The economics of sports 5th by michael a leed and allmen chapter 05

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 • Leagu

Competitive Balance

Chapter 5

FIFTH EDITION

The Economics of Sports

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.

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

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

Table 5.1

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

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

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 do 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

Figure 5.1

The Effect of Diminishing Returns

• The impact of another unit of a variable input (when added to a fixed input) eventually falls

and pay – star players

– And promotes competitive balance

• Drew Brees has limited value to a team that has

Tom Brady

– Brees adds little to wins, attendance, or revenue

– The added cost exceeds the added benefit

– Other teams can use him more effectively

Is Perfect Balance Profit

Maximizing?

• Winning has a bigger

impact in a larger market

– It adds more to gate,

media, and venue

– Big cities will win more

unless MCwins is also

A History of

Competitive Balance

• Yankee dominance of MLB is not new

– Appeared in 15 World Series between 1947 and 1964

• The LA Lakers and San Antonio Spurs won 9 of 13 NBA championships between 1999 and 2011

• The Montreal Canadiens won 10 Stanley Cups in the NHL between 1965 and 1979

– They were succeeded by NY Islander and Edmonton Oiler dynasties in the 1980s

• The NFL is more balanced, but the Browns and

Lions have never been in a Super Bowl

Competitive Balance in Soccer

from 2000-01 to 2011-12

• In England’s Premier League

– Manchester United, Chelsea, and Arsenal have won

5.2 Measuring Competitive

Balance

• Within-Season Balance (Variation)

– Compares teams within a season—across a league

– A low dispersion of team winning percentages means that the teams are evenly matched

• Between-Season Balance (Variation)

– Compares winners (champions) across time

– Some leagues have the same champions year after year

• Regular turnover is preferred

Within-Season Variation (cont.)

• We cannot compare the standard deviation across leagues or across seasons with a different number

of games

• As the number of matches rises, winning

percentages cluster around the mean

– If teams are evenly matched, then the probability of success in any game is close to 5

• We can apply the binomial distribution

• In a short season, a lucky team can have all wins and an unlucky team no wins

• The league can look unbalanced in a short season

Within-Season Variation (cont.)

– We need a better measure

– We compare a league’s standard deviation to the

standard deviation that would result if teams were

i

t i I

A

5 0

500

1 /

Interpreting the Ratio

• The ratio R gives a standardized measure

– Actual and ideal standard deviation fall as G rises

– We can now compare leagues and seasons with a

different number of games

– The formula appears on p 161

• As a rule, R > 1

• If R = 1, the league is completely balanced

– Outcomes are effectively randomly determined

• As R rises, balance worsens

How Do Leagues Compare?

• English Premier League was the most

balanced in 2011-2012

• The NFL, NHL and MLB have similar balance

• NBA is by far the least balanced

– This has been true in most years

• See Table 5.3 for the actual statistics

Table 5.3

– It is unclear what is a good or bad value

• We can use the frequency of championships

– It is hard to compare this across leagues

– See Table 5.4

Table 5.4

The Herfindahl-Hirschman Index

• HHI measures the concentration of championships

• In industrial organization, it measures monopoly power

• Let c i = #championships by team i

– T = #teams; N = #Years

– If HHI=1, one team always wins

– If HHI=1/N and N>T, complete competitive balance

– If HHI=1/T and N<T, complete competitive balance

iN

c HHI

1

2

Applying the HHI to Sports

• See Table 5.4

• the HHI for the Premier League is far greater

than for any other league

• the HHI for the NBA is also large

• the HHI for the NHL, NFL, and MLB are

substantially smaller

• the HHI for the NHL is the smallest, indicating

that the league was most balanced in the first decade of the 21st century

Illustrating Competitive

Imbalance

• The Lorenz Curve measures inequality in a

population

– It is typically used to measure income inequality

– We use it to measure inequality in winning

• Line up NBA teams by wins in 2010-2011 (p 164)

– 1230 games were played, so population = 1230

– The 3 weakest teams (the lowest decile) won 58

games

• 58 games correspond to 4.7 % of 1230

• Thus, the bottom 10% accounted for 4.7% of wins

• The next 10% accounted for 5.8% and so on

• The top 10% accounted for 14.7% of wins

The Lorenz Curve for the NBA

• Red line shows perfect

balance

– Adding 10% more teams

adds 10% more wins

• Blue line shows reality

– Bottom 10% wins less

account for 100% of wins

• The farther the blue line

0 0.2 0.4 0.6 0.8 1 1.2

5.3 Altering Competitive Balance

• All the major North American sports leagues have developed policies to promote

competitive balance

– Revenue sharing

– Salary caps and luxury taxes

– Reverse-order draft

• Players claim that the policies merely

depress overall salaries

• This section explores the policies’ effect on

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 do not affect the flow of resources

– They affect only who gets paid for them

– Simon Rottenberg (1956) first applied the principle to

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

With Transaction Costs…

• The Invariance principle breaks down if there are large costs to making transactions

• Benefits that do not exceed transaction costs are not realized

• Transactions costs could have prevented the

Angels from pursuing Pujols

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

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 2 million

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 do not spend their added revenue on talent

• Some teams might pursue profit over wins

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

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%

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 1 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

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 do 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

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

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

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

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

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