College Athletics Pipedream: Revenue Sharing

In the past month two D1-AA football programs from the Colonial Athletic Conference closed operations, citing costs – Hofstra and Northeastern. Both schools have a long gridiron history, and in Hofstra’s case, at least three fairly successful NFL players in the past 15 years. Within the same few weeks, Notre Dame paid more to fire its coach than the $4.5 million Hofstra says it costs to run the football program annually. The Irish also hired a coach, UConn extended basketball Coach Jim Calhoun’s contract to an annual salary above that $4.5m, and countless bowl games will make payouts to each school more than enough to cover those same expenses. Something is truly wrong with this picture.

It’s no secret that escalating costs related to facilities, coaches salaries, and general operations for each team combined with a growing chasm in revenue have created a well-defined class system in college athletics. The Knight Commission continues to study the topic and publish insightful research and editorials, but the problem is not going away. The impact on non-revenue sports has been seen or the past decade or so. Now the epidemic is spreading to major sports at low revenue schools. The next step is mid-major programs.

Hmm, increasing disparity in wealth leading to an increasing disparity in performance, and then feeding itself into a vicious, destructive cycle. Is this starting to sound familiar? Professional sports ring a bell, notably the uncapped world of baseball. One significant difference, colleges are supposedly not for profit organizations, and the goal of college athletics is to promote competition and academics, not improve the bottom line, yet the exact opposite is taking place.

I’m not naïve enough to think universities or athletic departments view themselves as not for profit, but if the NCAA and the conferences truly have a mission to serve student athletes they will create a more equitable distribution of finances. They mandate that athletes cannot benefit from money the school earns, similarly the school should only benefit to a certain extent from the athletes. The NCAA should centrally pool a portion of television contracts, sponsorships, bowl payouts, and other non-ticket revenue sources and reallocate to help fund the Hofstra’s of the world. Maybe small schools don’t receive the full cost of operations as a “stimulus package” and perhaps we have reached a time when students have to pay an annual fee to play, similar to youth athletics, rather than receive free tuition.

Big schools and big conferences would clearly never agree to this because they correctly argue they generate the money. However, if the NCAA truly supports its mission it will start to force its hand. Sponsorships and donations should go toward NCAA sports or NCAA football, not to Ohio State, the Big East, or the Orange Bowl winner. The NCAA should also seek funding from its professional counterparts, the NFL, NBA, and various Olympic governing bodies. These leagues already support youth initiatives, so it’s not a significant leap to seek contributions to keep small programs alive.

If the NCAA deincentivizes big schools by taking away the potential windfall paydays that come from winning, it may implicitly put a cap on coaches salaries and absurd capital expenditures to add more luxury suites every year. In essence, it may help make college sports continue to look like college sports, rather than a younger version of the professionals.

Forget Salary Cap, Baseball Needs a Profit Cap

Scott Boras set off a firestorm – like only Scott Boras – when he issued a doctrine about team spending and use of revenue sharing funding. It’s not a new debate, but more pertinent given the timing, at the start of a free agent period when teams may start to reign in payroll, thus cutting into Mr. Boras’ commission checks.

That aside, Jayson Stark wrote an interesting editorial outlining the facts and calling for a salary basement as a resolution, pointing the problem at the lower spending teams, similar to Boras. They both are right, but understanding the problem is one thing, solving it a completely separate story.

The Yankees, Red Sox, Mets, and Cubs are not the problem here. They play in big markets, maximize revenue to the best of their ability, then reinvest in the product on the field. They also play by the rules, paying a substantial tax on their earnings, similar to the US government taxing the rich more than they tax the poor (or at least that is how its supposed to work). Most people agree it’s the Pirates, Royals, Marlins, et al, who cash the “stimulus” checks, but stash the money in savings that hurt the baseball economy.

Ending revenue sharing is not the answer. Smaller market teams need some of the big market revenue to stay in the game. Its not feasible to think a team in Pittsburgh will earn the same local media revenue, sell as much merchandise, or get the same level of sponsorship as any team in a market with a substantially larger population and healthier economy. It’s just not possible. So some sharing is necessary.

As an aside, the fact the Florida is considered small market is a joke. Look at Miami-Dade County in terms of size, spending power, per capita income, television market, and almost any other statistic relative to Milwaukee, Pittsburgh, Cleveland, and others, and explain how Miami is small market. The Marlins problem is management, and the fact that the city will not support a baseball team, and that responsibility falls to MLB to fix or change.

Back on topic. The deeper problem is not that team salaries are low relative to the amount collected from revenue sharing, its that these teams are among the most profitable in baseball. MLB VP of Labor Relations Rob Manfred is correct that player development and team operations is a major expense that the public does not consider when looking at the face value numbers, but those expenses should still go into the P&L, so how do these teams end with a profit?

