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The Economics of Modern Professional Sports as Presented by Scott Corwon of IMPACTS

The Economics of Modern Professional Sports as Presented by Scott Corwon of IMPACTS

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Scott Corwon, the founder of IMPACTS and leading innovator in the emerging fields of diffusion and price theory, provides contemporary examples of the impact of professional sports pricing relative to demand.

The purpose of the IMPACTS presentation series is to effectuate knowledge transfer concerning topical mathematical and scientific issues. Significant published works form the basis for much of the presentation series, and these works are interpreted and presented by recognized leaders in the topic area. The presentation series is made possible through the generous support of IMPACTS.
Scott Corwon, the founder of IMPACTS and leading innovator in the emerging fields of diffusion and price theory, provides contemporary examples of the impact of professional sports pricing relative to demand.

The purpose of the IMPACTS presentation series is to effectuate knowledge transfer concerning topical mathematical and scientific issues. Significant published works form the basis for much of the presentation series, and these works are interpreted and presented by recognized leaders in the topic area. The presentation series is made possible through the generous support of IMPACTS.

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Scott Corwon, the founder of IMPACTS and leading innovator in the th emerging fi ld of diff i and price th i fields f diffusion

d i theory, provides id contemporary examples of the impact of professional sports pricing relative to demand. The purpose of the IMPACTS presentation series is to effectuate knowledge transfer concerning topical mathematical and scientific issues. Significant published works form the basis for much of the presentation series, and these works are interpreted and presented by b recognized l d i d leaders i th t i area. Th presentation series i in the topic The t ti i is made possible through the generous support of IMPACTS.

The Economics of Modern Professional S t P f i l Sports

Why care about sports economics?
• S t and recreation i d t i a bi b i Sports d ti industry is big business.

Amount
Estimated Size of the Entire Sports Industry, US Annual Company Spending for Sports Advertising, US $441.1 billion $32 billion

Year
2007 2007

Source
PRE PRE

National Football League (NFL) NFL League Revenues Overall Operating Income Number of NFL teams Avg NFL Game Attendance Avg NFL Team Value MLB League Revenues Overall Operating Income Number of MLB teams Avg MLB Game Attendance Avg MLB Team Value $6.54 billion $568 million 32 68,661 $957 million Major League Baseball (MLB) $6.08 billion $492 million 30 32,767 $472 million 2007 2007 2008 2007 2007 MLB Forbes MLB ESPN Forbes 2007 2007 2008 2007 2007 PRE Forbes NFL ESPN Forbes

PRE: Plunkett Research, Ltd.

Amount National Basketball Association (NBA) NBA League Revenues Overall Operating Income Number f N b of NBA t teams Avg NBA Game Attendance Avg NBA Team Value NHL League Revenues Overall Operating Income Number of NHL teams Avg NHL Game Attendance Avg NHL Team Value g Other Spectator Sports Leagues Horse Racing Golf Courses Fitness & Recreational Centers Other Amusement & Recreation $3.57 billion $293 million 30 17,394 $372 million National Hockey League (NHL) $2.44 billion $95 million 30 17,308 $ $200 million Other Sports Industry Revenue $3.7 billion $8.4 $8 4 billion $20.8 billion $20.3 billion $19.3 $19 3 billion

Year 2007-08 2007-08 2007-08 2007 08 2007-08 2007-08 2007-08 2007-08 2007-08 2007-08 2007-08 2008 2008 2008 2008 2008

Source PRE Forbes NFL ESPN Forbes MLB Forbes MLB ESPN Forbes PRE PRE PRE PRE PRE

Market Model
• Demand shifters
– – – – – Income Price of related goods Consumer tastes Market size Price expectations

$

S1

P1 D1 Q1
quantity

• Supply shifters
– – – – – Input prices Technology Taxes Price expectations Number of firms

Price Elasticity
• Measure of price sensitivity

%ΔQ E= %ΔP

d
• More substitutes • Big budget items • Longer time horizons g

• Elastic demand: |E| > 1 | | • Inelastic demand: |E| < 1

Elasticity… Elasticity
%ΔQ E= %ΔP
d

TR = $50,000 $ 50 E=? TR = $48,000

200 1100 = 0.18 = −0.82 E= − 10 0.22 45

40

D1
1000 1200
tickets

Price Controls
• Price Ceilings
– create shortages – create black markets
P1 Pceiling

S1

D1
Q1 shortage Qd tickets

Price Controls
• Price Floors
– Create surpluses
Pfloor P1

S1

D1
Qd Q1 tickets

surplus l

Maximizing Profit
• Profits = π = TR - TC • Profit-max rule: MR = MC

•What do the NY Yankees sell? •What kind of cost is Alex Rodriguez s salary? Rodriguez’s

Perfect Competition
$ S
MC ATC MR = P

P1

D
Q1
Quantity

q1

Market

Firm

Monopoly
• Relevant Market
– Any close substitutes? y

• Entry Barriers
–E Economies of scale i f l – Control over key input – Government restrictions

Monopoly
$
MC

Profits are maximized where MR = MC Price is set off of demand curve

P1 ATC1

ATC

D
Q1 Quantity

MR

Pricing Strategy: Phillies vs Flyers
• Each is a monopoly • MC a backward “L” • Does it pay to sell out?

