MAKING DOLLARS AND SENSE IN SETTING RESERVE PRICES (PART I) BY ROBERT L. LOSEY

Fasig-Tipton will be conducting its 2012 Saratoga Sales of select yearlings on August 6-7 and its sale of NY Bred yearlings on August 11-12. Whether you are a buyer, seller, or just an interested party, you are likely to find this thought-provoking two-part series on auction strategy and tactics intriguing and potentially useful.

(Robert L. Losey, Ph.D. is a financial consultant who taught finance at American University in Washington, DC and equine finance at the University of Louisville, Ky. Dr. Losey has bred and raced horses since 1972. His e-mail address is RLLosey@gmail.com)

___________________________________________

Two questions that owners of auction yearlings will wrestle with in the upcoming sales are: Do I want to place a reserve (minimum acceptable) price on my yearling? If so, how much?

There are many reasons you might want to bid on your own horse:

1) You don’t want to “give it away.”

2) You want the auctioneers to manage the bidding to your advantage.

3) Most importantly for commercial breeders, you want to maximize your sales returns.

Maximizing returns would be simple if consignors, like Mel Gibson in “What Women Want,” could read people’s minds. With Mel as consignor, his ESP would divine the top price that potential buyers were willing to pay, and the seller or his agent would then bid to just below that top price, pushing the potential high bidder to pay top dollar.

In the absence of Mel’s ESP, what the reserve-setting process boils down to is trying to balance the advantages from bidding up the price against the disadvantages that occur when the seller pushes the price so high that the yearling is bought back. The major disadvantage to a buyback is that, like new cars, yearlings drop dramatically in value when “driven off the lot.” If you’ve ever tried to sell a buyback, you know that if you get an offer at all, it will usually be well below the buyback price. Your alternatives after a buyback are to race the horse yourself, sell it privately, or incur 10% in commissions plus additional expenses carrying the horse to a future auction sale. Rarely can you expect to come out ahead of that last live bid you topped in the process of buying back your own horse.

An example illustrates the finances. Assume that you have a yearling you think is worth $50,000 and the bidding stalls at $48,000. You are considering bidding $49,000 in hopes that a potential buyer will bid $50,000. If your bid elicits a $50,000 bid from a buyer, you’ve made $2,000 more than you would if you kept your hands in your pocket. If your bid results in a buyback, assuming you can sell your horse for $40,000 after it goes through the ring unsold (or you can net $40,000 after all incremental expenses at the next sale), you’ve just cost yourself $8,000. Your bid of $49,000 in this situation will come out ahead over the long run if there is better than an 80% chance that a potential buyer will raise your $49,000 bid to $50,000. (Here’s the math if there is an 80% chance a $50,000 bid will be forthcoming: Bidding $49,000 trades a 100% chance for $48,000 for two alternatives: A) an 80% chance of $50,000 and B) a 20% chance of a $40,000 private sale. Thus you’ll average making .8 x $50,000 + .2 x $40,000 = $48,000.)

Other examples provide slightly different results, but they invariably generate similar prescriptions for sellers, namely that it is folly for a seller to bid up prices at auction unless the odds are strongly in the seller’s favor. For the odds to work in the seller’s favor the crucial condition is that the high bidder has to be willing to go one bid higher most of the time. In the example above, the bidder who bid $48,000 must be willing to go on to $50,000 eight times out of ten in this sort of situation to make this a breakeven situation for the seller. If your horse really is worth somewhere between $48,000 and $50,000 (and determining the value of a horse is a subjective matter that complicates setting reserves, but that is a story for another time), there’s probably only about a 50% chance that that your bid will elicit another bid from the last bidder standing. Thus a profit-maximizing seller would NOT make the $49,000 bid.

Part II of this article delves into auction tactics, and can be found in the posting of August 3, 2012.

Copyright © 2012 Horse Racing Business

Comments

  1. A realtor I know deals in exclusive residential real estate. She says that the biggest obstacle to making a sale is unrealistic price demands by the seller…and this is more so in current depressed markets. Horse consignors do the same thing with unrealistic reserve prices…as shown by the typically double-digit buyback rates. After paying the auction fees, the horses bought back take on more costs.

  2. If you are the owner, and you end up as winning bidder on your horse for $50k, do you actually have to write the check in the full amount to the auction house, plus fees and commissions, and wait for the auction house to pay you the winning amount back, before you can take your horse home? Or do you just pay the auction fees and commissions and take the horse home?

  3. You pay the commission only.

Speak Your Mind

*