A Conversation with Maxim Shkadov, Director general of Kristall Smolensk

Maxim Shkadov, 37, is the director general of Kristall Smolensk, Russia’s largest polishing factory, president of the Russian Diamond Manufacturers’ Association, and vice president of the International Diamond Manufacturers Association (IDMA). He recently talked with RDR about Kristall and the future of the industry.

Rapaport Diamond Report: Kristall has traditionally been export oriented and only sells 4 percent of its goods in the Russian market, where diamond consumption has been negligible for decades. With the infusion of the oil money into the country, is the domestic market becoming more interesting for Kristall?

Maxim Shkadov: Without any doubt. We are now actively attracting domestic clients. For one thing, the Russian market is growing fast, and though it’s too early to speak about consumption comparable to the international market, the growth trend is promising.

In November 2006, we launched direct sales of polished goods on the internet, and in six months we sold just under $300,000 worth of diamonds. Besides sales, we make use of the internet as an excellent means of information.

We need to form appreciation for diamonds first, because there is little knowledge and consumption culture in the Russian retail market. We have been running a whole program on diamond promotion and education for more than five years, where we aren’t just seeking to advertise our brand, but to form popular appreciation of diamonds.

RDR: Are other Russian diamond companies involved in the promotion campaign, or is Kristall on its own in this crusade?

MS: The understanding of the need for this hasn’t yet fully arrived. ALROSA should be involved in these activities, because they produce the core of the Russian Cut — the Russian rough mined in Yakutia, which is superior to many competitors. It’s a competitive advantage, which needs to be explained, but today we [Kristall] are the ones explaining it. ALROSA is now busy with things other than popularization. But it’ll come. We have a number of agreements with ALROSA in this area.

And of course, the jewelers should take part, too. But they have been reluctant because there is little domestic demand for Russian diamonds, and most sales are in the Indian goods segment. At this point it’s more convenient for jewelers to hold the consumers in the dark, which gives more room for pricing maneuvers.

RDR: Kristall Smolensk has posted quite optimistic results for the first quarter of 2007, with sales 49 percent up year-on-year to $96.9 million. Is the market getting back to normal after a difficult 2006?

MS: After a prolonged crisis, we are finally seeing a fairly active movement in the market, at least in our segment. I’d connect it to the fact that excessive supply in the market that existed for a while has gradually dissipated. In our segment many companies simply left the market, which led to a certain deficit, and we are one of several remaining companies that sell such [large] amounts of premium-class goods. We also recently launched a number of programs, including online sales and processing on commission, which are starting to bring results.

We managed to strike a positive balance in 2006, but it was very difficult. The first nine months were deadly for the whole industry, and many companies left the market. Any more jumps like 2006 may finish the polishing industry altogether.

RDR: What do you see as the biggest challenges for Kristall and other diamond manufacturers today?

MS: From the polishers’ perspective, the main challenge stems from the situation on the market of rough. With the departure of De Beers, we are now living through a very interesting time, when the competitive market of rough is being formed.

Diamond miners who have always had a monopolist mentality are now transitioning to the notion of a competitive market. But unfortunately, the market is going through convulsions, resulting in abrupt speculative price fluctuations, which have had a very negative impact on the market in recent years.

RDR: What would help to overcome this speculative period? What could the consequences be if nothing is done?

MS: In the first place, it’s a transparent policy from the suppliers of rough. As soon as we know the rules of the game, we’ll be able to adapt to them.

This situation, where rough costs more than polished goods, will lead to the decay of the manufacturing potential. We see now that over 50 percent of manufacturing in Israel has been closed down or transferred to other regions, according to the Israel Diamond Manufacturers’ Association [IsDMA] data. But bringing down the cost by transferring production to China or India makes no difference in such situation[s]. There is nothing to be done: The business becomes unprofitable.

Consequently, there is no technology development, no new equipment. You can judge what’s going on in the market by the fact that there has been virtually no new technology introduced in recent years. All this signals the degradation of the industry. So the whole chain is beginning to disintegrate. Sure, the market will stabilize at a certain point, but I’m afraid that many companies might disappear from the market by this time.

