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Interview with Maxim Shkadov by Vladimir Kulakov and John Helmer

The 36-year old Kristall Production Corporation is one of the world’s leading producers of polished diamonds, and Russia’s biggest. It remains 100% state owned under the supervision of the federal Ministry of Finance, and is headquartered at Smolensk, where it cuts and polishes diamonds, before distributing them for sale across the world. The sales network for Kristall’s stones covers the major diamond markets – Antwerp, Hong Kong, New York, and Dubai. Maxim Shkadov is the chief executive. On a visit to Smolensk after an interval of fifteen years –the first visit was in 1994, when Alexander Skhadov, Maxim’s father, was the CEO – this interview is the most detailed public assessment of how the Russian diamond industry has fared during the global collapse of demand.

 

Impact of crisis

Q: Your 2007 revenues were $404 million, a record. What was the 2008 total? What do you expect the 2009 figure to be?

Shkadov: The crisis that started in the middle of 2008 upset all plans, and therefore our sales last year totaled $280 million. Speaking of 2009, we are likely to surpass the sum of $200 million, but it is difficult to give an exact figure right now. You can call this year a survival year. For 2010 we set the bar at $220 million to $240 million.

Q: In terms of the overall value of the Russian diamond manufacturing market, what were the main market shares in 2007, 2008, 2009? How has the crisis affected your competitors, the foreign joint ventures?

Shkadov: There were several big and small players on the market in 2007, and Kristall’s share was in the range of 35% to 45%. If we take the whole Smolensk association, its share was about 50%. The polishing market was mostly represented by companies other than Kristall, by the Yakutian group, and the Moscow group. There are generally three centres — Smolensk, Yakutia [Sakha] and Moscow. But among them, unfortunately, there are very few Russian companies. The crisis has swept many companies from the market, and today you can say that the only fully-fledged operating Russian diamond manufacturer is Kristall of Smolensk; all the other enterprises are either partly operating or in stand-by condition. This was caused by the collapse of the market of finished goods. What the situation will be when we exit from the crisis will, among other things, depend on Alrosa’s selling policy as the monopoly supplier of rough diamonds. If foreign companies that hold joint ventures in Russia are given the opportunity to buy rough and export it, then nobody else will stay here, because polishing conditions in Russia are not attractive for investors, and today it is next to impossible to compete with rivals like China, India and Israel.

Q: How many cutters did you have in 2007? How many now?

Shkadov: We have been gradually decreasing the number of employees since 2005. This is mainly because we shifted to a generally bigger average carat weight for the diamonds we cut. For us the optimal number is 2,100 to 2,200 cutters — this is how many we have today. But around the year 2000 the maximum number of specialists we had was 3,000.

Q: What have been your sales to the state stockpile agency Gokhran this year?

Shkadov: I won’t tell you the exact sum, but it is about 50% of our production.

Q: What commercial sales inside Russia, what exports?

Shkadov: The percentage hasn’t changed too much — we sell about 3% to 5% on the home market. In the future we plan to broaden this sector. It won’t be easy, but we have good potential for this. We actively sell through our online shop, for example. Our over the counter sales volumes grow as well.

Q: What are the signs of recovery in demand, in the price of polished diamonds?

Shkadov: If we speak about state support, we managed to keep demand at the necessary level. The state showed itself as an effective proprietor. There still are many problems to solve. When survival of the branch was in question, the state’s help was timely and up to the mark.

Q: The financial crisis has seen quite a few sightholders [accredited diamond buyers] withdraw from manufacturing in Russia — what has been the consequence of this for Kristall, and do you expect this to continue in the foreseeable future?

Shkadov: It would be incorrect to view Russia separately from the rest of the market, because the crisis has affected diamond industry players and sightholders across the whole world. Certainly, Russia experienced the crisis in all respects, as well. We managed to keep the major part of our client base, but the sales level slumped seriously. But while immediately after the crisis began, the sale indicator dropped by 90%, now it has grown back by 50%. The shock has passed, but unfortunately it is still too early to say that the market is reviving. We cannot observe real transactions, real motion on the market today. What we can observe are speculative games and pseudo-investments in the rough market; they do not depend on the concrete situation in the market of finished diamonds. We could observe that the crisis was arriving — what aggravated it was the Indian bubble, and it burst. Today the Indian government makes investments into the sector from time to time to keep the fire burning.

If earlier De Beers as a transnational cartel had the policy of controlling diamonds from extraction to sales of polished, and the demand regulated the supply, then since 2000 a new team came to De Beers and asnnounced that henceforth everything should be controlled by the market. You understand that diamonds are not an average type of market goods with definable consumer characteristics. Diamonds are purchased emotionally, and that’s why their value should be always require support. Diamonds cannot be an object for speculation, for exchange trading. But, unfortunately, the new market specialists came with new ideas, and as a result the market skewed. Rough lost connection with polished; a pyramid formed; and that pyramid had a sad fate.

