Why Sotheby’s and Christie’s Don’t Operate Like Other Duopolies
Sotheby’s is one of two major art auction houses, and it carries one of the most recognizable and valuable brand names in the world. But a tumultuous past pair of years has made it a key locus of art world speculation.
Sotheby’s stock (NYSE: BID) suffered a sharp decline in share price beginning in June of 2015, three months after new CEO Tad Smith took the reigns at the house and just as the art market’s contraction began to take hold. The dive lasted through mid-February of this year and cut the share price of Sotheby’s in half. Since that time, shares have nearly doubled, almost grazing their 18-month high.
Meanwhile, earnings have been less rosy. Two weeks ago, Sotheby’s reported a third quarter loss of $54.5 million, compared with a loss of $17.9 million for the same period a year ago. The loss was exacerbated by a shift in the sales calendar, which saw the fall London auctions take place in quarter two of this year rather than quarter three. But the company predicts that fourth quarter sales and profits will also be down compared to last year. Part of this can be attributed to the number of long-term investments that have been made to steer the auction house in a new direction since Smith’s taking of the helm. But there are several other factors worthy of examination in order to understand the current dynamics at the top of the auction house pyramid.
Understanding the Duopoly at the Top of the Auction Market
The underlying problem is that Sotheby’s, with Christie’s, may be the only duopoly in the world that does not engage in follow-the-leader collusion on avoiding price cuts or giveaways. They do tacitly follow each other on certain things like auction scheduling and buyer’s premium increases. But other duopolies all implicitly collude: think Coke and Pepsi with syrup prices to bottlers, or Intel and AMD with chip pricing. All economic theory suggests that both houses would maximize earnings by mutually cutting back on commission waivers on consignments, on rebating buyer premiums to consignors (the so-called “paddle-plus”), and on other goodies such as tempting wealthy bidders with free first class tickets to attend auctions.
In any industry other than art auctioneering, an observer would expect each player to send signals to the other—and to the market—that they plan to eliminate these perks over several auction cycles. Sotheby’s management has suggested that they intend to move in this direction. But so far, Christie’s won’t play. The house hasn’t made the slightest indication, neither in their public statements nor with any direct action to indicate a winding back on incentives, even given the current market softness. So Sotheby’s has, in turn, continued to find themselves forced to pay for guarantees and irrevocable bids, and to rebate buyer’s fees to consignors in order to stay in the game. Its contemporary auction a week ago had 35 works that were guaranteed or carried irrevocable bids. Christie’s offered a markedly lower 17 guarantees in its contemporary sale.
Why does Sotheby’s not just unilaterally cut back on what they offer? Much of the firm’s value comes from the fact that the auction house is a seller of luxury goods. And a significant portion of that perception is generated through the lots it sells in the so-called Moët-and-Beluga auction trade of negotiating terms on major consignments. Assume that, as Sotheby’s board-member and major shareholder Dan Loeb has suggested, the firm cuts back on offering buyer rebates and implements expense-cutting. According to general market wisdom, it would be doubling down on an already existing disparity. Over the past three or four years, Christie’s has almost certainly spent more than Sotheby’s on rebates and promotions, both in absolute terms and as a percentage of sales. Of course, we can’t know this for sure: Sotheby’s, a publicly traded company, releases audited results quarterly that disclose these terms, but Christie’s is a privately held company (owned by art collector and French luxury-goods magnate François Pinault) and thus does not.
Perhaps an even more interesting question: If Sotheby’s did cut back on its terms significantly but Christie’s, unlike a sensible duopolist, declined to follow, how would consignors and collectors react? Would Sotheby’s be considered equal to Christie’s as a luxury brand if the latter’s auction sales were consistently two or three times the dollar value of Sotheby’s—and if Christie’s monopolized the iconic works that make headlines? Most market observers think not. So Sotheby’s has to continue to be as willing as Christie’s is to spend to maintain market share, even at the cost of profitability. The alternative is to risk falling back to being just another seller of high-priced goods.