And with De Beers — how do you get it to them that this box in polished diamonds costs 5 percent? But you are obliged to buy it because you are a sightholder, and you have to polish it because you need to run production. Maybe it does make sense to shift the responsibility to the sightholders, make them work harder to find new opportunities for making money. But where does this lead?

It’s hard to make a profit in the market where goods are in excessive supply. No matter what marketing initiatives you come up with, the market is price definitive and nobody is going to pay you 20 percent more than the goods are worth.

Everybody’s talking about the diamond 4Cs, yet, the most important “C” is the cost. And the cost can’t be more than the market is ready to pay. The price of the polished goods is market-based now, while it’s unclear how the price of rough is formed. This is probably the biggest problem in the market today.

RDR: Do you think an OPEC-type organization for rough traders could tackle this problem, as you have recently suggested?

MS: I didn’t call for an immediate creation of an OPEC-like body; we all know that cartel agreements are very unpopular now and nobody’s going to go this way. It’s not the issue of creating a controlling body formed after OPEC, but rather that the diamond-producing countries should be monitoring the development of the sector and establishing certain rules.

And this will help to prevent the crazy inflow of big money from India. And what if tomorrow China may want to conquer the market? They certainly have the money to try to do it. We are seeing now how the Chinese are trying to get into the Russian oil trade, and the government is not letting them, and rightly so, because they realize that this may only bring the profits down. Similarly, in the diamond business, say China wants to provide their producers $20 billion credit. They’d all go for the rough and the price would skyrocket, but then this rough wouldn’t go into the market and work as it should. And this is what everyone should understand, and [why they should] play according to the rules.

Look what’s going on in Africa, which produces over 50 percent of the world’s rough. African countries realized that, as diamond miners, they should unite to get the dealership centers transferred to Africa. And one can only admire them for trying to set up their own polishing industry. Of course, they understand that it will take more than a couple of years to put it in place, and they are encouraging sightholders to come and build plants and train local staff. These are very good ideas.

So this isn’t a new idea of mine; it’s something that’s already being implemented. Russia, as the second-biggest diamond-producing country, of course, has the right and the means to have its say in this market.

The question really is about an organization that would understand the rules of the game in the market to eliminate the fluctuations, or at least to forecast them. Previously, it was De Beers job, and they were able to do it for over a century. If we don’t pick up the slack now, the diamond price might sink, which, in turn, would hamper the mining. [In order] not to lose this industry, everyone should pay attention to this and create the rules of the game.

I don’t know what form it would take; perhaps the International Federation of Diamond Bourses or International Diamond Manufacturers Association could perform this function. But I believe the moment is ripe for this, and what’s going on in Africa is telling us that we all need to think about this.

RDR: How supportive of domestic manufacturers is the Russian government?

MS: The diamond manufacturers’ association is getting a lot of support from the Ministry of Finance, the supervising body. Unfortunately, it can’t do everything at once. There are many problems, which everyone understands, but the solution is difficult, as it involves masses of legislation. We need to change the value-added tax (VAT) law and extend the applicability of the president’s decree on diamond imports and exports. That decree abolished export quotas for ALROSA but didn’t do anything for the manufacturers, although we had submitted our suggestions. Russian manufacturers still face restrictions in the international market.

On one hand, we are being put into the free-market conditions: ALROSA should work without quotas, go out into the international market and work at the world prices. Nobody’s denying it. We, too, are ready to work in the international market at world prices, but, please, give us equal conditions with Israeli or Belgian industries. Otherwise, we won’t be competitive with them, especially in procurement of rough. So there is understanding of these issues at the state level, and the work is being done; it’s just that the process is protracted.

RDR: What’s in the plans for Kristall?

MS: Our marketing department is actively seeking new directions and we are developing the domestic market. We are quite active in the Middle East. Southeastern Asia has growing importance for us. Of course, we are expecting serious potential from China. We are now exploring our options in Africa, where we see many opportunities. So we are watching all potential sources of rough, although ALROSA certainly remains our priority supplier because our brand is based on Russian-mined diamonds.

by Maria Kolesnikova