You are on page 1of 8

2

forthcoming in the Australian Economic Review

At one time the attraction of overseas events was seen as a simple benefit to the nation as a whole. By attracting circuses, rock concerts or works of art to the country, promoters brought events whose social and economic rewards were shared by many. Recently, however, the perception that the value of an event is potentially widespread has changed. Today’s major events have a local value to a single city or State. And with this, the attraction of events has become a competitive rather than a cooperative venture. The high profile rivalry for major events such as the Indy Car, Formula One and Motor Cycle Grand Prix are but one manifestation of the notion that major events constitute local and not national public goods.1 What accounts for this change? On one level, the spillovers that major events provide are localised. When considering Grand Prix, the lion’s share of the benefits come from increased tourism expenditure. But this additional expenditure does not fall to Australia like manna from heaven. Studies have shown that the vast majority of tourism generated by such events come from “expenditure switching” domestic residents (Mules, 1995). Their tourist dollar is a scarce resource. So when one city wins an event others around the country lose a bit of their own business. Any State or city leaving the task of attracting major events to others will find themselves worse off in the tourism (or any other investment) stakes. On another level, the events themselves are larger and less divisible. While a circus can come to two towns, a major event cannot be shared. To the extent that the benefits of a particular event are local, this raises its marginal value in the competitive arena. Only one city will realise the benefits of a particular event, but this makes the costs of losing, discussed above, even more salient. The costs of losing and the indivisible nature of major events combine to generate fierce competition for their staging. To the extent that much of the benefits of events are of a public good nature, governments have armed themselves with special organisations to improve their competitive advantage. Beginning with the Queensland Events Corporation in 1988, Victoria and South Australia have followed with Special Events Units of their own (Mules, 1995). These organisations have as their primary objective the attraction of major events to their respective States on the basis of their potential economic impact. But the interest goes beyond such organisations and the highest levels of State governments have begun to play explicit roles in event attraction. This increased competition between the States for major events has been viewed as just another part of the new era of deregulation. The bidding for these events was seen as healthy and a warning to State governments against complacency (see The Australian, 18 December, 1993, p.16). An analogy was drawn with the increased competition in our industries that forced firms to be on their toes and become more

Of Grand Prix and Circuses*
by

JOSHUA S. GANS
School of Economics, University of New South Wales Sydney, NSW 2052 E-Mail: J.Gans@unsw.edu.au

First Draft: 27 December, 1995 This Version: 17 June, 1996

Abstract. The public competition between States for major events such as the Indy Car, Formula One and Motor Cycle Grand Prix is analysed from a simple game theoretic perspective. It is demonstrated that the such competition is, in general, harmful to the States themselves. Competition leads to greater payments for events to promoters, distortions in the type of event eventually held, and sometimes, the wrong State holding the event. These considerations give a prima facie case for central coordination of event attraction to Australia. Two Line Summary. Competition between States for major events results in higher payments, distortions, and, sometimes, the mislocation of events.

This is a revised version of the paper presented at the December 1995 Conference on “Regional Economic Issues in Australasia” sponsered by the Economic Society of Australia (NSW) and Business and Econometric Forecasting Group (CAER). I thank participants at that conference, Maxim Engers, Trevor Mules, Robin Stonecash and Trevor Stegman for useful discussions. All responsibility for views expressed lies with me.

*

productive. Bidding for events was said to ensure that:
1

Included here is rivalry for investment projects such as the Fox Movie Studios. The Olympics are an exception in that the rivalry was organised within Australia before a bid was submitted.

