It’s been six months since Sotheby’s reported its earnings for the fourth quarter of 2016. The stock jumped 16% on the firm’s strengthening auction commission margins, a necessary prerequisite for the company to keep moving the stock price forward after a multi-year siege by activist investors. Today, BID trades slightly below that initial jump in the mid-$40 range or about 10% above where it traded pre-commission news. That’s a full earnings cycle treading water. (Sotheby’s has a highly seasonal business. As a result, earnings that actually indicate the health of the business come only once every six months.) The latest report had sales and earnings essentially flat. So it should be no surprise to see the stock trading around the same level as six months ago or slightly lower as the stock often dips in the depths of Summer when the auction market is hiatus.

Viewed on that semi-annual basis, BID is holding on to those gains as management finds its footing and even scored several highly visible auction successes since. Seen from the angle of one month ago, when BID reached a multi-year high in the $57 range—a correction of more than 20%—the market has clearly voiced its disapproval of something in the auction house’s strategy.

At the stock market’s height in late July, there was a rush to validate BID’s record levels. Journalists dutifully trotted out sell-side analysts like David Schick who declared that Sotheby’s had “gone from more old-fashioned to modern, including more information flow between business units and more rapid digital media work.”

A Supposition

Stocks go up and down for many reasons. Divining why is nearly an impossible task. There are too many false correlations. Holding that in mind, let’s look back at the last six months. The market responded aggressively to Sotheby’s intervening earnings call. During that May report, Sotheby’s management filled the lack of directional financial information with strong claims that Sotheby’s was  engaged in a wholesale digital renovation of the company. That call came after the May surprise—and headline-grabbing—performance of Basquiat’s untitled head for $110m. Thus, Sotheby’s digital claims resonated even louder than before.

Here is our supposition: Sotheby’s management was hired with the imperative of raising BID’s price by demonstrating that the auction business could fundamentally change the margins of the fine art business by digitizing the company. Sotheby’s management aggressively promoted this idea over the course of many earnings calls through presentations of hopeful statistics. During its May call—building on its art market momentum—the digital claims had added puissance. The stock responded gleefully.

When Sotheby’s released flat earnings showing no meaningful results from these same digital initiatives, the stock sold off. In Wall Street’s usual fashion, it believed too much in Sotheby’s digital strategy all Summer. Judging from the stock price now, Wall Street no longer believes Sotheby’s digital initiatives have added any value. Why? Did Sotheby’s overplay their hand? Did Wall Street fail to do its homework? What are the prospects for Sotheby’s to regain traction digitally?

Let’s take a few moments to consider these questions.

Defining Sotheby’s Digital Strategy

The best place to start to understand Sotheby’s digital strategy is to see whether we can define it based upon the company’s own statements and initiatives. This ought be an easy task considering the level of confidence displayed by the analysts just one month ago. Surely the sell-side analysts had a clear understanding before some of them set a target price for the stock above the late-July peak.

If those sell-side analysts do have a clear understanding of Sotheby’s digital imperatives, they have not shared them with the rest of us. One searches through Sotheby’s statements to investors looking for a specific digital strategy statement. The best one gets is this from a slide in Sotheby’s investor presentation labelled “our four key priorities.” The first of the four priorities is to “implement a compelling growth strategy.” The second: “To embrace tech more effectively both internally and through client-facing products.”

If that seems too vague or broad, later slides detailing the growth strategy include among the bullet points items like “make data informed decisions,” “make online bidding seamless and easy,” and “leverage digital to draw in a new audience.”

From Sotheby’s May 2017 earnings call, that last item, attracting new customers, seems to have been the firm’s priority. CEO Tad Smith produced metrics on that call highlighting the way the firm’s videos attracted viewers more likely to register for an auction echoing another slide in the March 2017 investors’ presentation. That deck points to 2016 as a period when the technology efforts at Sotheby’s had “an emphasis on video.”

Sotheby’s As Media Company

Pause here for a moment to acknowledge that it is and ought to be hard to dis-entangle digital from a company’s overall strategy. Technology is a pervasive tool in contemporary life and business. Digital, like finance, touches every aspect of the enterprise simply because every employee performs his or her job in some way or another via a digital platform of some sort.

