You Don't Want to Believe It But It Is a Zero Sum Game

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Posted By: peter chao

It was a long, long, time ago...in a land far away. A sleepy undergraduate was learning the subtlties of Game Theory. Believe it or not, I learned something. A sales transaction is a zero sum game.

By this I mean, the retailer wins and the consumer loses. The reason why it's considered fair is that the retailer provides a service and is fairly compensated for it.

If the above is true then how do the auction houses do it. Is it done with mirrors. Here's what they managed to do. They have persuaded everybody that is a party to this game that they have won. When an item is auctioned off, the seller, the buyer, auctioneer, and other bidders all feel that they have won.

It's a pretty incredible feat considering the House normally takes approximately 40% of the deal. If they don't do it with mirrors, how do they do it. Let me know your thoughts on this.

I know you guys can't all be excited by your work. Here's a chance to actually exercise your brains and get rid of the cobwebs.

And here's another question that will keep you up at nights. Which auction house pulls off the trick the best.

Peter

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Posted By: Dan Bretta

Ummmmmmm.......what?

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Posted By: Max Weder

Peter

All I can say is that your understanding of game theory is completely different than mine.

Max

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Posted By: Dave F

LOL. I'm sure I didn't get the right take on this Peter. But it made me laugh.

Dave

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Posted By: Marc S.

Auction mentality rules. Auction houses often (but not always) command much higher prices for similar material than can be achieved elsewhere.

You try selling a 1965 Topps Leaders card in PSA 10 on Ebay or somewhere else directly for $24,000- I dare you.

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Posted By: peter chao

Your right, what can I say I'm sitting here bored on a Tuesday afternoon. The question I've posed is not really a game theory problem. What I've done is taken Game Theory and applied it to a real world problem. Who knows if I'm way off base guys, let me know.

Peter

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Posted By: Dave F

Peter...your way off base.

Unfortunately for me trying to figure out what exactly this thread is about would keep me up at night. But hey, maybe it's lawyers speak.

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Posted By: leon

I got the question though it could have been shortened to:

"why do folks use auction houses to sell items?"

In which case Mark S gave a succinct and correct answer.....I thought it was a good question....it just took a little while getting there....

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Posted By: barrysloate

Peter- if you can get my consignors to give me 40% of the take, I'll cut you in as a partner.

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Posted By: MVSNYC

i am reading a great book that my friend from Hollywood just sent me..."The Game: Penetrating the Secret Society of Pickup Artists" by Neil Strauss.

i highly recommend it.

MS

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Posted By: Dave F

Since you got the question, what does "the seller always loses" exactly mean? I may need to quit selling.

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Posted By: Jeff Lichtman

Peter, did you bill anyone $400 an hour for that bit of scholarship?

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Posted By: leon

I wasn't referring to that part of the question .....though I guess since the buyer is paying 15%-20% more due to buyers fees then maybe that is losing money for the seller since the auction house is getting it?

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Posted By: peter chao

Unfortunately I wasn't able to bill anybody for my contribution to game theory. You guys have generally covered all the bases, except for one. It's an important factor and goes to the core of the difference between retail sales and auction sales.

Peter

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Posted By: Dave F

Peter
Sounds like the seller only "breaks even" if he uses the B/S/T as opposed to auction houses or ebay.

Is that where you're going with it?

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Posted By: Marc S.

which one wasn't answered? Which auction house pulls it off best?

You can't answer a question like that, truly, given the number of houses that have hidden reserves and/or fake sales (this new PSA certification numbers...) That said, I think the obvious culprits are Mastro's, Sotheby's, REA and Hunt in terms of whom is able to get particularly crazy prices at times in what appear to be legitimate sales.

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Posted By: peter chao

Here it is guys, you've missed an important factor. In general for retail sales there is no future value. By this I mean that when you buy a Ford truck, you expect the truck to depreciate from the moment you buy it.

