Inning 7: Can Pro Sports Survive Prosperity?

“Ka-ching!” February 2002—Nearly 132 million American television viewers sat around the national campfire to watch Super Bowl XXXVI. Advertisers paid an average of $1.9 million for 30 seconds of commercial time during the broadcast.

President William Howard Taft at a baseball game, 1910. According to legend, the seventh inning stretch originated when President Taft, a man of ample portions, stood up to get comfortable, and everyone around him rose as a sign of respect. Nice story, but it’s not true. References to the seventh inning stretch date back to 1869. Photo courtesy of Prints and Photographs Division, Library of Congress. Click on photo for a bigger image.

“Ka-ching!” After the 2000 season, shortstop Alex Rodriguez left the Seattle Mariners to sign a 10-year, $252 million contract with the Texas Rangers. USA Today calculated that a worker earning minimum wage would take 23,525 years to earn $252 million.

“Ka-ching!” In early 1999, the NFL’s Washington Redskins franchise sold for $800 million.

Question: If times are so good, why has there been so much economic conflict in modern pro sports?

Note: “Ka-ching!” is a non-technical term for the sound of a cash register.

A. Winners and Losers: Revenues, Payrolls, and Competitive Balance

If ever there was a “Golden Age of Sports,” this could be it.

Old-timers might try to tell you that no one will ever match the heroes of yesteryear, but that’s just the way old-timers talk. The fact is that modern players are bigger, stronger, and faster than ever. (You could look it up.)

And when it comes to dollars and cents, times have never been better. TV revenues are strong, franchise values are sky-high, and salaries are breathtaking.

So, if things are that good, how come everyone in pro sports always seems to be arguing over money?

During the 1980s and 1990s, player strikes and owner lockouts cost both sides a fortune in lost salaries and revenues. And if that wasn’t enough to kill the golden goose, there were other squabbles that pitted “rich” owners against “poor” owners and superstars against “middle-class” players.

Meanwhile, fans just shook their heads and wondered why the millionaires and billionaires of pro sports couldn’t find a way to share the wealth.

Lack of money hasn’t been the problem. By any reasonable measure, the overall pool of wealth is big enough to make owners, players, media moguls, and sports agents richer than most of us ever dream of being.

But wealth is unevenly distributed in the world of pro sports. Some teams earn much more revenue than others, and they can afford to outspend everyone else in the bidding war for high-priced superstars.

“Poor” teams just can’t keep pace. If they splurge on a superstar, then they can’t afford to sign anyone else except inexperienced kids or washed-up veterans. Either way, there’s not much chance of making it to the play-offs. And in the world of pro sports, one thing is certain: Fans won’t pay top dollar—or even show up—to support a team that never has a chance to win.

That’s why owners worry that the lack of “competitive balance” between rich teams and poor teams will kill the entertainment value of pro sports. Their collective nightmare goes something like this:

The same wealthy, big market teams go to the playoffs every season. Fans in low revenue markets get discouraged and stay home because they know their teams don’t have a prayer. Even fans in prosperous markets begin to lose interest because a steady diet of wins can be almost as tedious as an endless string of losses. Ticket sales and TV ratings sag, advertisers begin to lose interest, revenues drop, and franchise values weaken.

It’s a sobering prospect, but players don’t buy it. The way they see it, owners are using competitive balance as an excuse to recapture a share of the revenues they lost when the reserve system ended.

Players also point out that competitive balance isn’t exactly a new issue. In the 36 seasons from 1920 through 1955—when owners were absolute rulers and there was still a reserve clause to hold down salaries—New York teams won half of baseball’s pennant races. (The Yankees won 21 American League pennants, and two other New York teams, the Giants and the Dodgers, won a combined total of 15 National League pennants.)

Weak franchises and perennial losers are nothing new either. There have always been teams like the old Washington Senators: “First in war, first in peace, and last in the American League.”

B. Trying to Narrow the Gap: Salary Caps, Revenue Sharing, and Luxury Taxes

Here’s a fact that goes a long way towards explaining why owners and players always seem to be at each other’s throats:

In 1974—one year before baseball’s reserve system ended—team owners were keeping more than 80 percent of league revenues for themselves, but by the end of the 1990s, their share had fallen to less than 50 percent, while the players’ cut had increased every season.

