Friday, June 1, 2007

Collective Bargaining's Effect on Baseball Economics

I. Introduction

Major League Baseball (hereinafter the “MLB”) has been mired in the past by collective bargaining trouble through lockouts, strikes and a publicized distaste between the Major League Baseball Players Association (hereinafter the “MLBPA”) and ownership. Until 2002, there were four collective bargaining agreements that ended up with a work stoppage since the 1972 agreement. The collective bargaining agreements in 1976, 1981, 1990 and 1994 all had bloody labor negotiations that caused either a strike or lockout in order to come to an agreement during those years. 1994 was by far the worst as it ended up with the cancellation of the World Series, the loss of thousands of games and millions of dollars. The 2002 Basic Agreement made many changes to the economics of the sport, four years later, the 2006 agreement has altered those changes and on the surface has lent to teams spending a greater amount on free agents. Thus far in the 2006-2007 off season it compares to the 2000-2001 off season, when Alex Rodriguez received his landmark ten year 252 million dollar contract. It is highly troublesome to see such a spike in spending in a particular off season and it has direct relations with the new agreement between players and owners, just as the 2002 Basic Agreement caused for the free agent market to decline. The 2006 Basic Agreement has received a high amount of praise as augmented by comments from those who run the sport. For example, Baseball Commissioner Bud Selig was quoted in saying, “This is historic for a number of reasons. First, it is the longest labor contract in Baseball history; second, we reached the agreement nearly two months before the deadline; and third by the end of this contract Baseball will have gone 16 years without a strike or a lockout” [Fisher, 39]. While the Agreement certainly did go peacefully by comparison, it has the potential to harm the economics of the game and harm the competitive balance of the MLB.

II. Wartime

The collective bargaining sessions in years past for the MLB have been some of the most storied bargaining agreements in labor law and have been the trend setters for all professional sports. The MLBPA was the first union ever to break through to achieve significant gains for players and have heavily influenced the labor models for all of professional sports. In the 1970’s, the MLBPA stood as a whole to develop two of the most important factors in regard to the growth of player contracts, arbitration and free agency. Though the players have made significant strides to influence their own salaries, the MLB is a monopoly. In being a monopoly MLB has control over the industry and its economic benefits. Internal control in baseball is by the MLBPA and the contest for economic power in the industry is between management and labor. The union has no influence on many matters such as team schedules, advertisement, promotions, rules, expansions, and the draft, which is where the MLB maintains an advantage. Thus, the league and its teams still enjoy large revenues.

Marvin Miller built the strongest union in all of professional sports to fight this monopoly and in doing so he led the players through two successful strikes and many labor disagreements. When Miller was appointed to the head of the MLBPA in 1966, the union had a filing cabinent and a bank account which contained $5,400. Immediately, Miller signed a $66,000 contract with Coca Cola to have players faces put atop the caps of Coke bottles. The MLBPA is now one of the largest unions in the entire country and certainly the standout for all of professional sports. Marvin Miller can be credited with the vast majority of the grunt work to getting it where it is today. In 1972, the players struck over the issue of the players benefit plan. Though the players did eventually win the strike, the most important result of that strike was that the players stood as a whole and accomplished their goals. It was the first of many victories for Miller and the MLBPA; unfortunately it took work stoppages in order to advance the union to its present day force. In 1981, the players struck again, and though the reasons for the strike were over free agent compensation rules and reduced market restraint through free agency. One thing that stands out from this particular strike was that it was a common event to see Miller and the owner’s chief negotiator, Ray Grebey, exchanging verbal attacks through the media. These verbal attacks have occurred over and over again between ownership and the players, until the 2006 Basic Agreement negotiations. In the other years leading up to the current agreement, every year had some variance involving the economics of the game that led to a work stoppage of some sort until the 2002 Basic Agreement.

