Chapter 4 Team Cost, Profit, and Winning

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Chapter 4Team Cost, Profit, and Winning

• To Accompany
• Sports Economics 2d.
• Rodney Fort
• (PrenticeHall, 2006)

2
Introduction
Owners are never the most popular sports figures
in a cityThere is a reason that no owner has
ever been pictured on a football card. -Gene
Klein, former owner of the SD Chargers.
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Overview

• The short-run and long-run decisions that
  confront sports team owners.
• Profit-maximization, subject to uncertainty, and
  the short-run and long-run decisions of owners.
• The tension created between fans, players, and
  owners by the owners financial bottom line.
• Profit variation and competitive balance.
• Sports accounting versus the value of ownership.

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Do Owners Really Maximize Profits?

• Are they fans with bigger checkbooks?
• Do they care about the bottom line?
• There is plenty of owner behavior consistent with
  profit maximization.
• Ultimately, its a hypothesis about behavior that
  can be tested.

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Do Owners Really Maximize Profits?

• Dont confuse the hypothesis with perfection!
• Owners are human and can make mistakes.
• Uncertainty makes maximizing profits a tough job!

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Tool Time Short-Run v. Long-Run

• Remember your economics principles
• Short-run (SR) Some factors of production are
  fixedthink contractual obligation.
• Long-run (LR) All factors of production are
  variable, or open to alteration by the producer.

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SR v. LR

• Owner behavior in the LR
• Owners choose quality (winning percent) to
  maximize profits.
• Owners make contracts to put the plan into action.

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SR v. LR

• Owner behavior in the SR
• Contracts represent fixed choices.
• Owners sell attendance and broadcast rights to
  collect on their quality choice.

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SR Sports Production

• SR Some factors of production are fixed
  (contractual obligations)
• Talent, on and off the field, typically over the
  course of a given season.
• The facility the team plays in, typically over
  its 20-30 year lifespan.
• Dont confuse the SR with a short period of
  actual physical time. The SR for stadiums can be
  decades!

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Intra-Season Roster Changes?

• SR or LR?
• SR Adjustments over time to achieve the
  long-run plan.
• LR Owner changes the quality choice altogether.

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LR Sports Production

• In the LR
• New stadiums can be built.
• The level of roster quality can be altered.
• Managers and coaches can be replaced.

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LR Sports Production

• Essentially, any time the owner steps back and
  takes a planning view, LR considerations are
  on the drawing board.

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SR Production and Costs

• SR fixed inputs dictate total fixed costs (TFC)
• Stadium costs (interest)
• Rosters costs
• Management costs
• Costs that must be paid whether the team brings
  a single paying customer through the gate or not.

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SR Production and Costs

• SR variable inputs dictate total variable costs
  (TVC)
• Team operations
• Stadium operations (for some owners)
• Scouting and player development
• Advertising and marketing

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SR Total Costs

• SR total costs (SRTC) are the sum of fixed and
  variable costs
• SRTC TFC TVC
• Fixed costs do not change with output.
• Variable costs have a particular shape due to
  diminishing returns to variable inputs.

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SR Total Costs

• Heres the hypothetical SRTC structure of the
  Seattle Mariners from the text
• Table 4.1gtTable 4.2gtFigure 4-1.

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Hypothetical SR Costs

• Mariners attendance
• About 2.9 million

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LR Production and Costs

• The analysis turns to the level of team quality.
• Calculate the winning percent differences in the
  standings (more power looking across numerous
  seasons)
• These differences are the direct result of
  off-field talent choices of owners.
• Its easy to measure talent by thinking of adding
  stars to a roster without any

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Stars and Winning
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LR Cost of Talent

• Adding stars creates higher quality (higher
  winning percents) but at a decreasing rate.
• When we know the cost of stars, we know the cost
  of increasing quality.
• At the margin, to get more winning percent
  becomes increasingly expensive (Figure 4-3)

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LR Cost of Talent
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The Rest of LR Costs

• Vertical shifts
• Adding in other LR cost considerations shifts
  total talent costs upward (Figure 4-4)

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The Rest of LR Costs
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An Important Tension

• The more any owner wants to win, the more its
  going to cost!
• The level of quality chosen will depend crucially
  on fan willingness to pay to cover the cost of
  quality.
• Owners temper their desire to win with their
  bottom line considerations.