$

MC2

MC1

P2 P1

Q1
Citizens Bank Park 43,500 Wachovia Center 19,500

MR

D

2006 Ticket Prices
Phillies Game Field Level $44 $ $38 $25 $27 $22 $20 $30 $22 $16 Season $39.75 $ $34.75 $21.83 $24.88 $24 88 $19.88 $17.93 Mezzanine $27.31 $19.88 $19 88 $14.88 $55 $45 $40 $23 $44.50 $38 $31.75 $20 Victor’s Restaurant Flyers Game $100 Season $84

Club Level

Lower Level $85 $69

Terrace

Source: philadelphia.phillies.mlb.com and philadelphiaflyers.com

The Role of Uncertainty
• Are the Yankees bad for baseball?
– Are dynasties a bad idea? – How often should the home team win?

• Why do teams sell season tickets?
– Transfers risk from team to fans – Why do fans buy them? y y

Attendance vs Winning Pct Pct.
1 0.9 0.8 0.7 0.6 06 0.5 0.4 0.3 0.2 0.1 0 0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1

1 0.9 0.8 0.7 0.6 06 0.5 0.4 0.3 0.2 02 0.1 0 0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8

2 2002 % of Capacity

2001 Winning Percentage

20 % of Ca 002 apacity

2001 Winning Percentage Wi i P t

NFL

MLB

Can Losing be Good?
• Cleveland Browns won all the time in AAFC • Fans of AAFC lost interest
– Even Browns fans – Attendance fell

• Attendance fell in MLB in 1950s
– NY teams in every World Series (sort of) – Why go see Pittsburgh play Cincinnati?

• Study looked at attendance in MLB
– C t ll d f d Controlled for day, ti time, weather, quality of opponent th lit f t – Attendance highest when home team won 60% of time

Regression A l i R i Analysis
• Regression is a form of statistical analysis of economic b h i and l i f i behavior d theory. y
– Regression analysis attempts to explain the variance of a particular variable of interest interest.

• Attendance Function
A = f(X1, X2, X3, …)

Regression Analysis
• Regression analysis can be used for predictive purposes, but in this presentation we will use it to test our economic theory. • Two ways that regression results can confirm economic theory: The sign and magnitude of the estimated relationship and the statistical significance.

Regression Example
• Consider a model of baseball attendance. We think that the following g g y items might influence overall team attendance in the following ways
Variable Price Population Concession Prices Income Team Quality Opponent’s Quality O t’ Q lit Weather Sign of Relationship Negative Positive Negative Positive Positive Positive P iti Ambiguous

A = β0 + β1P + β2POP + β3C + β4I + β5QH + β6QV + β7W

• Here are some actual regression results from Depken (2000, Journal of Sports Economics)

Franchise Economics and Owner Objectives j

Franchise Objectives
• Maximize profits? p
Profit = TR – TC

• Championships?
• Bad things can happen if bottom line is forgotten • C Case in point: O Ottawa S Senators
– Best record in NHL: 2002-2003 – Declared bankruptcy: 2003

• Ego premium? • Civic-mindedness?

Franchise Revenues
TR = RG + RB + RL + RS
– Where:
• • • • RG = Gate Revenue RB = Broadcast Revenue RL = Licensing Revenue RS = Stadium Revenue

Gate Revenues: RG
RG = α Rh + (1- α)Rp (1
• α = home team’s share • Rh = home team gate • Rp = pooled gate from all other teams
NFL: α = 60% MLB: α = 66% NBA, NHL: α = 100%

• Impact of Revenue Sharing
– Financial stability (early NFL struggled to maintain y( y gg league); "luxury tax" in MLB – Competitive balance – Shifts funds from teams that spend a lot on good players to teams that do not; tends to depress what teams are WTP for players (“tax on quality”)

Broadcast Revenue: RB
• National revenue is shared equally q y • Local revenue is not shared equally
– KC: A small market for MLB but not NFL – Green Bay would have disappeared

• Tradeoff: RB vs RG?
blackouts

• Wh t determines b d What d t i broadcast rights payments? t i ht t ?
– Demand by Advertisers – Super Bowl XLIII:
• NBC received $206m for 69 spots ($3m per 30 seconds)

