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ALROSA Sales: New Rules for a New Contract Period? - Review

28 december 2012

Three years ago, ALROSA changed its distribution system in a radical way moving from auctions to long-term contracts, Finmarket says in an article posted on www.finmarket.ru. December 2012 is a period used by the diamond miner to sum up "intermediate results" attained by the company, since it is a month when its three-year post-crisis contracts expire.

Now ALROSA is making out a list of long-term customers for a new contract period. In parallel, the company continues its efforts to improve the distribution system, which may bring about significant changes.

NEW CLIENTS

As of autumn 2012, ALROSA had 36 long-term contracts with foreign and Russian clients. They accounted for 60% to 70% of the total sales generated by the company.

"We are busily working to approve the list of customers for the new contract period, which we hope to complete by the start of the next year, so that no-one had a break in business activities. Of course, this list will undergo some changes and there will be some new customers," Vladlen Nogovitsyn, the head of ALROSA’s Customer Policy, told Interfax.

ALROSA is interested in increasing the proportion of customers who have their own diamond manufacturing facilities and even better - making final goods, jewelry, he said. Within this framework, at the end of the year ALROSA entered into new long-term contracts with two major jewelry brands - Tiffany and Chinese Chow Tai Fook, and also extended its contract with Rosy Blue.  

"Their production is continuous, so that they are financially stable. Moreover, jewelry companies are less affected by crisis, because the volatility of polished prices is much less than that of rough prices. Cooperation with such companies is our guarantee of stable operation, and the crisis period was a dramatic proof to this effect," Vladlen Nogovitsyn said.

He notes that such customers need a high-quality range of goods and they are willing to pay for it more compared with average market prices. "They are attracted by the quality of our diamonds, continued access to rough and lack of harsh price volatility. In other words, we always provide them with the same range of goods in their boxes, which they buy, and for that stability they are willing to pay more. Working with these companies allows us to accurately track trends and understand the real value of our rough," he said.

It turns out that by increasing the share of high-quality rough sold to jewelers the company can increase its revenue. Consequently, ALROSA is interested in this particular scenario.

Another advantage of clients with a vertically integrated production chain is the fact that they do not create distribution channels competing with ALROSA. "They are the final consumers of our rough diamonds which will not be re-sold after they find their way to them," Vladlen Nogovitsyn said.

DOMESTIC MARKET

The eight Russian companies having long-term agreements with ALROSA generate about 25% of the miner’s revenue. Unlike many foreign partners declaring their readiness to increase purchases, Russian customers, as a rule, tend to complain about too much rough coming from ALROSA and are also grumbling at high prices.

Historically, customers operating in the domestic market appear to be major consumers of large-size gem-quality rough produced by ALROSA. "The Russian Cut manufacturing system always used to work with a certain range of diamond goods. These were large stones of gem quality, which set the standard for the Russian Cut,” Sergei Goryainov, an expert of Rough&Polished, explains. “As I understand it, when discussing the range of supplied goods Russian manufacturers continue to choose the very best of rough."

"The Russian Cut manufacturing system, indeed, works primarily with large-size high-quality rough," Vladlen Nogovitsyn confirms. This is due to the current state of technological base and the high cost of labor (compared, say, to India, which has traditionally specialized in cutting small diamonds). "And this is seen even on the level of mental idiosyncrasies. It is rather hard to get someone work with stones having the size of one millimeter by one millimeter, sort them and make polished diamonds of such rough," Vladlen Nogovitsyn said.

"Some difference in the product range is there, but you cannot call it preferences, as any rough has a price, and sometimes using lower quality rough one can earn more," said the representative of one of the Russian long-term customers of ALROSA. According to him, high quality goods are not a guarantee of profit per se. "This is the difference dictated by the specifics of the Russian market, where there is no one able to work effectively with “Indian goods.” What is different about it is that compared to the export market Russian manufacturers have a preference in prices, which compensates for the export customs duty (6.5%)," Interfax’s interlocutor said.

In theory, ALROSA’s desire to expand trade with clients, who have their own jewelry production, may affect the interests of companies operating in the domestic market. The amount of large-size gem-quality goods in the miner’s total output is not that great, and the company will need to think how to distribute this rough among all customers.

There is another problem relating to the supply of domestic market. To maintain a positive margin in their business Russian diamond manufacturers often turn to re-selling their rough. According to some manufacturers based in Russia, they re-sell, as a rule, those parts of their boxes that are seen unviable to be cut at Russian factories (a box contains a set of stones of varying quality). But occasionally there is information coming from the market that Russian manufacturers are selling gem-quality stones.

"Strictly speaking, rough re-selling is a normal part of the activity of any diamond cutter,” says Sergey Goryainov. “However, Russian diamond manufacturers consume only a special assortment of diamonds and still they re-sell such diamonds in the market. It means that ALROSA is losing some part of its profits, because it could sell this kind of rough at its own discretion. On the other hand, because of this the miner cannot increase the supply of gem-quality rough to foreign companies, since it has been contracted to the Russian market. This is causing confusion among foreign customers."

