[An extended version of the recent Op-Ed published in The Art Newspaper, November 2018.]
The controlling shareholders of Bonhams recently sold their stake in the auction house to Epiris, a British private equity firm, which quickly brought on additional management. As a former director, I am encouraged by this new infusion of financial support and executive leadership. However, I believe the challenges in expanding market share for any auction house are structurally endemic to the industry and are not easily overturned by a fresh infusion of capital and personnel alone.
In the New York Times (“The Art World’s Elephant in the Room” 9/21/2018), Scott Reyburn recently suggests that Bonhams is an auction house “whose business model has (so far) relied on traditional lower and middle range art and antiques.” In Reyburn’s view, this market is languishing as an effect of growing income inequality, as the wealthy seek ever more expensive prizes, leaving the sub-$50,000 marketplace bereft of buyers and liquidity.
As the former Director of Business Development for Bonhams in the US, I can assert with confidence that Bonhams was very much motivated to break into the upper echelons of the Impressionist & Modern, and Postwar & Contemporary markets, where most of the highest priced works reside. However, over the past 10 years of my tenure there, less than a dozen artworks were successfully consigned in those categories with a hammer price over $1 million. Most works we sold successfully in that price range were in the Chinese, Russian and Old Masters sales, where we had relative strengths and comparative market share.
The fact that we were largely unsuccessful might reflect poorly on my efforts, I admit, but the fact that Bonhams, one of the four 18th century British firms to dominate the secondary market, could only manage to capture less than one half of one percent of these leading categories, suggests that there is a more specific, structural constraint at play in the marketplace, and which remains an obstacle for any firm jostling for market share.
Most art world observers may have a generic sense that Sotheby’s and Christie’s enjoy a monopoly, or more accurately a duopoly, in these signature categories, with the close ascension of Phillips in recent years. Indeed, according to Clare McCandrew’s reporting, these two dominant firms own over 80% of this market share for works over $1 million in these core categories.
However, a closer analysis would reveal that this is a very strange kind of monopoly indeed, at least measured against classic economic theory. Joseph Schumpeter outlined the basic theory of monopoly power based on three chief criteria: artificial scarcity, inefficient distribution of resources, and deadweight loss. In effect, a monopoly exists when one party (or a consortium) maintains strict barriers to entry and thus controls the market mechanism or a natural resource, and then artificially restricts supply in order to drive prices higher and increase their profits. Consumers, lacking another source or venue, are forced to pay inflated prices, and the effect is the inefficient distribution of the commodity compared to an unencumbered market, which leads to “deadweight loss,” or unused resources, as the cost of inflating the monopolist’s profits. Thus, for example, OPEC in the 1970s choked off the supply of oil, sending gas prices soaring while retaining huge reserves that could otherwise have been allocated more efficiently.
However, the auction markets appear to evince almost none of these classic features of monopoly power.
First of all, there are no significant barriers to entry. You could open an auction house tomorrow with simply an auction license and a business address (as one of my colleagues on the Antiques Roadshow did recently in North Carolina). It is essentially easier than getting a real estate license in most jurisdictions. Nevertheless, hanging up your shingle doesn’t mean someone will just go ahead and consign their $50 million Rothko with you. And that provides the first clue as to where the monopoly power is lurking.
Secondly, there is no single dominant player, but rather active and intense competition all the way up the food chain. No one firm controls the marketplace, ostensibly giving consignors alternative options, and in fact the internecine battle for market share at the top of the pyramid in fact provides favored consignors with many enticements, from global guarantees to hammer bonuses.
Thirdly, there is no evidence of artificial scarcity in effect. As most auction professionals will tell you, they will sell anything and everything they can get their hands on, with the modest exception of artist’s estates or concentrated collections that might otherwise flood the market and depress prices. Thus, there is no “deadweight loss” in practice, except of course for the roughly 28% of lots that failed to meet their reserve on the first go-round, and may now clog up storage rooms after being ‘burnt’.