Salary minimum’s are tough since teams do not to rebuild, may flush money into player development (i.e. future investments), or it could force teams to make poor spending decisions because they are forced to spend. An alternative method is a profit minimum. First, teams need to submit to more transparency with the league office (not necessarily the public). Use projected revenue numbers for the season, including MLB central fund contributions, and do not allocate any revenue sharing money until a small market team exceeds that forecasted number – whether its on player development, team payroll, or organization spending. At that time, teams eligible for revenue sharing can only collect when they have incur an expense. For example, Pittsburgh needs to sign a free agent, then it will receive the revenue sharing money to cover that players salary. Each team can continue to draw from this revolving credit line up to the amount they would receive under the current system.

Anything above that amount, the owners need to fund, similar to today. If they don’t exhaust the funds, then the money goes back into the central fund for redistribution to all teams – NOT into the owners pocket. Sports ownership is not a profitable business annually, owners know that coming in, the big profit comes when you sell a team whose value appreciates.

It’s not perfect, but another idea to put on the table. In the end, the only way to truly satisfy the public and the ancillary stakeholders is with full transparency, which I would not hold my breath waiting for. In this scenario, at least it takes the profit out of the hands of the owners and forces some transparency.

Should Sports Change Revenue Sharing to TARP-like Program?

Last week’s SBJ cover story on the state of Detroit’s sports teams battling through the recession further illuminates how hard the recession has hit that part of the country. Sports teams are the least of Detroit’s problems, yet they remain one of the few refuges for an area fraught with unemployment and failing businesses.

Three key points I took away from the story: 1) Detroit has phenomenal sports fans, it’s aggregate per-cap attendance across all four major sports as a testament; 2) for the most part, the city is blessed with top ownership (we know about the Lions), Davidson and Ilitch have put wining teams on the field, done right by the fans, and tried to do right by local business; 3) the recession is stronger than both #1 and #2, which will make it difficult to sustain these teams over the next decade.

Ticket sales and sponsorship revenue are the most critical and most volatile revenue streams for teams. The economy has put both under significant pressure in the Detroit market. Teams face a steeper trade-off in ticket sales vs. price reductions than most markets and its key sponsors lost significant marketing budget. Lions aside, since the NFL shares revenue in a more equitable manner across the league, each team expects a significant revenue drop this year, which immediately makes it more difficult to field a championship-caliber team.

Looking further down the line, the auto industry will never look the same, and the future of these key sponsors and a critical regional source of employment is in jeopardy for the long-term. That said, will Detroit teams require, and should they receive a boost from the league’s central pool, similar to the government backing its local companies.

From a pure market size perspective it’s a border line top 10 DMA (11 to be exact), but the unemployment numbers, per capita income, and discretionary income numbers make it a candidate for help. Should leagues focus more on helping these owners, who have proven they invest in the team, have loyal fan bases, and can be a key market for leagues than the low-income owners that reap the benefits of revenue-sharing, yet do not add much value to the league.

Putting absolute numbers aside, using forward-looking marginal revenue metrics, leagues should consider if adding each dollar they subsidize Detroit with adds more value to the league and other teams than each dollar MLB subsidizes Pittsburgh or Florida, for example. Market size, ownership wealth, and absolute revenue numbers don’t encapsulate who most needs revenue sharing. Leagues should visit which teams need it at the margin, and how much value the investment (and it is investment by the other teams) can add to the league at large. Detroit – along with other traditional sports cities in struggling regions, are good candidates to consider in the short-term.

CBA Talks Start to Hit Stride – What to Expect

SBJ last week did a cover story on the upcoming CBA negotiations for the four major sports, each whose contract expires in a different quarter in 2011, making 2010 a big year for negotiations. Less linked to the big four, but still worth watching, MLS enters what could become a ground changing CBA negotiation this winter.

The story gave a high-level background on each league’s situation and some overarching issues. First, don’t expect anything to get done easily or any earlier than after the league’s complete their next full season. Early indications are the NFL will lead in rhetoric – but big talk does not buy you anything. Football is the most interesting, and likely to be most watched labor talks since they have new leaders on both sides in DeMaurice Smith and Roger Goodell, the owners already declined to renew the current deal setting up a potential uncapped 2010 season, and NFL players have the shortest careers and non-guaranteed contracts. Though, as Peter King pointed out recently, the uncapped year carries many additional stipulations that actually benefit the owners.

Putting aside sport specific issues, expect a few macro-level concepts to emerge. Financial transparency is a major issue as more owners publicly proclaim losses, and commissioners claim few teams achieve profitability. Players expect to see proof if they are expected to make concessions to benefit leagues. Less critical to the negotiations, fans should expect to see proof as to why their teams slash payroll and never put a winning team on the field in certain markets. David Stern openly stated the NBA would be as transparent as needed, while the NFL is the antithesis, saying players have no need to see the books. Given that manipulating financial books and lack of transparency contributed to the current financial crisis, and federal government has made a move to increase filings by public companies, it makes sense for sports to follow that path – unless you have something to hide.

