the economics of modern professional sports as presented by scott corwon of impacts

Scott Corwon, the founder of IMPACTS and leading innovator in th i fi ld f diff i d i th idthe emerging fields of diffusion and price theory, provides contemporary examples of the impact of professional sports pricing relative to demand.

The purpose of the IMPACTS presentation series is to effectuate knowledge transfer concerning topical mathematical and scientificknowledge transfer concerning topical mathematical and scientific issues. Significant published works form the basis for much of the presentation series, and these works are interpreted and presented b i d l d i th t i Th t ti i iby recognized leaders in the topic area. The presentation series is made possible through the generous support of IMPACTS.

The Economics of Modern P f i l S tProfessional Sports

Why care about sports economics?Why care about sports economics?

S t d ti i d t i bi b i• Sports and recreation industry is a big business.

Amount Year SourceEstimated Size of the Entire Sports Industry, US $441.1 billion 2007 PRE

Annual Company Spending for Sports Advertising, US $32 billion 2007 PREAnnual Company Spending for Sports Advertising, US $32 billion 2007 PRE

National Football League (NFL)

NFL League Revenues $6.54 billion 2007 PRE

Overall Operating Income $568 million 2007 ForbesOverall Operating Income $568 million 2007 Forbes

Number of NFL teams 32 2008 NFL

Avg NFL Game Attendance 68,661 2007 ESPN

Avg NFL Team Value $957 million 2007 Forbes

Major League Baseball (MLB)

MLB League Revenues $6.08 billion 2007 MLB

Overall Operating Income $492 million 2007 Forbes

Number of MLB teams 30 2008 MLB

Avg MLB Game Attendance 32,767 2007 ESPN

Avg MLB Team Value $472 million 2007 Forbes

PRE: Plunkett Research, Ltd.

Amount Year Source

National Basketball Association (NBA)National Basketball Association (NBA)

NBA League Revenues $3.57 billion 2007-08 PRE

Overall Operating Income $293 million 2007-08 Forbes

N b f NBA t 30 2007 08 NFLNumber of NBA teams 30 2007-08 NFL

Avg NBA Game Attendance 17,394 2007-08 ESPN

Avg NBA Team Value $372 million 2007-08 Forbes

National Hockey League (NHL)

NHL League Revenues $2.44 billion 2007-08 MLB

Overall Operating Income $95 million 2007-08 Forbes

Number of NHL teams 30 2007-08 MLB

Avg NHL Game Attendance 17,308 2007-08 ESPN

Avg NHL Team Value $200 million 2007-08 Forbesg $

Other Sports Industry Revenue

Other Spectator Sports Leagues $3.7 billion 2008 PRE

Horse Racing $8 4 billion 2008 PREHorse Racing $8.4 billion 2008 PRE

Golf Courses $20.8 billion 2008 PRE

Fitness & Recreational Centers $20.3 billion 2008 PRE

Other Amusement & Recreation $19 3 billion 2008 PREOther Amusement & Recreation $19.3 billion 2008 PRE

Market ModelMarket Model

• Demand shifters– Income S1

$– Income– Price of related goods– Consumer tastes

Market size

S1

– Market size– Price expectations

D

P1

• Supply shifters– Input prices– Technology

D1

Technology– Taxes– Price expectations– Number of firms

Q1 quantity

– Number of firms

Price ElasticityPrice Elasticity

• Measure of price sensitivity

QEdΔ

=%

PE

Δ=

% • More substitutes• Big budget items• Longer time horizons

• Elastic demand: |E| > 1

g

| |• Inelastic demand: |E| < 1

ElasticityElasticity…

QdΔ% TR = $50,000

PQE

ΔΔ

=%

%$ E = ?

82018.01100200

E

50

40TR = $48,000

82.022.0

4510

1100 −==−

=E

D1

tickets1000 1200

Price ControlsPrice Controls

• Price Ceilings S1Price Ceilings– create shortages– create black markets Pcreate black markets P1

D1

Pceiling

ticketsQ1 Qd

shortage

Price ControlsPrice Controls

• Price FloorsS1

– Create surplusesPfloor

P1

D1

ticketsQ1Qd

lsurplus

Maximizing ProfitMaximizing Profit

• Profits = π = TR - TC

• Profit-max rule: MR = MC

•What do the NY Yankees sell?•What kind of cost is Alex Rodriguez’s salary?•What kind of cost is Alex Rodriguez s salary?

