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Sports Leagues as Coasian Firms

2011 February 15
by Phil Miller

Ronald Coase recently celebrated his 100th birthday.  I read a few articles and posts from around the internet about Coase’s contributions to economic thought.  One of his contributions was in the 1937 paper “The Nature of the Firm” in which Coase laid out a theory for why firms exist.

So, naturally, I thought about sports and I started thinking about why sports leagues exist.  My thoughts became this blog post that I originally posted at Market Power.   I thought I would share it here at TSE.  So here goes…

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Sports leagues are often considered to be economic cartels.  In the US at least,  leagues determine who gets to own member franchises, what territories teams can represent, and how many teams are in the league.

The textbook case of pure monopoly shows that monopolists restrict quantity and thereby can charge a price above marginal cost.  Similarly, the monopoly league theory of franchise location holds that leagues keep some cities open so that league members can extract maximum rents in stadium subsidy negotiations.  See Los Angeles and the NFL.

On the labor side, leagues have tried cartelization to monopsonize labor markets for playing talent.  Successful forms of this type of cartelization are the NFL’s Rozelle Rule and Major League Baseball’s notorious Reserve Clause.  The NCAA’s transfer limits in major college football and basketball monopsony power over the players on their teams.

Unsuccessful, at least in a legal sense, forms of cartelization were MLB’s Collusions 1, 2, and 3 in the mid 1980′s.  Does the American Needle v. the NFL SCOTUS case belong in the unsuccessful cartel pile?

Economics and league history thus tell us that sports leagues are cartels to some extent.  But cartelizaition does not explain why sports leagues exist in the first place.  Sports leagues can exist without economic cartelization – members just won’t be as profitable.  So there must be another reason for why leagues exist.

An explanation that may fit the necessary condition for why leagues form comes from Ronald Coase’s (1937) Nature of the Firm paper.  Coase argued that firms, centrally-directed collections of resources, form as a way to lower transactions costs.  They facilitate the costs of searching, information gathering, bargaining, and enforcing contracts.  Firms form to lower the costs of making transactions and thus provide value to their customers.

Where this transactions-costs-lowering argument seems to fit the necessary condition for league formation is in the setting of the various rules that define a sport.  For example, games can be played when the playing rules are unknown beforehand and determined on the spot, but this will generally be uninteresting to fans and frustrating to players.  One can make similar claims about playoff determination and champion definition.  And don’t forget about setting a playing chedule.

Calvinball may be fun to read about in comics, but it would be frustrating to play and watch.

I know I’m not the first sports economist to think of leagues as rule-making bodies necessitated by the “peculiar economics” of sports.  Rod Fort notes this function of leagues in his Sports Economics text.  But I don’t know of an association with Coase’s Nature of the Firm.

3 Responses
  1. Dan permalink
    February 15, 2011

    Phil,

    An issue with characterizing a league as a cartel is that the teams would not be competitors if not for the cartel. In OPEC’s case, each country would compete with each other, but for the cartel. However, in sports, each team needs the other teams in order to produce the product at all (the “peculiar economics”). From that perspective, some use the term “joint venture” to characterize a sports league.

    This gets at what the unit of organization actually is in sports. That varies depending on the market. For instance, a team contracts with a stadium for services. Thus, the team is the unit of organization. It might be that a minimum number of teams to even form a league might be 6 or 8 (with 2, you would just watch the same teams playing each other over and over). In this sense, 6 or 8 teams is the unit of organization. Perhaps college athletics, with hundreds of teams is a cartel of athletic conferences (the Pac-10 competes with the Big 12, etc.).

    Is the NFL a cartel of a few leagues (some might say so wrt the AFL and NFL)?

    Still, others argue that sports leagues are natural monopolies because fans want to see all of the best players playing against each other in the same games/season/playoffs.

    Maybe they really are “natural joint ventures” or “natural cartels”.

  2. Rob Macdonald permalink
    February 18, 2011

    Interesting topic Phil. the role of transaction costs has been grossly under-studied in the rush to model leagues (and especially league labour markets) in the zero transaction cost environment that Coase would likely compare to divinging the future by studying the entrails of a goose.

    The competing expert amicus briefs lodged by the Noll et al and the Daly et al camps for American Needle v NFL are interesting starting points for reading on these topics

  3. Phil permalink
    February 18, 2011

    Dan,

    A student asked this question in my Sports Econ course a couple of weeks ago. In terms of producing competition, I’d say the league is the unit of organization although you can argue that the separate teams are organizations in terms of acquiring talent, molding a team, and producing effort (or whatever you want to call it). But when it comes to the sale of media rights, ticket sales, clothing sales, etc the team is also the unit of organization and they could certainly compete against one another in the market for these goods. This is where the cartel aspect comes into play IMHO.

    Sports leagues certainly have some natural monopolistic observations (the merger of the NFL and the AFL, the occasional emergence and folding of competing leagues (WHL, XFL)).

    Off the top of my head: perhaps the natural monopoly arises for each team because it is virtually costless to let one more fan into a stadium once it’s built, up to capacity. Plus the network effects associated with being a fan provide a huge barrier to entry. Any new league would have to overcome these barriers to be successful.

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