In 2002, the Baseball landscape had changed from the Miller days. The main points of contention were to address competitive balance, to restructure the luxury tax, to address potential contraction and to put a drug policy into place. Leading into the 2002 Collective Bargaining Agreement, Bud Selig appointed a Blue Ribbon Panel to examine the issue of competitive balance led by four outside experts. The four outside experts included George Will, Paul Volcker, George Mitchell, Richard Levin, also included on the panel were twelve owners whose goal was to study the baseball economic system and to make recommendations as to how to improve it, especially with regard to competitive balance. In looking at the facts that panel had to face, between the 1995 season and the 2001 season, just four teams from the bottom half of team payrolls made it into the playoffs and none made it past the first round of the playoffs. Of the 224 postseason games that were played between 1995 and 2001, only five of those games were won by these teams from the lower half of the payrolls. A staggering .978 winning percentage for the upper teams. After a fifteen month study starting in 1999, three recommendations came from the Blue Ribbon Panel. The first of the recommendations was for baseball to increase revenue sharing by raising the tax on local revenue from 20% to somewhere between 40 and 50%. The second recommendation was that that the luxury tax was to be reinstated in the form that any team with a payroll over $84 million was to be taxed at 50%. The final recommendation from the panel was restructure the draft system to give an advantage to the weaker teams. As negotiations began for the 2002 MLB Collective Bargaining Agreement, these recommendations were returned to often, with contraction also being a major issue that was not discussed by the panel. As negotiations began, the owners badly wanted to solve the issued within the economics of the game as the panel discovered that just three teams had operating incomes between 1995 and 2000.

The first major issue that was looked at with this collective bargaining agreement was the issue of contraction. The owners strongly desired for two to four teams to be contracted from Major League Baseball to enhance revenues for clubs and to remove failing teams from competition. This was universally thought of as being a direct threat to the players union in that by removing just two teams, fifty jobs in the MLB would be lost. In doing this there would be more competition for jobs on the remaining teams which would certainly depress player salaries. The players union vehemently opposed this issue for those reasons, and the owners were not helped by the success of the Minnesota Twins, one of the targeted contraction candidates. Eventually the owners promised that they would not consider a contraction until 2006 and if they did decide to contract in 2007, the players would not challenge. Since, the owners have shown no sign of wanting to contract since the 2002 Basic Agreement as the competitive balance among the MLB has increased and the system put into place in the 2002 agreement has appeared to help greatly.

The second major issue that was discussed in 2002 was that of drug testing. The federal government and the public had begun to see the issues of the potentially rampant use of performance enhancing drugs. The economic implications of the use of performance enhancing drugs were that players were able to improve their bodies and have a greater productivity than if they were not on steroids, for this reason the owners and players kept the issue quiet. Money was to be made by the players if their performances on the field were increased through the use of steroids, and through greater productivity owners would make more money if their teams were more successful. It wasn’t until there was increased pressure from the government and public to address the steroid issue that the MLB and the MLBPA decided to begin to discuss a potential steroid policy. This was an item of limited contention; however it was a huge addition to the 2002 agreement.

The largest issue from the 2002 Basic Agreement was to address competitive balance and use the results from the blue ribbon panel. Entering into the 2002 agreement, there was a previous revenue sharing policy in which 20% of every team’s net local revenue was placed into a pool and divided evenly among each of the thirty teams. This theory allows for the lower payrolls to receive money from the pool and have the tax revenue be a net asset, while the teams that have payrolls in the upper region would be losing money no matter what the circumstance and would incur net liability. The two sides both agreed from the start that this percentage must increase in the name of competitive balance though the first offer from the players was 22.5% and the owners first offer was 50%. Through intense negotiation the percentage of net local revenue that was placed into the pool became 34%. What is so important about this was that having a high tax level there would be a strong deterrent to increasing salaries. A flaw to the system is that for every dollar that a team uses in money received from revenue sharing they will be taxed 47% on each additional dollar of revenue that they earn. In addition to having that deterrent to spend, the luxury tax allowed for teams that lowered payroll to receive an increase from the revenue sharing pool. Essentially low payroll teams were encouraged to reduce their payrolls as it is their most effective price maximization theory. With this money many of the teams have been able to fuel their player development systems and have begun to succeed. It has also allowed for teams to retain their star players instead of having to trade them as in years past. All of these reasons led to a depression in the market as compared to the year prior to the 2002 agreement. In the 2002-2003 off season, 30% of free agents received contracts worth less than $1 million as compared to 8% in the 2000-2001 off season. This trend continued through the rest of the agreement, while as each year passed, players did receive more money based on the market and on inflation

The nature of this agreement was unlike the 2006 Basic Agreement. The players and owners came down to the final hours before the deadline to agree. While the 2002 agreement did not end up in a lockout, it followed the pattern of its predecessors that failed to solve the MLB’s issues in a timely fashion. Much of the failures from the 2002 agreement, including the negotiating style, were remedied in the 2006 agreement.