"Probably, ALROSA has to somehow optimize its sales so that rough is distributed evenly and on a clear competitive footing," Sergey Goryainov believes.

IS EQUALITY DANGEROUS?

Now, when defining its sales policy ALROSA relies on the Regulations on the Procedure and Terms for the Sale of Natural Diamonds. The company adopted this document last summer, and its development lasted for almost two years under the supervision of the Federal Antimonopoly Service (FAS) of Russia, which found it necessary to develop unified non-discriminatory rules for customer access to rough.

"The Regulation approved by the FAS contains one fundamental rule – to harmonize the requirements to each client,” Vladlen Nogovitsyn said. “Russia is a member of the WTO, and a Russian company has to work on equal terms with customers from all other countries, including those operating in the diamond market."

Among the principles of non-discriminatory access to rough the Regulation cites the application of uniform criteria to selecting customers, equal access to rough, unified sorting procedures and "a unified procedure for making up standard boxes of rough independently of shipment routes, as well as compliance with the standard requirements for the assortment of similar boxes."

Vladlen Nogovitsyn noted that by the level of competitiveness Russian diamantaires are now keeping abreast with foreign manufacturers, and an equal approach cannot hurt them. "Russian companies are quite competitive,” Vladlen Nogovitsyn said. “And some businesses Yakutia, for example, are on a par with foreign diamond cutters. In manufacturing and diamond jewelry making in Russia there are companies that venture into a niche of goods worth about $ 1 500 – these are high-quality, expensive goods. Turning out exclusive products, they re-sell some part of their goods. In other words, they work like any foreign company, combining diamond manufacturing with trading operations."

The FAS itself does not exclude that some "business practices" favorable for the Russian market have been always there, said Andrei Tsyganov, the deputy head of the antimonopoly service. But with the adoption of the Regulation the Russian clients of ALROSA are not expected to be hurt - according to the FAS, the balance will be provided by the current Regulation, the auction system and Gokhran’s right of the "first night" for the best gems. Moreover, ALROSA’s Russian customers have a natural advantage - they can get acquainted with the contents of boxes faster than others, Andrei Tsyganov said.

Since the publication of the Regulation the FAS did not receive any consumer complaints about the terms of access to rough diamonds, the FAS deputy head stressed.

Russian manufacturers are cautiously evaluating the implications of the Regulation put into effect. If the Russian market will be flooded with large amounts of small-size rough, it will not be bought by Russian customers, said a representative of one of the Russian long-term customers of ALROSA. "It is easier then to buy rough in Belgium or Israel. But I think that things will not go that far until there are at least some manufacturers left in the Russian market," he said.

In turn, Vladlen Nogovitsyn also noted that the criterion in the Regulation which requires making up unified boxes does not mean that the assortment for Russian buyers will be drastically changed already in the next contract period.

FROM LIMIT TO NO LIMIT

While compiling the list of new customers, ALROSA will take into account, in particular, how customers bought rough diamonds when the market was bad. This rule is also spelled out in the Regulations on Sales. "This will be one of the main criteria for decision-making. If a customer bought less, in this case his share will respectively be smaller, and if you bought more, then you will get more," Vladlen Nogovitsyn said.

The opportunity to "buy less" was given by ALROSA to its customers in times of crisis by using selection based on keeping up with the limits set by the miner. ALROSA’s clients may not buy the whole monthly amount of rough earmarked for each consumer, but they must fit within the set limit. ALROSA may adjust this minimum purchase amount every month. For example, last August the limit was 60% of the contracted amount (the remaining 40% is the so-called "free part" which one may refuse to buy). From September to November, when the diamond market witnessed cooling demand, ALROSA raised the limit from 60% to 90%. In December, the limit was again set at 90%, said one of the ALROSA customers.

As a rule, the company's customers tend to exercise their "right to refuse " and acquire no more than what ALROSA deems obligatory, as Interfax was told at different times by the representatives of the Smolensk-based Kristall, Ruiz Diamonds and Rosy Blue, one of the largest India's long-term customers of ALROSA.

"Selection based on keeping up with the set limit is introduced in order to avoid the definition describing the "breach of contract obligations," says Vladlen Nogovitsyn. “Customers have certain contract obligations which they signed and are expected to fulfill. But at a time when the market was difficult, we evaluated the actual situation and did our best not to let our customers to come to the line, which would mean not only the rupture of agreement, but for someone, even bankruptcy."

In the next contract period, ALROSA plans to give up the selection based on keeping up with set limits and change the interaction pattern. The contract will prescribe a minimum amount of rough, the acquisition of which will be mandatory, said the head of ALROSA’s Customer Policy Department. "In addition to this amount the miner may offer some rough, which will be defined by a supplemental agreement to the contract. This supplement will be without strict obligations on our part and on the part of the client and will no longer mean breaking the contract in the event of non-performance."