Hockey may have the most to lose. It already teeters on the brink of obscurity, but it finally picked up some momentum recently with the Winter Classic, a great playoff, and two emerging young superstars. With off ice ownership problems permeating multiple franchises, another strike could obliterate the sport domestically. Further, as the lowest paid players of the four sports, its players can least afford a stoppage. It may be painful, it may be the last move in Bettman’s marred tenure, but both sides need it to happen.

Another overarching theme that should pervade is convergence among the deal structures within each league, perhaps other than the NFL since its revenue skews more towards national than local. Collective bargaining in sports is a mature process and both sides now have many years of data and experience to pull from. Each league sees what works and doesn’t work in their own league and in other leagues. That said, expect to see more parity develop between leagues. The NFL and MLB will discuss draft salary slotting, a concept the NBA perfected, the NBA and NFL may implement revenue sharing closer to what MLB does, while MLB will revisit the salary cap, which the other three leagues all use differently. Never will all four converge, but they may start to look and smell similar, with different percentage allocations and small concessions depending on the leverage in each situation.

Though unlikely, it’s always intriguing to see if any unions will decertify and challenge the league’s anti-trust exemption. That would cause some fireworks and be the equivalent of going all-in in poker.

New Era of Draft Contracts Impact Expectations, Player Development

Strasburg set the contract record for a draft pick, no matter what way you slice it, but it’s the overall trend that raises more concern. Strasburg could very well become the A-Rod of this generation of draft picks, or the Brien Taylor, either way he is one player. For a minute, let’s set aside the argument on the implementation of baseball’s slotting system, and if it should enforce a system similar to the NBA. With draftees controlling the leverage, more and more top picks are earning major league contracts for mid-range free agent dollars.

Given the reverse draft order, the worst teams, usually with a correlating low payroll, wind up selecting the players demanding these major-league contracts. Thus, the same teams who have cut back free agent spending and cut payroll through trades now must spend some potential free-agent money on draft picks who will not immediately contribute, historically not contribute the next two seasons, and may never earn what they are paid. Further, these contracts leave the bad teams handcuffed come next off-season. The draft has essentially become another free agent spending period. Washington signed two Top 10 players, each of whom will earn enough to make the top ten on their current payroll. The Padres traded Jake Peavy to reduce payroll below $30mm, then committed a significant percentage of the current payroll to an unproven draft pick.

Low payroll teams inevitably need any big money players they have to perform. Inserting draft picks among the highest paid players on the roster, not dissimilar from how the NFL works, incentivizes MLB teams to push recent draftees to the majors ASAP. The NFL overcomes that problem because every first-round pick makes the roster and gets a crack at playing almost immediately. If baseball intends to continue pumping this level of money into the draft, teams will by virtue push players toward an NFL model – demanding immediate contributions. The once systematic MLB development system will get turned on its head, as top draft picks are rushed to the majors in months, not years, and arrive with marketing programs, ticket packages, and media hoopla attached to their names.

My question, which requires additional research I have yet to do, is if these contracts have a marked effect on how fast players reach the majors, and how many reach the majors. Are teams short-circuiting their development, taking a ready-or-not, we need you to earn that money now, approach? Further, what are the long-term effects of rushing players to the majors, a study that may require years of data on long-term career trajectory before we can answer. It’s not the Evan Longoria’s or David Price’s or A-Rod’s, all player’s that lit up the minor leagues and earned a call-up that deserve attention, it’s the players that don’t perform in the minors yet teams must call-up because of the salary. What comes of those players, and how do teams handle them given the percent of team budgets they now invest at the top of the draft?

I’m in favor of a slotting system, more stringent negotiation timeframe, international draft, and trading picks all because it makes having a high draft pick a benefit rather than a concern. Until then, we see the impact on team budgets, but how that will affect player development remains an interesting question.

Should Owners Be Able to Profit on Poor Performance?

News that the Donald Sterling is earning an annual profit from the LA Clippers, while Mark Cuban is losing boatloads of money with the Mavs raises a question about the system – does ineptitude warrant revenue sharing?

Though each sport handles revenue sharing differently, the question arises on if the lower revenue teams are simply pocketing profits or actually plowing it back into the team to improve competitive balance, the real purpose of salary cap’s and luxury taxes. On one end the owners are running a business, and the goal in a capitalist society is to make money. On the other hand, some owners are sharing the money they earn for the better the game, how does the sport protect them from having other owners simply pocket that money and not invest in the product?

