What is the proper goal for a professional sports team, profits or championships?

Professor David Zaring asks if “the high-end sports team debt burden [is] a feature of private equity?”:

And plenty of other examples exist, as Americans continue to buy up the English Premier League, as concern grows that debt financing in high end soccer (Real Madrid, AC Barcelona are almost as debt ridden, Arsenal isn’t far behind) is reaching unsustainable levels. I’ll note that the most indebted teams are the ones who have been playing in the Champion’s League finals, of late, and the least indebted ones – those would be the non-private equity owned German teams (often owned by their fans, in fact) – are not. But that too, smacks of the risk-or-insolvency strategy that, fair or not, is almost as associated with private equity strategy as is a love of debt.

And one can go further. . . . It’s armchair empiricism at best, but if I were in major league baseball, the one American sport without a salary cap, I would worry about selling another franchise to a private equity firm.

This question runs right to the core of the paradox of big time sports, with a modern financial crisis twist. For traditional businesses, there is (generally) a single primary goal: become and remain profitable, thus ensuring that you survive. Many people assume that all businesses do this well and the only issue is how to fairly distribute their profits, but if you take the longer view you’d be surprised how much turnover there is among the largest companies — many that at one time were among the largest on the planet now no longer exist. A perusal of the companies that historically made up the Dow Jones Industrial Average confirms this. So remaining profitable is a constant struggle.

On the other side, you have the teams’ professed goal: to win games and championships. Of course it’s not clear that these two interests are aligned: sure, more wins tends to result in more ticket sales and sales of merchandise, but putting out such a good product requires expensive players, expensive coaches, and expensive facilities. There’s no guarantee that the “break-even” point from a profit or business standpoint would result in championship level output. It might be to have a winning season but avoid New York Yankees levels of expenses.

This tension is not new, and the two motives have generally been able to coexist. Everyone, at least implicitly, understands that sports teams must at least make some money (just ask the USFL what it is like to have an unprofitable sports franchise), but fans and the sports media tend to turn on owners who are perceived as pursuing profits ahead of wins. The most beloved owners tend to be the ones who establish an image of being willing to spend and even lose money to see their team succeed, even if in practice that is really the case. But things have gotten more interesting in recent years.

There are a number of factors now that have not always been present in major sports. The first factor is the one that underlies them all, which is that, at least in certain sports like professional football, it would be very difficult for a franchise to actually be unprofitable. This is because the league as a whole generates massive revenues, and it redistributes much of that revenue among the various teams, including TV revenues, merchandising, and even some team specific revenues get redistributed to other teams (though that may change). Buttressing this is that, despite the high demand for professional football, the league has an effective monopoly over the sport and limits the numbers of teams.

This sounds like a strange point but think about it: The NFL limits the league to keep the revenues per team artificially high, whereas if you wanted to open up the market for football teams (i.e. if we imagine the NFL didn’t enjoy all the legal exemptions it now does to restrict who can have a team), you’d see a lot of people starting new football teams because each one, even the bad ones, enjoys profits. It’s the old supply and demand argument: if you are making big profits making widgets, eventually — unless there are significant barriers to entry — others will jump in and sell widgets too and get profits too, until the market got saturated. Don’t think others would start teams? I believe they would (though I admit this example is very artificial) as there are many geographic areas of the country without a football team and, further, football, being a sport, would attract many wealthy hobbyists. Think about horse racing: The sport of kings is profitable for very few owners despite the large purses for winning, because, to oversimplify, wealthy people can buy a horse, get it cleared, and begin competing.

The point is that NFL teams effectively make monopoly profits, which allows them more freedom to “go for winning” as opposed to always focusing on profitability. But that’s not always the case with sports leagues, as we’ve seen with European soccer and other leagues, including non-NFL football leagues.

Next, you have the imposition of the salary cap, which is a great deal for owners and a terrible one for players. Of course, that is different than saying it is bad for sports fans, because it might well be good for them (competitive balance and all that). But it’s a terrible deal for players as a whole because it makes competing for salaries a zero sum game: Assuming teams max out the salary cap (as most teams effectively do in football), each additional dollar a player earns is taken from a teammate. On the other hand, for owners it protects them from the hard business versus winning decisions owners in leagues with looser salary caps must make. In Major League Baseball, every team is compared to the Yankees and Red Sox, simply because they tend to outspend everyone else. Sure, when a lesser team wins it’s a great underdog story, and occasionally it gives rise to superior management techniques as with Moneyball, but sports contests are like wars between countries: At the end of the day, the bigger team with more resources is probably going to win.

If you combine the above two points, you have a very owner-friendly system in a league like the NFL: You have guaranteed profits from your restrictions on other entrants into the market and you have alleviated pressure from the fans and media to focus on winning by spending more because of the salary cap.

But let’s get back to Zaring’s point about debt. (more…)