Owners would like to recapture some of the revenue that has shifted from their pockets to the players’ pockets. Players are determined to keep that from happening. Each side is convinced that it is right, and neither is willing to budge very much.

The way owners see it, they are entitled to a healthy share of revenue because they are the ones who organize the leagues and take the financial risks that go with operating a team. Without their capital and organizational skill the professional sports product would be a lot less valuable.

But players argue that they are the feature attraction. Fans buy tickets and turn on TV sets to watch them perform. They are bringing in the money, and if revenues rise, they want their share of the bigger pie.

When the two sides sit down at the bargaining table to talk about money and competitive balance, they almost always end up arguing over three main options:

• A salary cap
  
  
• Revenue sharing
  
  
• A luxury tax

A salary cap is just what it sounds like: a limit on team payrolls (and sometimes on individual salaries). In theory, a cap promotes competitive balance because it prevents rich teams from using their wealth to attract all the top talent. Owners love the idea because it allows them to recapture revenue by limiting their labor costs. But players don’t even like to hear the phrase “salary cap.” Why, they ask, should there be a ceiling on what they earn when there is no ceiling on the earnings of doctors, lawyers, CEOs, movie stars, rock musicians—or team owners?

Players prefer the revenue sharing option, which requires rich teams to share some of their wealth with teams that are struggling. Revenue sharing appeals to players because it doesn’t cost them anything. Most of the burden is on owners, and that’s why owners in every league except the NFL tend to shy away from it. (See Winners Share.)

The third option for addressing the imbalance between sports markets is a luxury tax, which is intended to: (1) discourage wealthy teams from spending so much on salaries, and (2) redistribute wealth from the richest teams to the poorest.

A luxury tax seems to be the one option that’s mutually acceptable to owners and players, but it isn’t particularly effective. Rich teams can afford to treat it as just another cost of doing business—the sports equivalent of a parking ticket. Poor teams are happy to get the extra revenue. And superstars don’t care because it doesn’t really affect their salaries.

Of course, the fact that a luxury tax is ineffective might also explain why it’s the one option that everyone can agree on.

C. Strikes and Lockouts: Things Aren’t Always What They Seem to Be

The battle over sports revenues has taken some interesting twists and turns in recent years. Owners and players still sit on opposite sides of the bargaining table, but owners don’t always agree with one another, nor do players.

Consider the 1994-95 baseball strike. On the surface it might have looked like just another fight between labor and management. But there was a lot more to it than that.

Here are the basics.

Owners agreed on one thing. They all wanted a salary cap to control labor costs and address the competitive balance issue.

Players were bitterly opposed to a cap—mainly because they saw it as the first step in a return to the days when owners were in complete control.

Congressional pages settle a “dispute,” 1922. Photo courtesy of National Baseball Hall of Fame Library, Cooperstown, New York. Click on photo for a bigger image.

The players pushed for more revenue sharing between rich teams and poor teams. But that wasn’t really an option because the rich owners were unwilling to part with more than a fraction of their wealth.

Because the owners were unable to agree on any other strategy, they decided to pick a fight with the players union. Their ultimate objective was to force players into accepting a salary cap.

But the players refused to buckle, and the strike finally ended when a relatively small group of influential owners pressed for a settlement.

Why were the players able to outlast the owners? Two reasons:

1. The players union was able to convince its members that the benefits of sticking together outweighed the risk and the cost of being on strike; and
   
   
2. Team owners didn’t have a strong enough common interest.

The owners of prosperous teams decided that the battle for a salary cap was costing them more than they could possibly hope to gain.

Denied!

The 1998-99 NBA lockout had a very different outcome.

At the heart of the dispute, wrote David Warsh of the Boston Globe, was the “inability to share out $2 billion in overall NBA revenues among 29 owners and 400 players.”

When the lockout began, players were getting 57 percent of the league’s revenues; owners wanted to roll that figure back to 53 percent. The lockout ended after both sides split the difference and settled on 55 percent.

