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Markets for the Digital Generation

Maybe it’s just confirmation bias, but I seem to be noticing a lot more news and commentary on secondary markets for tickets to live events.

The Sports Economist draws attention to an editorial over at ESPN:

TMQ’s Gregg Easterbrook, after a sensationalized introduction, asks an interesting question:

On Monday, sellers on StubHub were asking from $750 up to a rather comical $164,710 for tickets to the Ohio State-LSU game (the latter price is for a prime luxury-box seat). The season finale Giants-Patriots NFL game might be historic; on Monday, sellers on StubHub were offering tickets for $200 up to $26,000, depending on seat location or box quality. Once the NFL playoff pairings are known, scalper Web sites will come to life for those contests, too. The asking price is not always the selling price, of course. But bowl committees and NFL teams must be saying to themselves — if these seats really are worth hundreds or even thousands of dollars on the free market, we should be the ones pocketing that scratch. How long will it be until professional teams cut out the middle person and simply auction off tickets for whatever the market will bear?Any day now, the NFL is expected to announce a deal to affiliate all its teams with one online reseller, probably Ticketmaster or StubHub, formally acknowledging reselling as legitimate and bringing the NFL an expected annual fee in the $20 million range. This might be just the first step in converting sports-ticket selling into StubHub World.

If one thinks of tickets like shares of stock, it is unlikely that franchises will initially place 100% of each season’s seats by an electronic auction mechanism. But what percentage will be “placed,” and what percentage will be auctioned?

I think rich people in particular are willing to pay to sit in the same spot (”their” seats in some sense) near others that they recognize. The latter component may be modest, but it might also account for the some of the interest in prosecuting scalpers in the old days. Legal reselling increasingly puts that component at risk. This is a stretch, but one way of interpreting laws against scalping is that clubs didn’t mind you selling tickets to your friends, just any old high bidder.

Meanwhile, Fortune recently did a profile piece on Live Nation’s CEO Michael Rapino:

But Rapino isn’t satisfied with dominating the concert business. He is mounting an audacious attack on the record labels and seeking to poach their most important assets - their stars - by turning Live Nation (Charts) into a one-stop operation that handles their every musical need. His offer: We already operate your tours. Why not let us make your albums, sell your merchandise, run your website, and produce your videos and a range of other products you haven’t yet thought of? This is the age of the empowering Internet, after all. Artists are in charge. Who needs a record label?

Depending on whom you believe, Rapino’s strategy will either reinvent the ailing music industry and turn Live Nation into a powerhouse - or cripple his company. Certainly it’s brash talk for a concert promoter whose toddler-aged company has never put out a single record. But artists have been listening closely since Rapino landed a giant catch. In October he struck a first-of-its-kind deal with Madonna, who bolted her longtime label Warner Bros. and signed a ten-year contract estimated at $120 million to let Live Nation handle every part of her business except publishing.

For what it is worth I think they’ll make money on the Madonna deal, even without attributing a value (which is certainly non-zero) to the marketing/business development angle of this innovative and high profile deal.

For more of my thoughts on how I see these markets developing over time, I refer you to a few earlier posts:

• This Just In: Google pre-IPO shareholders owed upwards of $35 billion
• Tickets & Markets, Part 1 (On the shoulders of investment banks)
• Tickets & Markets, Part 2 (Copy, Paste…embrace the inevitability)

Now, I just need to figure out how best to get involved…

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Mountainview, CA - Having sold almost 20 million shares in 2004 at $85, and then another 14 million shares at $295 in 2005 (not too mention various block sales over the years), and with shares now trading at over $700 this represents almost $19 billion of lost value. In addition, since the IPO there have been roughly $3.4 trillion of transactions in Google shares on the secondary markets. Obviously it is unacceptable that not a penny of this is returned to the founders and employees of Google. While acknowledging the benefits that the secondary share market offers to investors and companies alike, and admitting (belatedly) that ‘it does not make sense to criminalize Nasdaq’, to redress this shocking state of affairs, the founders’ agents have suggested that they would be willing to authorize it against agreeing to a levy on all transactions. Set at 1% for example this would amount to returning approximately $35 billion to the Google entrepreneurs and their backers. “And this is just one company! Think of all the other entrepreneurs and venture capitalists that have heretofore been exploited by the maverick and rapacious stock market operators,” said Jim Smith of the recently formed Re-sale Rights Committee of the Santa Clara County Chamber of Commerce.

