The MT Interview: Gareth Penny of De Beers

De Beers boss Gareth Penny predicts a sparkling return to form after tough times in the recession.

by Andrew Saunders
Last Updated: 09 Oct 2013

Security is discreetly tight at the London office of the world's largest producer of diamonds, De Beers, on Charterhouse Street in the Hatton Garden gem district. Hardly surprising, give that it's claimed that diamonds sufficient to fund a lifetime of ease and comfort can be secreted about a naked human body – in the mouth, nose, ears and, er, elsewhere. It's easy to see how even the most upright of citizens could be tempted to stray from the straight and narrow by such dazzling riches.

'We call them treasures of nature,' says De Beers group CEO Gareth Penny. 'It's not like buying a car or a dress or a handbag – diamonds have a long-term sustainable value. There are not many fashion accessories that you can say that about.'

Once inside De Beers' inner sanctum, the sorting room, glamour is in short supply, despite the Croesan value of merchandise being assessed. It's a workplace, not a film set, and looks like an old-fashioned schoolroom, with tall windows and rows of white-topped benches.

Even the stones themselves – washed but otherwise as they come out of the ground – are low on glamour at this stage. Rough diamonds, they are De Beers' stock in trade and look like giant sea salt crystals. The sparkle comes later, when they are cut, polished and set by the numerous specialists further up the supply chain, before being sold by jewellers all over the world.

Penny himself is equally businesslike. Well set up and wearing a bespoke dark suit and tie, the 47-year-old is bluff, affable and definitely a bling-free zone: you don't have to be encrusted in diamonds in order to sell them.

Besides, too much public display would be impolitic, given the shocking trading period that De Beers - and the diamond industry generally – has had recently. Even in a climate where we've all become used to tales of recessionary woe, things were pretty grim in the gem trade. In the month after the collapse of Lehman Brothers in September 2008, global demand fell by a staggering 50%, and the resulting glut of polished stones brought prices tumbling down. 'After Lehmans, things unfolded very rapidly. We saw the business decreasing dramatically,' says Penny. 'At a time when people were suddenly worried about whether they could pay the mortgage or the school fees, we were dealing in a highly discretionary product. Retailers cut back and we were hit.'

And how! De Beers posted a post-tax loss of $743m in 2009, compared with a profit by the same measure of $515m the year before. Drastic measures were called for to adjust to this new commercial reality - production was cut almost in half, from over 48,000 carats in 2008 to 24,600 carats in 2009 - and budgets slashed by 50%. None of your 10% efficiency savings here.

Even though it no longer operates the controversial cartel that made De Beers one of the best-known names in price-fixing, the firm still mines some 40% of the world's diamonds. So by cutting production it can prop up prices - not an option available to many other recession-ravaged businesses. Even so, it must have been a fight for survival, but Penny, with his no-nonsense clipped South African delivery, manages to make it all sound relatively straightforward. 'We simply said to all the CEOs and function heads: "You've got to come in with a budget for 2009 that is half of what you had in 2008."'

He believes that only by thus devolving responsibility to the operational groups could such deep cuts be achieved without seriously damaging the prospects of the business.

'They have to be able to say "We took that decision". Plans imposed from head office never work.'

But taking out $1bn of costs in such a short space of time came at a high price – thousands of jobs, some 30% of the total workforce, were lost. Many of those hit were people who could ill afford it – relatively poor miners at De Beers' mines in South Africa and Botswana.

The impact of the recession was particularly bad due to the nature of the industry itself. Some $80bn of diamond jewellery is sold annually, but the business is highly fragmented. From hole in the ground to fiancee's finger, each diamond takes a meandering journey through innumerable middle-men, processors and wholesalers. Many of them are small family concerns, heavily reliant on credit to keep them trading.

'Liquidity was the biggest problem of all – even some of our largest customers had problems accessing cash. It created particularly severe effects,' he says.

But Penny believes the worst effects of the recession are in the past and that the supply chain is once again moving briskly. 'We're now seeing a return to profitability and market leadership equivalent to where we were before the crisis. We will put out a pretty strong set of financials at the half-year in July.' The change in fortunes has even led to rumours that a re-listing may be on the cards, but there are no plans for such a move, he says.

What's more, all that painful restructuring has put De Beers in a strong position to take advantage of the upswing. 'Variable costs will rise as production rises,' he says. 'But we reckon we can sustain a 25% reduction in costs – that's savings of $500m a year.'

