Diamonds. For thousands of years, they have been believed to bring good luck (and bad luck!) — health, wealth, and protection against most of the ills that can befall mankind.
They are also a multi-billion dollar business, although compared to the gold business, the diamond industry is small. (Read More: Are Diamonds the New Gold for Individual Investors?)
The worldwide retail market for diamond jewelry was $60 billion in 2010. Like the gold business, the diamond business is segmented into several groups:
- Miners and producers, who mine rough diamonds, then sort and sell them.
- Cutters and polishers: those who buy rough diamonds from the producers, then cut and polish.
- Jewelry manufacturers who create finished pieces.
- Retailers who sell the finished jewelry to consumers.
Some operate on several levels of this "value chain." And in recent years — particularly with the advent of selling jewelry on the Internet — a number of these lines have become blurred. There are retailers, for example, who may buy directly from wholesalers. (Read More: Diamond Investing Not for Faint of Heart.)
Miners and Producers:
According to Bain & Company, about 133 million carats of rough diamonds are produced each year. Botswana and Russia are the two largest producers; between them they have about half of the world's production. Australia, Angola, Namibia and Canada make up most of the rest.
There's even fewer diamond producers. In fact, four control about 65 percent of the market: De Beers, Russian producer Alrosa, and diversified mining companies BHP Billiton and Rio Tinto . De Beers alone controls about 35 percent of the market, with Alrosa about 20 percent. (Read More: Diamonds No Longer Rio Tinto's Best Friend.)
Why are diamonds found in so few places? Because large, commercially viable diamond mines are a rarity. Today, there are only about 20 major diamond mines in the world. And the big supply is even rarer — only 11 mines make up 62 percent of the world's production of diamonds by carat!
And they're getting even rarer. The last major diamond mine was discovered in Zimbabwe in 1997.
No matter how big the mine is, you've got to move a lot of rock to get at a very small number of diamonds. Production varies by mine, but the world's "richest" mine — the Jwaneng mine in Botswana — has to move a ton of rock to get 1.4 carats of rough diamond, on average.
That mine moves 8 million tons of rock a year and sells the rough diamonds for an average of $134 a carat. That's $1.5 billion in revenues, from a single mine. And it produces profit margins of 24 percent.
Cutters and Polishers:
The producers then sell their rough diamonds to intermediaries who cut and polish the diamonds. It's a costly process: most rough diamonds lose 50 to 60 percent of their weight going to polished form because material is cut or polished away.
De Beers has a particular sophisticated system for selling their rough diamonds. They sell roughly 80 clients they call "sightholders," using long-term contracts.
Other sales are made using auctions.
In the past, most of the cutting and polishing was done in only a few centers: Antwerp, Tel Aviv, New York, and Russia. Today, the majority of the smaller stones in the world (less than 3 carats) are cut in India, followed by China.
The reason: low labor costs. In the U.S., it costs about $100 a carat to cut a diamond; in India, it costs $10.
To lower production costs, diamond cutters are using sophisticated computer programs that map out the most efficient way to cut a diamond. In recent years, tremendous advances have been made using sophisticated laser cutting machines that can cut and polish diamonds with minimal human labor.
Once stones are cut and polished, it's time to get them into the hands of jewelry manufacturers. These sales typically take place in the central and regional offices of the diamond cutters, and increasingly at exhibitions that are held in different cities around the world. The two biggest are held each year in Hong Kong and Las Vegas.
Jewelry manufacturing is a fragmented business: there's more than 10,000 players in the world, most of whom are anonymous. There are, of course, a few very famous names who act as manufacturers as well as retailers: Tiffany , Cartier, Bulgari, Louis Vitton, Gucci, and Chanel, but more than 80 percent of the players are in India or China and do not brand their work.
Still, branding is where the big money is. Branding is crucial to profitability. According to Bain & Company, a diamond engagement ring by Cartier may enjoy a premium of 40 percent over an unbranded ring with a stone of identical size and quality.