OK, so I made the preceding article up. But, it makes sense right? After all it’s only fair. At least that’s the view of the (always-ahead-of-the-curve) entertainment industry as reported this week in Variety (thanks to Dom for the pointer):

“The secondary ticketing market offers benefits to music fans and the live music industry alike. It does not make sense to criminalize it,” said Resale Rights Society chairman-elect Marc Marot, manager of Yusuf Islam and Paul Oakenfold, and former chief executive of Island Records. “But there are real issues of consumer protection here, and it is unacceptable that not a penny of the estimated £200 million ($413 million) in transactions generated by the resale of concert tickets in the U.K. is returned to the investors in the live music industry. Where this trade is fair to consumers, we propose to authorize it by agreeing to a levy on all transactions.

“The online ticketing exchanges have consistently claimed that they wish to work with artists and the live music industry. This society presents them with that opportunity.”

I won’t go into it again in detail (see here and here) but it strikes me that instead of vainly trying to preserve an outdated business model by desperately looking to slap taxes and rents on anything that moves, artists and their agents should be looking to embrace the long proven and manifest advantages of robust, liquid and transparent markets to reduce their risks and refine their pricing. Every syndicate manager knows that having good secondary prices makes their job 100 times easier and - while certainly not the only factor - forms the foundation of the primary market pricing algorithm. And as the traditional securities markets become ever more sophisticated in their use of automation for primary distribution, perhaps the resulting marginalized and surplus syndicate managers should consider plying their skills in the market for live event tickets. The right way to help artists garner the true market value of their talents is to well, let the market work!

And lest anyone in the securities industry feel too smug about how much more enlightened they have always been, remember how Stanley Ross was enemy number one for many in the square mile when he pioneered gray markets 30 odd years ago, and as little as 5 years ago (still today in the US & in Equity markets) electronic bookbuilding platforms were not exactly met with a warm embrace…to use one of Pip Coburn’s favorite quotes on change (Machiavelli):

“… nothing is more difficult than to introduce a new order. Because the innovator has for enemies all those who have done well under the old conditions and lukewarm defenders in those who may do well under the new…”

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It seems that the Board of Citigroup is finding it tough to identify a suitable replacement for Mr. Prince…(from the FT):

Josef Ackermann, chief executive of Deutsche Bank, has turned down an approach from Citigroup about taking charge of the US bank, underlining the lack of high-profile external candidates for the job.

I would suggest that this is because they are running up against three problems:

1. They are fishing in too small a pool: the number of people who have previously or are currently running large financial services companies (or even just big divisions within them) is very very small…but I imagine that the Board is probably thinking (who can blame them in these litigious times) that now is not the time for inspired and/or lateral thinking.
2. Impossible to align incentives: the only reason anyone would accept this poisoned chalice of a job would be in return for very significant - and guaranteed - cash; but of course that is unacceptable (rightly so) to the Board because it would be giving away a very expensive free option and send all the wrong signals to investors, employees, regulators etc. And remember, given (1) we are talking very significant cash (probably in EUR or CHF to boot, even models don’t want to be paid in USD these days…)
3. But the number 1 reason is that…(drum roll please)… it is an impossible job. Citigroup (and they are not alone here, it’s just more obvious sans CEO) is too big. And more importantly too complex for any one individual to manage efficiently in its current form. Like many mega-financial services firms, it is a jumble of heterogeneous businesses, risks and activities some of which gain greatly from economies of scale, but others that equally have significant dis-economies of scale. And the combination of all these businesses injects massive complexity. Let’s just say that I would guess Mr. Coase would find Citigroup “unoptimal”. They have too many variables and not enough equations. For anyone to claim that they could “do it” would just be hubris.