EXPERTISE OF DE BEERS

There are only two diamond giants in the world, and although since 2005 the European Commission has been carefully watching that they do not cooperate, it is not surprising that ALROSA and De Beers are using similar methods in the field of marketing. Thus, the system of long-term contracts practiced by ALROSA is an analog of the sightholder system maintained by De Beers. Once setting out to sea to sail on its own after severing relations with De Beers, ALROSA placed its stake on competitive sales. De Beers was wary of this type of sales, but subsequently adopted the pattern, in fact, learning from ALROSA’s experience. Now once again it is the turn of De Beers to share their expertise.

In the new contract period, ALROSA decided to adopt the expertise of its competitor using the Intention to Offer (ITO) system, in which customers apply for necessary amounts of rough. If the market is positive, De Beers usually satisfies these requests by 50% to 60%. But in periods when the market is weak and the miner has large stocks, De Beers sells full amounts of rough to its customers. ALROSA will use a similar pattern, Vladlen Nogovitsyn explains: "If we accumulate a certain amount of rough or if this will occur due to irregularities in production, we will be able to offer this amount of rough to customers within the same month."

In addition, ALROSA will upgrade clients most active in competitive sales to the rank of long-term customers. "We have always resorted to this practice, but now such an opportunity is fixed in the Regulation," Vladlen Nogovitsyn said.

DOWN WITH DELAYS

ALROSA’s sales system has its own "bottlenecks" to be removed to make interaction more paying and convenient for customers. The more so, because some of the customers of ALROSA happen to be also sightholders of De Beers.

"The claims that customers have to ALROSA are not only centered on the lack of certain categories of goods, but also include too long terms of rough deliveries,” Sergey Goryainov said. “Now the system is designed so that customers get their diamonds at best in 2 weeks after signing the contract, although with De Beers this period, for example, does not exceed 3 days."

Such delays do occur and today they are caused by mandatory state control, explains Vladlen Nogovitsyn. State controllers must check the sorting of diamonds to be exported and endorse shipment documents which often takes time. By the end of the year, when the United Selling Organization of ALROSA is pressing to boost the performance of contracts, this results in a “bottleneck” because government officials do not have enough time to execute documents. This slows down decision-making in business and money circulation because clients are using borrowed funds, Vladlen Nogovitsyn complains.

The two-week delay allowed by ALROSA in shipments is extremely inconvenient for customers, as Interfax was told by Isi Morsel, CEO of Dali Diamonds, which was one of the long-term customers of the Russian monopoly. He hopes that ALROSA will be able to settle the matter as far as the alleviation of state control is concerned, which will make shipping faster.

Chaim Pluczenik heading Pluczenik Diamond Company confirms that delays in shipment of goods by ALROSA do occur and notes that sometimes it can take up to four weeks, "whereas, for example, DTC goods are always shipped the next day." "Specifically, our company does not have problems with financing. But as far as I know, the banks, which are financing the diamond business, have a negative attitude to the fact that shipments do not come in time," he said.

Usually, if the state control service is not overloaded by issuing documents for a large number of export contracts, the interval between the transfer of money under a sales contract and the shipment of goods takes about 5 working days, said Ashot Badalyan, the Moscow-based representative of Rosy Blue. "Of course, there are times, and on several occasions we faced such situations, when the state control service delayed the shipment of goods for up to 10 days due to congestion and the need to check each export consignment," he said. According to Ashot Badalyan, the state control service could spot-check export consignments, which would eliminate unnecessary delays.

AUTOMATIC SORTING

To improve the sorting procedure is another field where ALROSA may enhance its performance.

"Our system of preparing goods is different from what it is in Western companies,” Vladlen Nogovitsyn said. “There is now a need for better sorting of our diamonds. For a long time here it was cheaper to hire more workers than to develop sorting devices. As a result, we are currently sorting all the rough diamonds larger than three grainers (0.75 ct.) Smaller gems are graded only under the aggregated nomenclature, and rough prices within this range may differ to a large extent."

ALROSA has attracted a number of specialized companies and plans to start operating sorting machines by the end of next year. Their prototypes have already been made.

"Sorting is a very complex process. There are times when even an experienced diamond grader once again working with the same rough gives a different price. If automated devices will be introduced, such kind of errors will be excluded. That is, if there will be an error, it will be systematic and it will be much easier to fix it. This does not mean that now diamond graders are not needed – the point is that now we can do a deeper sorting. Automation will simplify putting together standard boxes," the head of ALROSA’s Client Policy Department said.

STEP TOWARD PUBLICITY

ALROSA has many questions raised on the eve of the new contract period. Will it be possible to find a balance between the desire to maximize the company’s profit and the interests of the diamond cutting industry? Will some of the "old" customers leave? In what way will the supplies to current customers be changed? Will the innovations introduced into the sales mechanisms be effective? Only time is able to give answers to these questions.

The new list of long-term customers will be completed by the start of 2013. ALROSA promises to post the list of customers on the recently launched online sales website. Such kind of publicity is in itself an achievement - until recently, this list was not known to the general public, as in fact was the case with the terms contained in contracts.