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Argyle Diamonds: where to now?

By Andrea Viltciullo, Joshua Anltear and Michael Disbwy

Introduction

The Argyle mine came on stream in 1983 as the first major diamond operation in Australia. It quickly estab­ lished itself as the worlds largest producer, in tenus of volume (carats) produced, with the majority of its initial production comprising brown-to-yellow, as well as some near colour less or colourless, rough diamonds. A very small percentage of its output includes the rare pink diamond - a highly prized stone that sells at a premium at an annual tender held in selected locations around the world. The Argyle Diamonds Company's relationship with the Indian diamond indusuy and its development of unique marketing strategies have enabled it to establish as a successful independent player in the marketplace, bypassing the all-powerful De Beers cartel, the Central Selling Organisation (CSO). At present, Argyle is at a crossroad. Sustain­ ability initiatives have extended the life of the mine beyond original estimates; now, the company must seek a new direction to maintain its competitive advantage in the diamond industry.

The Ar g yle com p any

Ashton Mining started exploring for diamonds in the Kimberley region of Western Australia in 1972, under the Kalumburu joint venture. The project commenced following a geologist's proposal to explore the Kimberley region for diamonds. The geologist was employed to

This case study was prepared under the supervision of Dr Peter Galvin of the Graduate School of Business, Curtin University of Technology, It is intended to be used as a basis for class discussion rather than as an illustration of either effective or ineffective handling of the situation.

devise an exploration program based on studies that suggested similarities between the Western AUstralian Kimberley rock known as lamproite and kimberlite, the diamond-bearing rock found in other parts of the wo r ld. Over the next few years, small diamond and alluvial deposits were discovered in the Ellendale area of the west Kimberley, In 1976, CRA Limited (later to become Rio Tinto Limited) took over management of the group, which became known as the Ashton joint ven­ ture. In 1977, testing of the diamond-bearing Big Spring No.1 pipe found small diamonds, but not ones large enough to justify a minf;. In August 1979, more diamonds were found in Smoke Creek. By October 1979, the main Argyle pipe (called AK1) had been found. It took a further three years to fully assess the deposit. In 1983, the joint venture decided to establish a mine.l

• Argyle's production

In 2000, Argyle's production was 26.5 million carats - approximately one-quarter of the world's production. Argyle's production from 1989 to 2001 is shown in figure C3.1 (page C2S). The majority of the diamonds in the Argyle diamond mine are'lower value, off-colour diamonds. These s.ell for much lower p�ces thado flawless white /.dia­ monds. In addition, Argyle's production includes diamonds that are suitable only for industrial purposes. For this reason, Australia may be the largest producer of diamonds in terms of carats, but it is still a long way from being the largest producer in terms of value. The value of world diamond production is shown in table C3.1 (page C2S).

CASE 3 0 Argyle Diamonds: where to now?

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45���������--------------�

 

40+';'::;:":':++'-,,!;;'

3

5 +��

 

30

G

2

5

5

20

15

  • 1 0
    5 o

II Figure C3.1: Total production of the Argyle diamond mine, 1989-2001

!ill Source: Argyle Operations Division of Argyle Diamonds 2001, Argyle Diamonds industry review 2001, West Perth, p. 14.

1/ Table ·Ca.1: Total v�lue of world diamond production, 2000

.

"

:;',

'.

::

.

.

.

Botswana

 

2.2

Russia

 

1.6

South Africa

 

0.9

Ang : I . a

.

0.9

Namibia

 

0.5

Democratic Republic of Congo

0.5

Canada

 

0.4

Australia

 

0.4

Other

 

0.4

Total

7.8

·,

II Source: Argyle Operations Division of Argyle Diamonds 2001, Argyle Diamonds industry review 2001, West Perth, p. 6.

Argyle predicts that world demand for diamonds will grow at 2 per cent per year (in real terms) between 2000

and 2006. The total world mine supply is estimated to increase at 4 per cent per year during the same period.2

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PART 5 Cases in strategic management

Activities

From 1998, diamond production at the Argyle mine WaS reduced to ensure future development of the mine. By pushing back the west ridge of the mine and moving waste rock and less ore in the short term, the mine life has been extended to 2006 at an average recovery rate of 30 million carats per year. Deep exploration of the AKI pipe has also identified a large underground resource that could extend the mine life by up to fifteen years.