Perfect CompetitionPerfect Competition

SMC$ S

ATC$

MR = PP1

D

Market Firm

Q1q1Quantity

MonopolyMonopoly

• Relevant Market– Any close substitutes?y

• Entry BarriersE i f l– Economies of scale

– Control over key input– Government restrictions

Monopoly Profits are maximizedMonopoly Profits are maximizedwhere MR = MC

Price is set off of demand

MC

curve

$MC

ATCP1

ATC1

D

MRQ1 Quantity

Pricing Strategy: Phillies vs FlyersPricing Strategy: Phillies vs Flyers

• Each is a monopoly $ MCMC• MC a backward “L”• Does it pay to sell out?

$ MC1MC2

Does it pay to sell out?

P1

P2

P1

MRD

Q1

MRCitizens Bank Park43,500

Wachovia Center19,500

2006 Ticket Prices

Phillies Flyers

Game Season Game Season

Field Level $44

$38$39.75$34.75

Victor’s Restaurant $100 $84

$$25

$$21.83

Club Level $27 $24 88

Lower Level$85 $69Level $27

$22$20

$24.88$19.88$17.93

$85 $69

Terrace$30$22

$27.31$19 88

Mezzanine$55$45

$44.50$38$22

$16$19.88$14.88

$45$40$23

$38$31.75

$20

Source: philadelphia.phillies.mlb.com and philadelphiaflyers.com

The Role of UncertaintyThe Role of Uncertainty

• Are the Yankees bad for baseball?– Are dynasties a bad idea?– How often should the home team win?How often should the home team win?

• Why do teams sell season tickets?– Transfers risk from team to fans– Why do fans buy them?y y

Attendance vs Winning PctAttendance vs Winning Pct.

1

0 60.70.80.9

1

apac

ity

0 60.70.80.9

1

apac

ity

0.20.30.40.50.6

2002

% o

f C

0 20.30.40.50.6

002

% o

f Ca

00.1

0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1

2001 Winning Percentage

2

00.10.2

0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8

2001 Wi i P t

202001 Winning Percentage 2001 Winning Percentage

NFL MLB

Can Losing be Good?Can Losing be Good?

• Cleveland Browns won all the time in AAFC• Fans of AAFC lost interestFans of AAFC lost interest

– Even Browns fans– Attendance fell

• Attendance fell in MLB in 1950s – NY teams in every World Series (sort of)– Why go see Pittsburgh play Cincinnati?

• Study looked at attendance in MLBC t ll d f d ti th lit f t– Controlled for day, time, weather, quality of opponent

– Attendance highest when home team won 60% of time

R i A l iRegression Analysis

• Regression is a form of statistical l i f i b h i danalysis of economic behavior and

theory.y– Regression analysis attempts to explain the

variance of a particular variable of interestvariance of a particular variable of interest.

• Attendance FunctionA = f(X1, X2, X3, …)

Regression AnalysisRegression Analysis

• Regression analysis can be used for predictive purposes, but in this presentation predictive purposes, but in this presentation we will use it to test our economic theory.

• Two ways that regression results can confirm• Two ways that regression results can confirm economic theory: The sign and magnitude of the estimated relationship and the statisticalthe estimated relationship and the statistical significance.

Regression ExampleRegression Example

• Consider a model of baseball attendance. We think that the following items might influence overall team attendance in the following waysg g y

Variable Sign of Relationship

Price NegativePrice Negative

Population Positive

Concession Prices Negative

Income Positive

Team Quality Positive

O t’ Q lit P itiOpponent’s Quality Positive

Weather Ambiguous

A = β0 + β1P + β2POP + β3C + β4I + β5QH + β6QV + β7W

• Here are some actual regression results from Depken (2000, Journal of Sports Economics)Journal of Sports Economics)

Franchise Economics andFranchise Economics and Owner Objectives j

Franchise ObjectivesFranchise Objectives• Maximize profits?p

Profit = TR – TC

• Championships?• Bad things can happen if bottom line is forgotten

C O S• Case in point: Ottawa Senators– Best record in NHL: 2002-2003– Declared bankruptcy: 2003

• Ego premium?