If the recession was the biggest external shock to hit De Beers in recent years, Penny was also in charge of what was probably the firm's largest self-imposed upheaval, too. He it was who headed the strategic review back in the late '90s which turned on its head the business model that had served the firm well for a century.

De Beers - which had spent most of its 122 years as a cartel, controlling at peak 90% of the world's diamond supply - morphed overnight into a modern, demand-led operation, with a high-end retail operation in partnership with LVMH. 'We have reinvented ourselves and positioned ourselves for the 21st century,' says Penny. 'Now we sell only our own diamonds, and we have eight operating entities: four upstream mining operations and four downstream branding and distribution businesses.'

As part of this business model, De Beers delisted in 2001 and was taken private by its three largest shareholders: Anglo-American, the Oppenheimers and the government of Botswana.

It was the biggest shake-up since the formative days of the modern diamond business. For although diamonds have been prized as natural wonders for centuries, featuring in royal jewellery since at least the 15th century, the status and value of diamonds today - dependent on their association with the eternity of human love – are largely a modern construct. And one that De Beers can claim its fair share of credit for.

De Beers' founder, the controversial British entrepreneur and imperialist Cecil Rhodes, started out renting mining equipment to prospectors in the South African diamond rush of the 1870s. In 1888, he bought out arch-rival Barney Barnato with a cheque for £4m (said to be the largest ever written at the time) and formed De Beers Consolidated Mines.

Named after the farm that marked one of Rhodes' first big strikes, De Beers controlled every diamond mine in the country, and soon formed a cartel with a distribution organisation in London. By ensuring that production was tighter than demand, the deal guaranteed scarcity and gave De Beers unprecedented influence over the price at which it could sell its products.

Exactly the sort of anti-competitive behaviour that is almost universally outlawed these days, it was, however, an enormously lucrative dodge. The vast sums that Rhodes accrued in this way enabled him to found his own country, the African state of Rhodesia (now split into Zambia and Zimbabwe) - as well as funding Rhodes University in the Eastern Cape district of South Africa, and the famous Rhodes Scholarship for overseas students at Oxford University.

De Beers' strategy for recovery into 2011 and above is based on the assumption that diamond production has peaked. 'Not many significant new mines have been found in the last 20 years,' says Penny, 'and all the evidence is that production peaked before the recession at around 160m carats (a carat is 0.2g) and is now in decline. Look after your diamonds; they are only going to appreciate in value,' he counsels.

At the same time, whole new markets are developing the taste for bling. On China's eastern seaboard, for example, diamond rings were unheard of 20 years go, but now half of all fiancees expect a rock on their engagement. 'We see 10% to 20% growth in China per annum,' he notes. 'There are cities there one has barely heard of, with maybe four or five million people, which are developing a whole new diamond acquisition culture.'

It can't happen fast enough for De Beers Diamond Jewellers, the firms' retail joint-venture. It's been struggling since the recession and in January CEO Guy Leymarie was replaced.

It's a demand-led mantra that the next big character after Rhodes in De Beers' history would heartily approve of. Ernest Oppenheimer was a swashbuckling diamond merchant and owner of the famous Cullinan diamond mine, who bought himself the chairmanship of De Beers in 1927. More than Rhodes, Oppenheimer was alive to the potential of marketing - he knew that the 20th-century alchemy of creating demand could make him as much money as the 19th-century technique of restricting supply.

So began the fashioning of diamonds as the ultimate symbol of love and commitment between the affianced, culminating in 1947 with the ad slogan 'A diamond is forever', surely one of the most effective and enduring of all taglines.

It worked – the family owns 40% of the firm to this day, and there are no fewer than three Oppenheimers on the board – including current chairman Nicky Oppenheimer.

By the late '80s, however, when Penny joined the firm, the writing was on the wall for the price-control operation. A huge and idle stockpile of diamonds sat in London, equivalent to vast sums of cash that could have been invested in the business.

What's more, the burden of competition law around the globe was making life increasingly difficult. The company could not maintain an operation in the US – the world's largest market for diamond jewellery - for fear of prosecution; if there were three or more De Beers execs stateside at any one time (the number required for business to be deemed to have taken place) they were all liable to arrest on anti-trust charges.