But the length and bitterness of the lockout took many people by surprise. NBA owners, executives, and players thought they had come up with a formula for peace and prosperity when they pioneered the salary cap concept in 1984.

But by the late 1990s, the cap had lost its effectiveness. The annual team cap had been allowed to mushroom from $3.6 million in 1984 to $26.9 million in 1997-98. And on top of that there was a loophole that allowed teams to re-sign their own players at any price. One example says it all: The Chicago Bulls were able to exclude Michael Jordan’s entire $31 million paycheck from their 1997-98 ceiling.

By the end of the 1997-98 season, NBA owners were ready to try something drastic. They voted to lock players out of training camps and even went so far as to set a deadline for canceling the entire season.

Their stated objective was to reclaim a “fair share of the revenues,” and they managed to prevail because (1) they were willing to throw their undivided support behind NBA Commissioner David Stern, and (2) the players union was unable to convince its members that standing together was worth the cost of losing an entire season’s paycheck. Much of the pressure to reach a settlement came from middle-class players and rookies who were beginning to wonder why they should endure the economic impact of a lockout when the issues at stake mainly affected the earnings of superstars.

Winners Share

The NFL has been the most successful at sharing the wealth and smoothing out the imbalance between markets. Its history of cooperative action dates back to the early 1960s, when team owners agreed to give NFL Commissioner Pete Rozelle enough authority to convince, cajole, and coerce individual franchises into cooperating for the common good.

Today, television and licensing revenues are shared equally, and gate receipts are shared generously, 60 percent for the home team and 40 percent for the visitors. The league also has maximum and minimum team payroll limits.

The results of the NFL’s cooperative approach are plain to see. Pro football tops all other sports in the revenues it generates from TV agreements and the sale of licensed merchandise, and the gap between its richest and poorest teams is by far the narrowest of all four leagues. NFL franchises thrive in small markets such as Green Bay, Wisconsin (pop. 102,000+) and in otherwise marginal markets such as Pittsburgh, where the professional baseball and hockey teams are struggling and there’s no NBA presence.

But even in the NFL, the owners’ interests are diverging and cooperation is beginning to break down. Newer owners, who paid top dollar for their teams during the 1990s and borrowed heavily to finance their purchases, are chafing under the old share-and-share-alike arrangement. Some are pressing to keep a larger share of the revenue their teams generate. And at least one owner has made separate advertising and licensing deals with competitors of official NFL sponsors and licensees.

Of course, none of this sits well with league officials and longtime owners. They prospered under the old system, and they are trying their best to preserve it. Whether or not they will succeedl is anyone’s guess.

D. Go Figure: The Difficulty in Measuring Team Revenue

There’s a long history of mutual mistrust between owners and players. Not only do they have a hard time sharing the wealth, they can’t even agree on how much money they’re fighting over!

If an owner claims to have financial difficulty, players raise their eyebrows and ask to see the team’s books. But the books often stay closed because most teams are privately held businesses rather than publicly traded corporations.

Publicly traded corporations—businesses that sell shares of stock to the public—are legally required to disclose detailed financial information to shareholders and prospective investors. But most teams are privately held businesses, which are owned by an individual or a fairly small group of individuals. They are under no obligation to share their financials, so most of them don’t.

And even when the books are open, owners and players often disagree over the numbers. To find out why, let’s revisit a concept from Inning 4:

The concept sounds simple enough until you start to think about how to define revenues and costs.

There are lots of perfectly legal ways to make profits seem smaller than they might actually be. The tale of Wayne Huizenga and the Florida Marlins illustrates just how complicated things can get.

Wayne Huizenga was said to have the best business sense in baseball—which may or may not be a compliment. He was a billionaire who made his fortune in waste disposal and video rentals, and when he founded the Marlins, he was determined to run the team according to sound business practices.

During their first season (1993), the expansion Marlins drew three million fans, and everyone thought fortune had smiled on Huizenga once again. But the 1994 baseball strike sent attendance plummeting to 1.9 million. And in 1995, only 1.7 million fans paid to see the Marlins.

After another disappointing season in 1996, Huizenga set out to improve attendance by opening his wallet. He spent heavily on free agents and pushed the Marlins’ payroll from $31 million to $54 million.