Operations

The development of the Argyle diamond mine was a two-stage process, starting with alluvial mining fol­ lo wed by open pit mining. Mining is likely to continue underground in the near future. The open pit mining of the AKI pipe has been the principal source of ore. T he open pit operation is a conventional mining operation, with poth Lamproite and waste being drilled and blasted, and then loaded onto large haul trucks to be taken to the processing plant. The processing plant at Lake Argyle uses a crushing, screening and heavy-medium separation method (HMS) and an X-ray sorter for diamond recovery. Two­ stage, heavy-medium cyclones (machines that spin the ore at high speeds) with a specific gravity of 3.0 form the heart of the separation operation. Material denser than the cut-off point forms the diamond-bearing material. X-ray sorting separates waste from concen­ trate. The recovered diamonds are washed in acid before sorting and shipment. All recovered diamonds from the Argyle diamond mine are sorted in Argyle's West Perth office, where they are prepared for international sale in Antwerp, Belgium. The finest pink diamonds are retained in Perth, where they are cut and polished in Argyle's own factory before being sold by international tender. Other pink diamonds are sold through regular commercial sales channels. All non-pink rough diamonds are sent direct to Antwerp for sale on the international market. Indian cutters and polishers purchase much of Argyles product.

..

Marketing

Argyle has successfully undertaken innovative mar­ keting initiatives focused on primarily the Indian dia­ mond industry. In addition, Argyle has successfully marketed its products in the largest market, the United States, which has resulted in increasing demand for small affordable diamonds (typical of the Argyle product) in that country and other major markets.

A small proportion of Argyle's production (less than 1 per cent) are the highly prized pink diamonds. The Argyle diamond mine is the world's primary source of pink diamonds. Once a year, Argyle conducts its pink diamond tender of the top forty to £ifty stones produced in a year, for which there is strong competition. Tender stones are displayed in Tokyo, Hong Kong, Geneva, Sydney, London and New York before sale by tender. In 2000, the pink diamond tender consisted of just forty­ seven stones totalling 46 .43 carats, featuring twenty-two diamonds of more than one carat. All lots were sold.

Diamond business history

Until the eighteenth century. India was the only known source of diamonds. Brazil then became the main pro­ ducer when diamonds were discovered in that century in 1726. It was not until the discovery of dianionds in the Kimberley region of South Africa in 1867 that the modern diamond industry was born. In the 18705 and 1880s, there was a frenzied rush to the newly discovered dia­ mond fields. The 'Big Hole' in the Kimberley became (and remains) the largest hand-dug excavation in the world, ceasing production in 1914 after prodUcing 1450566 carats of diamonds from 22.6 million tonnes of ore. Two companies 'emerged from the Kimberley dia­ mond rush: the Kimberley Central Mining Company and the De Beers Mining Company, named after the

De Beers brothers who owned the land before the rush .

In 1888, the two companies merged to create De Beers Consolidated Mines Limited. Single channel marketing developed from this com­ pany, known as the 'London Syndicate' - the precursor to the eso. For most of the twentieth century, De Beers controlled 80-90 per cent of the rough diamonds entering the pipeline (the various selling channels for new diamonds), with its wholly owned or part-owned mines producing more that 50 per cent of the world's total output. The London-based CSO bought other rough diamonds through purchase agreements, having buying offices in rough diamond-producing countries . The remaining 10-20 per cent of rough diamp-hds not controlled by the CSO presented little challenge to the CSO monopoly. Some diamonds in this section of the market were possibly smuggled out of countries such as Angola and the Democratic Republic of Congo to the open diamond market in Antwerp, Belgium. Given the unstable political situation in central Africa, the volume of the region's diamond

CASE 3 0 Argyle Diamonds: where to now?

