Monday, February 9, 2015

What happened to GAI Grading? And how a bad grading idea sunk their successor Global Authentic.

Introduction

In a past post, I wrote about how GAI grading (Global Authentication Incorporated) went bankrupt in 2008-2009 as the sports card grading market went from four mainstream competitors to three (e.g., PSA, SGC & Beckett).  That description was not fully adequate as the bankruptcy process in the United States is very complex.  While GAI did file for bankruptcy in December of 2008 (footnote 1), its bankruptcy petition was later dismissed by the courts when the company failed to notify all creditors about an upcoming creditors meeting and also failed to file a number of required legal documents. (footnote 2).

How GAI actually disappeared was through a "split up" after their bankruptcy petition was denied.  Mike Baker, who was head of the card grading division at GAI and a former grader at PSA, purchased the rights to grade cards under a slightly altered brand name, Global Authority, along with the pressing machines, supplies and other items needed to physically grade both cards and unopened packs of cards.  Global Authority was relocated from Southern California to Bettendorf, Iowa (footnote 3).  One can assume that rent was less expensive in that location.  The rest of the company’s assets, what little were left, remained in California in the form of Global Authentics, which was mainly an autograph grading company.

It is not clear how much creditors received for their outstanding debts, which totaled between $1 and $10 million (footnote 1).  Mike Baker, the new part-owner of Global Authority, was listed on the bankruptcy petition as the second of the unsecured creditors, so I suspect that his purchase of the card grading assets satisfied his claim and created cash for some other creditors.

Why did the original GAI fail as a business?

Without inside knowledge, it is hard to specify the exact reasons the original GAI failed as a company in California (more on its Iowa step-child later).  GAI was started in 2001 or 2002 by Steve Rocchi, who was its President and Chief Executive Officer.  He had been either pushed out or voluntarily left Professional Sports Authenticator (PSA) in 2001 after having founded PSA and had served as its President for over a decade.   However, PSA was part of a larger firm, Collectors Universe, so he was not head of the entire company.  Rocchi was the first employee of PCGS, the predecessor of Collectors Universe (parent of PSA) and served as its Operations Manager from 1988 to 1991 (footnote 4).  There was a clear brewha between Collector’s Universe and Rochi (for example, he is listed as a key employee on the prospectus filed for Collectors Universe to go public in 1999, but is missing from the 2000 Collectors Universe annual report), and he left to form GAI as a competitor.

From my recollection of the industry, GAI received good market acceptance upon starting operations.  Their grading standards were very similar to PSA’s standards, using a similar ten point scale for card grading.  All graded cards were also serial numbered and slabbed in tamper-resistant cases.  A card buyer could also check the certification number of any card sold on eBay.  Where GAI made their biggest splash was in introducing pack grading.  As the first unopened card pack grader, they were able to capture the market initially for grading packs.  In some senses, that made GAI an innovator in the market.

GAI falling into filing a bankruptcy petition, likely had to do with three events.  Again, I have no inside information of the company.

1. As the smallest of the four major grading companies, they were at a distinct disadvantage.  As I have discussed in other posts, the card grading market provides significant advantages to the firms that have the highest market share or have high market share within a card niche. (see: http://junkwaxandobservations.blogspot.com/2012/09/why-are-there-so-few-legitimate-card.html).  Other than in graded unopened packs, GAI was the smallest player in the industry.  This meant that GAI had less set builders trying to compile sets of GAI-graded cards and your cards were more marketable on eBay with the PSA or Beckett brand name.  The one market that they dominated for a while, pack grading, did not have set builders (e.g., you cannot build a set of graded packs).  Thus, no “pack registry” competition could exist among collectors to lock them into GAI pack grading.  Thus, any lock-in advantage from being the first-mover in pack grading did not exist.

Indeed, I think the only reason that GAI Grading even got off the ground is because many of their personnel were former PSA people.  That gave the company instant credibility, along with early cards being graded by GAI seeming to have high standards.  With low standards, they would have just become another one of the low-end grading companies whose graded cards are always more suspect.

Caption: This photo shows two labels or "flips" from graded cards.  The top label is the old GAI grading company that was based in California.  The bottom flip represents the subsequent Global Authority company based in Iowa.  While both companies are out of business, collectors have more faith in grades assigned by the older company (e.g., top label)

Also, in the early years of the 2000s, the card grading business was booming as many vintage cards still had not been graded and some junk era cards were still worth grading at that time.  This boom in grading may have masked the underlying weakness of GAI’s market position until the later part of the decade.

2.  In 2006, PSA introduced pack grading.  This service introduction must have cut dramatically into GAI’s unopened pack grading business where they had been the only show.  Without a registry to keep customers locked into grading their unopened packs through GAI, it made sense for many customers to switch to the biggest and most well known grading firm.  My guess is that PSA cut heavily into GAI’s volume with this service offering.  It also probably capped the price that GAI could offer for pack grading.

3. The 2008 financial and real estate market collapse shrank the demand for grading.  For example, PSA’s number of cards graded annually declined about 12 percent in the year between June 2008 and June 2009 (source: Collectors Universe 2009 Annual Report).  Because sports card grading and collecting are not necessities but rather luxuries in the economy, they decline when economic times get tough and people have less money.  The grading firms that were smaller than PSA likely suffered even worse percentage declines in sales or cards graded during the crisis.

