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.