It’s All About the Benjamins

Sports is obviously big in the entertainment business, but the financial status of teams is much less clear. Are they rolling in the dough because of the ridiculous prices of tickets and beer? Or are they struggling to survive because of the ludicrous salaries they have to pay to their star athletes? We can’t tell for sure, because teams don’t publish their financial statements, but with some simple economic concepts and a lot of supply and demand, we can take an educated look at whether we should continue to fund their stadiums through our tax dollars, or boycott their high prices. My evaluation says that teams are doing just fine, no matter how the bankruptcy filings, funding requests, and complaints might make it seem.

Here’s my theory: major league teams don’t want you to know how much money they’re actually making. If everyone was aware of franchises’ finances, taxpayers might be less likely to agree to fund stadiums, fans might protest ticket prices, and the teams would be left in a less favorable bargaining position when it comes to revenue sharing with the players and the league. Plus, as Deadspin found out, convincing the IRS you’re losing money turns out to be great for the bottom line.

This gives teams lots of incentive to understate revenues, emphasize expenses, and claim they aren’t making much profit. The New York Post even got one owner to admit teams were doing all right, though he does follows it with grumblings about costs going up and profit margins being tight.

Money In, Money Out

It helps to think about major league teams as individual companies, and consider their revenues and expenses. Teams bring in money from the sales of tickets and luxury boxes, concessions, stadium advertising, and from cable broadcasting rights. We all know how high the prices of tickets and food are, and yet it’s a drop in the bucket compared to the cost of cable broadcasting rights, which are a massive source of income for sports teams. In 2009, the per-team national media revenue for the NFL was about $95.8 million.  (And that’s just from the main cable networks, like CBS and Fox. It doesn’t include any special pay-channels or the internet, which are increasingly lucrative for leagues and teams.)

These broadcasting rights, along with the barriers to entry created by the leagues (to start a team and get into the NFL, every team and the league must agree to let you in), allow sports teams to get around the antitrust laws most businesses have to abide by. Sports teams within their leagues are able to create a sort of oligopoly where a small number of “suppliers” of sports can work together to manipulate profits to make more than what would be made if competition wasn’t limited.

On the other hand, running a team is a very expensive venture. Teams must pay players’ salaries, stadium operating expenses (including rent), and they must share part of their revenues with the other teams in the league. On the expense side, payroll eats up a huge portion of teams’ revenues. Players currently make about 57% of team’s basketball revenue in the NBA, ((That 57% number, NBA owners say, is too high and has become one of the most important issues in the current lockout.)) and NFL players used to make about two-thirds of football revenues. ((Lebron James makes $14.5 million, Peyton Manning makes $23 million, and Alex Rodriguez makes $32 million, which puts a dent in your revenue all by itself.)) However, these breakdowns may be changing during the lockouts, and they are also not as straightforward as they seem, since “basketball income” and “football revenues” are calculated a specific way and don’t include all money coming in.

Although there are salary caps and luxury taxes to attempt to keep team salaries down, players are hot and valuable commodities, and the best players go to the teams who are willing to pay for them. ((Salary caps and luxury taxes do more to improve the competitive balance between teams than they do to help teams manage expenses.)) The tradeoff with these higher-quality, higher-paid players is that they often bring in more fans, who pay the high ticket prices, which makes these expensive players a smart economic move.

This is the supply and demand of the sports labor market. Teams pay players for exactly what they are worth, what they will bring to the team.

Stadiums, too, cost money to operate, but what’s special about sports teams is they often don’t own their stadiums. Usually, the local government owns the stadium: It builds it with taxpayer money, and rents it to the team for a negotiated price. Whether these prices are reasonable is up for debate. Once again, it’s a supposed tradeoff for the city: having a stadium brings fans, who bring and spend money, which is good for the local economy, right? - That’s a debate for another time.

A Good Investment?

There are plenty of real, live examples of teams’ apparent successes and failures. According to Forbes, the New York Yankees are worth $1.6 billion, and the Dallas Cowboys are worth $1.65 billion. George Steinbrenner bought the Yankees in 1973 for about $8.8 million, and Jerry Jones bought the Cowboys in 1989 for $160 million. Any company showing that kind of a return on investment would be considered a success to say the very least. At the same time, though, the LA Dodgers have now declared bankruptcy and the NY Mets are in debt trouble too.

So is it possible for teams to fail, for a team to be a bad investment? Yes, but only with some real effort. The Dodgers’ and Mets’ problems are actually the result of owner frivolity and bad decision-making:  the Dodgers’ owners used the team as collateral for their own personal debt, which blew up during their divorce and the Mets lost tons of money in the Madoff ponzi scheme. Regardless, for every owner who doesn’t want a team anymore there’s a billionaire waiting to take it over. It seems to me as long as the demand for owning a sports team franchise continues, a team will always be a good investment.

Supply and demand, incidentally, triumphs in the story of sports team finance. The outrageously high prices charged for tickets and food and drink inside the stadium are simply a product of what you, the consumer, are willing to pay. The teams charge exactly the price that brings into equilibrium the supply of beer and the demand for beer. If they charge a dime more, there will not be enough customers buying to sell out their beer; if they charge a dime less, they will run out of beer before the end of the game. Same goes for merchandise, parking, and everything else a team does. There’s no set value, except what it’s been determined that you’ll pay. Franchise worth works the same way. The franchises are valued by the future cash flows expected, or by a multiple of the revenues currently coming in. Then, those values are realized by those who demand to own them.

From ticket prices, to player salaries, to franchise values, sports teams operate no differently from any other business operating within a market, although the market of a sports league is slightly different than most. The fact that demand remains strong means that owners don’t need to worry about their supply of money.