Where Sotheby’s capital strategy has become increasingly clear over time—to make human capital investment more flexible through an incentive pay structure and enhance the value of the two largest shareholders’ stakes by reducing the overall number of shares—the digital strategy is less readily apparent. It seems to fall into an internal effort and an external effort which the presentation lumps together in the phrase “client-facing products.”

The internal effort involves building the kind of data infrastructure that many other companies take for granted. Further down, we will look at what Smith said in the most recent earnings call about the slow pace of that effort. Although we only know what Smith tells about these efforts in the earnings calls, these internal will have more effect on the company’s margins than any other effort. This is what Schick was referring to when he said there was more information flow between business units and what Smith highlighted when he talked about his enthusiasm for the planned paperless auction room.

Externally, Sotheby’s has been directing us to look at: the digital marketing efforts primarily using video.

Previously, Smith had touted that viewers had of Sotheby’s videos were more likely to register to bid than visitors to the auction house’s website who didn’t watch video. On the Q1 earnings call in May, Smith went much further:

The truth is that over the past two years, Sotheby’s has become a powerful media company, with the ability to bring tis cale and scope to bear to help our clients sell something, buy something, promote something, market something or enjoy some something. We have numerous examples of our technological efforts beginning to pay dividends.

That was a bold statement and, no doubt, part of what analysts like Schick were relying upon when he declared Sotheby’s modernized. In that same call, Smith goes on to tout Sotheby’s digital marketing efforts as “innovating and learning” before remarking that Sotheby’s video views had grown 101% year over year.

The raw enthusiasm and relative numbers in a quarter with little else to interest Wall Street had exactly the effect Sotheby’s had hoped for. From May 12 to the July peak, BID rose another 13% on the twin promises of Sotheby’s ability to land exciting consignments like the Basquiat and market with Smith’s innovation and learning.

Touting the one thing Wall Street was most eager to hear is Smith’s job, even more so in a company driven by activist investors. Unfortunately, whatever the merits of Sotheby’s video programming, this August Wall Street learned the initiative has not yet produced results that appear in the firm’s bottom line.

Doing the Math

One problem with relying on sell-side analysts is that they don’t seem to check the auction house’s own math. In that May call, Smith presented a detailed example of Sotheby’s digital marketing success. He cited the results of a client email for a watch sale. The raw numbers behind the email—28k sent; 6.6k opens; 2.25k clicks—are a good example of why Sotheby’s efforts are showing up in the financial results.

Response rates in digital marketing are reported in percentages, not the total numbers Smith offered. Any digital marketer will tell you that 23% open rates are slightly above the retail average rate of 21% although the 8% click through rate is well above what you would see in other industries.

The truth of the matter is that the results we’ve been presented from Sotheby’s digital marketing efforts are average for the kind of company that it is. The content too is no better nor worse than its main rival, Christie’s. Both produce videos to push prized consignments. Both offer video recaps of successful sales to try to boost momentum and ooch along market share. Sotheby’s has experimented with the occasional overly dramatic attempt at borrowing interest from guest directors or celebrity narrators but none of this can be called effective or innovative. It’s just run-of-the-mill marketing.

It would be a mystery why Sotheby’s pushed these unremarkable statistics except for the fact that it worked so well. Even when announcing the flat numbers in the August earnings call, Sotheby’s brass doubled down on their digital innovation story. The August call had more stats and more claims of progress in digital marketing alongside the flat numbers.

Make or Buy

Going further into the realm of “client-facing products,” where many on Wall Street hope Sotheby’s can establish game-changing new economics, the executive team faces a series of difficult choices.

On the August call, CFO Michael Goss suggested earnings were impacted by continuing digital investment even though the main driver of flat earnings was a relative increase in compensation expense that tracked rising sales. Unbidden, Goss explained the lack of digital M&A activity—which Wall Street is looking for as evidence of innovation—on the fat that they “frequently, although not always, conclude that it is much more economic to make our e-commerce capability ourselves than to buy them from others.”

Make or buy is a classic business strategy decision. On the buy side of the equation, there’s a legitimate question as to whether there are any successful enterprises in the luxury, tangible property or fine art spaces that would be worthy acquisition candidates. On the make side, Sotheby’s has a backlog of fundamental internal software initiatives that are taking time to roll out. Like the digital marketing initiatives, there’s no evidence in the earnings release that technology is changing internal processes enough to have an impact on revenue or profit.

