competitive balance

Competitive Balance

Chapter 5

FIFTH EDITION

The Economics of Sports

MICHAEL A. LEEDS | PETER VON ALLMEN

Copyright ©2014 Pearson Education, Inc. All rights reserved. 5-2

Competitive Balance

• The term means different things to different people– Close competition every year, with the difference

between the best and worst teams being relatively small

– Regular turnover in the winner of the league’s championship

• More generally, it means degree of parity within a league


Learning Objectives

• Understand why owners and fans care about competitive balance

• Be able to use and interpret the different measures of competitive balance

• Describe and compare the tools that leagues use to promote competitive balance and the limitations of those tools.


5.1 Desire for Competitive Balance

• Fans and owners alike have a conflicted relationship with competitive balance

• On any given day, seeing one’s team win is preferable to seeing it lose

• But an uninterrupted string of wins is dull


The Fans’ Perspective

• A game with an uncertain outcome is much more exciting than a foregone conclusion

• Table 5.1 shows that from 1950 to 1958 attendance for both the Yankees and the entire American League either stagnated or fell because of Yankees dominance

• Evidence suggests that in many sports, fans prefer a game where the home team has a 60-70% chance of winning


Table 5.1


The Owners’ Perspective

• Competitive balance matters to owners because it matters to fans

• Leagues adopt policies to promote competitive balance because they enhance fan demand

• Leagues restrict team behavior if it leads to teams that are too strong or too weak (see Table 5.1)

• Balance is hard to achieve if some teams maximize wins while others maximize profits


Effect of Market Size

• There is considerable debate over the impact of market size on competitive balance

• There are three primary sources of disagreement– How to measure of success

• During playoffs or regular season?

– How to characterize market size• Market size has become more important with the

advent of broadcasting


Effect of Market Size (cont.)

•The third point of disagreement is how to measure the impact of policies, such as revenue sharing

•Profit-maximizing leagues do not want total balance – they want big-market teams to win more• At minimum, more populous locations will win

the league championship more frequently• Figure 5.1 shows an additional win is more

valuable in a larger market, so the optimum number of wins is greater


Figure 5.1


The Effect of Diminishing Returns

• The impact of another unit of a variable input (when added to a fixed input) eventually falls– This effect limits the desire of teams to stockpile –

and pay – star players – And promotes competitive balance

• Drew Brees has limited value to a team that has Tom Brady – Brees adds little to wins, attendance, or revenue– The added cost exceeds the added benefit– Other teams can use him more effectively


Is Perfect Balance Profit Maximizing?

• Winning has a bigger impact in a larger market– It adds more to gate,

media, and venue revenue

– MRwins higher in big cities

• Profit-maximizing leagues and competitive balance may be incompatible– Big cities will win more

unless MCwins is also higher

MR, MC

MRsmall

MRlarge

MC

Wins


A History of Competitive Balance

• Yankee dominance of MLB is not new– Appeared in 15 World Series between 1947 and 1964

• The LA Lakers and San Antonio Spurs won 9 of 13 NBA championships between 1999 and 2011

• The Montreal Canadiens won 10 Stanley Cups in the NHL between 1965 and 1979– They were succeeded by NY Islander and Edmonton

Oiler dynasties in the 1980s

• The NFL is more balanced, but the Browns and Lions have never been in a Super Bowl


Competitive Balance in Soccer from 2000-01 to 2011-12

• In England’s Premier League– Manchester United, Chelsea, and Arsenal have won

11 times

• In Germany’s Bundesliga– Bayern Munich and Borussia Dortmund have won 9

times

• In Italy’s Serie A– AC Milan, Inter Milan, and Juventus have won 11 times

• In Spain’s La Liga– FC Barcelona and Real Madrid have won 10 times


5.2 Measuring Competitive Balance

• Within-Season Balance (Variation)– Compares teams within a season—across a league– A low dispersion of team winning percentages means

that the teams are evenly matched

• Between-Season Balance (Variation)– Compares winners (champions) across time– Some leagues have the same champions year after

year• Regular turnover is preferred


Within-Season Variation (1)

• We could use the standard deviation of winning percentage– The standard deviation gives the dispersion of

performance by teams– It is the square root of the average squared deviation

from the mean– See formula on p. 159

• The mean performance is always .5 as there are a winner and a loser in every game


Application

• In 2011, the standard deviation in the American League was 0.067– The typical winning percentage varies by 0.067 from

the mean

• The standard deviation in the National League was 0.054, about three-fourths that of the American League.– The National Leagues was more balanced


Within-Season Variation (cont.)