Broadcast Money Trail y
Sports Teams and Leagues

Programming

Rights Fees $

Media Providers (Networks, Cable, Satellite)

Ad Slots

Slot Fees $

Advertisers (Consumer Products Producers)

Revenue from Broadcast Rights Agreements g g
Sport
NFL NBA MLB (1) MLB (2) NASCAR PGA NHL
Source: various sources

Years
2006-2011 2008-2015 2007-2013 2007-2013 2007 2013 2001-2008 2003-2006 2005-2008

Rights
ABC, FOX, CBS, ESPN ABC/ESPN, AOL Time Warner ESPN FOX/TBS FOX/NBC, Turner CBS, NBC Versus/NBC

Total Fees
$22.2 billion $7.4 billion $2.4 billion $3 billion $2.4 billion $850 million $207 million

Annual Average
$3.7 billion $930 million $343 million $429 million $400 million $212.5 million $70 million

Stadium Revenue: RS
• • • • Concessions Parking g Naming rights: pros; colleges; individuals Luxury seats
– don't count as gate, therefore, don't have to share
Example: • luxury suite rents for $500,000 per year • 20 seats • claim each seat is worth $50 team must share $3200 = 0.4 * 20 * $50 * 8 games

Why h Wh have we seen a move to small t ll markets by NFL teams?
– – – – Rams: LA St. Louis Raiders: LA Oakland Oilers: Houston Nashville Browns: Cleveland Baltimore

Revenue Sharing is the key!

Licensing Revenue: RL
• Generally shared with all teams • Cowboys broke ranks with NFL in 1995 by signing Pepsi for stadium sponsorship

Franchise Costs
TC = CP + CA + CT + CS + OC
• Player Salaries
– – – – – – Over 50% of team revenues Deferred compensation Bonuses Workers’ comp Opportunity Costs: Profit that Pension contributions could be earned in another city Player Development
• MLB and NHL

• Administrative
– Coaches and management – Marketing

• Travel • Stadium

Average costs and revenues (in millions) across the th major sports i 2006 j t in
League NFL NHL NBA MLB Gate Revenue 44.59 34.10 39.23 61.03 Other Total Revenue Revenue 159.75 47.10 79.87 109.33 204.34 81.20 119.10 170.37 Player Expense 125.47 44.17 68.77 93.30 Other Expense 61.11 33.85 40.58 60.55 Total Expense 186.58 78.02 109.35 153.55 Operating Profit 17.76 3.18 9.75 16.52

Accounting Games
• Book Profit and Depreciation Profit = TR – TC
Costs include interest expenses and depreciation of capital

– Corporate ta es depend on book profit taxes
• Paying high administrative costs reduces book profit • Interest is tax deductible (dividends are not) • Player contracts are treated as depreciable assets
– Bill Veeck – San Antonio Spurs example

Table C San Antonio Spurs Depreciation and Tax Savings 1993-4/1994-5 (All figures in $millions)

1993-94
Category w/o Roster DEP

1993-94
w/Roster DEP

1994-95
w/o Roster DEP

1994-95
w/Roster DEP

(1) NOR (2) DEP (3) NAD (4) Taxes ( ) (5) NADT Tax Savings

4.9 49 3.5 1.4 14 .5 .9 0

4.9 49 (3.5+10.7) -9.3 -9 3 0 -9.3 3.2

0.3 03 3.5 -3.2 -3 2 0 -3.2 1.1

0.3 03 (3.5+10.7) -13.9 -13 9 0 -13.9 4.9

Accounting Games
• Vertical Integration
– Media outlet buys sports team y p
• • • • AOL Time Warner Atlanta Braves Tribune Company Chicago Cubs Disney Anaheim Angels /Anaheim Ducks FOX LA Dodgers

– Double monopoly?

Upstream Firm p (Team)

Downstream Firm (Network)

Pdown Pup MC MR Qup D Qdown MR D MC

• Vertically integrated firm sets transfer price to allocate profit across combined entity
– Set low broadcast rights fee to reduce team profits in order to plead p p poverty during lobbying for p y g y g public subsidy

League Decisions
– Cincinnati Red Stockings (1869)
• “barnstorming”

– National League ( g (1876) )
• $0.50 tickets • No Sunday games • No beer
American Association (1882) $0.25 tickets on Sunday with beer!