3 (I) and (II) More preferable events were attracted. Events went to the States that derived most value from them;

4 Nonetheless, even in this simple case, the potential costs of interstate rivalry can be made explicit. 2 Here, I will consider only a game between three players -- the event promoter and two State governments. For instance, with regard to the Formula One Grand Prix, the relevant event promoter was the London-based Formula One Constructor’s Authority headed by Bernie Ecclestone and the bidding States were, of course, Victoria and South Australia. There may have been other important players -- for instance, other State governments, sponsors and overseas governments -- but they are not considered here. Putting them in would only complicate the story and not alter the nature of the costs to be demonstrated below. Before looking at the outcome of the game, some additional details need to be specified. The most important of these is the value of an event to the players. The promoter places value on having a “successful” event. This success could be in concrete terms such as high ticket receipts and television royalties. Or it could be something more subjective in line with the particular social and cultural goals of their organisation. Also, the promoter prefers to receive a higher compensation for holding the event. This compensation is, however, a direct loss to the winning State and hence, is a key item for negotiation. But States also place value on having a “successful event.” Success might be on the same criteria as the event promoter but the existence of tourism spillovers and potential tax revenues adds an additional element to a State’s preferences. Finally, a State that does not hold the event may face some losses in terms of tourists switching expenditures to the winning State. First, I will consider a contest over a single type of event. It is assumed here that the value of a “successful” event to the promoter is $200. The social value of an event to State Government 1 is $1000 and to State Government 2 is $800. (Recall these are just numerical examples and their levels are for demonstrative purposes only). These values are summarised in Figure One. It will be assumed here that the potential losses to each State of losing the event are $100. Note it is the fact that there are losses here rather than the size of these losses that is relevant for the outcomes discussed below.

But competition between States for major events is not like competition among firms. When firms compete, the beneficiaries are consumers who potentially buy more products of a higher quality and at lower prices. But who are the beneficiaries when two States compete to hold a major event? Here I will argue that it is the event promoter -- an organisation that holds monopoly rights over the supply of a given event. Moreover, this promoter is usually located away from Australia so that their profits are not even part of national income. For this reason, when looking at the healthiness or otherwise of interstate rivalry, the benefits or losses of the promoter should be left from the calculus. When this is done, the costs of interstate rivalry become high and numerous. How does a promoter gain from interstate rivalry? When bargaining with an individual State over the details of the event, the eventual outcome depends on the bargaining power of the promoter vis-a-vis the State. The promoter’s power in bargaining is strengthened when the promoter can make a credible threat to pull out of negotiations with one State. Credibility hinges on there being other bidders to turn to. By playing off bidders, the promoter extracts more of the rents generated by an event. And when the alternative bidder is another State, this increased share is a direct loss, not only for the winning State, but for the entire country. It is the goal of this paper to examine the potential costs of interstate rivalry from an economic point of view. In so doing, I will use the efficiency criteria of looking predominantly at national social welfare, but I will also show that individual States may lose from rivalry as well. It will be argued that the event the potential benefits of competition -- (I) and (II) above -- can be lost in the competitive struggle. Moreover, the more “strategic” a government in attempting to win an event -- e.g., by engaging in a silent bid to snatch an event from another State -- the greater the potential costs of competition.

A Simple Model
When a State government negotiates with a promoter for an event, from an economic point of view, they are playing a “game.” When another State chooses to bid for an event as well, this adds an additional player to that game. The simple game theoretic model here is a numerical example based on Gans (1995). It is designed to highlight the strategies and payoff outcomes that result from a major events game. As such, it is very simplistic and the numbers used should not be taken literally.
2

In the appendix, a more general model is specified verifying the specific claims in the numerical examples to follow.

5

6 The possibility of competition among the States allows the promoter to appropriate more of the rents generated by the event -- even if part of those rents is drawn from the losing State! This higher rent appropriation is the first cost of interstate rivalry. It is magnified by any duplication of bidding costs and losses in

Figure One: Simple Case

Promoter Value = $200

social harmony generated by the competitive proces.5 Note, however, that competition results in the State who values the event the most actually winning the event. State 2 could never out-bid State 1 in this bidding contest.

