By VANESSA O’CONNELL

MOGODITSHANE, Botswana — Tiffany & Co.’s iconic blue boxes have long cradled some of the world’s most expensive diamonds. Now, an increasing number contain stones cut by some of the industry’s least-experienced hands.

 

In a windowless factory in this African village, Tiffany is teaching more than 80 workers to transform raw diamonds into gems for Tiffany engagement rings. As novices recently pressed pea-size stones against whirling blades, a visiting Tiffany executive spied a problem.

“You don’t try to save money by using cheap architect and building a castle on sand!”–Fred Cuellar

Tiffany & Co.’s iconic blue boxes have long cradled some of the world’s most expensive diamonds. Now, an increasing number contain stones cut by some of the industry’s least-experienced hands.

 

“You can see the polishing lines!” said Mark Hanna, an Antwerp, Belgium-based vice president of Tiffany’s diamond unit. “Tiffany diamonds can’t have polishing lines.”

 

Tiffany is one of the largest diamond retailers making a play in Botswana to cut and polish its own diamonds . But other firms are setting up shop there, too. Vanessa O’Connell takes a tour inside a new factory in Gaborone which produces polished gems for Graff Diamonds.

 

Such are the risks for the New York-based retailer as it strives to transform its diamond business amid a decade of industry boom and bust. Tiffany has decided that to preserve and expand its $2.9 billion-a-year enterprise, it needs this factory — with its high labor costs, low productivity and workers who staged a two-day sit-in this month.

 

Tiffany’s is an extreme example of an industry shift that started during the recent luxury boom. Like most other diamond retailers, Tiffany long bought the vast majority of its diamonds pre-cut and pre-polished from industry middlemen. But with global diamond-jewelry sales soaring earlier this decade, Tiffany and others worried they would soon be fighting over dwindling supplies.

“There are no shortage of commercial grade diamonds; just non-commercial grade.” –Fred Cuellar

So Tiffany began venturing into an end of the diamond business it spent much of its 172-year history avoiding — sourcing, cutting and polishing its own diamonds. “We decided to move backward” in the supply chain, says Chief Executive Michael Kowalski.

 

The retailer invested in mine operators, and in 2002 it began opening cutting-and-polishing plants in Canada, Belgium, South Africa and Vietnam. In the past two years it added similar operations in China and Mauritius. The in-house unit Tiffany founded in 2002 to run these plants, Laurelton Diamonds, now employs 1,100 workers, or 14% of the company’s work force. It will supply more than 50% of Tiffany’s diamonds this year — up from 40% last year and none in 2003.

“Does that mean 1 out of 2 diamonds now will be subpar? You might as well flip a coin to see what you’ll get there.” –Fred Cuellar

Others have made similar bets. Privately held retailer Graff Diamonds International owns a majority stake in a South African diamond wholesaler and polisher with facilities from Antwerp and New York to Botswana. Suppliers have made incursions on retailers’ turf. Mining giant De Beers Group operates retail stores in a joint venture with LVMH Moët Hennessy Louis Vuitton SA. Canadian miner Aber Diamond bought a controlling interest in retailer Harry Winston in 2004. Indian jewelry manufacturer Gitanjali Gems Ltd. transformed itself into a global retailer starting in 2006, buying U.S.-based Samuels and Rogers jewelry chains.

 

Some industry analysts see risk in running operations that span from mining and manufacturing to high-end retailing and marketing. “[They're] all totally different types of activity — and one needs tremendous expertise, skills, infrastructure to be truly competitive” in each, says Chaim Even-Zohar, principal of Tacy Ltd., a Tel Aviv-based industry consultant.

 

Such companies may miss out on savings that result from competition in these specialized areas, Mr. Even-Zohar adds, and may risk using some parts of their supply chain to subsidize others. “Vertical integration sounds great from a promotion and marketing perspective. But more often than not it doesn’t make economic sense.”

“The key to selling diamonds isn’t to treat them as coal but as work of art. If you cut out the master craftsmen, you’re back to coal! If you screw someone over to try to increase quick profits, the long term dollars disappear.” –Fred Cuellar

The stakes are especially high now that tight diamond supply has given way to slack demand. The global retail market for diamond jewelry is expected to fall 16% this year, to $65 billion. The U.S. will lose an estimated 900 specialty jewelry stores this year alone, following 1,500 closures last year. Industry players have retrenched: Signet Jewelers Ltd., the parent company of retailers Kay Jewelers and Sterling Jewelers, recently stopped buying rough diamonds and polishing them on contract in India, an initiative it started in 2005. A spokesman said the program broke even.