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in their marketing, which brought them into conflict with the CSO. The entrants' desire to maintain indepen­ dence has been at least partly attributable to the way in which the CSO operates. Far from being a benevolent force in the industry, the CSO has gained a reputation for being heavy handed and ruthless in its dealings with diamond producers.4 It has always vehemently refuted these allegations.

t History of the CSO

The diamond rush in South Africa at the end of the nine­ teenth century resulted in a dramatic increase in the volume of diamonds produced. This increase in output posed a threat to the value of a product that relied on . scarcity to maintain demand, and prices began to fluc­ tuate wildly. Cecil Rhodes, the British colonial statesman and financier, realised that a control system had to be put in place to protect the price of diamonds in the marketplace. He thus merged South Africa's two largest mining companies - De Beers Mining and Kimberley Central Mining - to form De Beers Consolidated Mines.s At the time of Rhodes's death in 1902, De Beers controlled 90 per cent of the worlds gemstone trade in terms of both value and volume. The strategy of De Beers since then has been to hold back diamonds in economic downturns to shore up the price. In the good times, De Beers releases more stones to tal<e advantage of bull markets.6 This strategy was institutionalised in 1934, with the formal establishment of the CSO by Ernest Oppenheimer. The success of the CSO during this period was largely due to the consensus that ·it served the interests of all of the players along the diamond pipeline - the producers, the manufacturers, the whol�alers, the retailers and even the consumers. Beyond its role of maintaining market stability; the CSO was also respon­ sible for instituting an organised, mass marketing campaign to promote . diamond jewellery. The biggest success story from this campaign was Japan, where dia­ mond engagement rings had previously accounted for only 5 per cent of the market - a percentage that had increased dramatically to over 70 per cent by 2000. 1 The CSO's fortunes began to change in the early 1990s, largely due to the break-up of the former Soviet Union.8 The Russian Government consolidated all of its rough diamond production and associated systems into the Alrosa Diamond Mining Company. This cre­ ated a large and important player on the world scene, leading to a loosening of the grip of the CSO. This

change occurred as a result of a downturn in the Russian economy, to which that country responded by dumping its rough diamond stockpile on the market. The large injection of inexpensive product into the dia­ mond pipeline caused De Beers to lose dominance in the lower end of the market.9 The response from the CSO was to lower its prices for rough diamonds - a decision that put it on a collision course with the Argyle Diamonds joint venture, whose major focus at the time was on rough diamond production. Argyle's marketing contract with the CSO was due for renewal in 1996 and Argyle made it known that it would prefer to leave the CSO's distribution system. Argyle had a well-established marketing operation in place, via its Argyle Diamonds sales office in Antwerp, and it was strategically placed to leverage itself into the world market as an independent player. When previ­ ously faced with this type of challenge, the CSO had been able to exert market pressure to bring the pro­ ducers back into line. It was able to do this because it dominated channels and production levels. In this instance, however, the CSO had little control over the lower end of the market where Argyle operated; further, it faced the strength of Argyle's joint venture partner, Rio Tinto, which provided Argyle with an element of support that had been missing in other companies' challenges to the CSO.10 In 1?96, Argyle quit the esO. Within a few months of Argyle's defection, the value of low-quality diamo.nds dropped by one-third.H De Beers suggested that this massive fall in prices would not have occurred if Argyle had remained part of the CSO. This was just the first challenge to the CSO's dorninance, however. Argyle operated primarily in the lower value diamonds market segment, so the CSOs control at the top end of the market was not threatened. A much more serious threat, however, was looming in the form of Russia, Angola and, later, Canada.

� Argyle and the CSO

When Argyle came on stream in 1982, many industry pundits argued that this new and rich diamond ,field posed a serious threat to the De Beers diamonc):'mar­ keting monopoly. Maintaining the artificial price of diamonds required tight control over supply. Stock­ piling diamonds to prevent. a total collapse in prices during periods of weak demand had long been part of the CSO's market strategy. Leakage from Argyle produc­ tion (because not all of Argyle's production was des­ tined for the CSO) had the potential to undermine the

CASE 3 & Argyle Diamonds: where to now?

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eso's Illarketing arrangements, by circumventing its valuation system. 1 2. The eso offers diamonds to its brokers through a sales system known as 'sights', Brokers representing a group of clients farol the distribution channel for the esa. They are not permitted to question the quality, quantity or value of their 'sights'. Either the broker takes all me diamonds offered at the eso's valuation or none.13 Refusal excludes the broker from buying until the next scheduled sales meeting. If substantial quanti­ ties of diamonds were to be released before valuation takes place, then the eso's system of controlling dia­ mond prices would be undermined. This was thus the impetus for the eso to manoeuvre to ensure no rough diamonds from Argyle would enter the market without first being valued.14

-'

..