III. A New Look to Collective Bargaining

The main difference between the 2002 and 2006 basic agreements was the way that negotiations went. There was a mutual agreement between the two sides in the 2006 CBA to keep the talks out of the media and to have the negotiations finished in late October so that the deal could be announced during the World Series. MLBPA director Donald Fehr was quoted in discussion about the negotiations, “What was really different this time was the entire approach to bargaining. While it had its difficult moments, it was very pragmatic, very workman-like, very day-by-day” [Fisher, 1]. Collective Bargaining in the MLB has come a significant distance since the Miller era, but now there is a sense that Baseball has finally figured out how to bargain successfully while spreading positives and negatives to every team as well as to the players as the 2006 Basic Agreement exhibits.

The 2006 MLB Collective Bargaining Agreement addressed the economics of the game once again by restructuring the luxury tax again as well as changing the rules for the draft and prospects of the sport. The first of the changes was to the tax threshold to increase it significantly over the duration of the agreement to $136.5 million this year to $178 million when the agreement ends in 2011. The importance to having a higher tax threshold is that it is harder for teams to exceed the tax threshold. Though only time will tell, it seems as though by increasing the tax threshold as much as it was, spending was encouraged in this aspect since teams will have the ability to spend more money without having to worry about exceeding the tax threshold and be forced to pay the 39% on the dollar for every dollar that exceeds the tax threshold. Another major change to the revenue sharing plan was that instead of the 34% that was shared from local revenue during the 2002 agreement, that number was trimmed back to 31%. The significance of decreasing the percentage of shared local revenue is that there is now less money that teams of higher revenue will have to give up and lose with and the lower payroll teams will no longer receive as much money from this system. What seems to be apparently clear is that through these two methods the large market and high payroll teams will be able to spend more money because it has become harder to exceed the tax threshold and they will have to give less money to the local revenue pool, which for most high payroll teams was almost a certain loss. There were benefits from this collective bargaining agreement for small market teams as well in the form of the economics of the amateur draft system.

The 2006 agreement has added a deadline to sign draft picks that were not college seniors to August 15th and if a club were to fail to sign their first or second round draft picks they receive the same pick in the subsequent draft as a form of compensation. In doing this, it can be derived that teams will be able to be more strict as far as to what offers they are going to give to their draft picks because if they walk away by the deadline, teams will still receive a compensation pick in the following years draft. This is going to be a significant aid to teams because paying high draft picks significant amounts is a risk because teams compensate draft picks for their expected productivity in hopes that their productivity will eventually equal or in rare instances surpass their wage. This is going to provide teams a significant upper hand on drafted players because it is designed to reduce the wage given to early draft picks.

IV. Conclusion

In looking at baseball economics, what matters most is the present state of the game. The 2002 Basic Agreement was able to provide a significant amount of financial assistance to the lower class teams and for the most part, during the duration of that agreement teams with a low payroll did not do much spending on players, but rather they fueled their player development systems with the extra income. It has begun to surface as a successful endeavor as teams such as the Milwaukee Brewers, Tampa Bay Devil Rays and Pittsburgh Pirates have committed their future to the development of prospects from within. Without the funds given to them through the 2002 agreement, there would have been less of a possibility for this development. Whether or not this plan succeeds will show itself during the duration of the 2006 Collective Bargaining Agreement. The 2006 agreement encourages spending more than the 2002 agreement since it has become easier for high payroll teams to spend with the increase in the tax threshold and the decrease in the percentage of shared local revenue. So far it has showed just that. The 2006 free agent period has provided sportswriters with sizeable contracts that would have been considered extraordinarily large as compared to years during the 2002 agreement when the market was depressed. It seems as though this 2006-2007 off season has seen increased spending at a rate greater than the typical annual wage inflation. While during the next five years of the current agreement, headlines will most likely be dominated by enormous player contracts. There will also be benefits from the draft which is catered to the low payroll teams such as Milwaukee, Tampa Bay, or Pittsburgh and their recent plans to build their teams through internal player development. It appears as though the competitive balance issue may be coming as close as it ever has been to being solved. It is reasonable to expect further peace in 2011 as the globalization of Baseball continues and greater revenues are incurred.