• Civic-mindedness?

Franchise RevenuesFranchise Revenues

TR = RG + RB + RL + RS

– Where:• RG = Gate RevenueG

• RB = Broadcast Revenue• RL = Licensing Revenue• RS = Stadium Revenue

Gate Revenues: RGate Revenues: RG

R = α R + (1 α)R NFL: α = 60%RG = α Rh + (1- α)Rp• α = home team’s share• Rh = home team gate

NFL: α 60%MLB: α = 66%NBA, NHL: α = 100%

Rh home team gate• Rp = pooled gate from all other teams

• Impact of Revenue Sharing– Financial stability (early NFL struggled to maintain y ( y gg

league); "luxury tax" in MLB– Competitive balance– Shifts funds from teams that spend a lot on good

players to teams that do not; tends to depress what teams are WTP for players (“tax on quality”)

Broadcast Revenue: RBroadcast Revenue: RB

• National revenue is shared equally• Local revenue is not shared equallyq y

– KC: A small market for MLB but not NFL– Green Bay would have disappeared

• Tradeoff: RB vs RG? blackouts

Wh t d t i b d t i ht t ?• What determines broadcast rights payments?– Demand by Advertisers

Super Bowl XLIII:– Super Bowl XLIII: • NBC received $206m for 69 spots ($3m per 30 seconds)

Broadcast Money Trail

Sports Teams and Leagues

y

Sports Teams and Leagues

Programming Rights Fees $

Media Providers (Networks, Cable, Satellite)

Ad Slots Slot Fees $

Advertisers (Consumer Products Producers)

Revenue from Broadcast Rights Agreementsg g

Sport Years Rights Total Fees Annual Average

NFL 2006-2011 ABC, FOX, CBS, ESPN

$22.2 billion $3.7 billion

NBA 2008-2015 ABC/ESPN, AOL $7.4 billion $930 millionTime Warner

MLB (1) 2007-2013 ESPN $2.4 billion $343 million

MLB (2) 2007 2013 FOX/TBS $3 billion $429 millionMLB (2) 2007-2013 FOX/TBS $3 billion $429 million

NASCAR 2001-2008 FOX/NBC, Turner $2.4 billion $400 million

PGA 2003-2006 CBS, NBC $850 million $212.5 million

NHL 2005-2008 Versus/NBC $207 million $70 million

Source: various sources

Stadium Revenue: RS

• Concessions• Parkingg• Naming rights: pros; colleges; individuals• Luxury seats• Luxury seats

– don't count as gate, therefore, don't have to share

Example:• luxury suite rents for $500,000 per year• 20 seats20 seats• claim each seat is worth $50

team must share $3200 = 0.4 * 20 * $50 * 8 games

Wh h t llWhy have we seen a move to small markets by NFL teams?

– Rams: LA St. Louis– Raiders: LA Oakland– Oilers: Houston Nashville– Browns: Cleveland Baltimore

Revenue Sharing is the key!Revenue Sharing is the key!

Licensing Revenue: RLicensing Revenue: RL

• Generally shared with all teams• Cowboys broke ranks with NFL in 1995 byCowboys broke ranks with NFL in 1995 by

signing Pepsi for stadium sponsorship

Franchise CostsFranchise Costs

TC = CP + CA + CT + CS

• Player Salaries

+ OC

• Player Salaries– Over 50% of team revenues– Deferred compensation

Bonuses– Bonuses– Workers’ comp– Pension contributions– Player Development

Opportunity Costs: Profit that could be earned in another city

– Player Development • MLB and NHL

• Administrative– Coaches and managementCoaches and management– Marketing

• Travel• StadiumStadium

Average costs and revenues (in millions) across th j t i 2006the major sports in 2006

