September 7, 2009, Alexander Saveliev, president & CEO of TOPSERVICE, gives an exclusive interview to the "FINANCE" magazine
In what way has the crisis affected the industry?
- I would define this 400-500 million dollar industry as day-to-day goods in the category of electric appliances. And the industry is still strong. The crisis has affected it, no doubt but to a lesser degree than some other sectors of the economy where there was a 50% decrease of demand or even more. As for energy saving lamps, demand has fallen by about 15% when the sales of batteries maintain a similar level.
Why is that?
- Well, there is a rearrangement of demand from expensive goods to cheaper ones. Consumers pay more attention not to the brand but to the quality-price ratio. As far as I know, Duracell has got a significant recession in demand of their products while we have not. The Duracell Ultra batteries are two times more expensive than ours under our brand "Kosmos". It can be assumed that consumers prefer to buy cheaper goods but of the same quality as Duracell’s. What is more, “Kosmos” alkaline products are becoming more and more popular among customers. The segment of zinc-carbon batteries is of extremely high demand and the all imported products of that type are always sold in full. There is no production of batteries in the Russian Federation and the 99% of them are produced in China. Unfortunately the importers happened not to be prepared for a dramatic change in demand. The same situation is in the field of electric lamps. Relatively expensive brands as Osram and Philips have shown a rather big drop in sales while the cheaper ones are sold more successfully.
Has the crisis severely affected the company?
- Yes, "Topservice" was significantly loaned up. I wouldn’t like to come up with any numbers. The problem has been solved and the situation has been stabilized as we have agreed with the creditors to refinance the debts. In addition, we had to cut our staff more than twice. As a result of this the efficiency has increased as every member of the reduced staff is now doing multi-functional work. Due to the crisis, I doubt that we will increase our personnel in the nearest two years. What we are going to do is to continue enhancing the productivity of the existing staff. I think these people will be able to restore the pre-crisis sales.
Reducing the staff by more than a half, obviously has led to significant cost savings. Hasn’t it?
- Costs have been reduced not only by decreasing the number of workers but by optimizing the client base and radically revising our assortment line. Also we have moved to a cheaper office and replaced most of our warehouses. As a result we have statistically performed much better in the first half of 2009 than we have done in the last three years. I want to stress one of the key reasons why “Topservice” was highly inefficient before the crisis. Our company was run by the hired CEOs, actually I myself had implemented this idea several years ago. But it turned out that under such strong current competition in our industry the company stakeholders can manage much better themselves. In the end, all the three founders of “Topservice” returned to operational management. And now due to our efforts the company is showing a positive trend in development and that gives us hope to keep moving fast towards a better future.
"Topservice" is an OEM supplier. Where do you place your orders?
- Our main production bases are located in China, also we manufacture in Belarus, Korea, Japan, Ukraine and partly in Russia. Why these countries? We try to deal with the best plants in relevant segments in order to make products with the specifications that we need and our own design. If we are sure that energy saving lamps in terms of the price-quality ratio should be produced in China, we work with China. While the best batteries are produced in Japan, light bulbs are better made in Belarus than in Russia, so we place our orders there. An approach like this complicates and increases the cost of logistics.
Can’t you locate all the manufactures of your products in China only?
- We can not always get the best products from China. Moreover, our company doesn’t operate in the lower price segment, where the price is the most fundamental factor. “Topservice”’s desired target is to stay in the middle-class segment where the key issue is the price-quality ratio, you can not always find that in China.
How did you happen to come to the idea to be involved in the OEM production of electrical household goods?
- The company was founded in 1993, before that I had been working for the Senior Management of the Diplomatic Corps Service under the Ministry of Foreign Affairs (GlavUpDK) for six years. So I had travelled a lot to different countries communicating with foreign businessmen. As a result I had realized under the circumstances that we should have to create a business model in which a principal preference would be given to China. Although in the early 1990s it was not completely obvious for everyone and many of our fellow Russian businessmen worked with Europe and America. The company was "born" basing on my personal insight.
Why did you choose the OEM model?