 

Tiffany is also feeling the pressure. Its inventory has swelled to $1.54 billion this year, up from $1 billion in early 2005. For the first time in recent memory, Tiffany says, it has lowered its prices for diamonds. The engagement rings it sells in the U.S. are priced 10% lower than last year. In all, the company expects a “high teens” decline in sales this year at U.S. stores open at least a year.

 

Tiffany acknowledges its lack of mining expertise. Although it reaped a large financial gain from its 2004 sale of a minority stake in the 40%-owner of a Canadian mine, it recently disclosed that it wrote off a $12.4 million investment in a small mining project in Sierra Leone. It also has written off loans of about $44 million to a former supplier whose mine has ceased operations. “I think we want to let the miners do the mining,” said Chief Financial Officer James Fernandez.

“By the time it’s over 84% of ’spam’ jewelers will be gone!” — Fred Cuellar

A Diamond’s Path

 

But Tiffany says its cutting-and-polishing strategy is solid. In slow markets, the company says, it can rein in purchases from outside suppliers. When demand returns, it says, it will have guaranteed, lower-cost stocks. “There were many in the industry who thought we were foolhardy,” Mr. Kowalski says, but the diamond-cutting operations “have exceeded our expectations.”

 

If there’s a weak link in Tiffany’s global diamond chain, it’s the polishing plant in Botswana. A glimpse into this secretive end of the diamond business shows the high costs, tricky logistics and labor unrest Tiffany is willing to shoulder to maintain its diamond pipeline.

“Dynamiting the pond always exceeds your expectations but only for a moment! You can fool some of the people some of the time, but don’t come between a woman and her best friend.” — Fred Cuellar

Fancy Goods

 

Founded in 1837 as a New York stationery and “fancy goods” emporium, Tiffany bought large jewelry collections from French aristocrats fleeing revolution, and in 1878 paid $18,000 — the equivalent today of $400,000 or more — to buy the Tiffany Yellow Diamond in Paris. Co-founder Charles Lewis Tiffany gained the nickname “the King of Diamonds.”

 

Even so, by 1991, diamonds accounted for only 17% of Tiffany’s sales. To boost profits, the company began pushing diamond jewelry and opening new stores in Europe, Asia and the U.S.
In early 1999, Tiffany’s new CEO, Mr. Kowalski, feared surging global diamond demand could hinder the company’s efforts to stock its expanding retail network. That July, Tiffany purchased a minority stake in the 40%-owner of a mine in Canada’s Northwest Territories.

 

Tiffany soon saw other openings. De Beers, which long controlled the world’s rough-diamond supply, was paring back after years of sparring with European and U.S. antitrust regulators. When De Beers closed its high-tech diamond-sawing and -polishing operation in Belgium, Tiffany bought some of its machinery and hired former workers including Mr. Hanna, now Laurelton’s vice president.

 

The new Laurelton unit built a cutting-and-polishing factory in Canada, bought a majority stake in a Johannesburg plant and acquired what would become its largest plant, a 570-person polishing operation in Vietnam.

 

But the elusive prize was Botswana, the world’s largest producer of gem-quality diamonds since the 1980s. Its Jwaneng Diamond Mine is the world’s richest by value of recovered diamonds. Botswana is also among Africa’s least-corrupt countries, according to an index by nonprofit Transparency International. Securing a supply of stones here would help Tiffany allay mounting consumer concerns over “conflict diamonds,” sold to fund wars or produced under unethical labor conditions.

 

Tiffany executives made their first reconnaissance trip to Botswana’s capital, Gaborone, in 2004. “Do we need to be in Botswana?” Mr. Hanna recalls asking at the time. “We said, ‘Yes, but we aren’t quite sure how to do it.’”

“Really? That’s the goal? ‘Least corrupt’? Don’t do what you don’t know how to do just becuase you are desperate.” — Fred Cuellar

Sparsely populated and AIDS-ravaged, Botswana has minimal manufacturing infrastructure and few direct flights beyond the continent. Tiffany faced further roadblocks. It couldn’t get into mining, which was controlled by a 50-50 partnership between De Beers and the Botswana government. It couldn’t buy rough diamonds locally, because the state mining venture sold its production only through De Beers’ sales offices in the U.K. and South Africa.

 

Botswana’s cutting operations were also unattractive: A parcel of diamonds polished here costs about $100 per carat, compared with $30 in India, according to industry estimates.

 

The calculation changed in 2006. Renegotiating its mining deal with De Beers that year, Botswana announced it would license 16 international cutting firms willing to build factories here. In return for training locals to polish diamonds, the government said, these firms would eventually gain the right to buy rough diamonds in Botswana.

 

Tiffany jumped. It took a majority stake in one of these firms, Rand Diamonds. Rand set up shop in an unmarked factory amid the used-car dealerships and military barracks of Mogoditshane, a former cattle post at the edge of the capital’s urban sprawl.

