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South Africa: Mining Giant Launches Gem Spot Market
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Business Day (Johannesburg)
16 November 2007
Posted to the web 16 November 2007
Emma Muller
Johannesburg
BHP Billiton has launched a spot market for diamonds in a move that comes amid growing criticism of tender sales in the industry.
Strong demand for rough diamonds - because of world production declines - has caused prices at recent tenders to spiral.
Manufacturers have warned about eroding margins, while smaller players are complaining bitterly that they are unable to compete as the supply tightens.
BHP Billiton said it turned to consultants and auction theorists to seek an alternative for its tender sales.
The spot market concept it came up with removes one of the key concerns heard at diamond tenders: the "winner's curse", whereby bidders who have to guess what their competitor will offer are tempted to bid too high, and end up paying a premium.
While the concept is meant to provide better margins for its wholesale distributors over time, BHP Billiton said it also provided accurate price discovery. The system rewards those customers that create the most value, and not necessarily the highest price.
The concept allows customers to value a representative sample on which they place a bid and indicate the quantity they wish to receive. The offers that exceed the reserve price which BHP Billiton has put on the goods are then listed.
The highest offers for the amount available are singled out and the lowest of these highest bids becomes the market clearing price.
The clearing price becomes the price that all the winning clients pay for the particular item they bid for. The customers who win are those whose offer was higher than, or equal to, the market clearing price.
In cases where customers offered higher prices, they make a profit - namely the difference between their own valuation of the goods and the lower market clearing price they actually pay.
Describing the scheme as an important step in the evolution of its marketing programme, BHP Billiton said: "The concept removes the incentive to overbid, boosts the profit of better performers, makes more goods available to the most profitable customers and, finally, gives BHP Billiton accurate price discovery."
Asked if there was room for manipulation - for example, clients artificially pushing up the clearing price to ensure they obtained goods - it said: "The process has been designed so there is no incentive to do this.
"If customers were to make offers above their true valuation, they expose themselves to the risk of making a loss, but do not increase the likelihood of receiving profitable goods."
The spot market will apply initially only to what are called Melees and small goods, replacing tendering and elite channels for these goods. These are about 15% of BHP Billiton's Ekati mine production. The elite sales channel is designed for those wholesale customers prepared to pay a premium in return for a two-year consistent supply arrangement.
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"It may look like we're leaving money on the table. For individual sales, that's true. But over the long term, we'll benefit by ensuring that the goods are in the hands of customers who generate the most value for BHP Billiton," the company said.
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