Why are there so few legitimate card grading companies?

In my last post, I discussed why the sports card grading companies exist and why these companies are a product of the internet age.   The irony in this situation is that the card grading companies are relatively low-tech businesses that could physically exist without the internet or the technical advances of the last 50 years.

In terms of operations, they are labor intense as humans:

(1) Unpack your cards that have been mailed to the companies in 99 percent of the orders.

(2) Login your cards and segregate them from other orders in boxes or on trays.

(3) Review your cards at some point for authenticity and grade.  This work is largely straightforward for most modern cards.  It might require a little more expertise for older, rare or more expensive cards, which is why the companies charge more based on a card’s value (For example, grading discount specials are usually reserved for cards under a certain declared value such as $100).  Issues such as counterfeiting and restoration affect many more valuable cards, which therefore require closer inspection.

(4) Load your cards into holders, which are put into a pressing machine that seals the card in the holder.  These pressing machines are not multi-million dollar devises protected by patents or trade secrets.

(5) Pack your graded cards to ship back to you and check to make sure your order is complete and that all your cards are returned to you.

None of these basic activities is really high-tech or difficult to pull off.  The card-grading businesses have become more high-tech in the last 15 years with databases of graded cards (e.g., you need to have a database so that a card’s serial can be checked for authenticity) and the emergence of the set registries.  However, even the set registries, which would be the most difficult task to pull off, are not that high tech.  All card set registries are really just large database applications that can easily be developed by any thousands of small software firms, plus renting some storage space “in the cloud” for the data and any pictures people add to the registry.

This, again, raises the question of why are there so few legitimate card grading companies.? Indeed, three card grading companies (PSA, SGC and Beckett) do most of the mainstream card grading with PSA’s share of the market being well over 50 percent (and maybe closer to 80 percent) by just a casual examination of what is being sold on eBay.

Usually, for an industry or business sector to be dominated by a few firms, you need to have what economists call “entry barriers”.  Entry barriers are aspects of competition that confer advantage to existing firms in an industry at the expense of firms that want to enter that business.  If these advantages are great enough, the existing firms can earn high profits without new firms entering the industry and bringing more competition.  While potential new firms may see the profit that the firms in the industry are making, the managers of potential new firms choose not to enter the industry in question because it would cost too much to establish a competitive position because of the entry barriers.

Traditional entry barriers have been associated with large firm size, capital intensity and complex knowledge.  For example, two firms make all the large passenger jets in the world (Boeing & Airbus) because there are monstrous entry barriers into this industry.  Entering airline-making industry would cost likely hundreds of billions of $ dollars in plant and equipment to make sophisticated and large size jets and new competitors would also lack much of the knowledge that  Boeing and Airbus have gathered over the decades about how to produce such complicated products that require immense design and manufacturing knowledge.  So, even when Boeing and Airbus make a lot of money, no other companies enter the industry because investing the hundreds of billions of $ dollars needed to enter would be very risky (and largely a stupid move) without the knowledge of how to design and manufacturing large jets.  Indeed, the only future competitors that Boeing and Airbus will have will be firms whose governments (i.e., China & Brazil) subsidize the entry into the airline-making business by putting up the capital needed to overcome the entry barriers.  The free capital markets will not supply such capital because it would just be a large, bad investment with poor returns.  Governments are willing to do it for national defense or pride reasons.

Anyway, I have digressed from sports card grading.  The key point to take away is that none of the usual entry barriers exist in sports card grading industry.  It is not a capital intensive business.  It requires no special knowledge that is possessed by only a few people or protected by patents.  The machinery involved is not that complex.  The tech side of the business (set registry, web site, etc.) can be easily and cheaply outsourced.  There are few economies of scale that would give large firms a cost advantage.  Indeed, the investment required to start one of these businesses would likely be several hundred thousand dollars.  This would suggest many card grading companies could exist.