• We cannot compare the standard deviation across leagues or across seasons with a different number of games

• As the number of matches rises, winning percentages cluster around the mean– If teams are evenly matched, then the probability of

success in any game is close to .5• We can apply the binomial distribution• In a short season, a lucky team can have all wins and an

unlucky team no wins• The league can look unbalanced in a short season


Within-Season Variation (cont.)

– We need a better measure– We compare a league’s standard deviation to the

standard deviation that would result if teams were evenly matched

– The “ideal” standard deviation occurs when each team has a 50% chance of winning a given game

• The better measure is the ratio of the actual to the ideal standard deviation

– R = A/I


Computing Within-Season Balance

• The ratio of actual to ideal standard deviation– N = # Teams– G = # Games

– WPCTi,t = Winning percentage of team i at time t

G

WPCTN

R

N

iti

IA5.0

500.1

/

2

1,


Interpreting the Ratio

• The ratio R gives a standardized measure– Actual and ideal standard deviation fall as G rises– We can now compare leagues and seasons with a

different number of games– The formula appears on p. 161

• As a rule, R > 1• If R = 1, the league is completely balanced

– Outcomes are effectively randomly determined• As R rises, balance worsens


How Do Leagues Compare?

• English Premier League was the most balanced in 2011-2012

• The NFL, NHL and MLB have similar balance• NBA is by far the least balanced

– This has been true in most years

• See Table 5.3 for the actual statistics


Table 5.3


Between-Season Balance

• We can use the standard deviation of each team’s winning percentage– Unlike the within-season measure, there is no “ideal”

measure– It is unclear what is a good or bad value

• We can use the frequency of championships– It is hard to compare this across leagues– See Table 5.4


Table 5.4


The Herfindahl-Hirschman Index

• HHI measures the concentration of championships• In industrial organization, it measures monopoly power• Let ci = #championships by team i

– T = #teams; N = #Years

– If HHI=1, one team always wins– If HHI=1/N and N>T, complete competitive balance– If HHI=1/T and N<T, complete competitive balance

• See p. 164 for computations; What if the league had 10 teams?

T

i

i

N

cHHI

1

2


Applying the HHI to Sports

• See Table 5.4• the HHI for the Premier League is far greater

than for any other league• the HHI for the NBA is also large• the HHI for the NHL, NFL, and MLB are

substantially smaller• the HHI for the NHL is the smallest, indicating

that the league was most balanced in the first decade of the 21st century


Illustrating Competitive Imbalance

• The Lorenz Curve measures inequality in a population– It is typically used to measure income inequality– We use it to measure inequality in winning

• Line up NBA teams by wins in 2010-2011 (p. 164)– 1230 games were played, so population = 1230– The 3 weakest teams (the lowest decile) won 58

games• 58 games correspond to 4.7 % of 1230• Thus, the bottom 10% accounted for 4.7% of wins• The next 10% accounted for 5.8% and so on• The top 10% accounted for 14.7% of wins

– Figure 5.2 presents the results


The Lorenz Curve for the NBA

• Red line shows perfect balance– Adding 10% more teams

adds 10% more wins• Blue line shows reality

– Bottom 10% wins less than 10%

• Sags below red line– As we add better teams,

blue curve catches up– At 100% of teams, we

account for 100% of wins• The farther the blue line

sags, the greater the inequality

0

0.2

0.4

0.6

0.8

1

1.2

0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1


5.3 Altering Competitive Balance

• All the major North American sports leagues have developed policies to promote competitive balance– Revenue sharing– Salary caps and luxury taxes– Reverse-order draft

• Players claim that the policies merely depress overall salaries

• This section explores the policies’ effect on competitive balance


The Invariance Principle

• Free agency allows a player to go to the team that offers the best employment terms– Players sell their services to the highest bidder

• Owners claim that free agency is incompatible with competitive balance– Economic theory suggests otherwise

• Markets direct resources to the most productive uses– Property rights do not affect the flow of resources– They affect only who gets paid for them– Simon Rottenberg (1956) first applied the principle to

sports


How the Invariance Theorem Works

• In 2012 Albert Pujols was more valuable to the LA Angels than to the St. Louis Cardinals in terms of revenue