State 1 Value = $1000 Losing Cost = $100

State 2 Value = $800 Losing Cost = $100

Choosing the Type of Event
The previous model showed that while competition between the States lead to more compensation being paid to the promoter, it did ensure that the event went to the “right” State. Thus, it demonstrated the first claimed benefit of competition. This

As a benchmark it is worth looking at the situation when a single State (1) and the event promoter engage in individual negotiation. Since there is no competing State, the costs of losing the event here are zero. Therefore, State 1 will be willing to hold the event if the compensation paid is less than $1000. The negotiated compensation could be anything between zero and $1000, its level depending on the relative bargaining strength of the two parties. A determinant of the promoter’s strength is the possibility of an overseas alternative. I will subsume this possibility by assuming that the compensation is determined by a “split the difference” outcome. Therefore, State 1 offers $400 to the promoter for the event and this is sufficient to beat any international competition. In this case, the final payoffs received are $600 for State 1 and $600 for the promoter. This individual negotiation outcome is unlikely to be sustainable because State 2 will bid for the event even though it has a social value for the event less than State 1. If it did not it would lose $100. The effect of this competition is to weaken the relative bargaining position of State 1. The promoter can now make a credible threat to give the event to State 2 if 1 does not offer at least $900. This is because 2 can offer up to $9003 and still be better off than if 1 wins the event, in which case 2 would receive zero. In this case, State 1 offers “just above” $900 so that, in the end, the promoter receives a total payoff of $1100, while State 1 and State 2 receive $100 and -$100 respectively.4

simple model could not, however, speak to the second claim that competition led to more preferable events being attracted. This is because there was only a single type of event offered. In reality, there is substantial discretion over the characteristics of the event staged. State governments can choose an event’s precise location, its timing, the pricing of tickets, related expenditures that could improve tourism potential, its appeal to a television audience and regulatory concessions in terms of the environment, health and zoning. For instance, the picturesque location offered by Victoria for the Formula One Grand Prix improved its television appeal at the potential cost of environmental discomfort felt by local residents. Similar considerations have applied to tobacco sponsorship for the Adelaide Grand Prix and concessions surrounding the Fox Movie Studios in Sydney. This discretion means that the type of event held, as well as compensation paid, is a negotiable dimension and hence, an instrument of competition. This would pose no difficulty if the criterion for a successful event for the promoter was the same as that which maximised social value for the States. However, to the extent that tourism and environmental spillovers are realised within the State and not by the promoter, it is likely that promoters and States will have different preferences over the type of event offered. To capture this possibility suppose the values for two events to each of the three players are as depicted in Figure Two. There are two types of events -- S and P. Event S is preferred by both States over event P, but the reverse is true for the promoter.

3

The marginal benefit of winning the event is $800 - (-$100) = $900. If 2 bids this amount, it is at least as well off winning the event as opposed to losing it. 4 This is, in fact, a best case senario for State 1. It results if State 1 can make a take it or leave it offer to the promoter. If ex post bargaining power was equal then State 1 might have to pay $1000 for the event splitting the total social surplus ($1000 + $200) less the threat points of State 1 (-$100) and the promoter ($1100). To keep things simple, in this paper, the assumption of equal ex post bargaining power is made for individual negotiation but the outcome in competition is the same that would result from a first price sealed-bid auction or ascending bid auction. For more on these issues see McMillan (1992).

State 1 still receives greater social value regardless of the event staged. Finally, a loss of $100 still applies for the losing State.

5 There was certainly public anger surrounding both the NSW and Victorian winning bids for their respective Grand Prix.

7

8 This is the event distortion cost: interstate rivalry means that the event offered is distorted from the type that is socially optimal. The State trades-off the type of event offered against a reduction in compensation paid. In general, this trade-off will be more salient for economic than social or cultural dimensions of events. This means that claims and public protests that major events are being run too much on economic benefits to the neglect of environmental and other concerns could in part be the result of the competitive process between States. State governments are forced by competitive pressure to compromise on these dimensions in order to ensure they win the event, even if it is not the type they would most prefer. The size of the event distortion cost depends upon the relative value of event P being higher for 2 than for 1. Comparing event S and P, the difference is $100 for State 1 but only $50 for State 2. In the appendix, in a slightly more general model, I demonstrate that this difference in marginal value for events drives the magnitude of the event distortion. What if, however, these differences in preferences among States were so much that State 2 shared the promoter’s preference for event P, or at least was indifferent between the two? An example of such preferences are depicted in Figure Three. Here, while the individual negotiation outcome would result in State 1 staging event S, under competition, State 2 is able to out-bid State 1! This is despite the fact that the event with the highest social value is S in State 1. In this case, State 1’s best offer is event P and $950 -- its highest offer with event S involves the promoter receiving less. State 2 can match this and still receive a positive payoff. Therefore, the promoter gains $1350, State 2 loses $50 and State 1 loses $100. State 2 makes a loss but not as much as it would if it did not stage the event. This also demonstrates the possibility that, with competition, it may have been preferable for no event to be held in Australia at all! The more general model in the appendix demonstrates that in some circumstances 2 could still win the event without making a loss.