However, one entry barrier, that we usually associate with high-technology businesses makes this industry very much controlled by a few, if even one company (e.g., PSA).  That entry barrier is “network externalities” (as called by economists) or the “bandwagon effect” that exists in the sports card grading market.  Network externalities exist when there are competing “standards” in an industry and a particular standard gains more value for those who adopt it as that standard’s market penetration increases.  Think of this example:  When the telephone was first invented in the late 1870s, it had little value to the few people who owned telephones.  Why?  You could only call or talk to the handful of other people that owned telephones.  The real value of a telephone was only revealed only when lots of people started having telephones (i.e., market penetration went up) and you could call or talk to lots of people.  Thus, the value of the telephone for an individual user is proportionate to the number of other people that also have telephones.  In other words, the more people who joined the “network”, the greater its value is to individual users of that network.

We see this type of competition today all the time in tech businesses.  Think of the Apple’s iPhone versus phones run by Google’s Android system.  We have two competing standards of operating systems on these phones that are incompatible.  As more people adopt each one, each system gains more value to its users as software application developers develop more “apps”  for the expanded user base of either the iPhone or Android.  The bandwagon effect kills the smaller standards like Blackberry from RIM because nobody wants to write “apps” for their shrinking user base as the iPhone and Android expand.  Ultimately, the standards become an entry barrier as customers coalesce around a single or several standards and new standards cannot emerge because they cannot come close to providing the benefits of the existing standards to potential customers.

In the sports card grading business, network externalities exist because cards graded by each of the big three card grading companies are not compatible.  This creates the opportunity for bandwagon effects.  Think of this example: If you purchased some valuable sports cards at an estate sale and wanted to get them graded for reselling, which grading service would you choose?  In all likelihood, you would choose Professional Sports Authenticator (PSA).  Why?  Because PSA has the largest market share and thus the most collectors looking for those cards graded by a particular company on eBay.  Therefore, if you listed them on eBay, they would get the most views, all things equal, if they were graded by PSA.  In other words, there are many more PSA-centric collectors on eBay and thus demand is potentially higher for PSA-graded cards.

If you decided to keep the estate sale cards for a while after grading, it is still best to go with the market share leader in a bandwagon market.  This is because the money you invested in card grading largely goes to waste if the card grading company goes bankrupt and stops grading cards.  For example, there used to be four legitimate card grading companies when GAI (Global Authentication Incorporated) was in business out of San Diego.  GAI was started by former PSA employees and made a splash for a few years with pack grading and very consistent card grading.  Yet, by being late movers, they were fighting an uphill battle in establishing a market position against three other companies that had established standards.  GAI ended up going bankrupt in 2009. (footnote 1)  They were most likely forced into bankruptcy by the triple whammy of being a low-market-share standard, PSA entering pack grading as a competitor and the lousy economy after the financial crisis in 2008.  That being said, GAI graded cards are now “orphans” that buyers would likely crossover to other grading companies.  They would likely figure that crossover cost in what they bid in eBay auctions.  Also, the fact that GAI’s card grading business was sold to people that seem to be ripping off customers even makes owning a GAI graded card less valuable. (footnote 2)   Hence, not wanting to get orphaned is why people go with an existing standard like PSA when grading cards.

Caption:  Here's a Cal Ripken Fleer Rookie Card that I own and had graded by GAI five years ago.  Its value is now less because of GAI's bankruptcy and the troubles of its successor company.

Indeed, PSA was very smart in creating network externalities in this market as part of their business plan.  The winning firms in network externality markets tend to be early movers in an industry that establish a standard.  While I don’t know who started grading cards first, PSA was one of the early companies and they pushed very hard to get market share by advertising (developing the SMR magazine), creating alliances with auction houses and grading some of the premiere cards in the industry like the Gretzky-McNall T206 Honus Wagner card. (footnote 3)  This allowed PSA to have an early lead in building their standard.

Probably the greatest move PSA made to set their standard in stone was the development of the set registry idea.  The PSA set registry allows collectors to compete with each other on who has the best sets of various cards.  However, to compete in the PSA registry, all of your cards must be graded by PSA to count.  This was a brilliant idea on several fronts.  First, it created demand to grade cards that would not normally be graded because of their lower dollar value in order to work toward completing sets.  Second, it reinforces the exclusivity of their standard.  To play their set registry game, you must have PSA graded cards.  It’s little wonder SGC (Sportscard Guaranty Company) quickly followed PSA in establishing a set registry because it created greater value for their standard too.  This again hurt smaller players like the now defunct GAI.

Why not a PSA monopoly?

Four facts seem to keep PSA from having a monopoly on card grading.