Q: What are the lessons for you from this past year?

Shkadov: I’d say we have gained positive experience from the crisis. The market was cleansed of players who were striving to earn fast and easy money in speculative operations. There are companies which have been building their business for dozens of years, who organised their own production, and opened their own sales branches worldwide, who have their own collections of jewelry. This is real business. And there are companies which use all possible ways to get to the source of rough to carry out a fast speculation, and disappear. Unfortunately, the companies that mine and sell diamonds are now beginning to play such games as well. The crisis is a lesson for them, first of all, to carefully observe the market situation. Although mining companies have high profitability, they exist thanks to large-scale capital investments; they take big credits; and when the market suddenly collapsed and demand disappeared, this means there was something wrong with their policy. This crisis could have been avoided. If we take Alrosa in 2008 as an example, we can see that chief executive Sergei Vybornov thought he understood the market, while in fact he didn’t; he was doing what he wanted. He got used to speculation, and he decided to use that model for diamonds, which was an absolutely wrong step. In June of last year, he raised the priced by 25%, and in September the market came to a grinding halt. He chose absolutely the wrong moment.
 

Geography of sales markets


Q: What is the proportion of your sales in the various markets – US, Japan, China, Russia, Middle East, India, other Europe, and what is the outlook in each?

Shkadov: The market should be viewed a bit differently. The USA is the biggest consumer market. Japan is number two. South-East Asia is number three, and so on. But in our business dealer centres are located in four major spots: Hong Kong, Tel Aviv, Antwerp and New York. Now we have one more emerging centre, Dubai. Our network is organised so that most sales are carried out through these centres. Today companies of the whole world use those markets which suit them most. Dubai is currently an off-shore location, where a lot of diamonds are bought and sold. Before the crisis the proportion was the following. 40% of our production was going to the North American market; about 35% was going to Japan and South-East Asia, and another 25% went to the Middle East and Europe. Now this proportion has changed, because the American market has contracted, and the most dynamic market today is South-East Asia, mostly thanks to China. However it’s difficult to speak about the market in general, because the trends haven’t formed yet. We sell our production at all the ready markets, but certainly the volumes are not that big. Also, you should consider that consumers at different markets have different preferences — and what sells in America won’t sell in South-East Asia. For example, the Chinese will never buy stones with black inclusions.

Q: How has this changed since 2000?

Shkadov: I can’t say that the geography has changed too much. What I can say is that we arrived in the new Middle East market – the Arab countries are buying very actively.

Q: How do you see your relationships with China developing over the next few years?

Shkadov: We have our own sales company in Hong Kong for 15 years already, Smolensk Asia – this is our subsidiary and it covers all of the southeast Asian markets. It has an affiliate at the Shanghai exchange, and trading there has been very active lately. China is a market with a constantly growing potential; everyone looks at it with hope, but the local law does not allow for a faster growth. There are a lot of blocking measures which do not let the market develop at full force. China in general is a big polishing and diamond sales centre. Recently, the Chinese government began to stimulate demand, and the market players immediately felt it. The future evidently belongs to China, and we keep our finger on the pulse. China is interested in high-quality diamond production, and we supply it. We can see good potential for us there.

Q: What business do you do in Africa – especially in Botswana, Namibia, South Africa – and what prospects do you see there for the future?

Shkadov: For a while in the past we had experience of working with African countries, but currently we don’t cooperate with Namibia, Botswana, Angola or South Africa. In the past, we had a branch there for purchasing rough, but our experience could not be called a success. In addition, the legal base changed in South Africa — it is mostly protective for their consumers, which is certainly good for them, but it turned out for us to be more difficult to buy rough there, although we regularly participated in diamond tenders and cooperated with South African companies. Now everything has changed. Those companies now have offices in Antwerp and Dubai, so you can say that we indirectly work with African material everywhere through diamond market centres like Antwerp, Dubai and Tel-Aviv.

Q: How do you expect this may change in the next two to five years?

Shkadov: I’m sure that in the future our relations with Africa will develop. African countries supply a considerable amount of rough to the market, and they are capable of influencing it, so obviously we will have mutual interests. Although our major sources of rough are in Russia, we can use any material. Everything we buy we use for polishing; we don’t speculate. As soon as those countries develop stable selling structures working on normal market conditions, then we will be ready to cooperate. Namibia and Botswana are countries working exclusively with DeBeers, and South Africa mostly sells to DeBeers, too. Angola still cannot choose which is better, DeBeers or Russia, I mean Alrosa.
 

Make, cut, and changes in the nature of the polished output

Q: What is the distribution of your output by carat size. For example, in 1994, 90% of your production was of diamonds that were less than 1 carat.

