De Beers may become its own biggest competitor

This week in my ECONS102 class, we covered monopoly and firms with market power (a topic we actually cover much earlier in the semester in my ECONS101 class). One of the examples I talk about is De Beers, which had a stranglehold over the diamond market up until the late 1980s, but still commands a high degree of market power today. It is interesting to see what they are doing to maintain their market power. Bloomberg reported last week:

De Beers hasn’t even opened its first synthetic diamond store, but its looming entry into the market for man-made gems has already shaken the industry.

The unit of Anglo American Plc said three months ago that it plans to sell lab-grown diamonds at a fraction of the going rate, undercutting rivals like Chatham Created Gems Inc. and Diamond Foundry Inc. That’s already cut the price of man-made gems, furthering De Beers’s aim of increasing the premium paid for the diamonds it mines in Botswana, Namibia, South Africa and Canada.

De Beers will target younger consumers with its lab diamonds, sold under the Lightbox name for about $800 a carat. That’s a fifth of the price of existing man-made stones and one-tenth of the cost of buying a similar natural gem.

This is an interesting example of rent seeking, where a firm attempts to build (or maintain) its market power. It is also similar to a tactic we discuss in my ECONS101 class, which is where firms try to crowd the market by competing with themselves. However, I don't think that is De Beers' strategy in this case.

Synthetic diamonds are a close substitute for natural diamonds, and natural diamonds represent a highly profitable business for De Beers. If some of De Beers' competitors (like Chatham or Diamond Foundry) start producing high-quality synthetic diamonds and selling them relatively cheaply, then some diamond consumers will be induced to switch from natural diamonds to synthetic diamonds, and De Beers will lose profits. By selling synthetic diamonds itself at a very low price, clearly De Beers' goal is to make it unprofitable for the synthetic diamond producers to operate, by seriously undercutting their prices - a tactic known as predatory pricing. The synthetic diamond competitors won't be able to compete with De Beers for long at the low prices, and will soon go out of business (at least, that is what De Beers is hoping). At that point, De Beers can quietly exit the synthetic diamond industry and resume claiming high profits from natural diamonds (having taken a bit of a hit to its profits from both synthetic and natural diamonds in the meantime).

There is a problem with this strategy though, and it's a problem with predatory pricing generally. Unless there is some barrier to entry into the synthetic diamond industry, undercutting those competitors and forcing them out of the market is only a temporary solution for De Beers. As soon as De Beers exits the market, or raises the price of synthetic diamonds, some other new competitor can come into the synthetic diamond market. Unless De Beers can keep new competitors out of the market.

Is there a barrier to entry? I don't know the synthetic diamond market well, but I suppose that the number of ways that you can create high-quality synthetic diamonds is probably limited, and that Chatham and Diamond Foundry, as well as De Beers, use technologies that are covered by patents. Patents can create a (time-limited) barrier to entry into the market, since no competitors can use the technology covered by the patent. So, if De Beers makes it untenable for their synthetic diamond competitors to operate, perhaps this is a cynical ploy by De Beers to capture the synthetic diamond patents, either by a hostile takeover of the firms that are struggling to be profitable in the wake of low prices, or by buying the patents in a fire sale of those firms' assets?

It will be interesting to see how this plays out in the long term.