Tickets & Markets, Part 1 (On the shoulders of investment banks…)

Why is it that the market for (event) tickets is so dysfunctional? It’s not the first time I’ve written on this subject, and I had promised to revisit it… Over the last couple months a number of (notionally unconnected) events has catalyzed me in to making good that promise. As way of introduction, let me elaborate on my question: efficient organized markets in tickets for events have not been allowed to develop despite the fact that: (a) the existing market structure is horribly inefficient to the detriment of both buyers and sellers and (b) a vastly more efficient, tried and tested, robust market structure which could very easily be applied to ticket markets already exists and furthermore, especially given modern web technology would be easily adaptable to ticket markets.

Let me take each of these points in turn.

For any event, there are a number of roles that need to be fulfilled: the end product (the entertainer(s), sports teams, etc.), the producers (those who contract the end product and organize the production), the venue (real physical property but also broadcasters), the risk takers (those who underwrite the cost of the production and take the financial risk), the distributors and brokers (those who sell the tickets) and the audience (those that purchase the rights to see the event.) For some events these roles are fulfilled independently, for others the roles are sometimes combined (for example a promoter might both produce and underwrite an event) and most often, especially with respect to distribution, there are multiple participants for the same event. If you were to illustrate this process in a flow chart it would look something like this:

And this is typically how tickets are sold and distributed for the first time, in other words the primary market. And strangely enough it looks amazingly similar to how securities (bonds, shares) are sold and distributed in financial markets:

Trillions of pounds (euros, dollars, etc.) of securities have been (mostly) successfully underwriten and distributed over the years using this basic arrangement (or a variety of variations thereon); and the key reasons this framework has developed to help issuers sell securities to investors are basically twofold: (1) to arrive at a price that best achieves the goals of all parties and (2) to optimally allocate risk during the sales process to those best able and willing to accept and manage it.

Price discovery is at the heart of this process, and is driven by the goals of the issuer which almost always include getting the highest price but often qualified by meeting certain other – sometimes competing – objectives such as ensuring a certain distribution profile – perhaps encouraging new investors, or repeat investors, or certain types of investors; or seeking to engender a certain trading performance in the aftermarket – usually a gentle rise but sometimes a more explosive rise to attract publicity for instance; etc. In investment banks charged with underwriting securities, the job of advising the issuer on what price will best achieve their objectives falls to the syndication desk and the syndicate managers who are responsible for collecting, analyzing and synthesizing all the relevant information that goes into determining the optimal price. This includes such things as: investor demand or indications of interest, the size of the proposed offering, potential competing offerings concurrently in the market, general market conditions and prevailing secondary market prices for similar securities.

Let’s take this last point; I think you will find that if you as any banker or syndicate manager what they consider to be the most important factor when looking to start the price discovery process for a new security it will be the prevailing secondary market prices of similar issues. If their exist many true comparables, the market will hone in very quickly on the clearing price for the new issue; when the security being issued is relatively unique (no other issuers or securities in the market with comparable financial metrics and/or in a similar business for example), the early indicative pricing will most likely need to be tested with investors through an iterative feedback process, which in its most structured form is called ‘bookbuilding’. In this process, the underwriting syndicate solicits ‘indications of interest’ from investors, where they are asked how much they would be willing to buy and at what price. (In some instance, particularly in the bond markets, they might also be asked to give feedback on other parameters such as maturity and the size of the issue.) By building up a picture of demand, the underwriters can optimise the match between what investors are looking for and what the issuer wants to achieve.

Starting in 2001, just after I had joined DrKW, we invested heavily in building an online system to manage this process which until then had been managed (if it was at all) by the industry via manual collection and consolidation (in a spreadsheet) of email, (Bloomberg) electronic messages and yes – I’m not making this up – post-it notes brought to the syndicate desk by sales people. Indeed the term bookbuilding comes from the 19th/early 20th century practice of underwriters writing orders by hand into leather-bound ledger books that recorded the distribution of the new securities. So in over 100 years, the industry had only managed to replace the (aesthetically pleasing) leather books with Excel. Despite much resistance – and the fact that DrKW was a relatively modest player in the debt new issues market – within a few years, online bookbuilding became the norm in Europe. In my opinion this was a result of the higher level of competition amongst underwriters in Europe which gives issuers more leverage in the process and the incredible gains in efficiency and transparency enabled by online bookbuilding were quickly understood and appreciated by issuers. Of course anytime you introduce transparency to a process, those embedded in the system, at the heart of the process lose power, and the skills needed to succeed evolve. Historically the syndicate manager was alone in ‘knowing what was going on’ and was ‘indispensable’ and there were many banks and syndicate managers who were loathe to see this paradigm pass. Of course, the advent of e-bookbuilding opened up whole new avenues and possibilities for underwriters and their customers but not seeing the possibilities of change is not unique to investment banking… Interestingly – and perhaps this has evolved since I left the market a year ago – the US debt markets have not adopted these modern methods (and this despite their European businesses being amongst the largest players in European new issue markets, so they can’t say they aren’t familiar with the technologies and the possibilities), due in my opinion to the smaller number (of larger) players on Wall Street. (I didn’t say oligopoly!)

