In November the world’s two biggest auction houses reported that a staggering $2 billion-plus in contemporary art had been sold in a matter of days at their fall auctions. A roster of pieces by Andy Warhol, Mark Rothko, Alberto Giacometti, and others took the prices of modern and contemporary art into a stratosphere once limited to older classics. The Dom Pérignon, it seemed, was flowing in the executive suites of Sotheby’s and Christie’s.
Less than a month after the record auc tions, the CEOs of both companies announced they were stepping down. What in the name of Francis Bacon was going on? Underneath the gorgeous veneer of blowout sales figures, it turns out, the financial picture for the auction houses is considerably less appealing.
Call it the art-world paradox: The market is euphoric, cash is gushing—and the French-cuffed, bespoke-suited Sotheby’s and Christie’s have responded by engaging each other in a knife fight for market share. Only in this case, it seems, they are plunging their ivory-handled daggers into their own legs as much as they are wounding their rivals. The proof: Last year Sotheby’s enjoyed a 6% increase in revenues—but suffered a 9% decrease in profits. Christie’s is private—it strenuously insists its earnings are up—but when some numbers slipped out a year ago, well, the trend looked a lot like Sotheby’s.
In most industries middlemen make a mint when sales are soaring. That is usually not the case in the world of eight and nine-figure paintings and sculptures. “As art prices go up and there’s growth in the market, margins go down inversely,” says Michael Plummer, former chief operating officer of Christie’s Financial Services and now a principal in the art advisory company Artvest Partners.
One culprit with potential for significant damage: guarantees. Sotheby’s and Christie’s are so eager for the market share, prestige, and future business that come with prominent sales that they have taken to offering sweeping inducements for the rights to auction important pieces of art. Canny sellers are playing the two against each other and extracting promises that the houses will pay a minimum price even if nobody buys the work in question.
The bidding between Sotheby’s and Christie’s has become more frenzied than anything that occurs during the actual auction. In a number of instances, the houses have extracted only small, if any, fees on headline-making mega-sales. For example, when Jeff Koons’s “Balloon Dog (Orange)” was auctioned for $52 million in 2013, it was trumpeted as a record for a contemporary piece. But by Fortune’s calculation, Christie’s actually lost a modest sum on the transaction.
“I think we are in a fairly crucial moment in the art market,” says David Nash, who was a top Sotheby’s executive before co-founding the gallery Mitchell-Innes & Nash. “It will be interesting to see if the sort of reckless competition between Sotheby’s and Christie’s to get property away from the other will continue.”
The guarantees, as we’ll see, could pose a real risk. Sometimes works don’t sell or the bidding doesn’t reach the minimum price, and the two houses are increasingly finding themselves owning many millions of dollars’ worth of art. The next time the market tumbles, Sotheby’s and Christie’s could end up holding a very expensive bag.
The rivalry between Sotheby’s and Christie’s just may be the longest in business history. After all, when Christie’s—the spunky upstart, relatively speaking—was founded in London, King George III was still early in his reign, confident that those bothersome colonists on the other side of the Atlantic would be brought to heel. Next year will mark the 250th year in which the two auction houses have been competing with each other, making, say, Coke vs. Pepsi seem like a recent tiff by comparison. Sotheby’s and Christie’s are the behemoths of their realm; together they control 55.3% of global auction revenue.
The one time the duopoly made nice in recent decades, the result was disastrous: In the mid-1990s Christie’s and Sotheby’s were accused of conspiring to raise commission rates. In 2000, Sotheby’s pleaded guilty to criminal price-fixing, while Christie’s turned state’s evidence. Sotheby’s chief, Alfred Taubman, went to federal prison. Christie’s head, Sir Anthony Tennant, was indicted but refused to fly to the U.S. to face the charges; he died years later having never gone to trial. The two houses paid a combined $512 million civil settlement to its clients. (The good news about the brawl these days: It’s hard to imagine the two are in cahoots.)
The case affects the houses to this day; it forced them to explore different ways of raising revenues. They sharply accelerated the use of guarantees, which they had already been experimenting with. In exchange for taking a risk by committing to cover a minimum sale price, the houses would get a potential windfall: a percentage of any amount the work sold for above an agreed-upon price.