Reference List:

Abrams, Roger. Legal Bases: Baseball and the Law. Philadelphia: Temple University Press, 1998.

Abrams, Roger. “The Public Regulation of Baseball Labor Relations and the Public Interest.” The Journal of Sport Economics, Nov. 2003, 4(4), pp. 292-301.

Fisher, Eric. “Fresh Approach to Talks Keeps MLB on the Field.” Street and Smith’s Sports Business Journal, October/November 2006, 9(26), pp. 1, 38-39.

Gould IV, William B. ”Labor Issues in Professional Sports: Reflections on Baseball, Labor, and Antitrust Law.” Stanford Law & Policy Review, 2004, 15(1), pp. 61-97.

Miller, Marvin. A Whole Different Ballgame. Ontario: Birch Lane Press, 1991.

Mullen, Liz. “Players Gain in CBA, but Prospects Lose Some Leverage.” Street and Smith’s Sports Business Journal, October/November 2006, 9(26), pp. 39.

Staudohar, Paul D. The Sports Industry and Collective Bargaining. Ithaca: ILR Press, 1986.

Wassner, Brien M. “Major League Baseball’s Answer to Salary Disputes and the Strike: Final Offer Arbitration: A Negotiation Tool Facilitating Adversary Agreement.” Vanderbilt Journal of Entertainment Law & Practice, Fall 2003, 6(3), pp. 5-14.

Williams, Jack F. “The Coming Revenue Revolution in Sports.” Willamette Law Review, 2006, 42(1), pp. 669-707.

Zimbalist, Andrew. In the Best Interests of Baseball? Hoboken: John Wiley & Sons, Inc., 2006.

Zimbalist, Andrew. May the Best Team Win. Washington D.C.: Brookings Institution Press, 2003.

Zimbalist, Andrew. “Labor Relations in Major League Baseball.” The Journal of Sport Economics, Nov. 2003, 4(4), pp. 332-355.

Thursday, May 31, 2007

An Examination of the Effects of Revenue Sharing

Introduction

In August of 2002, on the doorstep of another work stoppage in Major League Baseball (hereinafter “MLB”), the league and the Major League Baseball Players Association (hereinafter “MLBPA”) came to an agreement to enter revenue sharing into the leagues policy. The decision to add revenue sharing to alter the economics of the sport came as a result of Bud Selig’s blue ribbon panel to examine competitive balance in baseball. Competitive balance in sports is measured by how well a league can field equally competitive teams and is an economic problem that is not going to be achieved anytime soon.

The problem is that the fans, owners and the league all do not want to have the competitive balance situation in sport. As according to the Louis-Schmelling Paradox, monopoly on winning is actually a bad thing for professional sports leagues. It states that competition is necessary for economic success as it will keep fan interest high. This theory is an important part to understanding the fans perspective of competitive balance. Fans do want to have teams that excel, though too much as it doesn’t become fun anymore for the fan, and a under producing team creates the same effect. Optimally, the fans want the chance of winning to be somewhere in the range of sixty to seventy percent. A real chance of losing provides interest and excitement to games. While having every team being .500 would be the perfect example of competitive balance, fans do not want that either because the chance of losing would be too great and the product on the field would only be average for every team. Fans thus do not want to have perfect competitive balance.

