How Do Auction Houses Work?

How Do Auction Houses Work?

In the world of art, antiques, and collectibles, auction houses stand as pivotal institutions that not only facilitate the buying and selling of valuable items but also attempt to preserve the cultural and financial value of the pieces they handle. Understanding the operational mechanisms of auction houses offers insight into a business model that balances supply and demand, expertise, and strategic marketing to benefit both sellers and buyers.

The Role of Auction Houses

At their core, auction houses are marketplaces, facilitating transactions between buyers and sellers. To match supply with demand, they use auctions to determine the most worthy buyer for each seller. Attracting high-quality lots, and bidders to bid on them, is the foremost goal of an auction house. One can often beget the other. An impressive lot will bring in more bidders and sellers are more likely to consign to houses with those bidders.

Auction houses employ ‘specialists’, agents with deep expertise in a collectible category, who advise clients on acquiring or disposing of items.

Attracting Quality Lots and Clients

Success for an auction house lies in its ability to attract both premium lots and high-caliber bidders. This is achieved through a reputation for excellence, a global network of collectors and dealers, and a deep understanding of the market. High-quality lots increase competition among buyers, driving up prices, while esteemed clients bring financial clout and prestige, creating a virtuous cycle of success.

Advisory Role

Auction houses provide valuable advice to clients, guiding them through the complexities of the market. This advisory role encompasses authentication, market trends, pricing strategies, and legal aspects, ensuring clients make informed decisions. By fostering trust and demonstrating expertise, auction houses build long-term relationships with their clients.

Large and powerful auction houses putting their stamp of approval on an item for sale is also part of their value-add. If an object is being sold by Heritage or Sotheby's you can be fairly certain that it is the real deal. If a major house finds an issue with an object before the sale closes, they will withdraw the lot from bidding and regroup. Smaller, less-established houses may be just as reputable, but they have not laid down the track record to prove it yet.

Auction houses must perform a delicate balancing act between achieving great prices for their consignors, as well as ensuring that buyers feel they got a good deal. This can be a challenge as houses will often charge rather exorbitant fees on both sides of the transaction. Great auction houses use these fees to ensure their marketplace is running smoothly and their clients are satisfied.

Understanding Auction House Fees

Auction houses are often scrutinized for their fees, perceived as steep by some. However, these fees fund a litany of services that often justify their cost.

Key fees include:

• Buyer's Premium: A fee paid by the buyer, based on a percentage of the hammer price. This fee varies with the price bracket of the item sold; each house is different and can change their premium schedule at a moment's notice. For reference, Christie's New York currently charges:
  • 26.0% of hammer price, up to $1,000,000
  • 21.0% of hammer price, between $1,000,001 and $6,000,000
  • 15.0% of hammer price, above $6,000,001
• Seller's Commission: A commission paid by the seller, which is calculated as a fixed percentage of the final hammer price. This percentage usually lies between 10%-25%. Significantly valuable consignments let clients drive down the fee, as high-value lots will bring in more bidders that can offset the fee reduction.
• Shipping and Storage Fees: Costs associated with marketing the lots in various locations to drum up international interest. This can often be baked into the Seller's commission, but each house's policy will differ.
• Artist Resale Royalties (Outside the US): A fee paid out to artists or their estates upon the resale of their work. Goes directly to the artist/artist's estate.

These fees compensate for the auction house's efforts in marketing, cataloging, authenticating, and managing legal and compliance risks, which are particularly significant for high-value lots.

These high-value lots drive much of the interest in sales, so much so in fact that houses will entirely waive commissions in order to boost the profile of the sale. Recent years have seen top art auction houses, namely Christie’s and Sotheby’s, compete to drive down seller fees in order to win high-profile consignments. The more valuable a work, the more leverage consignors have over the house; they can always take the work elsewhere. It is up to the house to negotiate a rate that sees them making up the loss in fees on that lot by driving up bids for lower end lots.

Financial Arrangements and Strategies

Auction houses employ several financial strategies to manage risk for themselves and their clients. These strategies are speculative on the performance of one or many lot in a sale, buyers and sellers can also make use of them to protect themselves when putting an object up for auction.