- In the modern world of the international division of labor it is the most competitive model of activities. It does work practically for all industries. Consider the production of computers, jogging shoes, just anything. You can hardly find any leading manufacturer that has a complete production cycle their items. Engineering processes are developed by one company and some others are involved in marketing and distribution. The main task for a brand owner is to put it all together and provide consumers with the best products. Just the same is in the segment of energy saving lamps: some make tubes, others electronics, plastics, lamp caps. Of course, there are a few companies in China offering a complete production cycle, but I wouldn’t say they are of the most competitive.
What are the weak points of the OEM model?
- The question is how to operate and serve this model in the most professional way. You can’t use here a simple sales formula: “buy cheap, sell high”. You have to create and promote your own brand. It is also crucial to monitor the quality of your products. In Chinese OEM plants such a system for product quality control must be implemented by the customer. Our "Topservice" Quality Control System consists of the following parts: production engineering assessment, management level monitoring and finally quality control, applied not only to the end product but the components as well.
Is not price control of the components an internal matter of the manufacturing factory? You only have to make a decision whether you accept such conditions and place your order there or not.
- You may of course not control the production procedure but this won’t get you very far. Energy saving lamps are related to high-tech manufacturing. If you are not aware of the production engineering, what a lamp consists of, how the quality of the components affects the quality of the end product and what company is their supplier, then do not expect to get a high-grade product. It often happens in China when at first the quality of products is good but then getting worse and worse. We have had such a bad experience more than once. In one region they produced low-quality items starting from our first order, but some others used a more sophisticated approach to achieve larger orders: at the beginning they made a product of proper quality and we ordered more, but then they supplied you a huge lot of deficient goods. You do not know what to do, how to get your money back. So the key point is to keep the required quality level as long as you can.
And is product quality not guaranteed by the contract between a customer and a supplier?
- An agreement in China has almost no value. You must be "a friend" to the man who respects and trusts you. The Chinese people respect you when you start your business from scratch, when you can keep your word and continue developing your brand, and when you can run their production capacity at full for a long time. Things like strong ties, stability and responsibility for your words and deeds stand very high in their esteem.
How do matters stand in other countries?
-We have legal, contractual relationships in other countries such as Japan or Belarus. But even there some personal relationships play a significant role. However, it is expressed at the most in China.
Do your own staff members monitor the quality of products in China?
- Both. Some work on a permanent basis and others come from Russia. They are both Russian and Chinese. A large group of people is involved in forming quality starting from the pre-shipment end goods sampling inspection up to a cargo inspection upon receipt. Surely it is impossible to check the whole production-run; otherwise you will finally get a "golden" lamp or battery. But the main characteristics must be under control.
So back to 1994, you simply did not have any opportunities to start your own production in Russia. Did you?
- No, but it also had to do with something else. I still would not risk investing in a plant of a complete cycle in Russia from scratch. Given the current market capacity of energy-saving lamps in the near term outlook, it is not an economically rational project. Only 60-70 million lamps and 700 million incandescent bulbs are sold in the market nowadays. Besides, a plant is not worth building if you mean to have a competitive business but not just a production of something, which is artificially protected by the state through custom duties. After all, China is the biggest producer of all lamps and batteries sold in the world. About 70% of local producers are export-oriented in spite of the huge domestic market. Thus, under the open market circumstances Russian production is unlikely to be competitive without additional support.
And if they impose custom duties on importing of energy saving lamps, will it become profitable to build a plant of a complete cycle in Russia?
- You have to specialize in different fields, and first of all in electronics. It affects most of the qualitative characteristics of lamps. We are not powerful in this field. In addition, it should be taken into consideration that a range of lamps varies by almost 100% during a year. Moreover, energy-saving lamps continue developing technically quite fast. Two years ago they were huge and one couldn’t fit them in household lights. The optimum size improvements will take a few years. So producing new models always requires a line revamping. In other words, a small company can’t afford to incur such costs.
