Sports and Profit Maximization

1. Sports and Profit Maximization Here we explore the world of sports and many aspects of what profit maximization means in this world.

2. Leagues Leagues are by nature cooperative bodies in that -teams are rivals that succeed at the expense of each other, -each team’s success depends on the success of the league as an institution. The authors assume that teams have the goal of profit maximization and that leagues exist to help meet this goal. This means, for example, that the Vikings want to maximize profit and the NFL exists to assist in this regard. Leagues -create common sets of rules -fix schedules -decide on revenue sharing arrangements -stage championships -create framework for entry of new teams and players into league -conduct marketing campiagns

3. Setting Rules Leagues have both on the field rules and off the field rules and those that do not play by the rules may be banished from the league. Players can be banned or disciplined for “throwing” games by manipulating the score (Black Sox sandal), betting on games in the league (Pete Rose, Alex Karras and Paul Hornung, for example), or engaging in activity that reflects poorly on the league (steroid use in MLB in recent years). Fans can be (and have been) restricted by not allowing beverage sales at all or after halftime or bad behavior by fans can lead to penalties being put on the home team. In recent years some rule changes have been the NFL’s limiting contact by players on defense, the NHL’s goal area moved away from end of ice and the NBA’s adoption of 3 point shot and allowing zone defense.

4. Setting Rules Football has changed rules so that the pass play has become more prevalent. Those involved in passing plays (of course the all 11 are involved, but the skill players and those that protect the “blind side” get more attention), perhaps, get better contracts. It is claimed this makes the league more popular. In the world of golf there is talk of banning a style of putting known as ANCHORING. This style is becoming increasingly popular and some professionals suggest it helps them make money. If the style is banned, the money made will shift back to players using traditional putting styles. The PGA tour will have to decide if allowing the style will generate viewership, or will it diminish viewership. In other words, the PGA Tour is worried about the total money generated for golf. The players benefit as a group if more money is generated.

5. Limiting Entry Existing teams limit other potential teams from entering the league and have an impact on where new teams will be located. Currently, the NBA, MLB, and the NHL each have 30 teams, the NFL has 32 teams, and Australian Football has 16 teams. What forces determine how large a league should become? Revenue side Existing teams benefit from a new team entering because there is an admission fee from the new team and the additional fan base and media outlets. It is thought that the benefits of adding new teams are positive for additional teams, but the benefits become smaller and smaller as new teams are added. The logic is that you would add most profitable teams first and then the lesser teams. So, the MR from more teams is declining.

6. Limiting Entry Cost side Costs to existing teams from a new team mean shared revenue is split over more teams and the new team means existing teams have fewer cities to be used as “escape” cities and those existing teams threat of relocating is reduced. On the cost side of adding teams the cost of additional teams is also positive, but the costs become larger and larger. (Remember the costs are additional teams with which revenue must be shared and costs associated with weaker threat status) These costs are thought to rise with additional teams. The optimal number of teams from the league point of view is the number where the marginal revenue of an additional team equals the marginal cost. In other words, add teams until the MR = MC of adding teams.

7. $ of MR and MC MC MR League size Optimal number of teams!

8. Limiting Entry Geography In some leagues existing teams have a boundary where other teams in the league can not be located. The logic is if another team could come in the existing teams demand curve would likely shift in and become flatter, exhibiting a greater elasticity of demand. This would make it more likely that the price charged by the home team would become lower and thus the team would have lower profit. Profits act as a magnet attracting new firms, but limiting entry in a league means existing teams can enjoy profits without the natural downward pressure on price and profit.

9. Marketing Leagues often advertise on a national basis. The design of the ads is to promote the league. Although each team may benefit differently from an ad, just because one benefits that doesn’t mean others can’t benefit from the very same advertisement. This means national ads have the property called nonrivalry. Plus, one team can not restrict another team from getting benefits from the ads. This means national ads have the property called nonexclusion. Goods that have nonrivalry and nonexclusion are called public goods. Public goods typically have an associated problem with them called the free rider problem. Free riders want to pay less than their true benefit. Most goods are not public. For example, if I eat a PBJ I alone get the benefits of it and I can exclude you from getting any of the benefit.

10. Marketing So at the national level a problem is to find out how much team benefits from the ads and a second problem is to make sure each pays their share. When you look at local advertising each firms has its own benefit and so it will want to run ads up to the point where the MB = MC of having ads.