Typically in a bookbuilt issue, all the investors are sold the securities at the same price (a modified dutch auction process) and all distributors are engaged contractually (by their underwriting agreement) to adhere to this price during the primary selling period. In the fixed income markets this innovation (yes until 20 or so years ago this did not exist) is called a ‘fixed-price reoffer’. This gives buyers the incentive to show their best price, knowing that if the securities are sold more cheaply, they will not be paying over the odds. In so doing, the likelihood of achieving the highest clearing price (meeting all the issuers other objectives) is highest.

Thinking about the methodological continuum of issuing securites, if ‘bookbuilding is at one end of this spectrum, at the other extreme we find the ‘auction’ and in the middle the ‘bought deal’. Of course there are many different ways to conduct an auction (the most commonly used in securities markets is the ‘dutch auction’ and variations thereon) but in the context of this continuum I would simply describe an auction as a distribution mechanism where price is the only selection criterea (for buyers) and where the seller shoulders all the pricing risk. This is usually an optimal distribution strategy for an issuer who regularly accesses the market, has securities that are easily priced by the market (due to extensive secondary trading history in similar securities) and has no additional (to achieving the best clearing price) distribution goals. Nobel prizes in economics have been won discussing the different kinds of auctions and optimizing outcomes, so I’ll leave it to you to dive into the literature if you want to learn more. The bought deal on the other hand has the underwriter shoulder all the pricing risk; this is simply where the bank(s) ‘buy’ the deal from the issuer and then subsequently sell it on to investors. The advantage to the issuer is that they have certainty of pricing, but as in an auction give up control of the ultimate distribution of their securities. This form of issuance is generally used by frequent issuers with a well established (and unlikely to change) investor base.

One last element worth highlighting – to round out this whirlwind primer of how securities are priced and distributed in international capital markets – is the ‘grey market’. This is a (contigent) market in the new security traded on a “when and if issued” basis (between parties who are outside the underwriting arrangements.) Grey markets tend to appear and/or trade actively if investors and dealers believe that the likely issuance price is wrong (either too high or too low). When Stanley Ross first introduced the idea of grey markets in when-issued securities 30 years ago, he was met with massive resistance from the underwriting community: after having ruled the roost – “like it or lump it” – for so long, I guess the syndicate managers of the day didn’t like being told, very publicly, that their pricing was wrong. Of course there are times when good reasons exist for a discrepancy between the issue price and the grey market, and smart syndicate managers today know when the divergence is justified and when it signals a flaw in their pricing and distribution strategy. And so grey market trading has become just one more tool in the new issue market’s price discovery toolbox.

To wrap up Part 1, I suggest you draw two conclusions: (1) the international capital markets over the last 30 years or so have developed a very sophisticated and robust methodology and process for pricing and distributing new securites, and (2) many (if not most) of the innovations that led to this state of affairs were vigorously resisted by the existing establishment at the time of their introduction (and this continues today). It is worth noting however that the power of good ideas and the forces of competition allowed these innovations to ultimately prevail. (Moral of the story: you can either ride the wave or stand in front of it and get dashed against the rocks…)

In Part 2, I’ll try to illustrate how I think all this is relevant for markets in tickets for any kind of event.

Il buono, il brutto, il cattivo

…or: Why is setting markets free so threatening for so many?

In general I’m not prone to getting too emotional about many things – a (British) colleague once attributed this to my Prairie upbringing, which he equated with quiet pragmatic determination. Don’t get me wrong, passionate yes, but emotional no. However, I must admit to getting completely wound up when I see markets that are shackled and controlled for no obvious purpose (other than to perpetuate the power of a select group of annointed insiders although of course this is never articulated and often (implausibly) vehemently denied.) My angst is made even worse when the restrictions are framed in a ‘this-is-for-your-own/the-public’s-good’ and we know best… What a load of rubbish!

