The Economics of Sports FIFTH EDITION Chapter Competitive Balance MICHAEL A LEEDS | PETER VON ALLMEN Competitive Balance • The term means different things to different people – Close competition every year, with the difference between the best and worst teams being relatively small – Regular turnover in the winner of the league’s championship • More generally, it means degree of parity within a league Copyright ©2014 Pearson Education, Inc All rights reserved 5-2 Learning Objectives • Understand why owners and fans care about competitive balance • Be able to use and interpret the different measures of competitive balance • Describe and compare the tools that leagues use to promote competitive balance and the limitations of those tools Copyright ©2014 Pearson Education, Inc All rights reserved 5-3 5.1 Desire for Competitive Balance • Fans and owners alike have a conflicted relationship with competitive balance • On any given day, seeing one’s team win is preferable to seeing it lose • But an uninterrupted string of wins is dull Copyright ©2014 Pearson Education, Inc All rights reserved 5-4 The Fans’ Perspective • A game with an uncertain outcome is much more exciting than a foregone conclusion • Table 5.1 shows that from 1950 to 1958 attendance for both the Yankees and the entire American League either stagnated or fell because of Yankees dominance • Evidence suggests that in many sports, fans prefer a game where the home team has a 60-70% chance of winning Copyright ©2014 Pearson Education, Inc All rights reserved 5-5 Table 5.1 Copyright ©2014 Pearson Education, Inc All rights reserved 5-6 The Owners’ Perspective • Competitive balance matters to owners because it matters to fans • Leagues adopt policies to promote competitive balance because they enhance fan demand • Leagues restrict team behavior if it leads to teams that are too strong or too weak (see Table 5.1) • Balance is hard to achieve if some teams maximize wins while others maximize profits Copyright ©2014 Pearson Education, Inc All rights reserved 5-7 Effect of Market Size • There is considerable debate over the impact of market size on competitive balance • There are three primary sources of disagreement – How to measure of success • During playoffs or regular season? – How to characterize market size • Market size has become more important with the advent of broadcasting Copyright ©2014 Pearson Education, Inc All rights reserved 5-8 Effect of Market Size (cont.) • The third point of disagreement is how to measure the impact of policies, such as revenue sharing • Profit-maximizing leagues not want total balance – they want big-market teams to win more • At minimum, more populous locations will win the league championship more frequently • Figure 5.1 shows an additional win is more valuable in a larger market, so the optimum number of wins is greater Copyright ©2014 Pearson Education, Inc All rights reserved 5-9 Figure 5.1 Copyright ©2014 Pearson Education, Inc All rights reserved 5-10 The Invariance Principle • Free agency allows a player to go to the team that offers the best employment terms – Players sell their services to the highest bidder • Owners claim that free agency is incompatible with competitive balance – Economic theory suggests otherwise • Markets direct resources to the most productive uses – Property rights not affect the flow of resources – They affect only who gets paid for them – Simon Rottenberg (1956) first applied the principle to sports Copyright ©2014 Pearson Education, Inc All rights reserved 5-31 How the Invariance Theorem Works • In 2012 Albert Pujols was more valuable to the LA Angels than to the St Louis Cardinals in terms of revenue • With free agency • The Angels paid Pujols to move to LA • Without free agency • The Angels would pay the Cardinals for the “rights” to Pujols • Pujols moves in both cases—the use of the resource is unaffected • The only difference is who gets paid • The reserve clause did not prevent player movement • In 1920 Red Sox sold Babe Ruth to Yankees • Connie Mack twice sold off championship teams in Philadelphia Copyright ©2014 Pearson Education, Inc All rights reserved 5-32 With Transaction Costs… • The Invariance principle breaks down if there are large costs to making transactions • Benefits that not exceed transaction costs are not realized • Transactions costs could have prevented the Angels from pursuing Pujols Copyright ©2014 Pearson Education, Inc All rights reserved 5-33 Revenue Sharing • MLB, NBA, NFL, and NHL share network TV revenue equally • NFL extensively shares all sources of revenue – Teams keep only 60% of home gate revenue – Huge TV package dwarfs other sources • MLB shares 31% of local revenue (minus “expenses”) – Central (non-local) revenue also goes disproportionately to teams in 15 smallest markets – They will have to spend this revenue on players Copyright ©2014 Pearson Education, Inc All rights reserved 5-34 Revenue Sharing (cont.) • The NBA is expected to vastly increase sharing – Teams will share