League Gate Revenue

Other Revenue

Total Revenue

Player Expense

Other Expense

Total Expense

Operating ProfitRevenue Revenue Revenue Expense Expense Expense Profit

NFL 44.59 159.75 204.34 125.47 61.11 186.58 17.76

NHL 34.10 47.10 81.20 44.17 33.85 78.02 3.18

NBA 39.23 79.87 119.10 68.77 40.58 109.35 9.75

MLB 61.03 109.33 170.37 93.30 60.55 153.55 16.52

Accounting GamesAccounting Games• Book Profit and DepreciationBook Profit and Depreciation

Profit = TR TCCosts include interest expensesand depreciation of capitalProfit = TR – TC

Corporate ta es depend on book profit

and depreciation of capital

– Corporate taxes depend on book profit• Paying high administrative costs reduces book profit • Interest is tax deductible (dividends are not)• Interest is tax deductible (dividends are not)• Player contracts are treated as depreciable assets

– Bill Veeck– San Antonio Spurs example

Table CSan Antonio Spurs Depreciation and Tax Savings 1993-4/1994-5

(All figures in $millions)(All figures in $millions)

1993-94 1993-94 1994-95 1994-95

Category w/o Roster DEP

w/Roster DEP

w/o Roster DEP

w/Roster DEP

(1) NOR 4 9 4 9 0 3 0 3(1) NOR 4.9 4.9 0.3 0.3(2) DEP 3.5 (3.5+10.7) 3.5 (3.5+10.7)

(3) NAD 1 4 -9 3 -3 2 -13 9(3) NAD 1.4 -9.3 -3.2 -13.9(4) Taxes .5 0 0 0(5) NADT .9 -9.3 -3.2 -13.9( )

Tax Savings 0 3.2 1.1 4.9

Accounting GamesAccounting Games

• Vertical Integration– Media outlet buys sports teamy p

• AOL Time Warner Atlanta Braves• Tribune Company Chicago CubsTribune Company Chicago Cubs• Disney Anaheim Angels /Anaheim Ducks• FOX LA DodgersFOX LA Dodgers

– Double monopoly?

Upstream Firm Downstream Firm p(Team) (Network)

PupMC

Pdown

D D

MC

DMR

DMR

Qup Qdown

• Vertically integrated firm sets transfer price to allocate profit across combined entityallocate profit across combined entity– Set low broadcast rights fee to reduce team profits in

order to plead poverty during lobbying for public p p y g y g psubsidy

League DecisionsLeague Decisions– Cincinnati Red Stockings (1869)

• “barnstorming”– National League (1876)g ( )

• $0.50 tickets• No Sunday gamesNo Sunday games• No beer

American Association (1882)American Association (1882)$0.25 tickets on Sunday with beer!

League DecisionsLeague Decisions• Setting the Rules

– # games, game format, equipment• Limiting Entry

Teams– Teams• Benefits:

– Entry feeMore re en e so rces– More revenue sources

• Costs: – Sharing of league revenues

Reduced geographical monopoly– Reduced geographical monopoly– Reduces threat of moving

– New leagues: ABA, WHA, AFL, USFLL id M k i• League-wide Marketing– Free-rider problem

• Competitive Balance and Revenue Sharing• Competitive Balance and Revenue Sharing

NFL Expansion FeesNFL Expansion FeesTeams Franchise Fee First SeasonHouston Texans $700 million 2002

Carolina Panthers and Jacksonville Jaguars $140 million 1995

Seattle Seahawks and Tampa Bay Bucs $16 million 1976Seattle Seahawks and Tampa Bay Bucs $16 million 1976

Cincinnati Bengals (AFL) $7.5-$8 million 1968

New Orleans Saints $8.5 million 1967

Atlanta Falcons $8.5 million 1966

Miami Dolphins (AFL) $7.5 million 1966

Minnesota Vikings $1 million 1961g $

Dallas Cowboys $1 million 1960

Original members of the AFL $25,000 1960

Phil d l hi E l d Pitt b h Pi t * $2 500 1933Philadelphia Eagles and Pittsburgh Pirates* $2,500 1933

New York Giants $500 1925

Original members of the NFL** $100^ 1920*Changed nickname to Steelers in 1940**NFL was known as the American Football Association its first two seasons.^According to accounts, this fee was never paid by the teams.