So what, should the Board just give up? Let it rumble along without a leader? Crazy as it sounds, I’m not sure they would be any worse off: it would probably save them a billion dollars of comp over the next 3-4 years and would avoid the risk of moral hazard thrown up by problem (2) and I’m not so sure the business would suffer unduly. It might get a bit testy at the top of the management pyramid but the people in the trenches probably wouldn’t see much difference in their day-to-day business. Of course the longer the Board takes to find someone, the more this case (might) be proved! But lest you dismay, even I am not so outrageous as to suggest the shareholders accept this as the least bad long term solution. No, if I were ADIA, Prince Waleed et al, I would be pressing Mr. Rubin to dedicating 2008 to the great unwinding/clean-up and switching my recruiting efforts to finding the 3-6 people who could lead (many of whom would ostensibly be Citi insiders) the future sons and daughter companies of Citigroup. Many of these proto-companies would not only be world leaders in their markets (like Citigroup), but would potentially be world beaters (unlike Citigroup); and there is no reason to think that in some instances they wouldn’t keep strong commercial ties with their siblings.

Just to be clear I’m not saying that building Citigroup was a mistake, just that it is unfinished business: a lot of interesting reactants have been brought together in solution, but now the end products need to be precipitated out. (Apologies to the non-chemists if this seems a strange metaphor.) Otherwise you’re just stuck with a beaker full of gray gloop, and the risk that it might explode to boot!

Finally some of you might be thinking “you’re just saying this because you aren’t up to the job and therefore can’t imagine that anyone else could be…hubris indeed!” Actually if its hubris you want, I would suggest that I could probably do as good a job as many (all?) of the candidates being considered - not the least because I would come without the same baggage and expectations, but am happy equally to admit that the complexity of the job (as currently specified) would be beyond my abilities. But let me finish by turning it around. Would you accept the job if it was offered to you? Seriously. Be honest. And if so, under what conditions? How much would you need to be paid?

The dilemma the Citigroup Board faces is that anyone who unflinchingly answers uncategorically yes (the usual “right answer” for a search) is disqualified as either a lunatic or a delusionary or both. Mr. Rubin I’m afraid I can’t help you with your search but I would be happy to serve at the pleasure of the Board if you want to brainstorm on reaction coordinates and such.

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(via FSJ)

Just waiting for the credit market version…

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One of the core tenets of the sixth paradigm will be the migration of value from transaction execution and (to a lesser extent) processing to data. In this context, Markit Group is in my opinion an excellent example of the kind of company that will emerge and be successful in the coming decade(s):

Markit was founded in 2001 as the first independent source of credit derivative pricing. Today, our data, valuations and trade processing services are regarded as the market standard in the global financial markets, helping our clients to reduce risk and improve operational efficiency.

As a private company with privileged relationships with 16 shareholder banks, Markit has unparalleled access to a valuable dataset spanning credit, equities and the broader OTC derivative universe. Our unique relationships with the bank shareholders give us the opportunity to work closely with these leading market makers to develop innovative solutions for the marketplace.

With close to 1,000 institutions as clients - including investment banks, hedge funds, asset managers, central banks, regulators, rating agencies and insurance companies - we provide round-the-clock support from our offices in London, New York, Chicago, Toronto, Amsterdam, Brussels, Luxembourg, Tokyo and Singapore.