But the guarantees backfired in 2008. The houses offered too much and received too little in upside. In the depths of the financial crisis, Sotheby’s and Christie’s were left owning hundreds of millions of dollars’ worth of unsellable art. Sotheby’s reported losing $78 million on guarantees in 2008, wiping out three-quarters of the year’s profits. CEO William Ruprecht vowed that “we are out of the guarantee business at least for a while.”
“For a while” turned out to be the operative phrase. As art prices rebounded, so did guarantees. In recent years, Christie’s has been viewed as the more aggressive player, gaining market share and making expensive commitments. It now commands 55% of the fast-expanding contemporary art market, vs. 36% for its main rival. Sotheby’s has been trying to catch up.
Because Sotheby’s is publicly owned, its finances receive greater scrutiny. Dan Loeb, CEO of its largest shareholder, Third Point, has been especially vociferous. When the activist hedge fund investor began to agitate for change in 2013, he slammed Sotheby’s as “an Old Master painting in desperate need of restoration.” He rejected its claim that its “lower market share was due to uneconomic and predatory behavior by Christie’s.” In one of many acid-tinged public rebukes, Loeb wrote, “It has been Sotheby’s who has most aggressively competed on margin, often by rebating all of the seller’s commission and, in certain instances, much of the buyer’s premium to consignors of contested works.”
In May, Loeb and two allies received board seats. Since then he has gone silent about Sotheby’s in public (he declined requests for comment), and so far there’s little sign that he has had a dramatic impact on the company, though he was certainly advocating a new CEO. (Ruprecht, the chief whose departure was announced in November, was slated to leave on March 31, when Tad Smith replaces him.)
There was plenty to irk a Dan Loeb in Sotheby’s 2014 results, which it announced in March. Despite the epic art boom, for example, the company’s profits were roughly half their 2007 peak. One key metric was ominous: “commission margins,” Sotheby’s revenues as a percentage of auction sales. That figure has been steadily dropping, from 16.5% in 2011 to 14.7% in 2014. The last time the margins dropped to such levels was right before the financial crisis. In Sotheby’s earnings call to discuss the 2014 results, chief financial officer Patrick McClymont acknowledged that the margins shrank “due to competitive conditions for winning high-value consignments.”
Christie’s, privately owned by French luxury-goods tycoon François Pinault, reveals few financial details beyond its sales ($8.4 billion in 2014, an increase of 17% from the previous year). The picture looked less rosy after some rare profit numbers came into view last year when income statements from Christie’s holding company were published in the Wall Street Journal. Christie’s auction sales increased from $5.3 billion in 2012 to $5.9 billion in 2013, but profits dropped from $153 million to $123 million. Commission margins proved even worse than Sotheby’s, sinking from 15.2% to 10.7%.
Auction house veterans acknowledge that the quest for market share sometimes reaches irrational heights. “Listen, there are moments of ‘Let’s just win,’ ” says one former executive. “If we lost three in a row, it becomes, ‘Let’s win this for momentum and confidence for the team.’ It’s like any sporting event.” To make the competition more intense, a passel of collectors, dealers, and international financiers have increasingly been offering guarantees too. In theory, that should provide a safety valve for the auction houses, allowing them to reduce their risk. But in the reality of a scorching market, it has pumped up the pressure for the auction houses to make pricey promises. In the fall auctions some 45% of the important evening sales at Sotheby’s and Christie’s had a guarantee by the house or an investor.
And so the inducements mount. Where once sellers haggled with the houses over whether a piece of art would be featured on the cover of the auction catalogue and over relatively small costs, such as who would pay for insuring the art during the sale, now Sotheby’s and Christie’s routinely spend lavishly on glitzy marketing campaigns and presale exhibitions of the works.
They even concede their two fundamental fees, which form the core of their income. The houses (as Loeb pointed out) now frequently waive the commissions they charge the seller, and sometimes give the seller a piece of the “buyer’s premium,” the commission paid by the other party. Suddenly an eight or nine-figure price tag isn’t as lucrative as it appears.
A presentation by Artvest in 2013 noted that “Christie’s recently secured a high-profile, highly valuable 20th-century art consignment by offering the consignor 115% of the selling price, thus accepting the deal at a certain loss just for market share and prestige.”