Source: http://www.profootballhof.com/history/release.jsp?release_id=1286

If a team always sells out its home games, economists would say it is very likely that:

a) A surplus existsb) There is excess supplyc) There is excess demandd) Prices are too high

If an industry is a monopoly, output is _____ and prices are th if it f tl titi_____ than if it were perfectly competitive.

a) Lower, lowerb) Higher, lowerc) Lower, higherd) Higher, higher

If demand for tickets to see the LA Lakers is inelastic,

a) Fans will respond to a price increase with a proportional decrease in quantity demanded.

b) fans will respond to a price increase with ab) fans will respond to a price increase with a less than proportional decrease in quantity demanded.

c) fans will respond to a price increase with an infinitely large decrease in quantityan infinitely large decrease in quantity demanded.

d) fans will respond to a price increase with a more than proportional decrease in quantity demandedquantity demanded.

If income increases and tickets to see a Notre Dame f tb ll l d th thfootball game are a normal good then the

a) demand for tickets will decrease. b) supply of tickets will increase. c) demand for tickets will increase. d) supply of tickets will decrease.

The fact that attendance rises at baseball stadiums during “bobblehead” days suggestsduring bobblehead days suggests

a) baseball games and bobbleheads are complementscomplements.

b) baseball games and bobbleheads are substitutes.

c) baseball games and bobbleheads are normal goods.

d) No information about baseball games andd) No information about baseball games and bobbleheads can be determined from this fact.

A negative aspect of anti scalping laws isA negative aspect of anti-scalping laws is

a) they prevent sell-outs. b) they cause people to pay more than

they are willing to in order to get ticketsthey are willing to in order to get tickets. c) they prevent the market from matching

willing buyers and sellers. d) th h t ti k t id) they hurt ticket agencies.

If the Knicks sign LeBron James to a big contract they i ti k t i bmay raise ticket prices because

a) their average cost curve shifts up. b) their demand curve shifts right. c) their marginal cost curve shifts up. d) their fixed cost curve shifts up.

If a game is not sold out, then the marginal cost to a team of accommodating one additional fan isteam of accommodating one additional fan is

a) almost infinite.b) about equal to the team's payroll c) essentially zeroc) essentially zero. d) about half the cost of a ticket.

To determine the market demand for tickets to see th B t B i l h kthe Boston Bruins play hockey we

a) add the marginal revenue at each price. b) divide the revenue of the team by the

number of fans.c) add the price consumers are willing toc) add the price consumers are willing to

pay at each quantity. d) add the quantity demanded at each

iprice.

The league with the most equal split of gate i t b t th h d i iti t ireceipts between the home and visiting teams is

a) The NFLb) The NBA)c) Baseball’s National Leagued) The NHL)

The "naming rights curse" refers to the fact thatThe naming rights curse refers to the fact that

a) teams that have sold their naming rights have performed poorly.

b) t ft i t littlb) teams often receive too little revenue for their naming rights.

c) cities generally do not receive any of ) g y ythe naming rights revenue.

d) firms that have bought naming rights have often run into financialhave often run into financial difficulties.

Over the course of a single season, the largest ti f t t iproportion of team cost is

a) zero. b) fixed.)c) variable. d) shared by all teams in the ) y

league.

The ownership of professional teams by media tl toutlets

a) prevents cross subsidization. b) is known as horizontal integration. c) is known as vertical integration. d) is becoming less common.

The Dallas Cowboys are such a valuable franchise b thbecause they

a) can tap into both U.S. and Mexican media markets.

b) have a tradition of winning that attracts fans from all over.

c) have done an expert job of i th lmanaging the salary cap.

d) have so many luxury boxes.

By declaring Subchapter S status owners of y g pprofessional teams can

a) increase their revenue flow and hence h i fitheir profits.

b) reduce the Corporate Tax Rate that they must pay. p y

c) use depreciation to reduce their personal taxes.

d) d th i t t t th td) reduce the interest payments they must make to their creditors.

Marketing for a league is a public good ifMarketing for a league is a public good if

a) all teams pay for the cost of advertising for small market teams.

b) ll t l h f thb) all teams pay an equal share of the cost of advertising campaigns.

c) all teams derive benefit from an )advertising campaign.

d) all teams pay some share of the cost of advertising campaignscost of advertising campaigns.