The Value of Scalpers – Why Ticketmaster Has It All Wrong – Part II

In Part I of this article, we analyzed Ticketmaster’s operations, particularly over the last several years. The conclusions we came to were:

  1. Ticketmaster appears to be increasing its staff at a rate that is too fast for its growth, and thus causing its gross margins to drop.
  2. Ticketmaster is acquiring businesses with a lower gross profit than its own, making inefficient use of its capital.

Now, it is entirely possible that both of these are actually acceptable, each for its own reason.

  1. Ticketmaster may be investing in personnel for rapid future growth, i.e. taking hits now for future profitability.
  2. Ticketmaster may be acquiring businesses that currently have a lower gross profit, but can be made profitable, either through integration cost reductions (that lovely word, synergies), or through better cross-selling, thus reducing the cost per sale.

So what does all of this have to do with scalpers?

There are many players along the value-chain of an event of the kind Ticketmaster handles. Once Ticketmaster has sold a pair of tickets for the Stanley Cup Finals to John and Jane Doe, they are largely out of the picture. Ticketmaster has brokered a transaction between the Does and the NHL. Ticketmaster, having sold and delivered the ticket, no longer has any value to the Does or, for that matter, the NHL. Let us assume that the Does paid $100 per ticket. From their perspective, it was worth right about $100 each to go watch the Pittsburgh Penguins beat the Detroit Red Wings. Now, it is entirely possible that, at some point, that value will change. For example, if John and Jane fall ill, hopefully only with a cold, it is now worth $0 for them to go, so they would rather sell the tickets at nearly any price. There is someone out there for whome it is worth, say $50 each to go, but clearly less than $100 (else they would have bought directly from Ticketmaster at the same time as the Does),  and thus it is a win-win situation. Conversely, if the Does could not buy the ticket from Ticketmaster because it was not worth $100 for them, but, rather, $150. Of course, by now, Ticketmaster is completely sold out, and in any case, Ticketmaster has set the price at $100. In this case, the only option for John and Jane is to find some other John and Jane who are willing to pay $100 but not $150 to go. They buy the tickets from them, the sellers clear a $50 profit per ticket, and the Does get their tickets for their desired price.

So what, then, is scalping? It is defined differently in different places, but, roughly, it is individuals (be they persons or companies) selling tickets for more than their face value, usually in some organized fashion. Thus, although technically one person privately selling to another for some price, whether above or below, is scalping, it is usually not treated as such unless it is at the event venue, or sold in a public manner like on Craigslist or another resale site.

In an open market, prices for most items are set by supply and demand, whether it is the price of milk, gas or a single share of Microsoft (GM, on the other hand, is basically worthless). For some people, it is worth $10 a share, for others $100. As of this writing, it is worth just over $23 per share. Now, when Microsoft goes public, it sells them at what it thinks is the best price. Let us assume it is $20 per share. Some people will buy at that price, others will think it is too high, while some will think it is too low and buy many to resell higher. While Microsoft does prefer to maximize the revenue from its share offering, it is also interested in an active post-offering market for a number of reasons. It understands that the more the market is active, at various prices, the more value it brings to Microsoft, in terms of potential investors for future debt or equity offerings, coverage for the company in the financial media (a.k.a. free marketing), and other benefits.

In order to pull the last pieces together, we need to understand the concept of “price discrimination.” In price discrimination, a seller recognizes that the apple is worth $1 to you and $3 to someone else. Ideally, the seller will find a way to sell $1 to you and $3 to the other person, maximizing his profit. He recognizes that selling it for $1 means getting 2 sales but giving up on an additional $2 in profit (assuming costs are the same), but selling it for $3 means getting one high-margin sale, but losing the second sale. In price discrimination, the seller finds a way to sell it to the first person for $1 and the second for $3. Microsoft, in its share offering, would far prefer to sell one share to the first person for $10, the second for $20 and the third for $100. This would absolutely maximize the net proceeds of the offering to Microsoft. However, Microsoft recognizes that it cannot do so, and must set a fixed offering price for everyone. It relies on the secondary market – all of those who buy it from the offering and then sell to others – to further set the share price. The entire set of businesses who have ever had a share offering, as well as the entire financial services industry, understands this dynamic, and recognizes that although Microsoft gives up on quite a bit of potential proceeds, it is in its long-run benefit to have an active market. As a matter of fact, many of the participants who do buy at a particular price, do so with the expectation of reselling soon (flipping the stock) for a higher price. Microsoft is thus constrained from performing price discrimination in its offering by three factors:

  • Legal and regulatory requirements
  • The need for an active market, with a set market price at any one moment
  • The understanding that doing so would cut out short-term investors, and thus eliminating many of its own direct purchasers

Let us return to Ticketmaster. In many ways, the tickets it sells are like shares. It can set different prices for different ticket types – two rows back as opposed to fifth-level mostly obstructed – but the prices of each class of ticket are largely set to the number the event organizers believe will maximize its profits. While many people do simply buy the tickets at those prices for themselves, or as gifts, there are many, possibly more, who buy them as an investment, to resell at a higher price as the date of the event gets closer. Of those who do buy it for themselves, there is always a partial investment incentive: “if I cannot use it, I can always resell it for a profit.” Thus, scalpers make an active secondary market in a valuable commodity, event tickets. Without the active secondary market, several things are likely to happen:

  • Investor purchasers will pull back, leading to reduced upfront ticket sales. This will appear to be good to Ticketmaster initially, as they feel they are gaining control, but will ultimately hurt their bottom line.
  • Secondary purchasers, like those who want to buy from the Does at $50, or those who decide to go after the event is sold out and are willing to pay a 50% premium at $150, will not only be unable to sell tickets, but they will quickly sour on the whole concept of getting any. The reality is that most people cannot plan concerts or sporting events months in advance, and many are willing to pay a premium for last-minute flexibility.
  • Non-investor purchasers, like the original Does, will be far more reluctant to pay $100 per ticket if they are concerned they will be unable to unload the tickets in a secondary market, if they are unable to go.

All of the above will have the following effects:

  1. Reduced ticket sales, both initially and leading up to the event.
  2. Reduced ticket sale prices, as people are more reluctant to buy, whether primary purchasers concerned about the ability to resell, or investor purchasers who have been banned from the market.
  3. Reduced overall attendance.

Of course, Ticketmaster will be hurt by this behaviour, but event organizers, to whom goes the lion’s share of the face price of the ticket, and who bear the risk of not getting sufficient positive return, or even a loss, on their concert investment, will suffer far more. It is unlikely that these organizers will suffer this state of affairs for long, and will quickly shift their business of ticket brokerage to other venues.

All of this begs the question, why is Ticketmaster so laser-focused on scalpers? Note: the last well-known company to use “laser-focused” in its annual reports (Ticketmaster does not, I am giving it to them) was Enron.

Ticketmaster appears to be bedeviled by two very human factors, which are blinding them:

  1. Broken Windows: Referring back to Frederic Bastiat’s “parable of the broken window,” Ticketmaster management only sees what it sees, and cannot see what it does not. All it understands is that there is lots of secondary market activity going on, profitable for everyone except for itself, at least directly. It does not see how this secondary market is actually benefitting them and their clients, the event organizers. To be fair, Microsoft has the benefit of lots of other companies going public, and thus it sees first hand the benefits of an active secondary market. Ticketmaster has become a virtual monopoly on direct ticket brokerage, and thus has, to some extent, locked itself into its own insular world, lacking the ability to see how others in the same space far.
  2. Fear of (Admitting) Failure: As we saw, Ticketmaster’s revenues are growing by double-digit percentages, but its strategy of growth and acquisition is leading to lower profitability. It cannot fathom that its own strategic and operational mistakes might be making these problems (a very human condition), and thus must look for outside factors. It must be the scalpers who are “stealing” Ticketmaster’s revenues.

Looking at these two factors, the parallels to the entertainment (music and movie) industry are eerie. In the entertainment world, prices kept rising, as the quality of entertainment fare, in most cases, kept dropping. At the same time, the Internet created new venues of distributing music, both copyrighted to major studios or labels as well as independents. The combination led to a drop in revenues and profitability that management found frightening. Once again, with a largely insular oligopoly structure preventing an ability to see how others in a similar industry succeed using varying business models, combined with a fear of admitting failure (in entertainment, more correctly straight hubris), led them to believe that it could anything, but not their own strategies. Thus, it must be the evil pirates who are doing it. Many pirates are illegal and damaging, but the memorable cases of the MPAA and RIAA suing grandmothers for millions of dollars simply showed their desperation to avoid admitting their own failures.

Ticketmaster has an enviable position of a well-known brand-name, solid infrastructure and operations, and relationships with just about every event organizer/producer in the United States, if not the world. They can and will easily destroy this if they cannot see where their own weaknesses are, and thank rather than attack the scalpers.

About Avi Deitcher

Avi Deitcher is a technology business consultant who lives to dramatically improve fast-moving and fast-growing companies. He writes regularly on this blog, and can be reached via Facebook, Twitter and avi@atomicinc.com.
This entry was posted in business. Bookmark the permalink.