Chapter 5
Competitive Balance
Leagues Want Balance
• Balance helps profits
– Attendance and TV ratings fall if one team dominates
– Even the dominant team can suffer
• What is competitive balance?
– Is it a good chance of winning each game?
– Is it turnover among champions?
• What do teams do to improve balance?
Teams, Leagues, and Balance
• What do teams want to do?
– Some – like the Yankees – pursue wins at the
expense of profits
– Others pursue profits at the expense of wins
• Leagues can limit behavior of teams to
promote balance
Balance and Marginal Product
• Diminishing marginal product limits the
desire of a team to acquire players
• The Los Angeles Lakers will not pursue
Dwayne Wade
– Already have Kobe Bryant
– Wade or other shooting guards will add little to
wins, attendance or revenue
• The added cost exceeds the added benefit
Is Perfect Balance Profit
Maximizing?
• Winning has a bigger
impact in a large city
–
–
–
–
More gate revenue
More media revenue
More venue revenue
Higher marginal revenue
• If costs do not vary by
city size, big cities will
win more
MR, MC
MRsmall
MRlarge
MC
Wins
Measuring Balance within a
Season
• Could use the standard deviation of winning %
– Gives the spread of performance by teams
– Problem: # observations (games) must be constant
• Cannot compare across leagues
• Cannot compare across seasons
• Key innovation: compare actual standard
deviation to the “ideal” standard deviation
– Assumes ideal means that teams are evenly matched
– Each team has a 50% chance of winning a given game
– Take the ratio of actual to ideal
Computing Within-Season Balance
• The ratio of actual to ideal standard
deviation
– T= # teams
– N = # Games
– WPi = Winning Percentage of team i
2
1
WPi  W P 

T  1 i 1
R
0.5
N
T
Interpreting the Ratio
• The ratio gives a “standardized” measure
– Actual and ideal rise with number of games
– Can now compare across leagues & years
• As a rule: R > 1
• R = 1 League is completely balanced
– Outcomes are effectively randomly determined
• As R rises: imbalance worsens
How Do Leagues Compare?
•
•
•
•
NHL is the most balanced (R=1.66 in 2008-2009)
NBA is the least balanced (R=3.07)
NFL (1.66) and MLB (1.75) are in between
English Premier League (1.97) worse than all but
NBA
Measuring Balance Between
Seasons
• Can use the standard deviation of each
team’s winning percentage
– Unlike within season do not have an “ideal”
measure
– Unclear what is a good or bad level
• Can use frequency of championships
– Hard to compare across leagues
Between Season Balance:
The Hirfindahl-Hirschman Index
• HHI measures the concentration of
championships
• Let ci = #championships by team i
– T = #teams; N = #Years
 ci 
HHI    
i 1  N 
T
2
– HHI=1  one team always wins
– HHI=1/N  complete balance
Illustrating Imbalance
• The Lorenz Curve
– Measures inequality in a population
– Typically used to measure income inequality
– We use to measure inequality in winning
• Line up NBA teams by wins in 2008-2009
– 1230 games were played so population=1230
– The 3 weakest teams won 55 games
• Bottom 10% accounted for 4.5% of wins
– Next 10% accounted for 5.8% and so on
The Lorenz Curve for the NBA
• Red line shows perfect
balance
– Adding 10% more teams
– Adds 10% more wins
• Blue line shows reality
– Bottom 10% wins less than 10%
• Sags below red line
– As add better teams, blue curve
catches up
– At 100% of teams, we account for
100% of wins
• The farther the blue line sags,
the greater the inequality
1.2
1
0.8
0.6
0.4
0.2
0
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1
Applying HHI to Baseball
• MLB owners have frequently complained
about the lack of competitive balance
• Can use the HHI to test this claim
• Over the period 1999-2008
– MLB was most balanced (HHI=0.14)
– NBA was least balanced (HHI=0.28)
– NFL (0.16) and NHL (0.18) were in between
The Coase Theorem and
Competitive Balance
• Coase claimed that markets direct resources to
their most productive uses
– Property rights do not affect the flow of resources
– They affect only who gets paid for them
– The theorem is most commonly applied to externalities
• Applying the Coase theorem to sports
– LeBron James will go where he is most productive
– The team where he generates the greatest income
How The Coase Theorem Works
• Assume that LeBron James is more valuable in NY than
in Cleveland
• Under free agency
– The NY Knicks pay James to move to NY
• If there is no free agency
– The NY Knicks pay the Cavaliers for the “rights” to James
• James moves - the only difference is who gets paid
• The reserve clause did not prevent player movement
– In 1920 Red Sox sold Babe Ruth to Yankees
– Connie Mack twice sold off championship teams in Philadelphia
Promoting Competitive Balance
• The Coase theorem breaks down if there are large
costs to making transactions
• Owners have tried to impose transactions costs
– Revenue sharing
– Salary caps and luxury taxes
– Reverse order draft
• These restrictions also promote monopsony power
Revenue Sharing
• We have seen that winning means more to
teams from big cities
– New York will naturally win more often
– Revenue sharing tries to reduce this source of
inequality
• All 4 major sports leagues share revenue
Should Revenue Sharing Work?