Smith addressed the backlog of internal initiatives in the August call. He produced two examples, one hopeful and the other plaintive, that should cause analysts to wonder how far Sotheby’s must travel before digital can have an impact on the auction house. One has to feel for Smith and his team. They inherited a firm that had failed to master the basics of information management in the late 20th and early 21st Century. Now, as the rest of the commercial world lights the after burners on big data and supply chain investments, Sotheby’s is mired in an effort to rationalize the process by which it produces and publishes catalogue entries or gets excited about launching an effort to create a paperless auction room.

The positive view of Sotheby’s efforts to re-engineer its business around software technology is that they don’t have to deal with legacy systems and technology debt facing firms that upgraded their systems earlier. The negative view is that Smith has been in harness for two and a half years already without a major internal tech initiative having been completed. Or, at least, one that has produced results.

High-volume low-cost software-driven vendor

At a more abstract level, there’s the suspicion that the high end auction business is somewhat immune to massive gains from creating a digital supply chain. The knowledge of who owns what and what it would take to get them to sell—or buy—is hard to turn into data. It’s the same problem investment banks face when trying to “own” the client relationships developed by their star bankers. Too much is dependent upon the star performers who either won’t share what they know or others cannot do much with that knowledge because they’re not, well, stars.

High end art dealing is still a personality-based, high-touch craft business (hence the prevalence of family enterprises like the Glimchers, Acquavellas, Hauser + Wirth and, to some extent, Zwirner) that gains little from information technology at the top of the value scale. The middle market, where Sotheby’s says it wants to gain both volume and market share, faces a different problem.

This is where Goss’s comments make the most sense. When the analysts rightly ask whether Sotheby’s sees acquisition opportunities in online distribution channels for business lines adjacent to its main lines like wine, watches or other collectibles he demurs that the company feels on more solid footing taking advantage of plummeting technology costs to produce their own ventures instead of buying a company in the space.

He’s right that there are no obvious candidates to buy and integrate. But making their own high-volume low-cost software-driven vendor of tangible assets might be a heavy lift for a company that is still resolving software bottlenecks within their core competency.

What’s Missing from Sotheby’s Digital Strategy

Buying an emerging digital auction house with a real proof of concept would be an easy and welcome use of Sotheby’s balance sheet, one that Goss and Smith would surely jump at to break their revenue log-jam. Building a category killer that can fundamentally reconfigure the economics of the tangible asset market would also be relatively easy if there was firm evidence that pointed the way.

So far, there is not. The Auctionata-Paddle8 debacle suggests Sotheby’s is rightfully wary of where it should focus its digital energy. Christie’s has done little in the realm beyond what the previous leadership built. That effort didn’t produce much of a reward for the CEO. There’s been little else in the way of competitive pressures.

Last week, Sotheby’s doubled down in the online sector by announcing it would forego the buyer’s premium in online sales. Its a bold move. One cannot help by admire Smith’s willingness to keep attacking the problem; however, there’s no evidence that the buyer’s premium is what’s holding back online-only sales. An auction house’s ability to identify and guarantee the integrity of a lot remains a costly process. In many different sectors of the art market, online sellers will tell you that identifying quality merchandise is the key to making sales. Finding something really good and guaranteeing that it is what it is is the expensive part. Once you’ve found it, buyers will find you online.

The issue with auction houses is finding supply. If they could create markets for the lesser items, it would expand sales. But no one has come up with a good way to do that yet. Marketing new luxury items is hard; marketing second-rate old luxury items is even harder.

Though that does raise an interesting question about online strategy. There’s nothing to prevent Sotheby’s from becoming a luxury retail channel for unique new items in the jewelry, design and other spaces. It would obviously require hiring merchant talent it does not already possess but that would add a complementary line of business.

Sotheby’s brand is the point of leverage. As the company has seen with its real estate licensing, the top of the auction market creates a brand halo of incredible value. Smart—and that’s where the danger lies—online retail alliances could do more for Sotheby’s channel ambitions than trying to break the cost structure of going down the value scale in its traditional categories.

Whatever Sotheby’s decides to do in digital, the events of the last month suggest it will not be easy or as easily rewarded as Sotheby’s activist investors had initially hoped.