Or consider the sale of Giacometti’s “Chariot” in November. Sotheby’s predicted that what it called one of the “definitive achievements of 20th-century art” would set a record—above $100 million. It promised the sculpture’s owner, Greek shipping heir Alexander Goulandris, that he would receive a minimum price. But the outsize hopes fizzled. The bronze sculpture attracted only one bidder, later revealed to be hedge fund billionaire Steve Cohen, who obtained the work for $90 million (plus an $11 million buyer’s premium). The Giacometti now rates as one of the most expensive sculptures ever sold at auction—but the house reportedly lost several million on the deal. (Sotheby’s declined to comment on individual sales.)
Critics charge that guarantees lack transparency and are a minefield of conflicts of interest, favoritism, and inside information. The auction house is required to disclose the existence of a guarantee but not the name of the person making it or the amount. That opacity feeds tales of guarantors, their identities unknown to other potential buyers, bidding up the prices on lots in which they have a financial stake.
There’s no mystery, counters Sotheby’s co-head of contemporary art, Alexander Rotter. “We are a public company,” he says. “Auctions are public. When someone bids $5 million on a painting, it is clear what the bid is and what is paid. It is much more transparent than the private market.”
Rotter’s equivalent at Christie’s, Brett Gorvy, is similarly dismissive. “There is no big secret going on,” he insists. If there is a perception of opacity, he says, it derives from the confidentiality of the agreement between the house and the seller, put in place to protect the seller. “It doesn’t affect the mentality of the buyer,” he says. “It’s a private deal, one between the seller and auction house. It is not relevant in determining the price of a work.”
Sotheby’s and Christie’s show no signs of dialing back their use of guarantees—and it’s clear they are material to the companies’ finances. It’s worth noting that the soaring scale of art prices can create the impression that, say, Sotheby’s is much bigger than it actually is. Yes, the company handled $6.7 billion in sales last year, but its actual revenues were $938 million.
As of right before the November sales, Sotheby’s had guaranteed $170 million worth of art. The company has doubled the upper limit on its outstanding auction guarantees from $300 million to $600 million, according to its financial statements. By comparison, Sotheby’s had $116 million in profits last year, according to S&P Capital IQ, and $420 million in cash and equivalents at the end of 2014.
There’s a second telling metric in Sotheby’s financials: the value of its “inventory,” guaranteed property that didn’t sell (or to a much lesser degree, art that buyers defaulted on). That number has quintupled, from $32 million in 2012 to $158 million last year. When an item doesn’t sell at auction, it is considered tarnished. It’s either kept off the market for several years or sold off privately at a steep discount. Either way, the piece incurs losses, though they can be hard to see on the financials because of the time lag and the fact that they’re not broken out as their own category.
The two houses insist they face no significant risks from their price commitments. “Sotheby’s has been strategic and prudent with guarantees and uses them when we feel strongly about the artwork and confident in our ability to sell it for our consignors,” says a company spokesperson. “That will continue this year.” Says Christie’s Gorvy: “We take a calculated risk … We are not gambling blindly.” He says a high-value work with a guarantee, such as Koons’s “Balloon Dog,” may not generate a profit on its own, but it brings in buyers for other works who make the overall auction profitable. A Christie’s spokesperson adds that its catalogues alert potential buyers as to which artworks are “subject to a minimum price guarantee or if the company has a financial interest in a lot.”
Both firms seem to be addressing their shrinking profit margins only around the edges. Christie’s implemented a new 2% “success fee,” charged to sellers whose artwork exceeds the high estimate. In February, Sotheby’s raised its rates for buyers (for instance, applying a 25% fee on the first $200,000 paid, rather than on, as previously, the first $100,000). But those seem like incremental steps rather than a long-term strategy.
After 2 1/2 centuries of competition, is either of the antagonists likely to ease up in the blood feud for market share and focus more on profits? Asking the question, as the old phrase goes, seems to be its own answer. For now the two will keep playing the guarantee game, something Artvest’s Plummer, who is also a co-director of the Spring Masters New York art fair, likens to “mortgaging your house and then going to Vegas.” As he puts it, “It may be an educated-guess bet you are making about the market. But that doesn’t account for sudden and unexpected things to happen in the larger macroeconomic world.” Many billionaire art buyers these days come from countries encountering turbulence, such as Russia (sanctions, a plunging currency) and China (a slowing economy). The last art plunge was only seven years ago. Even companies that are centuries old, it seems, can forget history.