Auctions: the Flipping Solution

It’s 2021 and the secondary market premium for certain luxury watches continues. There are plenty of Gregory Paus out there, taking a new, highly sought after [insert sports design from century-plus-old Swiss brand] and selling it for well over retail.

Highway to the Profit Zone

There’s been a collective gasp now that Rolex has found its voice and issued a public statement about the whole matter. That’s how unprecedented the situation is. As an economist, though, the dialogue about flipping is quite reminiscent of two magnets approaching each other with the same poles facing. They get closer and closer and then the forces become too great and the magnets slip away from each other. The discussion over flipping and the secondary market premium is quite similar: we never quite get to the crux of the matter, but we get close.

At the end of the day, flipping and above retail pricing on the secondary market are a consequence of many different circumstances. If you leave any of these circumstances out of the discussion, your picture is incomplete. It’s a bit like a cake recipe: you can try to leave out ingredients, but if you do, don’t expect your end product to resemble an actual cake. Most of these circumstances do boil down to one fundamental issue. Here it is:

Fixed retail pricing that is too low and isn’t market clearing.

That’s it folks. That’s the whole story. You can blame demand, but if demand is too high, allowing retail prices to rise would bleed off that demand until it meets supply. In fact, a rise in retail prices might even induce brands to bring forth more of what collectors want. It’s entirely possible that a brand like Rolex brought out a two-tone Explorer, one that nobody really seemed to ask for, because they feel more comfortable charging a higher price for precious metals.

Rolesor style

The Rolesor Explorer is 67% more expensive at retail than the steel model. This is a very indirect method for clearing the market for Explorers. If, instead, the retail price for a steel Explorer were closer to the Rolesor price, you’d get closer to market clearing because there would be fewer buyers for steel Explorers. The alternative, of course, is to make more of the steel Explorers that are in demand, but that is a different subject (albeit one that is worth exploring).

There are a lot of smart people in the watch industry that likely get this point. The obvious solution is to reset prices higher at their market-clearing level. Then, there will be no excess demand and there will be no flipping. The harder question is why the industry hasn't moved in this direction.

First is the fact that it is not straightforward to forecast the market-clearing price. However, it also isn’t impossible. Sales data on eBay show that the last 90-odd purchases of the new steel no date Submariner in the past year averaged around $12,500, which is about 56% above retail.

365 days of no date Sub sales.

That’s the kind of information you need in order to reset the price higher. There are a whole lot of eBay bidders who fell short just below that price. If you price at $10k, there will be fewer people trying to buy and you’ll move a lot of those sales out of eBay and into stores. You’ll come closer to market clearing.

However, the easiest way to resolve this issue is to stop selling at a fixed retail price and to start auctioning new stock watches. The auction will determine the price and it will quite likely be above the artificially low retail price that causes the shortage and flipping in the first place. Nobody needs to forecast the market clearing price if an auction model is adopted.

The U. S. Federal Reserve already did this kind of thing with its Term Auction Facility. In such auctions, bids actually have two parts: quantity and price. The auctioneer takes the bid with the highest price first and gives that person their quantity, deducting that amount from the total quantity available. Then the auctioneer goes to the bid with the second higher price, proceeding down the list of prices until all items are sold.

One can easily imagine such a situation for luxury watches.

The auctioneer's hammer.

It would work as follows: a brand determines its production volume for a reference and opens the auction. At closing, the winners are identified, quantities allocated, production takes place (if it hasn’t already) and the market clears (note: Ming did something like this recently with an uncapped production run). This kind of process (more formally, a divisible goods sealed bids auction) completely eliminates traditional authorized dealers. For certain brands, that would be a step too far. Auctioning is, essentially, a direct-to-consumer practice, although nothing would prohibit a dealer from bidding. There are many brands that are already reducing their dealer footprint and expanding into a wholly owned boutique model. For such brands, a direct-to-consumer auction may be feasible.

For example, Audemars Piguet is opening a series of “houses” around the world. Imagine a launch of a new Royal Oak in which collectors gather at these houses and participate in the auction (not unlike how the piece unique Black Panther was sold in a live auction on YouTube). Even if a collector doesn’t win in the auction, they share in the experience. This would completely change the retail experience for collectors, which is by-and-large disappointing and frustrating. It converts purchasing away from a retail model that is centuries old (and increasingly dying off) into the “get together” model which collectors organically show they prefer. In addition, it would give brands detailed and incredibly valuable information about who their collectors are and the prices they are willing to pay. The database of bids and registered bidders is something that auction houses, eBay and StockX gather on a daily basis. Running your own auctions gives you that information directly.

The other barrier to this practice is the fact that it places all price uncertainty on the brand.

That price volatility.

The authorized dealer model is valuable for brands because they have a predictable revenue stream from the dealers, who pay a known “wholesale” price as required by a contract. All the pricing uncertainty is born by the dealer. If the retail price is too low, then the dealer unexpectedly runs out of stock. If the retail price is too high, the stock sits and they have to surreptitiously move it to the grey market in order to free their capital.

In the auction model described above, nobody knows the price of a watch ahead of time. A brand also does not know its revenue, as a result. In fact, there is not “one price” for a watch. People that want the watch the most pay the most, and those with lower valuations pay less (we call this price discrimination). However, that is very close to the situation we have now. Flippers are selling to those with higher valuations, so those buyers are paying more. The principle difference in an auction world is that the brand earns additional revenue from the higher price, rather than the flipper. That is the upside for brands. The downside is that auction prices could be too low for the watches, causing the brand to sell at a loss. A reserve price can deal with such a situation, but a brand’s reputation can also suffer if watches don’t sell at expected prices. If a reserve is set at the wholesale price, though, brand revenue per watch will be at or above the amount presently realised through the dealer network.

The reality is that there are a variety of models that will stop flipping. For example, a brand could split its production run across traditional and auction channels. At the end of the day, any real solution requires that artificially low fixed retail prices must end. Any other strategy will only address flipping imperfectly and impartially.