However, for auction sales the expectation is the item you purchased will appreciate in the future. Guess what happens to the anticipated appreciation. It is divided in advance by the participants. That's why it seems like everybody wins. You've taken the future value of the item and divided it in the present.

Warren Buffett move over.

Peter

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Posted By: Marc S.

<<Peter
Sounds like the seller only "breaks even" if he uses the B/S/T as opposed to auction houses or ebay.

Is that where you're going with it?
>>

B/S/T only works when you know the "correct" value for a card, which often times no one does for something that is exceptionally rare (either by itself, or a condition rarity). Who would have been able to correctly price the Doolan Pirate Back last earlier this Spring, for example? Plus, direct sales by their very nature prevent the dick-swagging that you see at the major auctions. No one would have prices those cufflinks at Sotheby's at $60,000....but independent of the auction house's take on the commission, the consignor must have been ecstatic vis a vis the estimate/inherent value of those particular cufflinks.

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Posted By: Marc S.

you can't really compare a relatively-finite-lifed asset (like a vehicle) with a baseball card or other "investments".

Future anticipated appreciation in a truly efficient market will always be captured in the present value of the asset, given the knowledge of the asset, its potential volatility, etc. A baseball card is just a thing, much like a share of Google or even real estate. Not everyone anticipates appreciation, or even desire it. Many prefer potential volatility which will be discounted more by relatively risk-averse investors given those risk-lovers the potential to either win a lot or lose a lot, but will, on average, come out ahead. I don't think it ever is a case of everybody wins, especially in situations whereby an auction house is taking a significant cut along the way.

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Posted By: Rob Dewolf

I'm just impressed you used the correct version of the word bored, as opposed to board. Seeing as how that your/you're thing is so baffling.

"Your right, what can I say I'm sitting here bored on a Tuesday afternoon."

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Posted By: Dave F

Peter
At this junction I would suggest Warren Buffett stay seated. I am beyond clueless. You can't base a seller being a loser because he sells a card now for $400 that will perhaps sell 10 years from now for $850.

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Posted By: dstudeba

"Future anticipated appreciation in a truly efficient market will always be captured in the present value of the asset, given the knowledge of the asset, its potential volatility, etc."

This was like a ray of light in the confusing clouds of this discussion; and as a bonus is completely correct.

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Posted By: Jason L

and now I have to go to the doctor for various maladies which have flared up.

Peter,
please re-phrase all of your questions, and then directly state which part you are tying in to formal Game Theory.

If you are simply wondering why buyers and sellers both pay ridiculous amounts to a 3rd party to transact a sale for them, well, as far as I can figure:
-prestige
-ego (very similar to prestige)
-hope for higher realized value
-fun of making it an event
-competitive thrills of bidding process
-desire to escape financial and legal responsibilities of transaction

Now, after listing it out like that, (and making a large assumption that you agree with those items), a more funner project would be to see what percentage share of the premiums are assigned to each one!!!

Just for the record, every part of every one of my days is extremely exciting and rewarding at work (even in this bleeding market), so if any high net worth folk here want me to manage their money for them, shoot me an email!

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Posted By: barrysloate

Let me simplify this whole thread:

If you buy a quality baseball card today, there is a good chance it will be worth more tomorrow.

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Posted By: Dan Bretta

C'mon guys...he said he was sleepy when he learned Game Theory.

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Posted By: peter chao

I would elaborate on what Barry is saying. Let me put it this way, if the value of the item you were bidding on depreciated from the moment you bought it, would you continue to raise your bid at auction. If you were rational, the answer would be "no."

Peter

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Posted By: Marc S.

Efficent market theory:

Your quote: "Let me put it this way, if the value of the item you were bidding on depreciated from the moment you bought it, would you continue to raise your bid at auction. If you were rational, the answer would be "no.""

If someone anticipated that the value of what they were bidding on would drop, they would not buy it (assuming that they are buying an asset, like a baseball card, as opposed to a drug/medication which is needed today but might go down in price tomorrow). If someone expected that a card worth $100- today would drop to $90 tomorrow, efficient market theory would suggest that the price today would drop to $90 or less. NO ONE in a rational market pays more for an item today if there is relative certainty that it will be less tomorrow.