The Need to Diversify
Most firms faced with this profit dilemma in their core business would opt to diversify—and that is how Sotheby’s is responding. Another of Loeb’s suggestions was that Sotheby’s should be competing on service quality and expertise as much as it does on price. That seems to be the thinking behind Smith’s announcement in January of this year that Sotheby’s had paid $85 million to acquire Art Agency, Partners, the art advisory firm founded by Amy Cappellazzo and Allan Schwartzman. Cappellazzo and Schwartzman then became co-heads of Sotheby’s fine arts division, ranking above the auction house chairmen worldwide. In a conference call with analysts and investors, Smith said the acquisition was part of a strategy to expand services in art consulting, private purchases, and art investment.
The AAP expansion gives Sotheby’s a fourth leg to their revenue stream: auction commissions and fees, private sales, income from financing, and now advisory fees. The assumption seems to be that the latter three will capitalize on the brand name, will be high-margin, and will compensate for the auction business, which will be the public face of the company but remain low-margin.
In the time since, private sales activities at Sotheby’s have flourished. In the third quarter of 2016, private sales topped $168 million—up from $85 million in the same period of 2015. The house continues to invest in building out its private offering. In reference to private sales, Tad Smith said in a conference call earlier this month that he wants to see Sotheby’s develop customer research so that a bidder who lost out on an item at auction could be offered something similar from the auction house “within 24 hours,” presumably via a private sale or from Sotheby’s inventory.
The house’s financial services leg is more or less flat, likely not meeting the expectations Sotheby’s had for it eighteen months ago. More art lenders have entered the market, and there seems to be a limited number of art buyers and investors who are willing to pay higher interest rates and fees to borrow against art assets alone. However, Sotheby’s recent acquisition of the Mei Moses Art Indices indicates they’re continuing to invest in other aspects of this area of the financial services side of the business.
These shifts in strategy haven’t come without churn. The art world has expressed concern about the recent exodus of long term employees from Sotheby’s due to potential impacts on the house’s ability to acquire consignments and romance potential bidders. Among the most high-profile departures were star auctioneer Tobias Meyer, 25-year company veteran and worldwide head of contemporary art Cheyenne Westphal, and her former co-head Alex Rotter. This was described as a shift from old blood to new, from a culture of art appreciation to one of selling and use of analytics.
November’s New York Sales—and the Future
Due to a number of factors, last week’s annual week of auctions in New York failed to shed much further light on either the prospects of Sotheby’s or the evolution of its duopoly with Christie’s. Sotheby’s Contemporary evening auction sales of $277 million were six percent below those of the comparable sale a year earlier. The house’s star November offering in the Impressionist and Modern department was Edvard Munch’s 1902 painting Girls on the Bridge. It sold for $54.5 million, but may have attracted only a single real bid—from the lot’s guarantor.
The house’s white glove sale of David Bowie’s collection two days after the election was cited as proof that the market was alive and well. Every work sold, with many hammered down at prices far above their estimates. Much of this was clearly due to an “owned by David Bowie” premium on otherwise well-estimated works. And therefore, it does not tell us much about the art market in real terms. The overall problem for both houses remains attracting great consignments. (Some of this November’s evening auction lots were described as of “day-sale quality”.)
Some speculation has been had—including on the part of Smith—that the new President-elect’s impact on the market may help the houses access better material once again. Consignors are shy to uncertainty, of which this election had plenty, and shyer still to soft markets. And there is an argument to be made that the art market will benefit from a Donald Trump presidency. Most of what Trump promised to do during his campaign is inflationary: building infrastructure (including the infamous wall), increased military spending, and deporting low-income workers. He offered tax cuts and a rationalization of the corporate tax structure.
Each provides an inflationary stimulus on the economy in the short run, maybe a one year growth rate of four percent. Inflation encourages the ownership of hard assets, and advisors will argue it is a good time to acquire high-end art. Also, the current record highs for the stock market surely make investors feel richer—and more willing to spend. Maybe most importantly, this fiscal (and perhaps additional monetary) stimulus expected in a Trump presidency means that there is now no immediate concern about a recession.
This could have the knock-on effect of lessening the favorable terms given to pry top lots out of the hands of consignors, thereby pushing both Sotheby’s and Christie’s in the direction Loeb has suggested—and towards a more efficient duopoly overall.
Don Thompson is a professor at the Schulich School of Business in Toronto, and author of The $12 Million Stuffed Shark, The Supermodel and the Brillo Box, and the forthcoming The Orange Balloon Dog (April 2017)