The (Auction) House Doesn’t Always Win - By GRAHAM BOWLEY

Christie’s and Sotheby’s Woo Big Sellers With a Cut

When Christie’s sold Jeff Koons’s “Balloon Dog (Orange)” for $58.4 million in November, it seemed as if the auction house had just earned a pretty penny.

After all, Christie’s, like other auction houses, typically charge commissions to buyers and sellers, which for high-priced works might be an eighth to a quarter of the gavel price.

But the owner of the work, the newsprint magnate Peter M. Brant, said Christie’s certainly made no money from him. To secure his business, the house waived the seller’s commission, he said, and then, as a sweetener, gave him a large share of the buyer’s fees.

“I was not required to give them anything from the buyer’s commission until it reached a certain price — which it did not make,” Mr. Brant said in an interview, rather wistfully, since he was hoping for a higher price.

Factor in Christie’s other costs — buying insurance and newspaper ads, publishing glossy catalogs, moving the towering Balloon Dog to its Rockefeller Center headquarters, where it was parked outside for gawking — and the possibility of making lots of money seems to be limited.

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Christie’s would not comment on this, or any individual, sale. But Mr. Brant is not alone in his bargaining, and far from alone in noting that even as bidding prices go ever higher, the auction houses’ cut is rapidly shrinking.

Caught in a scramble to outmaneuver their competitors for the top works and market share, the major auction houses have increasingly offered all kinds of financial incentives to lure the top consignments — essentially giving away a big share of their commissions for the privilege of selling someone’s art.

“The process of consigning artwork to the major auction houses today is like buying an airplane ticket, and just as opaque,” said Thomas C. Danziger, an art market lawyer. “You never really know how much the guy in the seat next to you at the auction — or on your flight — has paid for the same ride.”

In this game, the biggest collectors receive the best deals, which, several in the industry said, has led to an auction house paradox: The pricier the artwork, the lower the profit margin.

That has not stopped the main houses — including Sotheby’s, Christie’s and Phillips — from doggedly pursuing a small clutch of millionaires and their art collections. The sales fuel splashy headlines and perhaps rope in other sellers. But these companies may also be repeating tactics that got them into trouble five years ago, when an art market bubble collapsed with the financial crisis, analysts and industry experts said.

The auction houses deny that they are trimming profits with givebacks or putting themselves at financial risk. Christie’s may have reaped little from the 10-foot-high “Balloon Dog,” but it made money on the whole night, in part because the sculpture’s presence helped attract other sellers.

“The evening sales are immensely profitable,” said Christie’s chief executive, Steven P. Murphy. “Yes, the margins on the top lots are much thinner than the middle market. But sometimes, volume makes up for that. A thin margin on a $50 million lot is still a profit.”

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But the activist hedge-fund investor Daniel S. Loeb, who announced last year that he had bought a 9.2 percent stake in Sotheby’s, has called for the ouster of William F. Ruprecht, its longtime chief executive for, among other things, giving up profits.

In a public letter to Mr. Ruprecht, Mr. 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 an interview, Mr. Ruprecht said it is impossible to compare Sotheby’s, a publicly traded company that releases audited results quarterly, with other houses, which are privately held. Christie’s is owned by François Pinault, the French luxury-goods magnate, while Phillips’s owner is the Russian company Mercury Group. And Mr. Ruprecht told analysts that an increase in the buyer’s fee last year had helped stabilize its business. Some analysts agree that conditions may get easier, if rising prices tempt reluctant sellers off the sidelines even without discounted fees.

The competition is fierce, in part because the number of elite collectors is small. According to Christie’s, about 150 collectors worldwide can buy a painting for more than $20 million.

“It is small but it is growing,” said Mr. Murphy, whose company has been seeking to expand the number of collectors in countries like China and India.

Typically, a seller might pay about 10 percent commission on a $100,000 artwork. A buyer would pay about 25 percent. But for some works of art — commonly those worth $1 million or above — sellers don’t usually pay anything.

And the buyer’s fee, which drops to about 12 percent for works worth more than $2 million, can be split among many parties. For the most expensive works, the sellers can receive 4 percent to 7 percent of that fee on top of the hammer price, a practice called “enhanced hammer,” auction experts said. Some of the buyer’s fee can also go to an outside guarantor, an investor who promises to buy the work for a minimum price. (That investor also typically receives a share of any amount above the minimum price.) What’s left of the fee goes to the house.

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Mr. Danziger, the art market lawyer, said that one of his clients, selling a postwar painting in November, received a part of the buyer’s fee, prominent placement on the auction website and in the catalog, and paid no commission. The work sold for seven figures.

Michael McGinnis, chief executive of the Phillips auction house, said marketing was a strategic way to promote sales and attract future business.

“You have to give some here to get some there,” he said.

In the case of the “Balloon Dog (Orange),” Christie’s arranged for an outside guarantor, identified several potential buyers, and structured the sale so it would get part of the buyer’s fee only if the price exceeded a certain target, which it failed to reach.

These arrangements cost a lot of money. Sotheby’s annual reports show that in 2011 and 2012, it gave up more than $40 million annually in sellers’ commissions, and analysts said this trend continued last year.

At Sotheby’s the total amount of buyers’ and sellers’ fees as a proportion of gavel prices has been falling steadily since 2009; in 2012, it was 16.3 percent, the lowest since 2008. Analysts expect a slightly lower number in 2013. In 2012, Sotheby’s profits were $108.3 million — up from 2008, but down from 2010 and 2011, when the market began to recover.

The figures for 2013 promise to be slightly better. But in November, the company acknowledged the economic pressures, including the negotiations over sellers’ commissions and buyers’ premiums. “Competition is still affecting our revenue margins,” Mr. Ruprecht said in a call with analysts at the time.

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Analysts said similar pressures are playing out at Christie’s, though Christie’s may be better placed to weather the competition because it sells more lower-priced artwork, where profit margins are fatter.

Auction houses offer guarantees backed by outside investors, but can also guarantee works themselves. Now Sotheby’s is preparing to offer more such guarantees to the richest sellers. In June, it tripled its borrowing capacity to $300 million.

The level of Christie’s direct guarantees is unknown. But the total value of artwork carrying guarantees has been increasing for the past three years, accounting for 10 percent of Christie’s lots sold in 2012, the company said.

Both houses said their level of risk-taking is well below pre-2008 levels, and they are offloading liability by having outside investors take on some of the new guarantees.

In 2008, both auction houses ratcheted back guarantees after prices fell sharply, leaving them with millions of dollars in unsold works, as well as painful losses. Following that, Mr. Ruprecht said Sotheby’s was abandoning them almost entirely and returning to a simpler model as agents for buyers and sellers.

The auction houses have also expanded into private art sales, becoming dealers in their own right. The transformation can sometimes mean owning the art, with the risks this entails.

“The auction houses are not set up to calculate the financial risk,” said David Kusin, who runs Kusin & Company, a consulting firm in Dallas that specializes in the economics of the art market. “Getting into a business they are unsuited for and unprepared for puts all market participants at risk.”

To some in the industry, it sounds a bit like 2008. Howard Rachofsky, a Dallas collector and former hedge-fund manager, sold his own Koons sculpture, “Balloon Flower (Magenta)” back then for $25.7 million at Christie’s in London.

Christie’s offered him an outside guarantee, too, no seller’s commission and a share of the buyer’s fee.

“They didn’t make a lot, they made a little bit,” he said. “But in terms of visibility, it gives bragging rights.”