The end result was a “good news/bad news” story. The good news was that attendance jumped to 2.3 million, and the Marlins won the 1997 World Series. Wayne Huizenga’s money had bought competitive success and made the Marlins a fan favorite.

The bad news? According to Huizenga, his team had lost more than $30 million on the season.

How could that happen? Economist Andrew Zimbalist wrote an article for The New York Times Magazine (October 18, 1998) that explained how the Marlins figured their financial losses.

According to Zimbalist, the Marlins’ 1997 financial losses did not reflect revenues credited to Pro Player Stadium, the Huizenga-owned sports facility where the Marlins (and Huizenga’s NFL team, the Miami Dolphins) played their games.

Those revenues included:

• $16.5 million from luxury suites and club seats
  
  
• $1 million from the stadium-naming rights for Pro Player Stadium
  
  
• $3.9 in revenues from the stadium parking lot
  
  
• $6 million from signs and other advertising at Pro Player Stadium
  
  
• $3 million from souvenir and merchandise sales at the stadium
  
  
• $5 million in stadium expenses, which Huizenga was, in effect, paying to his own company

Zimbalist also calculated that food and beverage concessions may have been understated by as much as $7.6 million. Add all those things together, and the Marlins’ 1997 finances don’t look so bad.

It is important to note that Zimbalist’s figures are estimates. But that gets back to our original point: Determining a team’s true financial condition is a tricky proposition.

E. Is There Really Any Such Thing as a “Poor” Team?

There is a way to gauge a company’s financial condition without seeing its books. Just look at the price people will pay to own it.

In pro sports, that means looking at franchise values, which are high and going higher. A few examples from the 1990s will tell you almost all you need to know:

1991: Major League Baseball owners approve the addition of two new franchises—the Colorado Rockies and the Florida Marlins. Each of the new franchises pays a $95 million entrance fee.

1992: The San Francisco Giants are sold for $100 million.

1993: Peter Angelos pays $173 million for the Baltimore Orioles.

1994: Robert Kraft buys the NFL New England Patriots for $162 million

1995: Owners approve the addition of two new baseball franchises—the Arizona Diamondbacks and the Tampa Bay Devil Rays. Each of the new franchises pays a $130 million entrance fee.

1997-1998: Peter O’Malley sells the Los Angeles Dodgers to Rupert Murdoch’s News Corp. for $311 million, or $350 million, depending on how you figure it. O’Malley’s father, Walter, had purchased the late, lamented Brooklyn Dodgers for $1 million in 1950 and then moved the club to Los Angeles in 1958.

1998: A group of investors pays $530 million for the NFL’s new Cleveland Browns franchise.

1999: Just when you thought franchise values couldn’t get much higher, the NFL’s Washington Redskins franchise sells for $800 million. The Redskins had finished their 1998 season with a losing record and hadn’t made the playoffs in six years.

2000-2001: The Boston Red Sox baseball franchise sells for $700 million ($660 million plus $40 million in debt assumption). That’s double the amount Rupert Murdoch paid for the L.A. Dodgers four years earlier.

Those are the numbers. Now here’s the question: Who would pay hundreds of millions of dollars for a troubled business?

The Greater Fool: Investing or Speculating?

Rising franchise values almost make owning a pro sports team look like a “can’t lose” proposition. Seems like the trick is to buy a franchise and wait for someone else to come along and offer a pile of money for it.

But that’s not entirely true. To find out why, let’s focus on baseball.

In early 2002, Forbes magazine estimated that the New York Yankees was worth $730 million, while the Montreal Expos franchise had an estimated value of $108 million. A quick glance at the numbers for both teams helps to explain the difference.

The Yankees are a high profile, high revenue franchise with a proud tradition. And their local TV revenues reflect the fact that they play their home games in New York—the biggest, richest media market in the United States.

The Expos, by contrast, are a small market team with sparse attendance and unimpressive local TV revenues. And while Montreal is a beautiful, vibrant city, it doesn’t make anyone’s list of “great baseball towns.” Nor would anyone ever confuse its crumbling ballpark with the “Field of Dreams.”