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Posted By: Marc S.

this is the first time in a while that I've laughed out loud reading a thread...

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Posted By: Peter Spaeth

You should read Mr. Chao's pronouncements more often.

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Posted By: Jeff Lichtman

Peter, what area of law is your specialty? And where did you go to law school?

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Posted By: peter chao

Guys, I'm glad that you find my posts entertaining. Actually, I try to be profound, but entertaining is good enough.

Peter

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Posted By: peter chao

You first. Let me know your specialty and law school and I will respond in kind.

Peter

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Posted By: Jeff Lichtman

Criminal defense. Duke.

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Posted By: Brian

I like applesauce

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Posted By: peter chao

Baseball Card Law (Real Estate litigation), Boalt Hall (U.C. Berkeley's law school).

Peter

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Posted By: J Levine

My understanding of game theory as applied here is rather limited. The idea that people bidding in large auction house's auctions tend to bid more and more often is less game theory than socio-economic theory.

Large auction houses tend to garner higher bids (re:PSA 10 Leaders card) for several reasons. #1 reason is a large auction house is insured and has a reputation and many high end (read as people with large sums of money to spend) would rather go through a large auction house as opposed to ebay or a "street" sale for that reason. They know and trust the auction house who actually has the card in hand. Trust is huge when making any large purchase. Sothebys, Mastro, REA, etc. all cater to this and make sure that they try to have a spotless record. Socio-economic theory suggests that people will take less risk the larger the sum of money they spend. Haven't we all bid that $1 on a risk auction with low feedback...how many of us are willing to bid $22,000 on a low feedback unknown seller?

In response to the appreciation value...Peter states that it is a zero sum equation. This really is not true. Taken as one equation = one transaction, this is true. What is not true is that this is not an isolated transaction like buying a truck. Baseball cards are not static and do not generally go down in value. What helps the auction houses is the long term. Cards, paintings, art, etc. tend to go up in value. Cards, art, etc. all tend to be sold again and again (granted the timescale may be huge as well). Now what makes the big auction houses tend to really make money is auctioning the same material over again. Granted it does not happen often but if the auction house makes one transaction (for arguments sake- a Baltimore Ruth) and later the card sells through the same auction house, they make more money off the same assest. Rarely do they sell for less. This is how the equations do not end up as zero sum. I also won't go into the discrepancy between seller and buyers fees and how that figures into an auction house making money.

It has been literally 20 years since I did this kind of thinking in college and teaching first grade really does not require higher level math and theory so if it does not make a lot of sense that is your reasons. If it does make sense, I will be shocked.

My two cents,

Joshua

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Posted By: Bill Todd

Econ is one of the few classes I did not sleep through. Here's how it (supposedly) works.

Everything has utility--money, labor, goods, even ideas and values. That utility can change from time to time depending on circumstances. Examples:
You'd willingly pay more for a "common" W502 if it were the last one you needed for your set.
You're willing to work 8 hours a day for a certain wage, but to get you to work more than that the employer has to offer you a higher hourly rate.

In a "perfect" transaction what each party gives up is exactly equal in utility to what they receive. Both parties are aware of this. Anything that pushes the transaction in one direction or the other is zero-sum--that is, one party gains what the other one loses, and both are aware of the difference. Example:
You know you're getting hosed (gag fully intended) every time you buy gas these days.

Peter's point is (at least I think so) that the auction houses set up an environment where people willingly get pushed off that equilibrium point, and still think they came out ahead. In fact, every party thinks they came out ahead--something that's simply not possible in a strictly economic sense. How does this happen? Are the auction houses in fact adding some utility? Bragging rights? Security? Pedigree? Simple brokering? If that's the case, then who does the best job of it?

