Tuesday, December 08, 2009

Revenue Sharing and Salary Caps: Will the NFL End Up Like the Big XII? 

Many folks point to the NFL revenue sharing system and its salary cap as the determinants behind the more-or-less balanced competition between the teams.

As we edge closer to a potential labor-management dispute, the NFL has decided to put part of the revenue sharing system on hold. From Chris Mortensen at ESPN.com:
In a significant move that could impact the flow of money to potential free agents and the competitive balance of teams, the NFL has notified the players' union that effective in March, owners will pull the plug on the $100 million-per-year revenue-sharing program that has subsidized lower-revenue clubs, multiple sources said.
The classic 1956 JPE paper by Simon Rottenberg contains the well-known and frequently-studied invariance hypothesis (IH). According to this hypothesis, the distribution of players does not depend on who has the right to tell players where they can and cannot play. Instead, each player tends to the market that values him the most at the margin.

Since a salary cap does not change the marginal value of players, it shouldn't ceteris paribus alter competitive balance.

Revenue sharing, on the other hand, reduces the difference between the amount of revenue teams can keep and, thus, can alter the value of players. Altering the system as the NFL appears to have done will, if it remains in place over the long haul, may create more of a disparity between "large" market and "small" market teams.

As a comparison, look at the Big XII conference in football. The Big XII (and every other college conference) is bound by a salary cap with player salaries = $0. When it comes to TV revenues, the Big XII operates under a split-pool revenue sharing system* where all television revenues are pooled together. Then half of the pot is divided up evenly among the 12 teams and the other half is divided up among the teams depending on how many telly appearances each team has made.

This means that teams like Texas, Oklahoma, and Nebraska, which have the biggest football followings and appear on TV most-often, get a bigger ladle from the money pot than teams like Baylor, Iowa State, and Kansas State.

In terms of the spread of championships, the Big XII has not been balanced. Nine of the fourteen championships have been won by either Oklahoma or Texas, including that classic game played between Texas and Nebraska last weekend. Throw the Huskers into the championship count, and 11 of the 14 championships have gone to the big market teams.

But they spend equally on players (if not coaches - click on the Big 12 link for more info).

With the divisional format in the Big XII, it is possible that an upset will occur where a "small" market team wins the overall championship over a "large" market team. Kansas State winning over Oklahoma in 2003 and, to a lesser extent, Colorado's 2001 defeat of Texas bear this out. But the spread over time tells a different story.

So we have a league with a salary cap that drives equal spending on player payments ($0) and unequal market sizes in terms of the amount of revenue received by teams when all is said and done.

So the question is this: Aassuming this descision by the NFL sticks (the NFLPA is challenging it, according to Mort), will the NFL begin to resemble the Big XII in terms of the spread of championships over time? Stay tuned, sports fans.

*Here, here, here, here, here, here, and here, are some posts and articles that describe the revenue sharing system in the Big XII and some of the surrounding controversies.

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Saturday, November 03, 2007

Revenue Sharing in MLB 

Michael Lewis has an Op-Ed in the NYTimes this morning, pointing out that the present revenue-sharing formula in major league baseball does little to affect the quality of the various teams on average and despite the fact that some small market teams do well now and then.

The reason? Revenue sharing has little impact on the expected marginal revenue and marginal costs of ticket sales, and it especially has little impact on the expected marginal revenue product and marginal factor costs of hiring more talent for the team. As a result, many teams like, say, Tampa Bay, respond to what is essentially a lump-sum transfer by pocketing the extra cash.

Lewis points to several other examples of teams that have received large revenue-sharing payments not by spending the increased revenue on more talent.

Since 1998, millions of dollars have been transferred from richer teams to poorer ones in an attempt to let all teams share in the economic advantages associated with playing in big markets — a large fan base, lots of press coverage and lucrative local cable television contracts. Last year, more than $300 million was transferred.

Yet since revenue sharing began, at least one team from each of the big four markets — New York, Los Angeles, Chicago and Boston — has appeared in every World Series except 2006. In the 10 years before 1998, in contrast, only two Series included one of those big-market teams.

The problem is that the teams receiving payments have come to use them as a primary source of income — rather than to build winning teams. The most extreme example has been the Tampa Bay Devil Rays. In 2006, this team had a payroll of about $35 million, $42 million less than the 2006 league average. Not surprisingly, it won only 38 percent of its games and filled less than 40 percent of its seats for home games. It also collected more than $30 million in revenue-sharing transfers. This past season, the team reduced its payroll to $24 million and had about the same level of success.

The Pittsburgh Pirates and the Kansas City Royals have also received significant revenue-sharing payments but kept payrolls low. These teams may well be slowly destroying their customer base. (The Rockies were not so parsimonious. With the team receiving $16 million in 2006, it increased its payroll for the next season by around $15 million.)

The problem is that transfers are based on local revenues. Teams that receive money are encouraged to invest it in their payrolls. But if a team actually attracts fans by fielding a winning team, its revenue-sharing receipts will be reduced.

So revenue-sharing also reduces the marginal revenue of an expected win, and not just for the big-market teams that are taxed to support the programme; it also reduces the incentive for small market teams, the recipients of revenue-sharing, to win too.

Of course there have been exceptions. But if this is the general case, perhaps it is time for a second look at the revenue-sharing formula.

Isn't basic economics fun?

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Friday, May 25, 2007

Redistribution is No Free Lunch 

In the April issue of the Southern Economic Journal, John Solow and Anthony Krautmann explore the effects of 1995 MLB agreement whereby 17% of all local team revenues (including broadcast revenues for the first time) were shared with the league. The authors ask, "Leveling the Playing Field or Just Lowering Salaries?" They bill their investigation as testing Rod Fort's earlier proposition that redistributing from rich to poor teams lowers the incremental value of winning for all teams, resulting in lower salaries than would be found without revenue sharing. In their own words:
Our results indicate that redistribution lowered salaries by approximately 22% without affecting league balance.
As always, there are caveats. This is just one study looking at MLB over 1996-2001. As the authors suggest, examining outcomes since the 2002 CBA raised the shared percentage to 34% and imposed a luxury tax will be useful.

Nonetheless, the study provides a specific confirmation of what makes a lot of sense -- that you don't make players more (or as) valuable by holding back incentives for the better teams. Yet, owners have been successful in selling this idea to rank and file players (as well as the media) and getting them to sign on to CBAs in a variety of sports that restrict player salaries in different ways.

The study has implications for the renewed debate about income disparity and related political appeals based on class envy. One would think that the idea that lower earning individuals living standards will be improved primarily by limiting or redistributing from the top would have been put to rest by comparing GDP per capita performance in the U.S. and Europe over the last 30 years (especially on purchasing power adjusted basis). At least in sports, there is a chance that revenue sharing will raise competitive balance and that this will raise overall demand for the league -- two big "ifs" but still possibilities.

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