So, where on earth is the monopoly effect at play? Well, one further insight arises from considering a counter example of a duopoly in practice, such as exists between Boeing and Airbus. These two firms dominate the commercial airline industry, and they compete based mostly on legacy relationships with airlines and the enormous inherent costs of shifting from one fleet to the other. However, the battle for market share remains on the field of innovation: whoever builds faster, lighter, more fuel-efficient planes is likely over time to enjoy greater market growth in the future, and so they invest enormous sums in research and development.
However, in the auction market, innovation plays virtually no role in deciding market share. All the major players offer essentially the same services and expertise, despite their prognostications and self-plaudits to the contrary. Furthermore, the promotion of newfangled online platforms or social media apps is not going to make a material difference as to where a significant $100 million estate is going to consign their property.
And this dilemma has been the Scylla and Charybdis facing many new entrants in the online space. In the past, I would often would ask promoters of these slick new platforms: what would Alex Forger do? Alex Forger is the retired Chair of the Trusts & Estates department of Millbank Tweed in New York, and was long known as the giant killer for major estates coming to auction, including Jackie Kennedy’s and Bunny Mellon’s. The question is: under what circumstances would Alex Forger (or a person of his ilk) consign a major estate to a dotcom? The simple answer is: when hell freezes over, and therein lies part of the answer to our conundrum.
Most auction property comes from estates, and are managed by attorneys and executors who for the most part have not consigned before, or will not do so again for the client in question. As a one-off affair, they are understandably highly risk averse and are thus attracted to the powerful brand position of an auction house and their demonstrable market share in the category. As a result, this endemic conservative undertow strongly favors the dominant players who can recite past successes in these same categories.
However, even at the core of this duopoly there remains intense competition for estates, and in the absence of any forward edge of innovation, the only mechanism for gaining advantage resides in the commission structure on offer. In effect, whoever offers the best terms wins, and that has driven a countervailing effect: not deadweight loss, but rather the ballooning and metastasizing effect of buyer’s premium.
Buyer’s premium first emerged in the 1970s when Sotheby’s was having an off-site sale and realized they could charge an ancillary fee of 10% from buyers to help offset the overhead costs. What they soon realized is that buyers have no negotiable power in this scenario: if you truly want that Camille Pissarro watercolor, you are going to have to pay our buyer’s premium, because you can’t get it anywhere else. And that set off an arms race of ever larger and more onerous increases in the buyer’s premium boondoggle. (It is sort of astonishing that several executives from the major firms went to jail in the 1990s for actively colluding over setting equivalent rates for seller’s commission, and settled the charges for $512 million in 2001, as shortly thereafter in 2003, Christie’s raised their published bands for buyer’s premium, and were swiftly followed 6 weeks later by Sotheby’s at roughly the same tranches, followed in tow by the other auction houses. No one needed to actually talk about it, or actively collude in this respect, because it was an inherent feature of the marketplace that you could not compete unless you matched your competitor’s base commission terms.)
They have subsequently raised the bands of buyer’s premium in concert at least three times, and have been followed in lock step by their smaller competitors. Buyer’s premium may remain a scourge on the marketplace, as an engrossed tax on bidders that is particularly infuriating—as the cumulative rates make it nearly impossible on the fly to calculate what amount you are actually bidding—but it is a natural effect of monopoly power.
In effect, this fee has mushroomed precisely because it allows the auction houses to apparently negotiate more favorable terms with those sought-after estates on the seller’s commission. If you are already ostensibly collecting 25% from the buyer, then you can offer 3% or even 0% seller’s commission to unsuspecting estates who think they are getting a bargain.
All of this is to say that in the auction markets, it is not a monopoly of prices but rather of monopoly of commissions. No auction house is artificially inflating prices by holding back inventory and creating artificial scarcity. Rather, as the dominant players can only compete on terms, they will progressively lean on buyer’s premium rates to extract competitive terms for sought-after estates, and every would-be competitor must match those rates to stay in the game. If a monopoly extracts a price from all market participants, it resides in buyer’s premium, and the logic of competitive commissions.
As a result, it is nearly impossible to garner market share from the dominant players, in the absence of true innovation, or the wholesale abandonment of buyer’s premium as a categorical differentiator. This would be a highly risky strategy, but would at least set one apart and expose the mechanisms of monopoly power. Whether the Alex Forgers of the world would be persuaded is another matter.