Bill

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Posted By: DYLAN

Just want to point out since everyone is using automobiles as a comparison, not all depreciate. I was watching one of those car auctions on ESPN2 and just about every car(all rarities of course) that sold for 2,000 60 years ago was selling for half a mill now!
And the above example quoted isnt a true zero sum game. Take poker for instance one wins exactly the amount one loses (ignoring the possibility of a house rake) Poker exlemplifies zero sum games not mastronet lol

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Posted By: barrysloate

Bill- in your example the auction house gets a fixed commission, so they can clearly measure their gain. It is called their net profit.

The result for the buyer is more abstract. One buyer might pay $1000 for item A and feel he overpaid, while another may pay $1500 for the same thing and brag to his friends that he got a great deal. I guess that is the utility curve.

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Posted By: peter chao

Let's say that a Cobb with Cobb back is bought at auction for $50,000. Look what each party gets out of the deal. The Auctioneer gets their percentage. The Seller gets the net sales price. Basically, that's the same as saying the future value to the Seller is 0. In other words the Seller is willing to surrender any claim of the future value in exchange for the net sales price.

The buyer purchases for a price equal to the market value. To him it is the value of the card in his collection plus an expected future appreciation (i.e. present value).

Peter

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Posted By: Mark

Jeff: Since you brought up law schools, which one does US News and World Report rank higher as between yours and Peter's?

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Posted By: Max Weder

Does this have any Fin 48 implications? That's all I want to know. Otherwise, it is making my brain hurt.

Max

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Posted By: peter chao

Pay attention, there's a test at the end. Actually a lot of the theory is not very useful. I'm sure that Barry does fine just going by instinct.

Peter

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Posted By: barrysloate

Here's another way to look at it: in my current auction I have lots that are very interesting to me, and lots that aren't. But that is irrelevant. It is important to me that each of them does well, and a commission on a boring lot is the same as a commission on an interesting one.

A buyer has a completely different read on it. An interesting lot is potentially worth a great deal to him, while a boring one is relatively worthless.

I'm not sure what this proves, but it must prove something.

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Posted By: John H.

"Guys, I'm glad that you find my posts entertaining. Actually, I try to be profound, but entertaining is good enough."

Peter, I'm not sure entertaining is the right adjective for what we find many of your posts to be. Obscure might be more accurate.

John

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Posted By: Jeff Lichtman

Mark, can't say that I've checked such a ranking since I've been a lawyer; I'd be embarrassed honestly to actually take the time at this stage of my career to make such an effort. I mean, how lame would that be? I'm more concerned with my ranking as a criminal lawyer in the country anyway. Why don't you check that out and get back to us?

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Posted By: Kyle

MileHigh is only charging me 2.5% for their upcoming auction. That's much cheaper than eBay, and Paypal.

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Posted By: Jeff Lichtman

2.5% for the consignor's fee? Did you have a large consignment?

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Posted By: peter chao

I'm sure that Jeff will agree with me. In the legal profession you have a bunch of Alpha males that are at each others throats. The last thing you think about is the law school somebody went to, that is yesterday's news. It is about survival and developing a reputation. I'm sure that Jeff would pretty much agree. It certainly isn't for everybody. In many cases it's not even the profession for people that graduated from law school.

Only 25% of my law school class is still practicing law. Almost all of them passed the bar. Very few of them changed their profession because they couldn't make it financially. The majority changed their profession because they found a profession or business that they enjoyed more.

And why not, if you can work in a more enjoyable business and make money at the same time, go for it.

Peter

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Posted By: Jeff Lichtman

I don't know that I have more than a few friends from law school that still practice.

I have one memory from the early 90s of a friend of mine from college -- he worked for a different firm in my building but we shared law libraries -- who was standing at the copy machine making a mound of copies while wearing his double breasted suit buttoned to the hilt, cufflinks flashing. He gave the appearance to me of being a very important copier. I remember thinking, "Good Lord, don't ever let it get like that for me." I have never worn a double breasted suit or cufflinks in my life because of that memory.