Figure Two: Choosing Type of Event I Event S Promoter Value = $200

State 1 Value = $1000 Losing Cost = $100

State 2 Value = $900 Losing Cost = $100

versus Event P Promoter Value = $300

State 1 Value = $900 Losing Cost = $100

State 2 Value = $850 Losing Cost = $100

In this case, a “split the difference” individual negotiation outcome has State 1 offering event S and $400 to the promoter. This results in payoffs to the promoter of $600 and to State 1 of $600.6 Once again, State 2 will have an incentive to bid for the event given its potential losses. It could beat State 1’s individual offer with an offer of event P and $400 and still make a positive payoff. However, the competitive equilibrium of this bidding contest will have State 1 offering event P and $950. This would match State 2’s best offer. It involves event P only because State 1’s best offer of event S would include compensation of $1000 resulting in a payoff of zero. By offering P, 1 ensures a positive payoff of $50, with the promoter receiving $1250 and 2 losing with -$100. This example highlights the possibility that competition, while resulting in the State valuing the event most still winning, has it winning an event that is less beneficial.

6

Observe that another “split the difference” outcome is for State 1 to offer Event P and $300 to the promoter. Once again, each would receive $600. However, this outcome is less plausible in more general cases (see Gans, 1995) and hence, is excluded here.

9

10 occupied with an election campaign. The Kennett government did not even inform the

Figure Three Choosing Type of Event II : Event S Promoter Value = $200

then Liberal opposition in South Australia of their intentions. In July 1993, Kennett flew to London on the pretext of attempting to attract the musical Sunset Boulevard to Melbourne. Instead, he met with the Formula One chief, Bernie Ecclestone and negotiated the deal eventually signed in September, 1993 (see Neales, 1993).7 The final deal remained unannounced until December 1993, days after the South Australian election, on the pretext it might harm the winning Liberal party there. Given the costs of competition derived above, the idea of choosing a strategy based on silent bidding might, prima facie, be seen as an extremely shrewd one. However, a proper game theoretic analysis shows this shrewdness to be superficial. To see this, with the payoffs of the simple model above (Figure One), suppose that State 2 initially held the event. By engaging in a silent bid, could State 1 have obtained an outcome better than the competitive one in which it received a payoff of $100 (a net gain of $200 given that 2’s operation of the event)? If State 2 had initially won the event with its best bid of $900, then matching this bid would not make 1 better off than the open bidding outcome. What if 2’s previous offer was less than $900 (say, $700)? At first glance, this would allow State 2 to submit a silent bid of just above $700, win the event and achieve a better outcome than the competitive senario. But this calculation neglects the decision process of the promoter. The promoter could accept the silent bid but equally could alert State 2 and institute an open bidding contest. Indeed, so long as 1’s silent offer is less than $900, the promoter will have an incentive to do this. At this point the objection might be raised that the promoter may not know that 2’s best bid is as high as $900. If this were the case, however, the promoter would have an incentive to find out. One of the best ways of doing this is instituting an open bidding contest that forces parties to raise their bids until one of them drops out. This signals that bidder’s best bid. Incomplete information on the part of the promoter does not make a case for profitable silent bidding on the part of State 1. Somewhat paradoxically, to the extent that a silent bid is accepted, it may indicate a lack of information about 2’s best bid on the part of State 1. If State 1 overestimated 2’s best bid and the promoter knew this, it would be in its interest to accept the high silent bid, lest an open bidding contest actually reduce 1’s initial offer. Thus, engaging in silent bidding at best results in the openly competitive outcome and at worst can lead to what is termed in auction theory as the “winner’s curse.” That is, when the value of an object being auctioned is common across bidders, each has an incentive to bid more if their private information on that value is more optimistic. In this case, winning a bidding context is bad news in that it implies that your valuation

