What is a fair mark-up?
Monday, 18 November 2013
What’s a fair price to pay for a stake in a tournament player asks Alex Rousso?
What is a fair premium for tournament players to ask for when looking for backers? It’s a question which has been asked many times. Most frequently, it’s couched in (ahem) quite disparaging language by the more trolling of forum posters.
Troll or not, the point is a valid one: should poker’s equivalent of venture capitalists be charged a premium at all, given that without their investment, the grinders in questions would – one presumes – not be able to play the tournament?
The most common theoretical answer is that the price of an investment is whatever the market deems to be its value. This is the most-often-cited reply with regards to the price of a small business: ie, it’s worth whatever you can get for it. In that sense, the open-market pricing of tournament staking is a fair model. Ask too much and you won’t sell (and you’ll likely get 2+2ed to death into the bargain); ask too little and you’ll sell out quickly and have to turn away disappointed backers.
Markets, however, are not perfect, and I believe this warrants deeper study. Most market imperfections are not relevant for this enquiry. The cost of entry, for example, is virtually zero. Any dummy can (and, believe me, I have) post on a forum or Twitter and say that they have a stake in a tournament up for sale. As there are plenty of players looking for staking, there is plenty of liquidity in the market, and hence there are no monopolies. And try as I might, I can’t think of any externalities to this market, unless one counts a total misunderstanding of risk on the part of the backer (more on this later).
No, the biggest imperfection is limited information. In other markets, this means buyers not having enough information at their disposal to accurately price a something. Think of buying a television in the provinces before the internet existed. Chances are the buyer in this circumstance would either go to the electronics store in their local small town, or at a push go to the department store in their nearest city. It would simply not have been worth taking a trip to Tottenham Court Road, the epicentre of electrical shops in London, to compare discount store prices. The internet changed all this. Suddenly, information was abundant, and prices tumbled as a result.
In staking markets the lack of information comes not from volume of stats offered – decent players will post all sorts of figures from Hendon Mob, Sharkscope and so on – but from the quality of these figures. As I’ve covered in other articles, a big enough sample size to accurately judge ROI – even for an internet player – runs into the tens of thousands of buy-ins. Most players can only post results of (low) thousands of tournaments. Much as they would counter otherwise, this isn’t enough.
This fact – that ROI can’t be as accurately assessed as players would have stakers believe – gives staked players the opportunity to massage their figures. After all, mark-up is most often given as a factor of ROI.
Players with an ROI of 45% might charge something like 1.22 mark-up, the common standard being a 50/50 split of projected profit between staker and backed player. This, in itself, gives rise to survivorship bias: players with the good fortune to be able to post an impressive ROI figure are more likely to go after (and get) backing than equally-skilled players who have not run so good.
But even if the figure were accurate, is 50/50 a fair split of projected profit? Let’s consider some other investors of capital. When you buy a house, the chances are you can’t pay for all of it at once. So you go to a mortgage lender to foot the bill for the difference (similar to poker staking so far). The mortgage lender will offer you that money at a premium to the price you would be able to get. To explain, if you did have the money, you could invest it yourself, but usually for less return than your mortgage rate (ie, a loss for you, the staked “player”), or if you had access to enough credit, you could borrow directly from the money markets at the lower LIBOR rate (that, after all, is what the banks do in order to give you your mortgage). In this case the lender (the backer) is making a profit.
Granted, the staker in poker also makes a profit, but there is a major caveat: if you fail to keep up the payments on your house, the mortgage lender gets to keep it. In other words, there’s considerably less risk for the mortgage lender than the tournament staker. Is the premium the tournament backer gets recompense for the risk of all that capital? The market seems to say so, but perhaps it’s getting it wrong.
Perhaps the answer is that the backer in poker is not after a small return for low risk. They’re going for a big return – in the case of online majors, up to one thousand times their stake. Personally, I’m not sure this return is worth the risk of losing all one’s investment. The pat answer here is that backers don’t just buy one stake in one player but many packages in many players, where each package might contain up to, say, 50 tournament buy-ins. To that I would counter that any backer who thinks that can outrun variance by staking hundreds of tournaments should look at my article The Vegas Trip Simulator. Just as with posting an accurate ROI figure, it seems that tempering variance in MTT poker takes tens of thousands of trials. That’s a long staking career!
So what should be done? My conclusion is that the backer should temper their risk by lowering the premium they pay on their investment. It could be argued, after all, that would-be high stakes players should actually be paying for the privilege of accessing all those high stakes fish that – without their benefactors – they would not be getting near. Is it ludicrous to ask whether players should be selling at negative mark-up? Well, if they are that sure of their ROI, maybe they should be. If a player claims to have an ROI of 40% and sells stakes at 0.9, they will still be making (EV) money providing they don’t sell more than 80% of their buy-in. In essence, my question is: why should the backer pay the premium, why not the staked player?
I’ve already given the answer above: it’s because the market says so. Players can ask for a premium, and they get it. But I can’t help thinking that the big driving force behind this is lack of knowledge of markets and investments. It seems like the backer is just paying a premium for another gamble. As I hope I’ve shown, the savvier investors not only minimise their risk, they even get paid to take risks.