..

.

".

t How the GSC controls the diamond industry

The eso holds sights ten times per year to divide its latest quota among approved diamond brokers. These brokers place their orders (on behalf of-their clients, me cutters and polishers) in advance; the eso then decides who gets what.15 Once this decision is made, the eso undertakes the quairit process of placing allo­ cations into 'little brown boxes" which the brokers then inspect. The brokers accept or reject the allocation; no negotiation on the price or mix is possible. As noted earlier, rejection of the allocation means the broker is then excluded from the sale until the next meeting.1 6 Through £his market control, the eso constructs and maintains the artificial value of diamonds.17 Dia­ monds are graded against a sample of the thousands of diamonds held by the eso. The esa can vary the com­ position and size of the sample, thus raising or low­ ering the value of a particular type of diamond or the price. These dual levers of market control provide De Beers with the capacity to depress the price paid to diamond producers.1S This ensures that diamond pro­ ducers who want to go it alone would face being squeezed out of the market by the esa, which would simply lower its prices.

t Future of the Gsa

By 2000, the eso's share of the rough diamond market had fallen to a little more than 60 per cent, with the bulk represented by goods extracted from mines in

which De Beers holds a significant share or owns out­

right. The eso's competitors are no longer a disorgan_

ised group of independent companies distributing their production via informal channels. These independents are now largely affiliated with natural resource groups that are larger than De Beers.19 The eso has responded by adjusting its role along the length of the diamond pipeline via its clients, whom the CSO is increasingly involving in the marketing of diamond jewellery down­ stream.20 The eso is also making moves to enter the market directly, as a purveyor of fine jewelle ry. 2 1 The economic downturn in Asia created problems for the CSO, but the new diamond mines in Canada threaten to further dilute the CSO's share of the market. There has also been huge growth in the market for cheap, low-quality diamonds, particularly in the US market. The danger for the CSO is that the downturn in the lower end of the industry may eventually have a knock-on effect at the higher end.22 The Argyle deci­ sion to separate from the eso proved that it is possible to bypass the eso and survive. If the new larger players follow suit, however, then the market will tumble. The saving grace for the eso is the fact that De Beers - via its South African mines and joint ven­ tures in Namibia and Botswana - still controls approxi­ mately 50 per cent of the world's high-end diamond

production.23

Argyle's marketing strategy

Argyle Diamonds produces approximately one-quarter of the world's diamonds, with the majority of produc­ tion entering the lower end of the market.24 From the outset, this has posed a marketing challenge to Argyle. Argyle has continually sought to expand existing mar­ kets and to develop and grow new market segments via innovative marketing strategies such as the company's relationship with the Indian diamond industry and its marketing of its coloured stones, particularly the highly prized pink diamonds.25 The eso's tight control over diamond producers has restricted the independent marketing efforts of many producers, but Argyle is one producer that used the cartel to its advantage. Between 1983 and 1996, most of Argyle's rough diamonds were marketed via two sales agreements with De Beers. The first sales agreement (1983-91) enabled Argyle to establish itself in the

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PART 5 Cases in strategic management

diamond industry, promoting industry and investor confidence in the viability of the mine. It also gave the company time to gain expertise in sorting, valuing and marketing its diamonds.26 This experience gave Argyle the confidence to design and develop marketing sys­ tems that would take it forwards along the diamond pipeline and establish the company's competitive advantage in the marketplace. In the same period, Argyle initiated sales direct to market. This distribution channel, via Argyle Diamond Sales in Antwerp, became the primary outlet for all of Argyle's production in 1996 when the second sales agreement with De Beers ended. Argyle initially devel­ oped this channel because it believed that total reliance on a third party might limit its abi1ito obtain the maximum prices for rough diamonds. 7 Many in the industry regarded this move as risky: but Argyle worked to build product demand, primarily by expanding its involvement in the Indian diamond industry with the establishment of the Indo-Argyle Diamond Council (IADC).28 Currently, the majority of Argyle's customers are Indian-based companies, with approximately 90 per cent of Argyle's rough diamond production destined for this market. 29 The other major marketing focus of Argyle has been on brand and market positioning for its coloured output. This niche market was launched in the late 19805 with a promotional campaign that established the champagrie and cognac (brown) diamond lines. Argyle's coloured diamonds campaign, however, con­ tinues to focus on the rare and much sought-after pink