State 1 Value = $1000 Losing Cost = $100

State 2 Value = $900 Losing Cost = $100

versus Event P Promoter Value = $400

State 1 Value = $850 Losing Cost = $100

State 2 Value = $900 Losing Cost = $100

The notion that the “wrong” State could win the event is the selection cost of competition. It casts doubt on the notion that competition ensures that the State that could gain the most from the event will hold the event. Observations that a particular State wins an event does in itself justify the social optimality of the result. It could easily be the case that a slightly different event held in another State could have generated a greater social value.

Silent Bidding and Snatching Events
The picture painted by the above models is that of an open bidding contest. However, the reality can seem quite different. The example of Melbourne’s snatching of the Formula One Grand Prix from Adelaide in 1993 is a good indication of this. There, no open bidding contest emerged. The Victorian government bid for the event without the knowledge of the South Australian government who were otherwise

7 Ironically, when he announced in November, that Melbourne would bid for the event, commentators suggested that he hold just the type of meeting already held earlier (Young and Stenberg, 1993).

11 was biased upwards. Hence, because of imperfect information, the winner is cursed and ends up paying too much (see McMillan, 1992). Therefore, the promoter’s ability to switch to an open bidding context nullified the seeming shrewdness of silent bidding. This ability can allow a form of implicit competition and potentially can exacerbate rather than reduce the costs involved in interstate rivalry.

12 apart in the same city, may maximise tourism potential from overseas without any overall domestic cost. Such considerations are complex and are left for future research and inquiry.

Conclusions and Policy Implications
Interstate rivalry over major events has the hallmark of a “winner-take-all” market (Frank and Cook, 1995). The possibility of losing costs means that the decision to bid and bid fiercely form part of a Prisoner’s Dilemma game. No State can afford to be left out of the bidding despite the fact that a cooperative outcome would leave the winning State better off. There is a negative externality generated by the decision to compete by the eventual losing State. This is the source of the potential costs identified in this paper. Before turning to the policy implications of this it is worth noting the potential impact of political motives. State governments might act in negotiations and bidding for political rather than overall State interests. This introduces numerous distortions into the eventual outcomes and are explored in more detail in Gans (1995). Broadly speaking, it is found there that if a politician’s preferences for an event differ from the social optimum, then interstate competition can lead to beneficial outcomes. Specifically, if social preferences for an event are more aligned with the promoter than the politican then competition can improve event selection. Nonetheless, the potential beneficial effects of competition arise only in special instances that are not particularly plausible for recent Australian cases. Given the costs of competition identified in this paper, what can be done? There is scope for some coordination of bidding by States for major events. In a best case senario, some central organisation could sort out the preferences of respective States and organise a bidder and bid that is free of the distortions identified here (e.g., as in Olympic bidding). However, such an institution carries with it all the potential costs of centralisation -- length of decision-making, imperfect information and inflexibility -and these must be traded-off against the costs identified in this paper. Moreover, the operation of a coordinating agency is difficult and, as previous attempts concerning sporting events (e.g., by the Australian Sports Commission) have shown, these are subject to non-cooperation by member States. But the case for some central coordination of major event attraction goes beyond the concerns raised in this paper. To the extent that the tourism generated by events is from domestic sources, some coordination could raise the national value of these events. For instance, it is plausible that holding the Motor Cycle and Formula One Grand Prix within a few weeks of one another in separate cities, as opposed to months

13

14

Appendix
In this appendix, I reState the model of this paper using variables rather than numerical examples. The variables that describe payoffs are summarised in Figure Four.
S 1

Figure Four: General Model Event S Promoter Value = π S

Consistent with the numerical examples it is assumed here that (i)

S S P v − c1 > v2 − c2 , (ii) π P > π S , (iii) v2 > π S , (iv) v2 > π P , and (v) c1 , c2 > 0 . That is,