Perhaps most telling of all, diamonds were no longer even making much money. The group as a whole seemed strong, thanks to a 35% cross-holding in Anglo-American, which De Beers had at the time. 'We had a third of Anglo's revenues and a huge dividend. But distilled out, the results from the diamond business were paltry,' says Penny. 'We had to change; the old model simply wasn't commercial any more.'

And so De Beers ceased to operate as a distribution house for diamonds from any and everywhere and began selling only stones from its own mines in Canada, South Africa and Botswana. Its stockpile was slowly run down and profitability blossomed even as market share fell, from over 60% to about 40%.

To the uninitiated, the recessionary trials of the industry come as a surprise. Why don't diamonds do what gold does, and boom in a downturn? They are both vital to the jewellery trade, after all. But for all their portability and high value, diamonds are not a commodity – they are hard to trade. 'An ounce of gold is an ounce of gold, a barrel of oil is a barrel of oil, but a diamond is not a diamond. In this room, we are sorting them into 12,000 categories - 12,000 price points. And that's before they have been cut and polished. Every stone is different.'

Once out of the ground, rough diamonds are virtually untraceable, however, a characteristic that has been instrumental in creating one of the industry's biggest-ever controversies: the troubled tale of 'blood' or 'conflict' diamonds.

These are stones sold by warlords and illegitimate governments to finance civil war, armed uprisings, 'rebellions' and all kinds of violent mayhem. The best-known examples are the civil war in Angola, where blood diamonds kept a grisly conflict going for years, and the grim internecine strife that tore Sierra Leone apart in the late '90s.

In theory, a diamond strike should be the answer to a poor country's prayers – properly administered, the proceeds from such a lucrative trade can turn the fortunes of entire regions around quickly. This, says Penny, is what has happened in Botswana, thanks to Debswana, the diamond mining operation owned jointly by De Beers and the government of Botswana.

Eighty percent of the revenues earned by Debswana go into the country's treasury. 'Botswana has transformed itself in 40 years from one of the poorest countries to a decent middle-income country. I am proud of that,' he says.

But things don't always turn out so well. Kimberlite pipes – the geological formations in which the stones are found - don't go looking for stable governments and responsible leadership. It has proved too easy for whoever gets the toughest gang of hoods together to take control of a diamond mine and start using the proceeds for their own nefarious purposes.

For a long time, this sordid trade was the industry's dark secret. But when Greg Campbell's book Blood Diamonds – centred on the appalling conflict in Sierra Leone – came out in 2002, the lid was lifted on an illicit and hugely lucrative trade to which many a blind eye was turned in the legitimate diamond trade, and that cost the lives of thousands. A film of the same name starring Leonardo DiCaprio followed: it grossed $170m, and punters started asking awkward questions about the provenance of the diamonds in their jewellery.

The backlash threatened to wreck the industry. 'We have never mined a single diamond in Sierra Leone,' says Penny. 'So you might say: What the hell's it got to do with us? But if consumers ever start to question the connection between diamonds and love, then you have the potential to undermine the whole proposition.'

And although De Beers may never have mined diamonds in conflict zones, in the days of the cartel it probably sold them on, albeit unwittingly. It was simply impossible to tell – hence its decision to stop trading in other producer's diamonds and sell only those from its own mines.

The answer to the problem was to create a paper trail for legitimate stones from source to jewellery store, through a complex and hard-to-manage series of partnerships called the Kimberley Process. 'It's about collective responsibility. De Beers holds itself as the leader of the industry, so it's our responsibility to do something about it,' explains Penny. 'That's why we worked so closely with 74 sovereign governments and 100 different NGOs to develop the Kimberley Process.'

Introduced in 2003, this is a voluntary certification scheme that requires rough diamonds to be shipped in tamper-proof containers, accompanied by a forgery-resistant and numbered certificate of authenticity. Kimberley Process diamonds can also be shipped only between participating countries, to minimise the risk of conflict diamonds entering the supply chain.

It has been remarkably effective, allowing the industry to present a formally united front for the first time and largely succeeding in putting customers' minds at rest. Yet it's not without its critics, most recently over the subject of what to do about Zimbabwe.

The troubled African state's involvement in the Process has become increasingly controversial as allegations of corruption and violence surrounding the mining of diamonds in newly discovered deposits in the Marenge district have emerged. The New York-based Human Rights Watch campaign group has called for Zimbabwe to be suspended from the scheme – but the Process's own monitoring group disagrees.