up to 50% of local revenue (minus “expenses”) • The NHL transfers income to teams – In bottom 15 smallest media markets – If the market has a base population under million Copyright ©2014 Pearson Education, Inc All rights reserved 5-35 Revenue Sharing (cont.) • Revenue sharing equalizes revenue across teams • Goal is to reduce incentive of big teams to pursue talent • This will not work if – Sharing shifts down MR of a win for all teams equally – big-market teams still have higher MR – Teams that receive revenue not spend their added revenue on talent • Some teams might pursue profit over wins Copyright ©2014 Pearson Education, Inc All rights reserved 5-36 Salary Caps • NBA, NFL, and NHL all have salary caps (not MLB) – Salary caps are neither a salary limit nor a cap • They set a band on salaries: both upper and lower limits to payrolls (not individual salaries) • Take qualifying revenue (QR) of league – Not all revenue “qualifies” – Definition varies from league to league • Players get a defined share of the QR • Divide total player share by # of teams • Add & subtract a fudge factor (5-20%) to get the bounds Copyright ©2014 Pearson Education, Inc All rights reserved 5-37 NFL Example • Players receive – 55% of national broadcast revenue – 45% of NFL Ventures (merchandising) revenue – 40% of aggregate local revenues • Each team must spend at least 89% of the cap • Overall, players must receive at least 95% Copyright ©2014 Pearson Education, Inc All rights reserved 5-38 Hard Caps and Soft Caps • The NFL has a hard cap – Sets a firm limit on salaries without exceptions • The NBA has a soft cap with many exceptions – Mid-level exception • Team can sign player to the league average salary • Even if it is over the limit – Rookie exception • Team can sign a rookie to his first contract • Even if it is over the limit – Larry Bird exception • Named for former Celtics great who was its first beneficiary • Team can re-sign a player who is already on its roster • Even if it is over the limit Copyright ©2014 Pearson Education, Inc All rights reserved 5-39 The NBA and Soft Caps • All the exceptions have undermined the cap • This has led to further rules – The NBA now caps individual salaries as well – The NBA has a luxury tax to prevent teams from abusing the exceptions • This has nothing to with luxury boxes • Teams pay a tax that increases for every $5 million over the cap • A team $15 million over the cap must pay a $37.5 million tax Copyright ©2014 Pearson Education, Inc All rights reserved 5-40 MLB’s Luxury Tax • Tax starts at 17.5% for first-time offenders – Threshold is $178 million in 2011-2013 – Rises to $189 million in 2014 • Tax rises with the number of abuses • NY Yankees have paid the tax every year Copyright ©2014 Pearson Education, Inc All rights reserved 5-41 The Reverse-Order Entry Draft • Ideally, it levels out talent over time • Teams select new players according to their order of finish in the previous season – Weakest teams get the first choice of new talent – Strongest teams get the last choice Copyright ©2014 Pearson Education, Inc All rights reserved 5-42 What Was the Point of the Draft? • Did teams just want to keep salaries low? • Was is a cynical move by weak teams? – Eagles’ owner Bert Bell proposed the draft – The Eagles happened to have the NFL’s worst record • Was it an idealistic move? – The NY Giants & Chicago Bears agreed to the draft – They were the dominant teams & had the most to lose – Tim Mara (Giants owner): “People come to see competition… We could give [it to] them only if the teams had some sort of equality.” Copyright ©2014 Pearson Education, Inc All rights reserved 5-43 Weaknesses of the Draft • It can lead to “tanking” – Teams lose intentionally to improve draft position – That is why the NBA has a draft “lottery” • Under a lottery – The weakest team has the best chance of choosing first – But it might not • It works only if teams can identify talent Copyright ©2014 Pearson Education, Inc All rights reserved 5-44 Identifying Talent: Moneyball • Billy Beane, the Oakland A’s general manager, found underrated players • He saw that teams – Overrated physical skills – Underrated on-base percentage • Using different criteria in player selection kept his small market team competitive • Other teams eventually caught on – A’s have fallen on hard times as a result Copyright ©2014 Pearson Education, Inc All rights reserved 5-45 ... measure – We compare a league’s standard deviation to the standard deviation that would result if teams were evenly matched – The “ideal” standard deviation occurs when each team has a 50% chance... Education, Inc All rights reserved 5-16 Application • In 2011, the standard deviation in the American League was 0.067 – The typical winning percentage varies by 0.067 from the mean • The standard... is the square root of the average squared deviation from the mean – See formula on p 159 • The mean performance is always as there are a winner and a loser in every game Copyright ©2014 Pearson