1’s net value of holding event S is greater than 2’s, the promoter values event P more highly than S, the value to 2 of either event exceeds that to the promoter for those events, and the costs of losing are positive. Because payoffs are linear in the compensation amount, this means there are no wealth effects and hence, that the value maximisation principle must hold. Milgrom and Roberts (1992) State this principle as: “An allocation among a group of people whose preferences display no wealth effects is efficient only if it maximises the total value of affected parties. Moreover, for any inefficient allocation, there exists another (total value maximising) allocation that all of the parties strictly prefer.” (p.36) Thus, any outcome in this game maximises the total payoff of the negotiating parties. Value maximisation means that the event chosen in any outcome is the one that maximises total payoffs. Therefore, I will begin with an assumption that the sum of payoffs for the promoter and State 1 are the same for both events, i.e., (vi) v1S + π S = v1P + π P . This assumption was implicit in the example in Figure Two. Note that (i) and (vi) imply that no value maximising outcome involves State 2 -- State 1 will always win the event. Under (vi), there are two “split the difference” individual negotiation outcomes between State 1 and the promoter: (1) State 1 offers event S and compensation, x = 1 (v1S − π S ) ; and (2) State 2 offers event P and x = 1 (v1P − π P ) . 2 2 Because of value maximisation and (vi) there are always two such outcomes. However, as mentioned in the paper, more general models without value maximisation tend to favour individual negotiation outcomes such as (1) and so here I use that as the benchmark case.8

State 1 Value = v1S Losing Cost = c1
versus

State 2 S Value = v2 Losing Cost = c2

Event P Promoter P Value = π

State 1 Value = v1P Losing Cost = c1

State 2 P Value = v2 Losing Cost = c2

Evaluating the effect of competition involves three steps. First, the best offers
S for State 2 for both the S and P events need to be determined. These are x = v2 + c2 P P S and x = v2 + c2 , respectively. If π P + v2 > π S + v2 , then the offer with the P event will

maximise the promoter’s payoff. To win the event, State 1 must submit a bid that allows the promoter to achieve the same payoff as it would with 2’s best P offer, i.e.,
S P P π P + v2 + c2 . These are x = v2 + c2 and x = v2 + c2 for events S and P respectively.
P S P S State 2 will prefer the P offer if v1P − v2 > v1S − v2 ⇒ v1P − v1S > v2 − v2 , that is, if the

marginal loss from moving from event S to event P is greater for State 1 than for State 2. In this case, the competitive outcome will involve 1 offering event P. This final condition is critical in generating a positive event distortion cost. If this condition does
8 Note, also, that the “split the difference” outcome is also arbitrary. The point is that competition weakens that bargaining power of State 1 to such an extent that it would always be better off making an offer involving event P.

not hold competition does not change the type of event held, although it does still result in a rent appropriation cost.

15 Selection costs can arise if the sum of payoffs for the promoter and State 1 for events S and P are less than the sum of payoffs for the promoter and State 2 for event
P P, i.e., if π S + v1S + c1 , π P + v1P + c1 < π P + v2 + c2 . In this case, State 2 will always

16

References
Frank, R.H. & P.J. Cook (1995), The Winner-Take All Society, Free Press: New York. Gans, J.S. (1995), “Competing for Public Goods and Private Business,” Discussion Paper, No.96/2, School of Economics, University of New South Wales. Neales, S. (1993), “How The Deal Was Done.” The Age, 18 December, pp.1-2. McMillan, J. (1992), Games, Strategies and Managers, Oxford University Press: Oxford. Milgrom, P. and J. Roberts (1992), Economics, Organization and Management, Prentice-Hall: Englewood Cliffs. Mules, T. (1995), “The Economic Impact of Special Events,” paper presented at the Regional Economic Issues in Australasia Conference, University of New South Wales, 8th December. Young, C. and M. Stenberg (1993), “Melbourne Faces Uphill Battle for Grand Prix,” The Age, 8 November, p.4.

have a feasible bid that can match the best bids of State 1. This includes the relevant
P situation of when v1S − c1 > v2 − c2 , i.e., when event S for State 1 maximises social

value.