• With free agency• The Angels paid Pujols to move to LA• Without free agency • The Angels would pay the Cardinals for the “rights” to Pujols• Pujols moves in both cases—the use of the resource is

unaffected• The only difference is who gets paid• The reserve clause did not prevent player movement• In 1920 Red Sox sold Babe Ruth to Yankees • Connie Mack twice sold off championship teams in

Philadelphia


With Transaction Costs…

• The Invariance principle breaks down if there are large costs to making transactions

• Benefits that do not exceed transaction costs are not realized

• Transactions costs could have prevented the Angels from pursuing Pujols


Revenue Sharing

• MLB, NBA, NFL, and NHL share network TV revenue equally

• NFL extensively shares all sources of revenue– Teams keep only 60% of home gate revenue– Huge TV package dwarfs other sources

• MLB shares 31% of local revenue (minus “expenses”)– Central (non-local) revenue also goes

disproportionately to teams in 15 smallest markets– They will have to spend this revenue on players


Revenue Sharing (cont.)

• The NBA is expected to vastly increase sharing– Teams will share up to 50% of local revenue (minus

“expenses”)

• The NHL transfers income to teams– In bottom 15 smallest media markets – If the market has a base population under 2 million


Revenue Sharing (cont.)

• Revenue sharing equalizes revenue across teams • Goal is to reduce incentive of big teams to pursue

talent• This will not work if

– Sharing shifts down MR of a win for all teams equally – big-market teams still have higher MR

– Teams that receive revenue do not spend their added revenue on talent

• Some teams might pursue profit over wins


Salary Caps

• NBA, NFL, and NHL all have salary caps (not MLB)– Salary caps are neither a salary limit nor a cap

• They set a band on salaries: both upper and lower limits to payrolls (not individual salaries)

• Take qualifying revenue (QR) of league– Not all revenue “qualifies”– Definition varies from league to league

• Players get a defined share of the QR• Divide total player share by # of teams• Add & subtract a fudge factor (5-20%) to get the

bounds


NFL Example

• Players receive– 55% of national broadcast revenue– 45% of NFL Ventures (merchandising) revenue– 40% of aggregate local revenues

• Each team must spend at least 89% of the cap

• Overall, players must receive at least 95%


Hard Caps and Soft Caps

• The NFL has a hard cap – Sets a firm limit on salaries without exceptions

• The NBA has a soft cap with many exceptions– Mid-level exception

• Team can sign 1 player to the league average salary • Even if it is over the limit

– Rookie exception • Team can sign a rookie to his first contract • Even if it is over the limit

– Larry Bird exception• Named for former Celtics great who was its first

beneficiary• Team can re-sign a player who is already on its roster • Even if it is over the limit


The NBA and Soft Caps

• All the exceptions have undermined the cap• This has led to further rules

– The NBA now caps individual salaries as well – The NBA has a luxury tax to prevent teams from

abusing the exceptions• This has nothing to do with luxury boxes• Teams pay a tax that increases for every $5 million over

the cap• A team $15 million over the cap must pay a $37.5

million tax


MLB’s Luxury Tax

• Tax starts at 17.5% for first-time offenders– Threshold is $178 million in 2011-2013– Rises to $189 million in 2014

• Tax rises with the number of abuses• NY Yankees have paid the tax every year


The Reverse-Order Entry Draft

• Ideally, it levels out talent over time• Teams select new players according to their

order of finish in the previous season– Weakest teams get the first choice of new talent– Strongest teams get the last choice


What Was the Point of the Draft?

• Did teams just want to keep salaries low?• Was is a cynical move by weak teams?

– Eagles’ owner Bert Bell proposed the draft– The Eagles happened to have the NFL’s worst record

• Was it an idealistic move?– The NY Giants & Chicago Bears agreed to the

draft– They were the dominant teams & had the most to

lose– Tim Mara (Giants owner): “People come to see

competition…. We could give [it to] them only if the teams had some sort of equality.”


Weaknesses of the Draft

• It can lead to “tanking” – Teams lose intentionally to improve draft position– That is why the NBA has a draft “lottery”

• Under a lottery– The weakest team has the best chance of choosing

first– But it might not

• It works only if teams can identify talent


Identifying Talent: Moneyball

• Billy Beane, the Oakland A’s general manager, found underrated players

• He saw that teams – Overrated physical skills– Underrated on-base percentage

• Using different criteria in player selection kept his small market team competitive

• Other teams eventually caught on– A’s have fallen on hard times as a result

competitive balance

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