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LR Profits

• For every quality choice, there will be a revenue
  structure and a least cost structure at which
  that revenue can be obtained.
• In the LR, choose the quality level with the
  largest of these profits.
• In the SR, a particular attendance level will
  maximize profits for that level of quality.

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LR Profits

• Here are two possibilities in this LR
  consideration.
• WL relatively lower quality team.
• WH gt WL relatively higher quality team.

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LR Profits
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LR Profits

• But this is just two possibilities
• PH at WH (higher quality)
• PL at WL (relatively lower quality)
• How would a consideration of all of the
  possibilities look?
• Lets think about it first

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LR Profits

• Assumption
• Eventually, costs increase faster than revenues.
• Results
• Increase with quality P(WH)gt P (WL)
• Reach a maximum
• Decline after the maximum
• A picture based on our earlier diagram and this
  assumption

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LR Profits
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Long-Run Profits Implication

• Lets draw another owner in this picture a
  lovable loser.

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Long-Run Profit Notes

• Profits constrain winning.
• The profit maximizing level of quality may be
  below 0.500 in some markets!
• Profit variation can harm competitive balance.
• Small market does not necessarily mean economic
  losses!

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Economic v. Accounting Profits

• When will a billionaire pay hundreds of millions
  for something that loses money on an annual
  basis?
• Income expense sheets v. The value of ownership.

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Economic v. Accounting Profits

• The value of ownership
• Related business opportunity.
• Some costs may actually be profit-taking.
• Revenue shifting can reduce taxes for partial
  cross-ownership.
• Roster depreciation allowance, coupled with a
  pass-through structure for the team, can reduce
  personal income taxes for owners.

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Economic v. Accounting Profits

• Owners can show poor, for tax purposes
• Owners can plead poor for political purposes
• But assets that increase in value, like teams,
  do not as a rule lose money in the long run.

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Economic v. Accounting Profits

• Lets look at the idea behind roster depreciation
  and what it really means for the value of
  ownership.
• The Padres released income expense data for 1997,
  1998, and 1999.
• The owner group purchased the team in 1995 for
  94 million

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Padres (Brief) Income Expenses
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Economic v. Accounting Profits

• The Padres were allowed
• 94/2 47 million in roster depreciation.
• Over 5 years 9.4 million/yr.
• Over 3/5 years 28.2 million.
• Actually took 10.78.38.4 27.4 million.

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Reasonable Padres Position
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Economic v. Accounting Profits

• The Padres did lose money. But
• Not 22 mil/yr
• 3-year average 960,427.
• We dont know how they did in 1995 and 1996.
• Are other values of ownership worth 960,427 per
  year as an investment?

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Economic v. Accounting Profits

• Padres Prices (originally an expansion team)
• 1969 12.5 mil (1.51 infl gt 18.9 mil)
• 1990 75 mil (1.43 infl gt 107.5 mil)
• 1995 94 mil (1.23 infl gt 115.6 mil)
• Real annual growth rate about 7.2 over all.
• Well see how the current owners do.

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Economic Profits A Lesson

• NBA team sales values from Forbes magazine.
• 2002 Celtics
• Forbes Value 218. Sale Value 360.
• 2004 Nets and Suns
• Forbes Value 214/282. Sale 300/401.
• Forbes understates by 19 to 39.
• Why?

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Summary

• The short-run and long-run decisions that
  confront sports team owners.
• Profit-maximization, subject to uncertainty, and
  the short-run and long-run decisions of owners.
• The tension created between fans, players, and
  owners by the owners financial bottom line.
• Profit variation and competitive balance.
• Sports accounting versus the value of ownership.