• Even if teams share all revenue equally
– League revenue is greatest when big-market
teams win
– The incentive to have big-market teams win
does not go away
• Not all teams pursue winning equally
– Losing teams often have higher profits than
winning teams
– The Marlins and Nationals have higher
operating income than the NY Yankees
Introduction to the Salary Cap
• NBA, NFL, and NHL all have salary caps
• Caps set upper and lower limits to payrolls
• Take qualifying revenue (QR) of league
– Not all revenue “qualifies”
– Definition varies from league to league
• Players get a defined share of the QR
• Divide total player share by # of teams
• Add & subtract fudge factor (~20%) to get
bounds
Hard Caps and Soft Caps
• The NFL has a hard cap
– Sets firm limit to salaries
– No exemptions
• The NBA has a soft cap with many exceptions
– Mid-level exception
• Team can sign 1 player to the league average salary even if
it is over the limit
– Rookie exception
• Team can sign a rookie to his first contract even if it is over
the limit
– Larry Bird exception
• Named for former Boston Celtics great who was its first
beneficiary
• Team can re-sign a player who is already on its roster even
if it is over the limit
The NBA And Soft Caps
• The salary cap has not helped competitive
balance in the NBA
• All the exceptions have led to further rules
– The NBA now caps individual salaries as well
as team payrolls
– The NBA has a luxury tax to prevent teams
from abusing the exceptions
• Teams pay $1 for every $1 over the cap
MLB’s Luxury Tax
• Takes the place of a salary cap
– Team pays a tax for exceeding a target payroll
– Tax rises with the number of abuses
• Detroit Tigers paid a 22.5% tax in 2008 as
first-time violators
• NY Yankees paid a 40% tax for sixth
consecutive violation
The Reverse Order Draft
• Ideally levels out talent
– Weakest teams get first choice of new talent
– Strongest teams get last choice
• Works only if teams can identify talent
• Can promote “tanking” to improve draft
position
– That is why the NBA has a draft “lottery”
– Lottery means that weakest team might not
choose first
Identifying talent: Moneyball
• Billy Beane, the Oakland A’s general
manager, found underrated players
– He saw that teams overrated physical skills
– And underrated on-base percentage
• Using different criteria kept his small
market team competitive
• Other teams eventually caught on
– A’s have fallen on hard times as a result
A History of the
Reverse-Order Draft
• Introduced by NFL in 1936
• Caused by bidding war for Stan Kostka
– Star running back for the University of Minnesota
– Philadelphia Eagles & Brooklyn Dodgers competed to
sign him
– Drove salary offers to that of Bronko Nagurski – the top
star of the day ($5000)
What Was The Point of the Draft?
• Did teams just want to keep salaries low?
• Was is a cynical move by weak teams?
– Bert Bell, the Eagles’ owner proposed the draft
– The Eagles happened to have the NFL’s worst record
• Was it an idealistic move?
– The NY Giants & Chicago Bears agreed to the draft
– They were the dominant teams & had the most to lose
– Tim Mara (Giants owner): “People come to see
competition…. We could give [it to] them only if the
teams had some sort of equality.”