Sports and Profit Maximization
Here we explore the world of sports
and many aspects of what profit
maximization means in this world.
Leagues are by nature cooperative bodies in that
-teams are rivals that succeed at the expense of each
-each team’s success depends on the success of the
league as an institution.
The authors assume that teams have the goal of profit maximization
and that leagues exist to help meet this goal. This means, for
example, that the Vikings want to maximize profit and the NFL exists
to assist in this regard.
-create common sets of rules
-fix schedules
-decide on revenue sharing arrangements -stage championships
-create framework for entry of new teams and players into league
-conduct marketing campiagns
Setting Rules
Leagues have both on the field rules and off the field rules and
those that do not play by the rules may be banished from the
Players can be banned or disciplined for “throwing” games by
manipulating the score (Black Sox sandal), betting on games in
the league (Pete Rose, Alex Karras and Paul Hornung, for
example), or engaging in activity that reflects poorly on the
league (steroid use in MLB in recent years).
Fans can be (and have been) restricted by not allowing beverage
sales at all or after halftime or bad behavior by fans can lead to
penalties being put on the home team.
In recent years some rule changes have been the NFL’s limiting
contact by players on defense, the NHL’s goal area moved away
from end of ice and the NBA’s adoption of 3 point shot and
allowing zone defense.
Setting Rules
Football has changed rules so that the pass play has become more
prevalent. Those involved in passing plays (of course the all 11 are
involved, but the skill players and those that protect the “blind side”
get more attention), perhaps, get better contracts. It is claimed this
makes the league more popular.
In the world of golf there is talk of banning a style of putting known as
ANCHORING. This style is becoming increasingly popular and some
professionals suggest it helps them make money. If the style is
banned, the money made will shift back to players using traditional
putting styles.
The PGA tour will have to decide if allowing the style will generate
viewership, or will it diminish viewership. In other words, the PGA
Tour is worried about the total money generated for golf. The players
benefit as a group if more money is generated.
Limiting Entry
Existing teams limit other potential teams from entering the league
and have an impact on where new teams will be located.
Currently, the NBA, MLB, and the NHL each have 30 teams, the
NFL has 32 teams, and Australian Football has 16 teams.
What forces determine how large a league should become?
Revenue side
Existing teams benefit from a new team entering because there is
an admission fee from the new team and the additional fan base
and media outlets. It is thought that the benefits of adding new
teams are positive for additional teams, but the benefits become
smaller and smaller as new teams are added. The logic is that you
would add most profitable teams first and then the lesser teams.
So, the MR from more teams is declining.
Limiting Entry
Cost side
Costs to existing teams from a new team mean shared revenue is
split over more teams and the new team means existing teams
have fewer cities to be used as “escape” cities and those existing
teams threat of relocating is reduced.
On the cost side of adding teams the cost of additional teams is
also positive, but the costs become larger and larger. (Remember
the costs are additional teams with which revenue must be shared
and costs associated with weaker threat status) These costs are
thought to rise with additional teams.
The optimal number of teams from the league point of view is the
number where the marginal revenue of an additional team
equals the marginal cost. In other words, add teams until the MR
= MC of adding teams.
$ of MR and MC
Optimal number of
Limiting Entry
In some leagues existing teams have a boundary where other
teams in the league can not be located. The logic is if another
team could come in the existing teams demand curve would
likely shift in and become flatter, exhibiting a greater elasticity of
demand. This would make it more likely that the price charged
by the home team would become lower and thus the team
would have lower profit.
Profits act as a magnet attracting new firms, but limiting entry in
a league means existing teams can enjoy profits without the
natural downward pressure on price and profit.
Leagues often advertise on a national basis. The design of the ads is
to promote the league. Although each team may benefit differently
from an ad, just because one benefits that doesn’t mean others
can’t benefit from the very same advertisement. This means
national ads have the property called nonrivalry.
Plus, one team can not restrict another team from getting benefits
from the ads. This means national ads have the property called
Goods that have nonrivalry and nonexclusion are called public
goods. Public goods typically have an associated problem with
them called the free rider problem. Free riders want to pay less
than their true benefit.
Most goods are not public. For example, if I eat a PBJ I alone get the
benefits of it and I can exclude you from getting any of the benefit.
So at the national level a problem is to find out how much team
benefits from the ads and a second problem is to make sure
each pays their share.
When you look at local advertising each firms has its own
benefit and so it will want to run ads up to the point where the
MB = MC of having ads.