League Decisions
• Setting the Rules
– # games, game format, equipment

• Limiting Entry
– Teams
• Benefits:
– Entry fee – More revenue sources re en e so rces

• Costs:
– Sharing of league revenues – Reduced geographical monopoly – Reduces threat of moving

– New leagues: ABA, WHA, AFL, USFL

• L League-wide M k i id Marketing
– Free-rider problem

• Competitive Balance and Revenue Sharing

NFL Expansion Fees
Teams
Houston Texans Carolina Panthers and Jacksonville Jaguars Seattle Seahawks and Tampa Bay Bucs Cincinnati Bengals (AFL) New Orleans Saints Atlanta Falcons Miami Dolphins (AFL) g Minnesota Vikings Dallas Cowboys Original members of the AFL Philadelphia E l Phil d l hi Eagles and Pittsburgh Pirates* d Pitt b h Pi t * New York Giants Original members of the NFL**
*Changed nickname to Steelers in 1940 **NFL was known as the American Football Association its first two seasons. ^According to accounts, this fee was never paid by the teams.

Franchise Fee
$700 million $140 million $16 million $7.5-$8 million $8.5 million $8.5 million $7.5 million $ $1 million $1 million $25,000 $2,500 $2 500 $500 $100^

First Season
2002 1995 1976 1968 1967 1966 1966 1961 1960 1960 1933 1925 1920

Source: http://www.profootballhof.com/history/release.jsp?release_id=1286

If a team always sells out its home games, economists would say it is very likely that:
a) b) c) d) A surplus exists There is excess supply There is excess demand Prices are too high

If an industry is a monopoly, output is _____ and prices are _____ th if it were perfectly competitive. than f tl titi

a) b) c) d)

Lower, lower Higher, lower Lower, higher Higher, higher

If demand for tickets to see the LA Lakers is inelastic,

a) b) c) d)

Fans will respond to a price increase with a proportional decrease in quantity demanded. fans will respond to a price increase with a less than proportional decrease in quantity demanded. fans will respond to a price increase with an infinitely large decrease in quantity demanded. fans will respond to a price increase with a more than proportional decrease in quantity demanded. demanded

If income increases and tickets to see a Notre Dame football f tb ll game are a normal good th th l d then the

a) b) c) d)

demand for tickets will decrease. supply of tickets will increase. demand for tickets will increase. supply of tickets will decrease.

The fact that attendance rises at baseball stadiums during “bobblehead” days suggests bobblehead
a) b) c) d) baseball games and bobbleheads are complements. complements baseball games and bobbleheads are substitutes. baseball games and bobbleheads are normal goods. No information about baseball games and bobbleheads can be determined from this fact.

A negative aspect of anti scalping laws is anti-scalping
a) b) c) d) they prevent sell-outs. they cause people to pay more than they are willing to in order to get tickets tickets. they prevent the market from matching willing buyers and sellers. they h t ti k t th hurt ticket agencies. i

If the Knicks sign LeBron James to a big contract they may raise ti k t prices b i ticket i because
a) b) c) d) their average cost curve shifts up. their demand curve shifts right. their marginal cost curve shifts up. their fixed cost curve shifts up.

If a game is not sold out, then the marginal cost to a team of accommodating one additional fan is

a) b) c) d)

almost infinite. about equal to the team's payroll essentially zero zero. about half the cost of a ticket.

To determine the market demand for tickets to see the Boston B i th B t Bruins play h k we l hockey
a) b) c) d) add the marginal revenue at each price. divide the revenue of the team by the number of fans. add the price consumers are willing to pay at each quantity. add the quantity demanded at each price. i

The league with the most equal split of gate receipts between the home and visiting t i t b t th h d i iti teams i is
a) b) ) c) d) ) The NFL The NBA Baseball’s National League The NHL

The "naming rights curse" refers to the fact that naming curse
a) b) c) ) d) teams that have sold their naming rights have performed poorly. teams often receive too little revenue t ft i t littl for their naming rights. cities generally do not receive any of g y y the naming rights revenue. firms that have bought naming rights have often run into financial difficulties.

Over the course of a single season, the largest proportion of team cost is ti ft ti
a) b) ) c) d) ) zero. fixed. variable. shared by all teams in the y league.

The ownership of professional teams by media outlets tl t
a) b) c) d) prevents cross subsidization. is known as horizontal integration. is known as vertical integration. is becoming less common.

The Dallas Cowboys are such a valuable franchise because th b they
a) b) c) d) can tap into both U.S. and Mexican media markets. have a tradition of winning that attracts fans from all over. have done an expert job of managing th salary cap. i the l have so many luxury boxes.

By declaring Subchapter S status owners of y g p professional teams can
a) b) c) d) increase their revenue flow and hence their profits. h i fi reduce the Corporate Tax Rate that they must pay. p y use depreciation to reduce their personal taxes. reduce th i t d the interest payments they must t t th t make to their creditors.

Marketing for a league is a public good if
a) b) c) ) d) all teams pay for the cost of advertising for small market teams. all t ll teams pay an equal share of th l h f the cost of advertising campaigns. all teams derive benefit from an advertising campaign. all teams pay some share of the cost of advertising campaigns campaigns.

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