The Industrial Organization of Sports
Part I:
Profit Maximization

Profits a Touchy Subject
We don’t want teams to worry about p
We want Ford to worry about it
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Are sports purer than business?
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Nostalgia ain’t what it used to be
Bad things can happen if forget bottom line
Case in point: Ottawa Senators
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Best record in NHL: 2002-2003
Declared bankruptcy: 2003

Alternatives to Profits
Personal publicity
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Team as toy
The “Ego Premium”: $40-70 Million
Spillovers
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Team helps sales in other areas
 Ted Turner
 Chris von der Ahe
Civic-mindedness?

Basic Question
Why is NFL most profitable sport? (Excel)
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Every team profitable
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Profits and market values greatest
What happened to baseball?
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Half the teams lost money last year
Why is NHL a basket case?
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Lowest profits and market values by far
Underlying question: Why do leagues exist?

Think of League as Synonymous with Team Sports
Wasn’t always so:
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7-year gap in baseball (1869-1876)
 Took another 20 to stabilize
44-year gap in football (1876-1920)
 Took another 15 to stabilize
Alternative?
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Barnstorming
Uncertain payoff
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Dependent on winning
 Red Stockings in 1869 vs 1870

Leagues and
The Economics of Clubs
James Buchanan – Nobel Laureate
What is right size of league?
New members a new source of revenue
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Entry fees
 $50M fee put Ottawa in debt from outset
Access to new markets
May also be a drain
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Must divvy up among more members
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Revenue sharing
Competitive Balance

Getting It Right Can Be Hard:
Baseball in 1901
NL only league in early 1890s
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Saw problems if too many teams
 Uncompetitive & unprofitable franchises a drain
Zero sum rule: Add city A => Delete city B
1890s: Cities Grow Rapidly
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More cities able to support teams
NL vulnerable to entry
 In 1901 AL entered “open” cities

Gate Revenue:
Earliest Source of Revenue
Revenue from ticket sales
NFL shares the most
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Home team keeps 60%
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40% goes league-wide
Originated in early weakness of NFL
One reason why profits so close
Luxury boxes an important exception
Baseball started sharing 34% this year
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Roughly 3X what used to share
NBA & NHL share nothing
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Making playoffs vital source of revenue
 Ottawa’s early exits hurt

Television:
The Key to the NFL’s Success
Became dominant revenue source in 1960s
Reason why football surpassed baseball
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Needed limited antitrust exemption
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No NFL on Saturdays in Fall
Doubleheader Game makes a national game
Has 8-year $17.6 billion contract
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Without TV: NFL’s revenues comparable to NHL
Baseball Luddites
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Reluctant to put on TV – or even radio – at all
Favored local coverage over national

TV a Key to Equality
Revenue shared equally
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True for all leagues – but pot much larger
KC: A small market for MLB but not NFL
Green Bay would have disappeared
Ottawa faces double whammy
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Small network contract for NHL
Small local media market

Venue Revenue:
Why Are Cowboys so Valuable?
One of most valuable franchises BUT
Smaller media market than Houston
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Houston couldn’t keep the Oilers
Shares bulk of media revenues
Gate revenue not huge
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Texas Stadium not huge (~66,000)
Shares 40% of home revenue
Key is stadium deal

Luxury Boxes
Texas Stadium refurbished in 1989
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Has 370 luxury suites: ~1.5X next highest
 “Venue revenues” 6X league average
One reason for moves in NFL
 New stadia all have more than older
Naming rights Untapped in Dallas
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Reliant pays Houston $300M over 30 years
Is it worth it?
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Naming Rights “Curse”
What do CMGI, Enron, PSINet, and United Airlines have in common?

Luxury Boxes:
An Exception to Sharing
Big Revenue
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Rent for 10s or 100s of thousands
Don’t have to share revenue
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Count only admission in revenue sharing
 Most of revenue counts as concessions
Does not count against “salary caps”
 Caps form upper AND lower limits
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Players want to see counted

Recent NFL Moves
What do they have in common?
All go from larger city to smaller city
NFL no longer has team in LA
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Bad for NFL – why?
Why do they move?
Large individual benefits
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Biggest source of “private income”
Costs widespread

Tragedy of the Commons
Individual benefits – but group hurt
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Eventually individual also hurt
But keeps doing it
Name from “Commons”
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Common Green in center of town
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People put livestock there
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Why bother to use own land?
Result: overgrazing
Common Resource
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Rivalry but no exclusion
 Examples: Overexploitation
Applies to NFL – but NOT baseball

Paper Losses and Real Profit
Profits are not the only way to get rich
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Bush tax plan in reverse
The O’Malleys & “unprofitable” Dodgers
Operating Profit vs Book Profit
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Deduct interest payments
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Bias to issue debt & not equity
Much debt from initial purchase (ego premium)
Deduct Depreciation
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What is depreciation?
What depreciates?

Depreciation, Taxes & Veeck
Bill Veeck – my favorite owner
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Innovative marketer
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From Eddie Gaedel to exploding scoreboards
Could use his autobiographies as MBA text
Moral figure
 Integrated AL
 Opposed exploitation of players
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Saw unique loophole in tax laws
Team can depreciate players
 What is depreciation?

An Application of
The Veeck Loophole
In 1993 group bought San Antonio Spurs for
$75M
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Claimed players worth 50% (maximum):
$37.5M
Depreciate players over 3.5 years
Straight-line depreciation: deduct ~$10.7 annually
Turns $0.3M profit into $10.4M loss

The “Subchapter S” Variant
What is a “Subchapter S” corporation?
Sole owner declares team income as personal income
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Can write off $10.4M against other income
If (rich) owner in 40% tax bracket
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Reduces taxes by $4.16M