The combination of these three events likely clobbered GAI grading.  They must have been walking a thin line of staying in business before the financial crisis since they filed for bankruptcy in December 2008, and the bellwether of the crisis, Lehman Brothers Bankruptcy, occurred only several months earlier in September 2008.  This hypothesis is supported by the fact that almost a year earlier GAI was evicted from their office space in Southern California and was also cited for operating without a business license (footnote 5).   

My guess is that money was always tight at GAI.  The large decline of revenue caused by the financial crisis was likely the last straw as it would have been likely that they could not have covered their fixed costs of rent and utilities.  The fact that GAI employees were some of the creditors listed in the Chapter 11 filing indicates that they could not make payroll at the end.

The Disaster in Iowa

After moving to Iowa and re-starting as Global Authority, the company never really got off the ground and then basically committed suicide with a major strategic blunder.  The company’s CEO was Demian Werner and GAI’s Mike Baker was director of grading and authentication.  Werner was likely the source of capital to the firm as Baker had to purchase the card grading assets from GAI (this is pure speculation by me, however).  From the little information that I can find publicly about Werner, he is based in Bettendorf, Iowa, was active is selling sports collectibles and now runs a small security firm based in Bettendorf, Iowa (footnote 6).

Global Authority originally started by attending shows and grading cards under the Global Authority brand name.  They even started a Facebook page that still exists as of this writing on February 9, 2015 (https://www.facebook.com/globalauth).  In May of 2010, Global Authority announced the idea that would become their undoing:  Free Grading (footnote 7).

Why was free grading a terrible blunder?  Here’s how it worked.  A customer could submit cards to Global Authority.  They would be graded for free.  The customer would then choose the cards to encase and pay the grading/encapsulation fee only for those cards.  This seemed like an offer to good to be true.  As one blogger wrote:

FREE CARD GRADING.  Did that get your attention?  In a time when the economy is soft and people’s discretionary (collecting) income is less than it used to be, GAI is the first only only card grading service to offer this value.  Collectors can choose to have there cards returned to them graded or pay to have them encased.  From the very beginning, card entry, tracking and easy of use of GAI’s service is some of the smoothest and best that I have used.  You can watch and control your submissions through the whole process.  The advantage of having you enter your cards into GAI’s live system is a quicker turn around time.  Instead of having to wait for them to receive your cards and have them enter them, you are already one step ahead with having entered your cards yourself.  Once your cards are graded, you can choose to have any or all of them encapsulated, returned or placed on consignment with GAI.  With regular e-mail updates of when they receive your cards, grading is finished, encapsulation is finished and when they send out your cards, you are never left out of the loop and wondering what or when the next step is.  The card holders themselves are stack-able and the thicker memorabilia card only required a slightly thicker holder.  What I really like about GAI’s holders is the card information and grade on the top spine.  This saves time and makes for easy identification of your graded cards when stored vertically.  The value and ease of use of GAI’s on-line submission make their service one that collectors and dealers both will enjoy.  I strongly recommend GAI grading service for collectors who like to have more control in the grading process and to see if their card is worth encapsulation after the free grading. (pasted from http://www.going9baseball.com/2011/07/07/bike-spoles-and-show-boxes-global-authority-inc-grading-service-review/ on February 9, 2015)

It was too good to be true.  Think of the economics of this grading strategy.  How many modern sports cards exist in the world that are only worth something more than pocket change if graded a GEM-MINT 10?  Tens of millions is the answer.  Think of the 1990 Fleer Michael Jordan (and like cards) that one cannot sell on eBay for fifty cents ungraded but will sell for $25.00 if graded GEM MINT 10.  Hence, this grading strategy attracted a tidal wave of junk era submissions to Global Authority where the vast majority of cards would not turn into revenue but still had to be examined.  It’s very likely that customers might submit 100 cards with only the 3 that graded GEM MINT 10 being converted to actual revenue.  Global Authority would still have to look at the other 97 cards and also ship them back to their original owners.

Given this situation, Global Authority literally drowned in submissions.  As a small operation, it was largely swamped by a tsunami of cards that would likely not lead to revenue.  This title wave of cards also creates costs.  You have to have a system of keeping orders separate, and legitimate graders pay for insurance to cover the cards that are in their possession for grading.  The costs of managing this tsunami of cards were extremely high for such a small amount of revenue.

The results can be seen by running a Google search on the words “Global Authority” and “Better Business Bureau” (use quotes around the words).  Global Authority soon fell months behind on processing orders and eventually the whole system collapsed with no cards being graded.  Some orders were lost.

You will see Global Authority roasted on chat boards all over the sports card collecting world for ripping off customers.  Customers sued them, contacted the Iowa Attorney General and complaints exist even to this day.  As of 2014, the company was no longer grading cards and was trying to return submissions to their owners.  All presence of their web site has been pulled off the internet, so one can safely assume they are out of business.

What does the story of free grading tell us?  First, customers are not always right in every aspect.  Customers would love companies to give their products or services away for free.  Customers are always right when it comes to promised service and quality within a desired price range, but that is quite different.  Second, a business has to think through the economics of pricing very carefully.  It’s clear that neither Baker nor Werner put enough thinking into the free grading concept before launching it.  Maybe Global Authority was desperate for volume at the time of the pricing idea, but volume can sometimes drown a business, especially when it is unprofitable volume.

End Note