Shkadov: Today the most popular are stones of up to 0.30 ct; another traditional range is 1-1.5 ct. The market of big-size stones was affected by speculation most of all; I mean stones of 3 ct and bigger. As a result of speculation, rough became very expensive, and consequently polished grew in price as well, and demand for this assortment decreased considerably. In 1994 the median size was 0.11 ct, and by 2007 it had grown to 0.30 ct. From 1994 to 2007 the share of stones bigger than 1 ct grew from 10% to 45%. Because of India, the range of small stones began to grow in price, at least twofold since 1994; and production of this range at our enterprise became unprofitable. Moreover, our methods, technologies and way of treatment developed as we shifted to more expensive rough.

Q: What have been the main changes in the way you organize production in the plant since 1994?

Shkadov: There have been fundamental changes in technology. For example today 99% of sawing operations are done with lasers. We have developed and introduced new machines for rough and preliminary finishing that operate automatically or semi-automatically. Since 2005 we have been actively rearranging production for specialised treatment of different sorts of stones. The task has been to reach maximum effectiveness for each and every specialist. If a specialist is most skilled to make Princess cut of 0.30 ct, he will make only that kind of stone. Such a division of labour is more profitable for both the enterprise and the specialists. Today production is flexible and market-oriented. The crisis showed us that this was the right path to take. Computerisation lets us manage the whole process in two and half hours. The formula of rough choice is smart and simple. The sum of money received from sales is divided by the required carat size and we get the average or median price of rough we need to buy. Today this price is half as much as it was before the crisis, and we have had to shift to smaller sizes. That’s how it works.

Q: With the state of the art technology, what yield do you estimate for each rough stone, on average, if the standard estimate is that below a yield of 45%, the cutting may be unprofitable?

Shkadov: In 1994 our yield was around 39% to 40%. It hasn’t changed much, but now it’s about 42 to 42.5%. When you increase the yield, you worsen the quality of the cut and make of the stone, so this indicator is not the most important one.

Q: What changes does the market demand for your portfolio of shapes? What changes have you noticed in demand for colour, shapes?

Shkadov: Before 2008 there was a wave of popularity of fancy diamonds, princesses and Asscher-cuts. Now it’s difficult to predict new trends. We traditionally sell round stones. It’s our classic shape.
 

Faberge’s new marketing model

Q: In September, as you know, Faberge, now owned by South African Brian Gilbertson, launched its new diamond jewelry line, with a new marketing model for this type of luxury stones. Buyers use website access, rather than retail shops; they also buy stones as rough and commission Faberge to make up articles according to design models. What has been the market reception of this new marketing model for high-end diamond jewellery?

Shkadov: Well, I doubt that there is much demand for rough on the consumer market, but certainly companies try to meet consumer interests, and provide maximum service for them. Today, Kristall also lets consumers choose the stone and the model they like, and to purchase ready-made jewelry via the internet. So what Faberge does today, I believe, is absolutely right. The brand name is good, and the quality should be equally good. Some European companies sell Russian diamonds, but prefer not to mention it fearing that would ruin their individuality. We have been working with Harry Winston, Tiffany, Cartier, Van Cleef and others. But before our diamonds reach the client, they pass through a series of buyers and sellers, intermediaries.

Q: Branding diamonds – what has Kristall done to market its brand-name in the market?

Shkadov: Certainly, Kristall is a brand name, but currently only at the B to B market. It was not too long ago that we entered the B to C market, but exclusively in Russia. It is our next step to work on the international level. But you should remember that the crisis upset many plans. We used our brand name when selling diamonds in America, but heavy competition and the crisis made us abandon that idea simply not to spoil the name. The biggest rival was India, and together with the market circumstances, it became impossible for us to work there. As a result, about 1,500 companies in all have now left the US market. There was also the issue of controlling and financing the whole diamond pipeline from mining of rough to selling the finished product to the consumer. There isn’t a single company in the world that could do that. Before the crisis De Beers tried to destroy the dealer segment, and now you can observe that the plan didn’t work. Dealers are a necessary part of the market. The merchandise they keep in their stores does not even belong to them — they exist thanks to orders and pre-orders. That’s how the market works.

Q: What do you think Russian buyers want in terms of diamond brand?

Shkadov: High quality, first of all. Honesty, and guaranteed genuine diamond production equal to the money they pay. Unfortunately, in Russia compulsory certification of diamond production does not exist. And this gives jewelers a set of loopholes to exploit. In America, for example, this is impossible. Not a single shop will buy a stone without a certificate given by laboratories. If you offer such a procedure to our jewelers, they will destroy you. Certificates cost nothing in comparison with the price of production, and the price won’t grow if you certify diamonds, so cost here is not the issue. We have a certification laboratory here in Smolensk, but only Kristall certifies its production there.
 