But at the turn of 2008 you opened the domestic production line of energy saving lamps at the plant of precision instruments in Saransk…
- The reason why we did that was to do with our expectations that some prohibitive duties on import of energy-saving lamps together with the customs duty on import of bulbs would be brought in. We tried to follow the current situation in order not to be thrown out of our key market. But the line in Saransk is only an industrial assembly and it is not our own production. Economically it is justified as we can monitor the quality of products. This is not only due to the possibility of final quality control, but also due to an independent purchase of components. So you can control the costs. Gain in cost of products compared with the ones made in China may reach 10-20%.
So, it is a similar OEM-model but with Russian production. Isn’t it?
- Yes, We and our Chinese colleagues invested into the plant in Saransk and provided it with correspondent engineering processes. It took us a year just to work out a project. The city administration and the government of Mordovia were very interested in it – the project created over fifty new jobs. Saransk had been chosen due to several reasons. Saransk is a historical center of lighting production in Russia. They are highly engaged in electronics and there are workers in town who don’t need to be trained. Plus to this there is inexpensive labor in there just like in China. As now the cost of labor in China has already started growing. And what is really important, is that it is a huge problem to find a well-rounded man for high-tech assembly in China. Even if you find such a worker – he would cost you a fortune. We have been looking already for six months in the city of Ningbo near Shanghai for a professional with a number of qualities such as the knowledge of English, good communication skills and who specializes in lighting and electronics. In Russia, I can easily find such a person but not in China.
How much did this project cost you?
- I can’t tell you the exact cost but it's less than 1 million $. However that meant we ourselves maintained responsibility and control over the assembly process, purchasing components, arranging distribution, marketing and branding. But in general, we are waiting for the next engineering revolution in the sphere of lamps based on LED technology. I think in the five-year term energy-saving light sources will be completely replaced by them.
So, right now should be a great moment for you to get involved in the development of LED technology more intensively than energy-saving lamps as now their introduction is under legislative leadership.
- First of all, it is a matter of cost recovery. An energy saving lamp reaches breakeven point in about half of a year. When you pay 50% less in electricity bills it is less of a single-time purchase but more of an investment in future savings. As for LED products, they break even in 6-8 years. So it is a real obstacle for their sales. But the segment continues growing on the score that there are some spheres where it is not possible to do without LED items. Sometimes it is necessary to minimize heat emissions or light some remote places where it is most convenient to install a lamp and forget about it for many years. But for everyday consumption LED lamps will have an acceptable payback period in no less than five years.
Is your company going to invest in such a prospective segment in the nearest future?
- Certainly, we and our Chinese colleagues keep following up the market and even begin making the first steps towards it. We hope to be involved in this project early next year. I do not want now to go in detail beforehand. For the time being we are producing goods of high demand and LEDs will not be a part of it any time soon.
Where will you get the money for this new project?
- Our company intended to invest into further development of compact fluorescent lamps (CFL) and LED technology even before the crisis. With this in mind we planned to arrange a private offering to several investors and it would happen in our industry for the first time. We expected new investors to join "Topservice" to finance realization of new advanced technology initiatives, expansion of production volumes and distribution enhancement. We were ready to sell around 10-25% of our shares to them and we had a real offer. ING, the largest Dutch bank was the agent in this deal. When the crisis happened in August, our potential investors blocked the deal. But I think this is a temporary situation. Interest for energy efficiency has not diminished and when investors get back to the country we will try to be the first in line.
"Topservice" has introduced its products in the very competitive European market. Why is that? Have you already developed the Russian market and the market of the CIS?
- We are not afraid of competition. For example, when we joined the Russian market with batteries, there had been already forty brands presented here. Now the vast majority of them are much smaller than "Topservice" while we have a firm 10% market share in alkaline batteries and about 15% in energy saving lamps. We have made great progress in the CIS as well but there is no official statistics on those countries so far. Europe in fact it is a very interesting and prospective market. We feel quite strong technically and in terms of product knowledge. In addition we have our partners in China. All these factors help us promote our products in persistent and aggressive ways. Sales of goods under the brand name "Kosmos" began six months ago in Greece. We plan to promote our brand and deliver the goods to other European countries in the nearest future. But at this stage it is too early to speak about the results.
Interviewed by Olga Shevel.