Sotheby’s Can't Keep Banging the Hammer for Business Growth

Sotheby's (NYSE: BID  ) , the only publicly traded art company, admits that the majority of the volume of transactions in the art market happen outside major auction houses, as art dealers and art galleries also facilitate art-market activities. While art galleries also play an agency role like auction houses do, art dealers act as principals in the art market by buying and selling to make their own profits. As Sotheby's goes head-to-head with its main auction-house rival Christie's, it may be letting go of some easy revenue and profit opportunities in other segments of the art market.

The business of art dealing
Known for its reputable auction business, which traces its roots through predecessors that go way back to 1744, Sotheby's may not feel the need to really engage itself in other types of art business. The company has a very inactive dealer business and no real gallery pursuits. Sotheby's acquired an art dealer called Noortman Master Paintings in 2006, but the business is adding little value now as the category of master paintings has fallen out of collectors' favor. As of the end of 2013, the remaining inventory of principal holdings of this dealer unit was worth only $11 million. 

An opportunistic principal dealer business should and can make a more positive financial impact on an art company if the company operates it in accordance to the prevalent collecting tastes of potential clients, instead of basing its organization on pre-selected art categories. Unlike an art agent that earns a commission from the sales of artworks that have been on consignment at the agency, a principal art dealer retains the entire sales revenue from a transaction.

Why art dealing?
Getting better potential returns, of course, requires the art dealer to first put in its own investment capital to finance the purchases of artwork, and this can be a challenge. In addition, Sotheby's also has to deal with the limited growth opportunities in its auction business. The company already has about 47% of the total aggregate auction sales between Christie's and itself, an almost-even split of the market with a strong rival. The principal art dealer business may just offer Sotheby's a meaningful growth alternative.

It can be easier for an auction house to expand into the art dealer business than the other way around. Auction is a more complex and specialized trade, whereas art dealing mostly involves one-on-one transactions for the dealer's own good. Furthermore, with a level of expertise in artworks and established relationships with many art collectors, an auction house like Sotheby's can easily apply this experience to its own advantage to profit from sourcing, locating, and then selling artwork as a dealer. The same business thinking can work similarly well in the art gallery business, which is more in agreement with the agency role of an auction house.

The art gallery business
An auction house and an art gallery both bring the art seller and buyer together to potentially make a deal, but they do it differently. An art gallery brokers a deal by presenting the works of a particular artist through a gallery show to interested potential collectors who then decide whether to make a purchase at the price preset by the gallery. While Sotheby's has co-invested with an art gallery, Acquavella Galleries, to form an art company called Acquavella Modern Art, the partnership is nonetheless not a gallery operation.

Acquavella Modern Art basically functions as an art dealer but with little involvement by Sotheby's, which is present mostly through its equity investment. Its purchased artworks are sold through both auctions at Sotheby's and shows at Acquavella Galleries. However, a gallery of its own would help Sotheby's grow more handily outside the auction market, which can have restrictions on the selection of artworks for entry and the granting of bidding access to buyers. Thus, it might unintentionally become insufficient for Sotheby's own business.

Why art gallery?
It's true that the majority of artwork up for sale don't end up in the auction lots of Sotheby's and Christie's, and only the likes of Picassos, Monets, or Van Goghs will show up there. Auctions are where top-ranked artworks chase top prizes. Other artwork, for example pieces from budding artists, don't have to be sold to the highest bidder when they are still trying to gain wider recognition. Art galleries are a fitting form of art business to serve this different part of the art market where artists and collectors may find an auction house unfit for their needs.

Outside of its busy semi-annual auction seasons, Sotheby's should have plenty of time to deal artworks and organize gallery shows to obtain increased sales that might not easily come from its auction business. Not only could these additional art business activities in Sotheby's slow-moving first and third quarters help compensate for the seasonality of auctions, they also complement Sotheby's capability as an auction house and should be an integral part of its art business.

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