Add all that together, and it is easy to see why a prospective buyer would pay a much higher price for a big market, high revenue team like the Yankees.

When you get right down to it, a sports franchise is an asset—a form of property that has value to its owner. And the value of any asset—a sports team, a house, an office building, or a share of stock—depends mainly on how useful or valuable it is to its owner, either at the present time or in the future.

When investors offer to buy a team, they usually base their offer on how much revenue they expect the team to generate in the future. Sellout crowds, strong TV ratings, and a nice stadium all help to provide a healthy revenue stream and increase the value of a franchise.

But with the selling price of sports franchises rising so quickly, it’s time to wonder if buyers are speculating rather than investing in a revenue-producing asset. Are owners counting on the fact that a “greater fool” will always come along to pay more for their franchises than they did?

Tough to say. The $530 million price tag for the Cleveland Browns sounded awfully high until someone paid $800 million for the Washington Redskins.

F. Is It Time for True Competition Off the Field, Too?

Strikes, lockouts, holdouts: Why is there so much economic conflict in sports?

Economists James Quirk and Rodney Fort think the market power of leagues is to blame. They contend that the leagues’ monopoly profits (monopoly rents) have become “the prize package” at the center of most disputes.

The NBA, NFL, NHL, and Major League Baseball are not actual monopolies. (In fact, only Major League Baseball is exempt from federal antitrust laws.) But the “Big Four” have been very successful at limiting competition and maximizing revenue. Whether they’re pressuring local politicians for a new stadium or negotiating with media executives for a bigger TV contract, pro sports leagues enjoy tremendous bargaining power because they have the market to themselves.

“Eliminate that monopoly power,” say Quirk and Fort, “and you eliminate almost every one of the problems of the sports business.”

The authors of Pay Dirt and Hard Ball propose a solution: bring about true business competition.

They call for a Justice Department antitrust action to break up each of the existing leagues—MLB, the NBA, the NFL, and the NHL—into four independent leagues, each with roughly eight teams. The leagues would compete against one another for everything—players, TV contracts, franchise locations, and fans. There would be no more territorial monopolies, so, in theory, any city that could support a team would have one, and the most lucrative markets would attract a cluster of competing teams. A very limited antitrust exemption would permit the competing leagues to coordinate post-season playoffs and championships.

Quirk and Fort believe that the introduction of market forces would narrow the difference between “have” and “have not” teams by reducing the revenue imbalance among league cities. Three or four teams competing for TV revenues and gate receipts in the New York market would make the “Big Apple” more like the “Twin Cities” in terms of revenue potential, and as the revenue gap narrowed, so would the payroll gap. Quirk and Fort also argue that cities would feel less pressure to provide stadium subsidies, because if an existing team threatened to move, another team would be free to take its place.

At bottom, say Quirk and Fort, eliminating sports monopolies would shift power “from the insiders—owners and players—to the rest of us—fans and taxpayers.” If team owners and general managers are compelled to make decisions in a competitive market environment, fans will reap the benefits.

The argument is powerful—in terms of economic theory, public policy, and popular appeal. Introducing more economic competition to the pro sports business would almost certainly diminish the market power of sports leagues and return a measure of control to fans and local officials.

But don’t expect competition to be a cure-all. The appeal of pro sports hinges on a mix of intangibles. On one level, fans are consumers in search of the best value for their entertainment dollars. But on another level, they are “willing saps” with a strong attachment to the home team. Yes, they like the action and excitement of pro sports, but they also go to a game because it offers them a sense of being connected to the past—their own past and the distant past. Some teams—the Cubs, the Red Sox, the Redskins, the Knicks, the Maple Leafs—might almost be immune to competition because there’s such a strong emotional link between them and their fans.

And there’s no guarantee that reducing the level of league profits will put an end to strikes and lockouts. Owners and players have argued over money since the days of high-wheeled bicycles and handlebar mustaches, when the main bones of contention were health insurance, pension plans, and $1,000 raises. Splitting the loot has always been a source of conflict in pro sports, and that isn’t likely to change—regardless of how much loot there is to split.

Sometimes, fighting over money can be a sport in itself—especially when big egos collide.