Using wins and losses as a measuring stick is difficult because of the numerous variables that come into play. Teams can invest in the product and still not recognize success, so that can’t be used as a measuring stick. The NHL mandates that revenue receivers show operational improvements in the form of improved ticket sales and revenue generation, which Nashville had to fight to the end to maintain eligibility this season. However, success impacts those metrics as well.

I don’t claim to have the answer, but I do feel the league revenue models need to become more granular and reward good business and team management, not simply low income teams. This would prevent an owner with a poor track record like Donald Sterling from profiting off his team – and staying the league for 28 years, despite an ineptitude that would never suffice in any other business arena. It would also help weed out the teams that are not sustainable earlier in the process – hopefully preventing a Phoenix Coyotes situation before it reaches this point. Maybe contraction is necessary, or moving to new markets, or changing owners. Today’s system masks inherent problems.

Two components I would reassess are national television revenue sharing and ticket sales. Rather than simply share national TV rights fees evenly among all the teams, allocate it based on a merit. Institute a system similar to what the NBA has tried that forecasts team revenue based on market size, and use this relative benchmark to rank teams. Incorporate on field success into the equation, again using a relative market size figure, talk into account player development statistics relative to draft position, again a relative measurement that is not impacted by the cash available to invest in the team. Add other factors as necessary to create a scoring system. Any teams not scoring at the level they should, do not receive the full share of revenue. Those at or above the benchmark receive the full share. The excess revenue not allocated can go into escrow, or allocate it to the highest ranked teams in this system.

Performance directly affects ticket sales, thus even a well-managed team that simply does not have the resources to compete will not sell tickets. Create a system with shared gate receipts, 70-80% (compile ana analysis to find the right number) to the home team, the rest to the visitor. Some ticket price normalization is required to equitably handle teams that charge higher prices. The best teams don’t lose out on revenue because they are likely the best road draws. However, some quality teams that struggle to draw at home – Tampa Bay Rays, Minnesota Twins – will benefit from the bigger road crowds they can draw, rewarding management’s ability to build a quality product. Teams that invest in stars also reap rewards from the buzz they generate on the road. It’s an idea to add another variable that will smooth out the variance between have’s and have not’s, but incorporates the quality of the product.

Overall, leagues should revamp the system to prevent low budget ownership from benefiting off a system designed to help the sport. More granular sharing of national revenue based on a meritocracy that rewards teams who best apply the resources they have available – both in running the business and the team – will lead to appropriate competitive balance. An ancillary benefit is the self-segmentation of ownership, as only owners committed to winning and focusing on team operations will be part of the system, while owners hoping to skim profits get weeded out.

EPL TV Rev Sharing Idea Could Work

Last week English Premier League (EPL) TV revenue figures showed how the league distributed the record $1.6B it brought in this season. The way I understand the system, each team receives a flat fee as part of the negotiated television contract. Then teams receive additional funds based on incentives, such as national television appearances and related success factors. Sports leagues don’t want to take lessons from the EPL to promote competitive balance or salary structure, given the top four teams annually dominate the league and buy the best players. However, if applied in a different manner the revenue sharing idea has merit.

Recently the NBA announced it would increase the amount of money in the revenue sharing pool next season. The league uses a complicated formula produced by McKinsey consulting to distribute money to teams that qualify. In other words, a team cannot simply cut costs, not try, then pocket the money. As revenue sharing becomes a more prominent part of almost every sport, these checks and balances are crucial.

Applying the NBA model to TV revenue is interesting. League’s could start by setting aside a percent of the annual broadcast revenue to be equally divided among teams. The remaining money would then be allocated based on an incentive program, in one of two ways.

The league could use an outside consultant, such as McKinsey, to create a complex formula that rates teams on a number of various metrics that take into account financial need, business model implementation, marketing success, and competitiveness, to name a few. The premise is to determine how much a team is doing with what it has to work with, and how well it’s executed. Based on this formula, teams are ranked, and receive a percentage of the remaining money.

A second way is to take the remaining league TV revenue, and split it into different categories. Put a certain percentage towards the financial need teams, another portion to marketing efforts, and so on. Then rank the teams based on each metric, and award a percent of the revenue for that metric to each team accordingly.

The goal is to reward teams that do well and punish teams that don’t. Obviously, it needs to go beyond a simple win-loss analysis. If both the Twins and Yankees earn playoff berths with 90 wins, the Twins should rank higher in earning the shared revenue because they will likely have done more with what they have to earn those wins than the Yankees. Likewise, if a team rolls out a new marketing campaign and sees a 10% increase at the gate as a result, they should be rewarded for the grassroots efforts. While a team in the NBA like Memphis that gave away its only superstar should not simply receive extra revenue because it divulged its greatest asset in a cost saving move.

Clearly, more analysis and research is required to develop the right system, but performance based incentives for shared revenue is one way to reward teams that need additional revenue and work hard for it, while avoiding hand outs.