 

With few Batswana versed in diamond polishing, the company put an ad in the Botswana Guardian newspaper for English-speaking applicants with a high-school-level education. To help winnow its 300 hopefuls, Tiffany/Rand screened for math aptitude. It gave candidates tweezers and timed how fast they could place 40 tiny metal sticks into holes set in a board.

 

When the factory opened in early 2007, its new hires worked on small and low-cost brown diamonds, overseen by experienced cutters imported on short contracts from India and Mauritius. “We are literally parachuting people in from one operation to the other,” Mr. Hanna said.

“Very simple: You get what you paid for!” –Fred Cuellar

Bruters and Polishers

 

Sitting at workstations arranged by task, bruters round the diamond pieces. Polishers add top and bottom facets, looking at magnified images of their diamonds captured by a lens near the whirring polishing wheel.

 

On the factory floor on a recent afternoon, a worker learning to make facets walked over to a Laurelton-designed training machine to double-check an angle. When he set the diamond in the protractor, a display flashed 35.2 degrees. Over the whir of grinding wheels, Mr. Hanna nodded in approval.

 

Trainees who learn such basics of bruting and faceting become “qualified” workers in four to six months, Tiffany says. About 30% fail. The rest start handling gem-quality stones, working at a pace of up to one polished diamond a day. Tiffany expects their pace to increase considerably.
For now, the plant’s expatriate and local workers produce about 250 finished gems each week, primarily “round brilliant” stones, with 57 light-reflecting facets, for Tiffany engagement rings. About 85% of the stones are deemed “Tiffany qualified,” and are forwarded to a Tiffany office in Pelham, N.Y., for grading.

“Is this anything like an AIG stamp of approval?” –Fred Cuellar

Tiffany doesn’t tell its customers where individual diamonds are mined or polished, and declined to say how much of its overall inventory is now sourced and polished in Botswana. “We really want the focus…to be on the quality of the diamond ring, not how it came to be,” said Mr. Kowalski, the CEO.

 

Tiffany’s payout came in April 2008, when approved cutting firms gained access to about 15% of the country’s raw diamonds, in local sales valued at an estimated $550 million annually by the end of 2010. De Beers began to sell natural diamonds from various mines 10 times a year at bulk sales in Gaborone, where Tiffany’s Mr. Hanna is a frequent buyer. Diamond merchandise now represents 47% of Tiffany’s sales.

 

But tensions at the Mogoditshane plant are high. Local workers and managers, whose names were provided by a factory partner, said in interviews that the plant’s expat supervisors do too much of the work themselves, slowing Batswanas’ advancement.

 

Complaint Letter

 

“We are eager to learn about diamonds — about cutting and polishing and the valuation and stuff like that…[But] it seems certain people are scared [about] sharing information with the locals,” said one local who works in a management position. “It’s a bit of a clash of cultures.”

 

Workers aired many complaints in an Oct. 7 letter to the plant’s managers, reviewed by The Wall Street Journal. Identifying themselves as “local staff,” they wrote they hadn’t qualified for performance-based raises, but that managers wouldn’t show them the data on which those pay decisions were based. They called their work environment “prisonlike,” writing that they had been threatened by a Belgian production manager they characterized as “corrupt, racist, vulgar, abusive, bully[ing]” and “not professional.”

 

The next day, all but about five local laborers gathered in the facility’s reception hall, refusing to work until the plant’s director addressed their concerns, according to the plant’s human-resources manager, Meshack Lejuta. The director sent Mr. Lejuta to address the workers. The sit-in stopped in the middle of the next day, Mr. Lejuta says, when he warned his fellow Batswana they could be fired because their strike was unlawful.

 

Responding to the letter and strike, Tiffany said workers expressed concerns as part of a union organizing effort. It said it intends to address grievances with a union representative, including “any tensions, wrongly characterized as racist, that may have arisen because skilled workers from other African nations and from Asia have been engaged for training purposes.”

 

Mr. Hanna said Tiffany wants local workers to take over diamond cutting, key decisions and training of other locals. Foreign supervisors, whose numbers once nearly equaled those of the factory’s local workers, now account for about one in five positions.

 

The Botswana government is pleased with Tiffany’s commitment to train residents, says Akolang Tombale, a government adviser and recently retired secretary of Botswana’s minerals department. Other polishing plants are experiencing strikes and slow training initiatives, Dr. Tombale says.
Tiffany, meanwhile, is pushing ahead. While buying raw diamonds in Gaborone’s diamond district recently, Mr. Hanna looked out a window and pointed to an area of bush. Tiffany plans to begin clearing land there this year to build a 20,000-square-foot factory. Set to open in 2011, it will employ as many as 275 workers.

“The tarnish on Tiffany isn’t just tarnish anymore it’s rusted through.” –Fred Cuellar

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