There are (sadly) a million examples of this in the naked city, yes Virginia even in supposed enlightened bastions of freedom, markets and democracy. The catalyst for this particular rant – and perhaps setting the scene for future vignettes of the same kind – was an article in the Economist discussing the extraordinary measures the organisers of the Glastonbury festival went through to kill the secondary market in tickets:

Ticket touting is nothing new, as any West End theatre-goer will attest. But promoters argue that the internet has transformed the business from a few men in grubby coats outside a venue into a fully fledged industry. Sporting bodies and the music industry have been urging an official crackdown on touts for several years.

Defenders paint touting as merely the market’s way of correcting artificially low ticket prices. The deals are between willing buyers and sellers. And touts do not always make a profit. Attendance at Royal Ascot, an annual high-society parade with some horse-racing attached, plummeted when it was moved from Berkshire to York in 2005. Glum touts were offering tickets to curious locals at a fifth of their face value.

Indeed, the existence of a secondary market implies that demand outstrips supply. Why don’t promoters simply charge a market-clearing price for the tickets instead of bashing middlemen who do?

Actually the Economist gets it slightly wrong: the existence of a secondary market implies that the clearing price is not the price at which the sellers have offered the tickets – ie that demand at the sale price outstrips supply. But the question as to why promoters don’t seek out this (clearing) price remains. In fact there are two reasons – one good and one bad – but neither are ever put forward by these promoters to defend or explain their pricing policy, perhaps because neither would lend itself to support prohibition of secondary markets, so they resort to the Ugly argument:

Because that would be “unfair”, they say, leaving “genuine fans” squeezed out of popular events by dilettantes with fat wallets.

The Good
Their pricing policy is predicated on maximizing returns over the medium to long term and reducing uncertainty (volatility) in their cash-flows (thus lowering their future cost-of-capital.) So yes they might ‘leave money on the table’ on an given single event but they create positive marketing spin that feeds into future events and/or ancilliary products. They also attract a more broad and heterogeneous customer base, creating a more robust, sustainable market for their products over time. (Even in the context of the same customer: think of the 20 year old student who can afford to queue for 5 hours but can only afford £20, who 20 years later can’t afford to queue for 5 hours but will pay £200 to see the same act.)

The Bad
By not using price as the rationing method, the intermediary acquires real power by being able to allocate the oversubscribed product subjectively. (And creates a black economy in the process where the face value of the goods bear no resemblance to their real value. Think Zimbabwean dollars…) Unfortunately all too often I suspect the driver (for seeking market control) is for this reason alone.

The article goes on:

Economists (and cynics) offer another explanation. Stefan Szymanski, at London’s Imperial College, points out that it is in promoters’ interests to underprice their products. “You get a much better PR payoff if your event is oversubscribed,” he says. “And since demand is hard to predict, the rational thing to do is to underprice aggressively.” Canny firms recoup their losses on the door by selling overpriced merchandise and refreshments to the captive audience inside. [The Good]

Though ministers have made sympathetic noises to the anti-tout lobby [why???], they have stopped short of banning the practice. Only football tickets are off limits, and that was designed to squelch hooliganism by segregating rival supporters, not to promote social justice. [An example perhaps of the only good reason for intervening in otherwise transparent and functioning markets - ie to protect security; for instance I would not go so as far as to argue for a free market in arms, however the burden of proof (that control is a matter of security) should be robust...)]

So entertainers are looking at other options. The Concert Promoters Association wants to attach a set of conditions to all tickets, preventing resale at a profit. It plans to send them to the Office of Fair Trading for approval. But it seems unlikely that Britain’s competition regulator will rubber-stamp such a price-fixing agreement. [I bloody well would hope not!]

If promoters can’t beat the touts, they may join them, auctioning some tickets off to the highest bidder. “If we can’t get the secondary market outlawed, we’ll take control of it,” says Rob Ballantine, the CPA’s spokesman. That may not put the men in the grey mackintoshes out of business, but it could cramp their style. [Framing the problem in the context of 'control' says it all...it's all about power, not the punter.]

Ok, ok but why get so wound up? It’s just about tickets to sporting events and rock concerts. Well no. This is rather a very good (ie easy to understand) parable of far too many markets for goods and services. And like weeds in a lake, unchecked this behavior risks cutting off the lifeblood of our market economies. The great irony is that in the guise of ‘protecting the common man’ from the ‘brutality’ of the markets, these controllers actually exacerbate and entrench the potential inequality engendered by market forces. This is about individuals or individual groups preferring personal power and wealth at the expense of optimal institutional and economic outcomes. And this behavior is prevalent in far far too many markets for goods and services, including – perhaps especially – in the markets for distributing financial securities. Maybe I should write a book: ‘Memoirs of a Syndicate Manager…’ Anyone (who is honest with themselves) involved in the IPO or debt new issues markets will of course recognize The Good, The Bad & The Ugly.

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