The founders - led by Lance Uggla and Kevin Gould, seasoned capital markets traders and managers both - understood that having good clean, well-packaged data was essential to the growth of any traded market and that this was not a given in (many) OTC markets, picking one in particular - credit - that had great growth potential but particularly poor data availability as a natural starting point for their business. Since then they have grown the business impressively both organically and through judicious acquisitions which focused on bringing their management, distribution and platform strengths to smaller companies focused on certain market niches. I was privileged to serve as a founding Director on their Board (representing DKIB) and so when I saw that they had recently closed on the acquisition of International Index Company (on who’s Board I also served) I must say I was pleased, having first floated the idea of this deal to Lance when I was Chairman of IIC a few years ago. The strategic fit is very good and with Markit’s resources behind it, IIC will be able to continue to improve and strengthen its leading franchise in fixed income indices.

I enjoyed tremendously my time working with Markit and fully expect them to continue to be leaders in the development of modern markets data services in the years to come. They are definitely someone to keep an eye on.

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I’m about as far away from being knowledgeable about horse racing (and betting on horse racing) as you can get, so I might have this all wrong, but it would seem to me that their are remarkable similarities between the “starting price” (for a horse race) and a “fixing (price)” on an exchange. (Previous thoughts on gambling v. trading here.)

Historically, starting prices (for UK horse racing) were set by the big bookmakers and as was pointed out in the June 2004 BBC programme “Battle of the Bookies”, these were routinely subject to manipulation by the big high street betting shops; with a relatively small stake (in comparison to the total amounts staked in their shops) they could move the on-course prices used to determine the starting price, generally shortening the odds of the favorite(s). The programme pointed out that with the advent of Betfair, this was getting harder and harder to do as arbitrageurs popped up to trade the price discrepancy between what was available “on-course” at the prices trading on the exchange.

Indeed if you look at fixings on financial markets, these are highly regulated by the exchanges and regulatory authorities to eliminate and prohibit this kind of artificial price setting. (See for example the rules of the London Stock Exchange.)

Indeed, the starting price is nothing more than the strike against which the bookmaker sells his outcome options on the race. The closer the starting price is to the “true price” (all outcomes add up to a 100% probability), the lower the margin for the options writers. As is the case in financial markets as well, the “OTC” (over-the-counter) providers of derivatives are often loathe to see prices migrate to a (commoditized) exchange environment as the usual result is significant margin compression as prices become transparent. The parallels aren’t perfect but in this context it doesn’t surprise me that the traditional “dealers” (read: bookies) aren’t very happy with Betfair’s plans to publish its own starting price:

In early November 2007 it was reported that Betfair was set to make a big announcement regarding the publication of its own SPs. On 13 November 2007 The Guardian reported;

“Betfair has spent two years developing a robust system to allow bets to be placed at its own SP. As a result, three extra columns will soon be added to its display for every win market on its British and Irish racing service: one for bets on a horse at the Betfair SP, one for “lay” bets against it at SP, and a “guide” price in the middle showing what the SP is likely to be…..SP bets will have some differences from “normal” bets on Betfair. Whereas normal bets can be cancelled until the moment when a rival gambler accepts the other side of the bet, SP bets cannot be cancelled once placed. Punters can, however, specify a minimum price at which they are willing to back, and a maximum price for lay bets.”

In the table below we look at the November Handicap run at Doncaster on November 10 2007, and compare the official SP with the “Betfair SP”. The horses are listed in market order and not order of finish.

The first thing to note is that the SP over-round on Betfair, including commission, totalled 108.5 against an official SP over-round of 127.9.

Of course if your business model (as a bookie) requires a 20%+ gross margin, things could get a bit tough…The question then becomes one of (a) can I continue to innovate and go “up-market” (more complex products - ie exotic derivatives) to preserve margins and/or (b) can I make my (”flow”) operations more efficient so that I can profit from much thinner margins (but probably) higher volumes? I suspect the answer to both questions is potentially yes but requires a fundamental reappraisal of one’s business model: a new paradigm. Unfortunately something that successful incumbents (and their managers) in every industry often find extremely challenging if not impossible to do.

(It also raises the question as to whether the distinction made between businesses subject to regulation by the Gambling Commission and the FSA is more a question of semantics than anything else. Merger anyone?)

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