• Minimum Price Guarantee: Ensures sellers receive a predetermined price, even if the lot's final price does not reach expected levels. Let's say a consignor and the house agree upon a $10 million minimum price guarantee, outside of other potential financial meddling, we can expect one of three outcomes:
  • The work fetches a hammer price below $10 million. Even if the work were to reach $9.5M, the consignor would receive the $10M from the house and the house would receive the work that went unsold. Quite a bad outcome for the house, and a pretty good one for the seller.
  • The work fetches exactly the hammer price of $10 million. The consignor again receives the $10M from the house, but in this case the house also collects the buyer's premium of around $1.5M—or 15% of the hammer. The work itself goes to the new buyer; a lukewarm outcome for pretty much everyone involved.
  • The work fetches a price above the hammer price of $10 million. This is where things often get tricky, oftentimes the upside beyond the guarantee will be split between the house and the seller. If the seller negotiated a 50/50 split and the lot were to reach $15 million, the seller would receive $12.5 million—equal to their guarantee of $10M plus their split of the $5M upside or 'overage'. The house receives $3.25M, equal to the sum of the overage ($2.5M) and the buyer's premium ($750K). All parties would likely be satisfied with this outcome, both the house and the seller profited admirably, and the seller did not need to bear the risk of the lot going unsold.
• Third Party Guarantee (Irrevocable Bid): Similar to minimum price guarantees, third party guarantees or irrevocable bids are financial agreements between two parties as to the outcome of a lot in an auction. The key difference here being, one of the parties is not the auction house. If the house is unwilling to accept the risk associated with a guaranteed lot, they may sell the option to guarantee the lot to one of their clients. This form of guarantee can become quite a bit more complicated due to the involved parties having much more financial wiggle-room than a large auction house might. One key difference is that third party guarantees often involve a split of the buyer's premium in addition to the overage split. Using our $10 million example from earlier, here are three scenarios that could play out following bidding on a lot:
  • The work reaches a $9M hammer, a price below the guarantee. If the guarantor agreed to accept the work upon it being bought-in, then she must now pay the house the $10M guarantee; or whatever percentage of the guarantee that the house sold them initially. I know, simple right?
  • The work reaches exactly a $10 million hammer, the exact price of the guarantee. Most deals that reach the exact guarantee are a bit of a wash. Depending upon deal structure, the third party guarantor may receive some of the buyer's premium; in this case around $1.5 million. Though since there is no overage to be split, the result is not very profitable for any party involved.
  • The work reaches a $15 million hammer, $5M above the price guarantee. The guarantor is licking his or her chops at this outcome. They will receive their negotiated portion of the overage, let us say 75% (equal to 37.5% of the total $5M overage) of the auction house's share, or $1.875M. On top of that the guarantor would receive their 'financing fee', which is a fixed percentage of the guarantee price that is paid out of the buyer's premium. A $10M guarantee would yield a $500,000 sum paid out to the guarantor.
• Reserve Pricing: The minimum price a seller is willing to accept, ensuring lots are not sold for less than desired. Minimum prices exist outside of guarantees. Consignors can simply tell the house the lowest price they'd accept, if it is not reached at auction, the work is simply returned to the consignor.

This financialization of auction proceedings has come under scrutiny as houses have been accused of over-using them in order to juice up results. For example, the Fisher-Landau Evening Sale at Sotheby’s saw all 31 of the lots up for sale come with a minimum price guarantee; 17 of those came with an irrevocable bid from an anonymous buyer. Since these arrangements are private, the individual who placed the IB is able to bid on the lot—potentially driving up the price beyond where it would have otherwise landed. Guarantees sometimes can have the opposite effect though, houses may not divulge who the guarantor is, but they are required to reveal the existence of any and all guarantees. Meaning, lots with guarantees can struggle to significantly outkick their estimate range; bidders be reluctant to bid too far past a guarantee, lining the pockets of a third party.

Proponents of the guarantee argue that it allows for a more efficient art market. Guarantees can allow sellers to consign more risky works that otherwise would not be brought to auction.

Additional Terminology

• Chandelier Bidding: A technique used to stimulate bidding by starting with bids below the reserve price, not reflecting actual offers. You will hear the auctioneer make bids that are seemingly in the room, but in reality they are what she will refer to as "in my book" or "here with me". Meaning that they will not be able to accept any of these 'bids' as a winning one, since chandelier bids will never go past the reserve. Both the auctioneer and the bidders understand this phenomenon, but it is the motion used to begin the rhythm of bidding for each lot.
• Bid Spotter: An individual employed by the house who assists the auctioneer in tracking who is bidding on each lot. The spotter will also keep detailed notes on who bids on which lots. So that the house has a record of the demand for each individual work.
• Underbidder: The second-highest bidder, who may be approached if the highest bidder cannot complete the purchase. Underbidders are tracked by the auction house to help them understand the market for that individual work.
• Bought-in: Refers to lots that do not sell, typically because bids do not meet the reserve price.
• Withdrawn: When lots are pulled from auction, often due to sellers' last-minute decisions.

Auction houses play a crucial role in the art and collectibles market, facilitating transactions between buyers and sellers while ensuring the integrity and value of the items traded. Through their expertise, strategic financial arrangements, and comprehensive services, they justify the fees charged and maintain their position as essential institutions in the global art market. Understanding how auction houses operate provides valuable insights into the complexities and dynamics of buying and selling valuable items at auction.

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