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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 Are sports purer than business? Nostalgia ain’t what it used to be Bad things can happen if forget bottom line

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The Industrial Organization of Sports

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The industrial organization of sports l.jpg

The Industrial Organization of Sports

Part I:

Profit Maximization


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Profits a Touchy Subject

  • We don’t want teams to worry about p

  • We want Ford to worry about it

    • Are sports purer than business?

    • Nostalgia ain’t what it used to be

  • Bad things can happen if forget bottom line

  • Case in point: Ottawa Senators

    • Best record in NHL: 2002-2003

    • Declared bankruptcy: 2003


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Alternatives to Profits

  • Personal publicity

    • Team as toy

    • The “Ego Premium”: $40-70 Million

  • Spillovers

    • Team helps sales in other areas

      • Ted Turner

      • Chris von der Ahe

  • Civic-mindedness?


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Basic Question

  • Why is NFL most profitable sport? (Excel)

    • Every team profitable

    • Profits and market values greatest

  • What happened to baseball?

    • Half the teams lost money last year

  • Why is NHL a basket case?

    • Lowest profits and market values by far

  • Underlying question: Why do leagues exist?


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Think of League as Synonymous with Team Sports

  • Wasn’t always so:

    • 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?

    • Barnstorming

    • Uncertain payoff

    • Dependent on winning

      • Red Stockings in 1869 vs 1870


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Leagues andThe Economics of Clubs

  • James Buchanan – Nobel Laureate

  • What is right size of league?

  • New members a new source of revenue

    • Entry fees

      • $50M fee put Ottawa in debt from outset

    • Access to new markets

  • May also be a drain

    • Must divvy up among more members

    • Revenue sharing

    • Competitive Balance


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Getting It Right Can Be Hard: Baseball in 1901

  • NL only league in early 1890s

    • Saw problems if too many teams

      • Uncompetitive & unprofitable franchises a drain

    • Zero sum rule: Add city A => Delete city B

  • 1890s: Cities Grow Rapidly

    • More cities able to support teams

    • NL vulnerable to entry

      • In 1901 AL entered “open” cities


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Gate Revenue:Earliest Source of Revenue

  • Revenue from ticket sales

  • NFL shares the most

    • Home team keeps 60%

    • 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

    • Roughly 3X what used to share

  • NBA & NHL share nothing

    • Making playoffs vital source of revenue

      • Ottawa’s early exits hurt


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Television: The Key to the NFL’s Success

  • Became dominant revenue source in 1960s

  • Reason why football surpassed baseball

    • Needed limited antitrust exemption

      • No NFL on Saturdays in Fall

      • Doubleheader Game makes a national game

  • Has 8-year $17.6 billion contract

    • Without TV: NFL’s revenues comparable to NHL

  • Baseball Luddites

    • Reluctant to put on TV – or even radio – at all

    • Favored local coverage over national


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TV a Key to Equality

  • Revenue shared equally

    • 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

    • Small network contract for NHL

    • Small local media market


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Venue Revenue:Why Are Cowboys so Valuable?

  • One of most valuable franchises BUT

  • Smaller media market than Houston

    • Houston couldn’t keep the Oilers

    • Shares bulk of media revenues

  • Gate revenue not huge

    • Texas Stadium not huge (~66,000)

    • Shares 40% of home revenue

  • Key is stadium deal


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Luxury Boxes

  • Texas Stadium refurbished in 1989

    • 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

    • Reliant pays Houston $300M over 30 years

    • Is it worth it?

      • Naming Rights “Curse”

      • What do CMGI, Enron, PSINet, and United Airlines have in common?


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    Luxury Boxes:An Exception to Sharing

    • Big Revenue

      • Rent for 10s or 100s of thousands

    • Don’t have to share revenue

      • Count only admission in revenue sharing

        • Most of revenue counts as concessions

      • Does not count against “salary caps”

        • Caps form upper AND lower limits

          • Players want to see counted


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    Recent NFL Moves

    • What do they have in common?

    • All go from larger city to smaller city

    • NFL no longer has team in LA

      • Bad for NFL – why?

      • Why do they move?

    • Large individual benefits

      • Biggest source of “private income”

    • Costs widespread


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    Tragedy of the Commons

    • Individual benefits – but group hurt

      • Eventually individual also hurt

      • But keeps doing it

    • Name from “Commons”

      • Common Green in center of town

      • People put livestock there

        • Why bother to use own land?

        • Result: overgrazing

    • Common Resource

      • Rivalry but no exclusion

        • Examples: Overexploitation

    • Applies to NFL – but NOT baseball


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    Paper Losses and Real Profit

    • Profits are not the only way to get rich

      • Bush tax plan in reverse

      • The O’Malleys & “unprofitable” Dodgers

    • Operating Profit vs Book Profit

      • Deduct interest payments

        • Bias to issue debt & not equity

        • Much debt from initial purchase (ego premium)

      • Deduct Depreciation

        • What is depreciation?

        • What depreciates?


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    Depreciation, Taxes & Veeck

    • Bill Veeck – my favorite owner

      • Innovative marketer

        • From Eddie Gaedel to exploding scoreboards

        • Could use his autobiographies as MBA text

      • Moral figure

        • Integrated AL

        • Opposed exploitation of players

    • Saw unique loophole in tax laws

      • Team can depreciate players

        • What is depreciation?


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    An Application of The Veeck Loophole

    • In 1993 group bought San Antonio Spurs for $75M

      • 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


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    The “Subchapter S” Variant

    • What is a “Subchapter S” corporation?

    • Sole owner declares team income as personal income

      • Can write off $10.4M against other income

    • If (rich) owner in 40% tax bracket

      • Reduces taxes by $4.16M


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