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?