diamonds.30

Argyle's relationship with the Indian diamond industry

Argyle's relationship with the indian diamond industry began in the early 19805 at a time when India was emerging as an important cutting centre for diamonds and when manufacturers there were anxious for more raw material. The Indian polishers initially found Argyle's diamonds difficult to polish because they had a stressed crystal structure, irregular shapes and etched surfaces.3� Argyle sought to help the polishers overcome these difficulties by assisting polishing factories to pro­ cess its stones. Argyle leveraged this relationship with the Indian cutting industry so as to launch its smaller and mainly coloured diamonds in the diamond and jewellery industry. Argyle's output now represents 10 per

cent of the Indian diamond manufacturing industry - an industry that grew by 200 per cent in volume and 150 per cent in value between 1983 and 2000.32 In 1994, the IADe was established as a targeted, cooperative marketing campaign by Argyle and a group of Indian jewellery manufacturers. Its stated aim was to assist these manufacturers to enter the competitive US market. Some of the lADe's market development initiatives in the United States include market research, promotional activities, sales introductions and also technical assistance.33 These market initiatives, coupled with Argyle's knowledge of the US market and under­ standing of dynamics within the trade34 enabled the IADC to overcome initial US reluctance to purchase diamonds and diamond jewellery that originated from India. In 2000, the lADC program focuser;l on primarily the large national and regional jewellery chains' and mass merchandise departmeQt !1tores.35 ,

Brand differentiation for coloun9d diamonds

Since the mjd-1980s, Argyle has recognised that its brown diamonds - which comprise a Significant per­ centage of Argyle's production - would be difficult to market to retail outlets with6ut a carefully planned strategy. In t.l).e mid-1990s, it launched a marketing campaign that established the champagne and cognac brands. These brands were rated according to a C1-C7 colour scale of increasing amounts of colour.36 This scale and the champagne and cognac brands have since become widely accepted in the industry.

Argyle's coloured diamond marketing strategies, however, revolve around pink diamond production. Argyle is the world's primary producer of pink dia­ monds. Its recovery of these stones, although they rep­ resent only 1 per cent of the mine's total production, is consistent enough to form the foundation of Argyle's coloured diamonds marketing strategy. Argyle's pink diamonds' have provided a unique opportunity to add value to overall production by becoming the mate�al

for which the Argyle mine is best known.37

,/

Argyle further leveraged this opportunity by initio ating special auctions (called tenders) at which it sells its pink diamond output to invitation-only trade clients. The size of these polished pink diamonds averages about one carat. Around 40-50 carats are sold at these auction events each year, with prices achieved typically in excess of US$lOO 000 per carat.38

CASE 3 Argyle Diamonds: where to now?

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Rio Tinto

Rio Tinto is the third-largest mining company in the world, with a market capitalisation of US$24 billion (figure C3.3) and annual earnings of US$1.66 billion in 2001.39 With a corporate office in London, the com­ pany is based on six principal product groups (Iron ore, Energy, Industrial Minerals, Aluminium, Copper, and Diamonds and Gold) and two support divisions (Tech­ nology and Exploration). Within the product groups, each operation has a local management structure and associated support services (Human Resources, Logis­ tics, Information Technology). In Australia, Rio Tinto has fifteen operating mine sites and four processing facilities. Three of the business units have headquarters in Perth.

tRio Tinto's· diamond interests

In 2000, Rio Tinto acquired Ashton Mining, which was the 40 per cent joint venture panner in Argyle. As a result, Rio Tinto gained 100 per cent control of Argyle Diamonds and also access to a range of other diamond mining projects in Angola (SDM) , Indonesia (Cem­ paka) and the Northern Territory in Australia (Merlin), giving Rio TInto access to 25 per cent of the worlds

diamond production by volume. In addition to these

holdings, Rio Tinto has a majority interest in the

Murowa diamond project in Zimbabwe and Canadas

Diavik diamond project (scheduled to begin production ill 2003).