Owners and leagues also do not want for there to be perfect competitive balance either, they believe that competitive balance does not lend to the maximum profit yield. Leagues most often wish to see large market teams have the most success. Examples of large markets are New York or Los Angeles, areas with large populations. The reason for this is that those areas have more fans and to have them succeed more often will bring in more fans for the teams and thus the league, all generating further revenues. Leagues have an amount of championships that they can give and they wish to allocate the championships to be divided between teams based on their market size. While New York wins three out of five, a small market teams, such as Kansas City would win once and a mid ranged team such as St. Louis would win twice. This creates the most amount of revenue for the league because the winning is spread around based on the interest and amount of fans that the league can accommodate. Most owners don’t care about competitive balance, for most of them want to win each year. They want to appeal to fans, who want to win ideally sixty to seventy percent of their games, so they wish to make that level. A team that wins sixty to seventy percent of their games is considered extremely successful and for the most part, there are very few teams that come close to seventy percent. Owners desire to maximize profits and not having a competitive balance is what owners want.

Owners of small market franchises have made the issue of competitive balance so prevalent. Mostly they are representatives of teams that are considered small market franchises that haven’t been able to win, or struggle to do so and need the help of the league to be able to get increased revenue and their chance to win. As the following comparison of the Kansas City Royals and the New York Yankees will prove, the difference in revenues between market sizes is certainly something that needs to be addressed and is a reason why revenue sharing needs to continue.

The Market Size Difference

The 2002 Collective Bargaining Agreement instituted the revenue sharing process which meant that each team would pool 34% of their total revenues from the year and receive back an equal share from that pool. Unfortunately, that data is not easily found so what I had to do to get the figure shared was to multiply each teams operating revenues each year from 2002 through 2006 by 34% to get the amount that teams put unto the pool. By dividing the sum of those numbers by thirty, I got the amount of money that each team received back. By taking the difference between the shared revenue totals of each the Kansas City Royals and the New York Yankees and the total that each team received from revenue sharing, I was able to determine the amount of money that the Royals benefited from through revenue sharing and how much the Yankees lost from the process. The Royals consistently gained with totals of 12.49, 10.63, 12.96, 13.86, and 16.11 (in millions) while the Yankees lost 34.43, 36.97, 41.44, 40.54, and 44.75 each year during the life of the 2002 collective bargaining agreement. This has been a significant step that the league took in order to react to the issues of competitive balance. The revenue gap between the two teams for every year during that period was well over one-hundred million dollars, a figure that increased each year. In 2002 the revenue gap between the teams was $130.2 million and rose to $179 million by 2006.

In 2006, the MLBPA and the league came to accordance again on the newest collective bargaining agreement which saw a change to revenue sharing. This change to revenue sharing was to decrease the percentage of revenues shared from 34% to 31%. This is without a doubt going to help large market teams because of the widening gap between revenues. If anything, the percentage should have increased since the total team revenues have increased from $1241.7 million to $1737.9 million. This is a significant change in revenues and forecasting would show that by the time that the next agreement expires after the 2011 season, the revenues will have risen even further and competitive balance will suffer during this span. Between 2002 and 2006, the Royals had winning percentages of .383, .512, .358, .346, and .383 while the Yankees had percentages of .630, .623, .623, .586, and .599. Though the Yankees have gotten marginally worse through the years of revenue sharing as teams with similar resources have been able to catch up to them with the revenue sharing and luxury tax. The Royals have gotten no better while having some of their franchises worst seasons ever. Revenue sharing on the surface has not changed the competitive balance of the MLB, though there are signs of hope.

Conclusion

Small market franchises on the whole have been able to receive significant amounts of additional revenue from the changes made to the economics of the league in the 2002 basic agreement. These teams have been able to take their added revenues and spend them effectively in either putting together a farm system or spending on the free agent market. The Milwaukee Brewers have not had a winning percentage over .500 since 1992, though they have shown signs of improvement each year since the 2002 basic agreement by in large because of the additional revenue that they have been able to put into player development. In order for their team to win sixty to seventy percent of their games it will take creative management. At least the possibility of being able to succeed in the economic landscape of the MLB with a small market team exists still significantly due to the addition of revenue sharing. I expect that with the change in revenue sharing percentages, the competitive balance in the MLB will decline steadily, making me question the decision of the MLB to decrease the rate.