Yes, the Process is a headache to maintain, says Penny. 'Every now and again you find something that is trying to pull it apart and you have to put it back together again. The process isn't perfect and will be forever challenged – corralling all that together, you can imagine.' But it's worth the effort. 'You can't separate the commercial drivers of this business from the ethical ones.'

Like its industry, De Beers is a complex entity comprising numerous subsidiaries, partnerships and joint-ventures – no fewer than 12 distinct subsidiaries at the last count, ranging from the mining businesses like Debswana and De Beers Consolidated Mines through distributor the Diamond Trading Company and industrial diamond operation Element Six to the retail end, the aforementioned LVMH joint-venture De Beers Diamond Jewellers.

Doesn't that make it tricky to run? Perhaps, says Penny, but it's the nature of the beast. 'In almost all our underlying businesses we have partners. The countries in which we mine, for example – they don't want to be shareholders in copper or nickel mining operations, but they do in diamonds. People just think differently about diamonds. It doesn't make it easy, but it doesn't mean you can't all be successful.'

Despite its tripartite ownership structure, De Beers remains a family concern at heart - the plate of the door of the London office even announces the home of 'The De Beers Family of Companies'. What's it like working for one of the wealthiest families in the world?

'The Oppenheimers are a brand in themselves. It does add a dynamic to the business. It means we can take a longer view. And I couldn't ask for a more knowledgeable or supportive chairman than Nicky [Oppenheimer],' says Penny diplomatically. 'His family has been in the industry for a hundred years and he is hugely experienced. I listen carefully to his advice.'

Not that Penny is a stranger to the trade himself. The godson of Julian Ogilvie Thompson, former chairman of De Beers and Anglo-American, Penny was born and raised in the privileged surroundings of wealthy Cape Town. No slouch academically, he attended Bishops, one of the Cape's smartest public schools, before taking A-levels at Eton, and, appropriately enough, was a Rhodes Scholar at Oxford, where he read PPE.

Married to Kate, he has two kids aged 10 and 12. He spends as much time as he can at home in Dorset – although he has places in London and Johannesburg too. When he isn't working, he likes to walk the moors and sail as an antidote to all the travelling that his job entails.

He has 12 direct reports and tries to be more mentor than control freak. 'The quality of the top team is everything. If you are going to sleep at night or have any chance of a normal life, you can't do it all on your own. I don't think the role of CEO in a multinational business is about haring around forcing people to do things. The businesses have to run well without someone constantly lording it over them.'

But there is stick as well as carrot in his method. 'You have to be willing to have the tough conversations if the performance isn't there, and sometimes you will be disappointed and have to replace someone. That's actually healthy.'

Perhaps chastened by the experience of keeping the ship afloat during the recession, Penny has taken on board a few key lessons for the future. 'For one, you have to run a much stronger balance sheet. Sitting on some cash doesn't do any harm.' A flatter, more efficient organisational structure is another tenet, as is the need to be very much more selective about capital expenditure projects.

But, above all, he wants De Beers' modus operandi to be more sustainable and for the industry to become one that its customers as well as its employees can be proud of. 'A well-run diamond business can transform a region or even a whole country. There are 700,000 or 800,000 people polishing diamonds in places like Surat in India; people who 10 years ago sat on the floor are now working in air-conditioned factories. I don't think one has to apologise for that. But the value of a diamond comes from supply and demand, and the demand won't be there if people don't continue to find them attractive. So we have to ensure that the way we work, mine and operate protects the reputation of our products.'

If he can do that, the piles of uncut rocks in the sorting room should remain a tempting prospect to the light-fingered for quite a few years yet.

FOUR CHALLENGES FACING PENNY

  1. Make the industry more resilient by driving institutional interest in diamonds as an investment
  2. Keep working to clean up the seamier side of the diamond trade
  3. Get his flagging retail venture back on its feet
  4. Steward its mines carefully so that De Beers doesn't run out of product to sell

PENNY IN A MINUTE

1962: Born 24 December, Cape Town. Educated at Bishops Diocesan College, Eton and Oxford
1988:
Joins De Beers' then parent company Anglo-American as management trainee
2001:
Director, sales & marketing for De Beers' subsidiary the Diamond Trading Company
2003:
Joins De Beers' main board
2006:
Group MD (now CEO), De Beers family of companies
2010:
Adds chairman, Debswana (De Beers' joint venture with the government of Botswana) to his portfolio

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