Rio Timo's majority interest in the Diavik mine is set to position Rio Tinto as a m�jor gem diamond producer, while maintaining its position as one of the largest overall diamond producers globaIIy.4o Company litera­ ture predicts that the Diavik mine will have a twenty­ year life and produce 7 million carats of diamonds per year at its peale 'Diavik has one of the highest in-situ values per tonne of any diamond mine in the world, more than twice that of BHPs Ekati mine in the same

region. This high value

  • 5 [carat per) tonne

...

is largely driven by grades of over

in

A154-South, the main pipe , .41

Diavik's importance to Rio Tinto, however. lies in its ability to leverage off the organisational knowledge and processes of Argyle. While Diavik has large reserves of gem quality diamonds, and the majority of Argyles output are rough diamonds of near-gem quality, Argyle has a long-standing, efficient and capable customer base. It also has well-established relationships with dealers, manufacturers and jewellers. Rio Tinto anticipates that the possible overlap between the Diavik and Argyle cus­ tomer bases will greatly assist the successful manufac­ turing and distribution of the gem-quality diamonds from the Diavik project. 42

.

;

US$ billion

iii Figure C3.3: Market capitalisation of the mining sector, 28 September 2001

IIiII Source: Adapted from figure 3.1 in Breaking new ground, Report of the Mining, Minerals and Sustainable Development Project, 2002, p. 59. Reproduced with permission of Earthscan Publications Ltd.

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PART 5 Cases in strategic management

24.

Information from Argyle Diamonds, www.argylediamonds.com.au (accessed November 2002).

25.

Ibid.

26.

Ibid.

2 7.

JE Shigley, J Chapman 6< RK Ellison, 'Discovery and mining of the Argyle diamond deposit, Australia', Gems & Gemology, Spring 2001, pp. 26-41.

28.

Ibid.

29.

Information from Argyle Diamonds, www.argylediamonds.com.au (accessed November 2002).

30.

Ibid ..

31.

Ibid.

32.

Ibid.

33.

Ibid.

34.

Ibid.

35.

Argyle Diamonds 2001, op. cit.

36.

Shigley. Chapman 6< Ellison 2001, op. cit.

37.

Ibid.

.38.

Ibid

,

39.

Rio TInto, Rio Tinto annual report and financial statements 2001, 2001, www.riotinto.comllibrary/reports_PDPsl200C financiaCannualReport.pdf (accessed 23 November 2002).

  • 40. Rio linto, Rio Tinto diamonds: industry review 2002, 2002 WW1Juiotinto.com (accessed 25 November 2002).

'

  • 41. Ibid, p. 16.

  • 42. Ibid.

  • 43. Ibid.

  • 44. Ibid, p. 5.

  • 45. Additional sources used in the preparation of this Case study are: Israel Diamonds, 'A visit to Argyle', 2001, p. 76, http:// web2.infotrac.galegroup.com (accessed 24 November 2002); Argyle Diamonds, Argyle Diamollds stlstainability report 2001:

expanding our /10riZOllS, 2001, www.argylediamonds.com.au (accessed 25 November 2002); M Bazler. P Hancock, A Berry & RJarvis, ContemporalY accounting, 3rd edn, Nelson, Melbourne, 1999; R Goff, 'Aurora borealis in a rock', Forbes, vol. 163, no. 7, 1999, pp. 158-9; C Gooch. 'Is the price of diamonds too high?'. 1998, www.globalpolicy.orglsoceconl tncslangola.htm (accessed 24 November 2002); Mining Technology. www.mining.technology.comlprojectslargylel (accessed 23 November 2002); Rio Tinto, Rio TIntof act sheet series: a world leader ill mining. www.riotinto.com (accessed 26 November �002); M"�uro', 'The dia�19nd wars" Asian Business. vol. 36, no. lO, 2000, pp. 49-51; 'The nature of diamonds - facts about diamonds'. www.sdnhm.orgl exhibitsldiamonds/facts.htmV (accessed 23 Novembcr

2002).

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PART 5 Cases in strategic management