Fact 1: While PSA seems to have a vast majority of market share in sports card grading, other standards can exist if a firm can get enough cards graded and just enough market share to make their standard viable.  An example from another industry is Mac computers versus PCs (Macs and PCs used to be incompatible before VMware, etc.).  While Apple almost died in the early-to-mid 1990s, the Mac survived because it had a big enough niche in the education markets and desk top publishing to survive as a second standard for PCs.  Therefore, a second standard can dominate a niche part of the marker.

This is exactly what has happened in the sports card grading market.  SGC is considered to be the best grading company in many collectors’ opinions on vintage cards, especially pre-World War II cards.  I am not exactly sure why this perception exists, but it is backed by the facts.  For example, I recently went to both PSA's and SGC's web sites and looked up the population reports of three different types of cards.  Population reports can show all cards graded by a particular company and the data below compares SGC to PSA in cards graded.

Type of Card               SGC Graded              PSA Graded        PSA-to-SGC Ratio

T206 (1909-11)              81,207                      144,373                        1.78

All 1950 year cards        11,377                        34,240                        3.01

All 2001 year cards           9764                       111,063                      11.37 (footnote 4)

As can be seen in the numbers, the PSA advantage in population of graded cards grows as we go from older to newer cards.  While PSA has a 1.78 ratio of graded cards in T206 cards, the ratio grows to a whopping 11-1 advantage in 2001 baseball cards.

Thus, seeming to have a focus on vintage cards has carved out a survivable niche for SGC.  It seems to be the second standard that exists in sports card grading.

Fact 2: The standards are not fully incompatible as sports card collectors can cross their cards between companies for a fee.  So once a card is graded by PSA, it does not have to remain a PSA-graded card forever and can be crossed over or re-graded by another card company.  Therefore, cards are not locked into a particular company.  That being said, crossing cards over is expensive for most collectors, so if PSA grades the most cards on their first grading attempt, they are likely to stay PSA graded.  Therefore, one cannot move costlessly between standards.

Fact 3: Some collectors do not care about which company grades their cards, especially collectors who do not build sets.  The set registry is the biggest lock-in to a particular company.  There are many collectors and sellers of cards that do not care about sets but rather only buy or sell stars, particular players, etc.  I suspect that this is where Beckett gets a lot of their business.  They have the weakest registry (It wasn’t even working the night I got the information above from PSA or SGC).

Fact 4: A weak standard can exist if its profitability is not that important to the company that owns it.  Again, I use Beckett as an example.  Beckett Grading is the smallest of the remaining three players, but they do not seem to care very much from their pricing and lack of specials to attract volume.  My best guess is because grading is subservient to other services at Beckett such as price guides and their online marketplace, they keep it in their product/service mix but do not try to grow it too much.

Caption:  Who the heck was FGA?  I received this card as part of buying out another person's small collection.  This card is probably worth more cracked out of its case.  However, it does save me having to use a toploader!

My own observation on the Big 3 Grading companies…

This has been a long post, but I thought that I would close by adding my personal observations on the grading companies.  I have used all three to grade cards before (and GAI before it went bust), so I have some experience with all of them.

SGC (Sportscard Guaranty)

I am a huge SGC fan and have three sets on their registry.  I like grading my vintage cards through SGC because their grading system is pretty mechanical and therefore very predictable.  PSA seems to give more credit to subjective eye-appeal, which I never seem to understand, and also seems to penalize poor centering more.  Since many vintage cards were cut by humans or less precise older machinery in factories, centering is more of a random issue in vintage cards.  SGC’s customer service is outstanding and you can get answers to almost anything with one telephone call.  Also, they once lost several cards that I sent in with a large order and they promptly replaced these cards with ones they purchased on the open market in the same grade.

On the downside, I get nervous about SGC being the lower market share standard.  I have a lot of money invested in SGC graded cards.  If they would go out of business, I would lose a lot of my investment value and would incur costs to crossover to PSA.

PSA (Professional Sports Authenticator)

I have been a PSA Collector’s Club member since 2000, and PSA is the king of grading.  There are many things to love about PSA.  They also have awesome customer service and their standard or brand is the best currency in grading (see all of the above discussion).  Any modern or autographed cards I get graded always go to PSA.

