Chapter 5 Sports Market Outcomes I: Leagues, Team Location, Expansion, and Negotiation

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Chapter 5Sports Market Outcomes I Leagues,
Team Location, Expansion, and Negotiation

• To Accompany
• Sports Economics 2Ed
• Rodney Fort
• (PrenticeHall, 2006)

• Free market economics is the process of driving
  enterprises out of business. Sports league
  economics is the process of keeping enterprises
  in business on an equal basis. There is nothing
  like a sports league. Nothing..
• -NFL Commissioner Paul Tagliabue.

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Overview

• Leagues both facilitate play and maintain the
  business structure of a pro sport.
• Leagues establish and maintain territorial
  exclusivity for member teams.
• Owners act in economic joint ventures through
  their leagues.
• Single dominant league outcomes dominate the
  pro sports business.

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Why Leagues?

• Leagues apparently facilitate the interests of
  owners. Otherwise they wouldnt join them in the
  first place.
• Two primary functions
• To create a league rather than a loose
  affiliation of team owners
• To make play happen.
• To create the business structure of a sports
  league (conference)
• To make profits happen.

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Single-Entity CooperationMaking Play Happen

• Setting the league schedule so that interest in
  the league grows, rather than just interest in
  the few strongest teams.
• NFL scheduling parity efforts.
• MLB travel parity efforts.

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Single-Entity CooperationMaking Play Happen

• Setting the rules, including officiating and
  appeals. Rules determine the relative
  contribution of different skills to game
  outcomes.
• Change the rules, change which type of
  contribution is more important
• Impacts on the game, fans, and economic value of
  players.

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Single-Entity CooperationMaking Play Happen

• Creating the league championship structure,
  including playoff levels and the number of games
  in each series.
• When did MLB go to divisions? 1969.
• When did MLB go to 3 divisions? 1994.
• Why?

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Joint Venture CooperationMaking Profits Happen

• Much of the cooperation between owners in a
  league does not involve single-entity issues.
  Instead, this cooperation impacts the economic
  welfare of league members (and, ultimately,
  fans). The main areas
• Territory definition and protection.
• Expansion and relocation.
• Negotiations (TV, labor, and host cities).

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Territory Definition and Protection

• Weve already seen that leagues set up and
  protect exclusive territories for owners. This
  is the source of each owners market power.
• The Franchise Agreement Why is a sports team
  NOT like McDonalds?

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Territory Definition and Protection

• Results?
• Higher prices and restricted output relative to
  more economic competition.
• Potentially highly variable franchise values
  across different owners depending on the
  willingness of fans to pay for quality in
  different markets.

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Expansion and Relocation

• Expansion and relocation impact the value of
  existing territories and the growth of the value
  of the league, itself.
• In any expansion or relocation decision by a
  league, there are
• Direct financial issues.
• Strategic issues.

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Direct Financial Issues

• The Financial Value of Expansion Leagues try to
  extract the value of operating profits, including
  any contribution to national TV rights, net of
  negative local impacts. In terms of expected net
  present value, NPV
• Vt All values at time t.
• Ct All costs at time t.
• NPVe Net present value of Vt Ct.
• DNPVn Other NPV issues
• TV contract impacts
• Diminished quality of opponents

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Expansion Fee

• The sum of these direct financial estimates is
  the financial value of expansion. The fee
  depends on competition
• NPVe lt F lt NPVe DNPVn
• Little competition Closer to RHS
• Lots of competition Closer to LHS

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Practical Issues

• There are some practical issues
• Owner Viability Long-term viability builds
  brand. Look for heavy leveraging.
• Expansion Draft Another chance to put some
  costs off on new owners.
• Postponed Shared Revenue Prove yourself worthy.
• Profit Extraction and Owner Behavior Bid on
  market power returns, then owners will extract
  them, or lose money on the initial investment.

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Overlooked Implication

• Profit Extraction and Owner Behavior
• The expansion fee is set on current owners best
  guesses about market power returns.
• New owner pays it.
• What do we expect of new owners
• Extract market power returns, or fail to recoup
  the initial investment.
• This aint philanthropy.

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Strategic Issues Expansion

• Believable threat locations An alternative
  location for the team that politicians in the
  current host city believe is truly a viable
  location for the team.
• Believable threat locations enhance the current
  owners bargaining power (stadiums and other
  subsidies) with their current hosts.
• But leaving a viable location open has a
  downside
• Rival leagues.

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So, Why is LA Open for the NFL?

• Tell the story along the lines developed so far
• Houston v. Los Angeles in the last expansion.
• Which has the higher expansion fee?
• Other Considerations?
• Strategic Considerations?
• All things considered
• Houston can certainly make sense over Los
  Angeles.

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Joint Venture Activity Negotiations

• Negotiations are characterized as joint venture
  activity because they do not have to be done by
  leagues, as opposed to individual teams.
• Basic economic and business intuition
• Negotiations are turned over to leagues rather
  than individual owners because owners consider
  themselves better off doing it that way.
• Chapter 3 covered TV, and well spend entire
  chapters on labor-management relations and host
  city subsidies.

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Wheres the Competition?

• One way that competitive balance could be
  enhanced is if there were more teams in the
  largest revenue markets. This could happen if
  there were more leagues. But (for consideration
  in a later chapter)

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Wheres the Competition?

• Single dominant league result
• The profit potential of additional franchises in
  the megalopolis cities has been one factor
  driving the entry of rival leagues in the past,
  and might in the future as well. Still, all in
  all, it appears that leagues have managed to
  expand sufficiently to deter entry while still
  preserving enough vacant sites to make move
  threats believable, which is bad news, of course,
  for fans and taxpayers.
• - Quirk and Fort (1999, p. 136).

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Summary

• Leagues both facilitate play and maintain the
  business structure of a pro sport.
• Leagues establish and maintain territorial
  exclusivity for member teams.
• Owners act in economic joint ventures through
  their leagues.
• Single dominant league outcomes dominate the
  pro sports business.