Geography of sourcing for rough

Q: There are many complaints about Alrosa’s pricing of rough diamonds for the manufacturers. Can you say what these were during the time Vybornov was chief executive between 2007 and 2009?

Shkadov: The problem is that Alrosa’s policy at that point was no policy at all. As to his methods, he was using shock tactics at the market, and you know what the results were. You can comment on a policy by a specialist, but when a person acts willfully, without considering what he was doing, you can’t comment on that kind of policy.

Q: What negotiations have you held with Fyodor Andreyev, the new CEO of Alrosa, and Yury Okoyomov, the new head of sales, since they took over in July?

Shkadov: I have known Fyodor Andreyev for a long time; we met when he was working for a different company, and his nomination to the presidential post at Alrosa was very positive news for me. The first order he gave as president was to resume sales, because sales are what Vybornov had prohibited. A company working without commercial activity is nonsense. With Okoyomov we have been working for a long time, since the days when he was heading the Yakutian sales branch of Alrosa. Both of them are professionals, who understand the way the marketplace works, and the diamond market in particular. For us it is certainly very easy to find common ground with them, and we quickly renewed our cooperation with them after they took office. We had an agreement, and it began to operate again. We set the parameters of supply together.

Q: What changes do you expect to see in Alrosa’s pricing in relation to the international benchmarks?

Shkadov: I believe those changes must be based on market conditions, and any company which feels that demand is on the rise will lift prices. This is a natural process. Now the changes in Alrosa’s policy will be balanced and conservative. If there is no real demand for the finished goods, agitation of prices for rough will be a temporary phenomenon. Prices, assortment, volume of sales will be chosen rationally.

Q: What proportion of your rough were you importing from outside Russia last year – from what sources, including De Beers?

Shkadov: For over three years we have been importing 10% of our total supply requirement. Recently we were importing more, because of Vybornov’s policy, and Alrosa’s refusal to sell its production. For half a year we have had to rely on imported stones, so I’m reluctant to give the statistics.

Q: How will Kristall address supply shortages going forward?

Shkadov: As of today we don’t have any supply shortages. Our basic supplier is Alrosa, and now we have definite agreements with them. We have had shortage problems before, but we solved them.

Q: How do you account for the fact that at the moment prices of polished are lagging behind the growth in prices of rough?

Shkadov: I wouldn’t say there is a clear-cut trend. I believe polished reached the bottom and stopped there, and perhaps then rose slightly. Meanwhile, the prices for rough had slumped by 30% to 50%. So what we see now is a correction by several percent upwards, but this cannot be called serious growth. This does affect Kristall, too, because the situation isn’t a normal one for thediamond market. If the price of polished remains low while the price for rough goes up, then it is because of speculation on price movement, not a reflection of underlying consumer demand and sales prospects. These are trader games, nothing else. Rough can find no other application but cutting. This is common sense. If rough is used for financial speculation, this is very risky.

Q: What is your policy toward participating in international tender sales of rough – such as the Letseng (South Africa) tender? How do you choose which to participate in, which to miss?

Shkadov: We always participate. We are interested in almost all types of tenders, and we win many of them. In the beginning you have to run a risk, then your experience shows you what to do. It is obvious that the first time is always risky. You have to be cautious, you have to be observant. Then you develop a concept or plan for this or that source. That’s the way we started to buy from Lesotho. Their rough is constantly appearing at the market, and for today its characteristics are especially valuable.
 

The future

Q: what is the likelihood of restructuring of the state corporation, conversion of Kristall to a shareholding company, and to privatization?

Shkadov: In point of fact, we are now a shareholding with 100% shares belonging to the state. The company will not be privatised. It is on the list of strategic state enterprises precluding this. No changes are being planned.

Q: What do you see as the prospects for foreign investment in the Russian diamond manufacturing sector? There have been many attempts by the Indians – what results?

Shkadov: All investments by Indian companies will lead to a) deterioration of our quality and b) these investments will only favour our competitors. All these so-called investors want is just to get to the Russian source of rough; they need nothing else. Having one million cutters in India, they would destroy everything here. That’s why we will never have Indian manufacturing investment here. We would like to work with investors on terms of cooperation in production. Those investors who understand the specifics of our process and would like to work with us are most welcome. But if investors want to use us as a conduit for rough, this is not what we do.

Q: What is the future for the former Soviet diamond manufacturers – in Armenia, Belarus, Ukraine?

Shkadov: They have a difficult future, indeed. Without state support they will not survive, because the heavy burden of competition, together with the Indian state policy in this sector, doesn’t allow these countries to contemplate an especially positive perspective for them. Their priority task is to cooperate with Russia. But you see what is going on with the Ukrainian and Belorussian politics. One day we are friends; another day we are not. We have stable relations only with Armenia. Before the crisis, they had good momentum. Armenia has good potential and good cutters. The only problem is how to organise sales now, after the crisis.

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