Certain things also bother me about PSA, however, including:

(a) The grading standards are extremely subjective, especially at high numbers between PSA 8 and PSA 10.  I have never submitted a card that has received a PSA 10, and it bugs me.  Moreover, I have purchased a number of PSA 10s on eBay and cannot tell the difference from the PSA 9’s that PSA always sends back to me when I send in cards to grade that I think are 10's.  I know there are others who share this same paranoia.

(b) As a middle class person who collects cards, it irks me that SMR Magazine and the whole mini-industry to whom PSA seems to want to cater is rich trial lawyers or investment bankers who detail in SMR how hard they have worked to develop a 1952 Topps set with an average PSA grade of 8.87.  I think collecting gets a little ridiculous when everything needs to be a PSA 10 to be awesome.  I want tort reform partially so any trial lawyers have to sell their PSA registry sets!

(c) PSA’s grading specials usually have these ridiculous turnaround times like 45 business days and minimum 25 card submissions.  This move is obviously to encourage you not to use their specials but rather have your cards graded at higher, regular prices.  Part of the problem here is that many modern cards do not have enough market value to justify being graded at PSA’s regular prices.

BGS, BVG, BCCG (Beckett)

Beckett has never seemed to fully know how to handle the age of the Internet.  While they do have one of the strongest names associated with collecting cards, the internet undermined their business model of selling price guide books and magazines.  It took them a long time to figure out the online subscription model that they now follow, and they committed a lot of errors along the way such as selling their whole sports card database on a CD-ROM for $34.95 (I still have that CD.  A great buy  - - - I never had to buy another Beckett product for about three years!)

Likewise, with grading, they seem to be always a day late and a dollar short.  For example, they have no set registry up at this time (9-3-2012) and their earlier registry was not as well designed or functional either PSA’s or SGC’s registries.  While I have been quite happy with the quality of their grading and holders when I submitted cards to their BGS or BVG services (BVG stands for Beckett Vintage Grading), I have not submitted cards to Beckett in several years because their pricing is higher when compared to what you can get with specials at SGC or PSA.

Also, their BCCG service has confused the marketplace.  While I like the idea of an inexpensive low-end service that lacks some of the bells and whistles of regular grading (such as inner sleeves and computerized databasing of cards), their choice of a 10 point scale, similar to PSA and SGC, but with different meaning is completely nonsensical and hurts Beckett’s overall grading brand.  For example, a BCCG 8 means a card is only Excellent or Better (similar to a PSA 5 or SGC 5), which can be used to scam novice buyers. (footnote 5).  Also, it seems that BCCG graders must spend about 3 seconds looking at each card because they will seem to slab about anything and give it some number.  My advice is “buyer beware” on anything graded by BCCG.

Overall, Beckett seem the most confused about their grading service of the Big 3 graders.  I suspect it is because grading plays a smaller role in their overall business model than PSA or SGC.  I think it’s in their portfolio because they feel they have to have it, and they are hedging their bets just to stay in the industry.

1.  http://www.sportscollectorsdaily.com/global-authentication-files-chapter-11/

2. For Better Business Bureau Complaints against http://iowa.bbb.org/article/card-grading-company-in-bettendorf-leaves-sports-fans-empty-handed-36474

3. http://www.honus-wagner.org/2008/02/honus-wagner-t206-price-and-owner.html .  There has been some controversy around the Gretzky-McNall T206 Honus Wagner card and whether it was altered by previous owners and its authenticity.  These issues are beyond this post’s focus.

4. These numbers were gathered on 8-20-2012 form both company’s web site.  The years chosen were not completely random as I collect T206 cards and 1950 Bowman cards.  Year 2001 was chosen because it is Albert Pujols and Ichiro Suzuki’s rookie card year.  Only baseball cards are included in the annual numbers.  For 1950, this would largely be the 1950 Bowman set.  It would include many sets from 2001.  Also, the numbers probably overstate the actual population of cards still-in-grade by each company because of crossover grading whereby one card is crossed over from one company to the other.

5. There is a nice eBay guide that talks about this problem.  It can be found here: http://reviews.ebay.com/The-BCCG-grading-problem-DON-apos-T-OVERPAY-FOR-CARDS?ugid=10000000175139486