the company's new website as well.

Weighted Average Cost of Capital (WACC) - as defined in this paper, this measures the cost of capital or internal interest rate the company pays to finance new expansion. As the company is now held as part of Anglo American, this metrics is even more critical as it is used as the basis for arguing for more internal funding.