Gerald W. Scully
The Concise Encyclopedia of Economics


by Gerald W. Scully
About the Author
Major league sports, as every reader of the sports pages knows, is a major league business. As a result economics has a lot to say about how players, teams, and leagues will act under different circumstances. But would you believe that economics can be used to predict which teams will win and which will lose? It can.

How good a professional sports team is depends, of course, on the quality of its players. Since teams compete for better players by offering higher salaries, how good a team is depends to a large extent on how strong it is financially. The financially stronger teams will, on average, be the better teams. And the financially stronger teams will, on average, be the ones in bigger cities.

A team's financial strength (its profitability) is its revenues minus costs. A team's main cost is player salaries. Because a given player will earn roughly the same no matter which team he plays for, each team's costs for a given-quality roster tend to be equal. But revenues derived from fielding a given-quality roster vary dramatically within a league. Teams earn revenue from ticket sales, concession income, and the sale of broadcast rights. All of these factors vary directly with market size. Therefore, all other things being equal, teams in large cities have higher revenues. For example, in 1990 the Los Angeles Dodgers drew 3 million fans to their home games while the Cleveland Indians drew only 1.2 million.

This is why teams in large cities tend to get better players than teams in small cities. Consider the baseball owner deciding how good a player roster to build. He or she will maximize profits when the revenue from one more win equals the cost of producing that win. The cost of a given win record (the quality of players on the team) is roughly the same for every team in a league. But the revenue from a win record varies with the size of the market. For example, if the win record of the New York Yankees rises by 10 percent, the owner of the Yankees will get, say, $10 million more in revenues from concession sales, ticket sales, and the value of broadcast rights. But if the win record of the Kansas City Royals rises by the same 10 percent, revenues would increase by only, say, $2 million.

Therefore, because the incremental revenue from a given increase in wins is higher for the Yankees, and the incremental cost is about the same, a rational owner of the Yankees should pay more for players and should, on average, do better than the Royals. Sure enough, professional sports teams in cities with large populations tend to have records above .500 while teams in cities with small populations tend to have records below .500. It is no accident that large-city teams historically have dominated as championship teams. It is easy to see why this is so in the era of free agents, when a star player can move to whichever team will pay him the most. But as I will explain below, it also was true when teams "owned" player contracts and players were not free to accept a higher offer.

One factor that matters for team revenues is the league's rule for dividing the gate receipts. In basketball and hockey the home team gets all of the gate receipts and the visitor gets nothing. In baseball the split is 85-15. In football the gate division is 60-40. When the home team gets to keep more of the gate receipts, the teams in bigger cities get more of the benefit from their inherent financial advantage. When the split is more equal, the financial advantage of being in a bigger market is less.

But in all sports, revenues from national television contracts have grown as a percent of total revenues, and these revenues are divided equally among the clubs. As a result the differences in the financial strength of teams have narrowed. Big-city domination, while not completely eliminated, has diminished.

By their very nature sports leagues are cartels that exclude competition from other companies. You cannot start a baseball team and hope to play the Yankees unless you can get Major League Baseball (the cartel) to grant you a franchise. The antitrust laws prohibit cartels, but professional sports is the only private business in the United States that is largely exempt from those laws. Ever since a 1922 court decision (Federal Baseball Club of Baltimore v. National League et al.), baseball has been totally exempt. No other sport enjoys such a blanket exemption from antitrust, but all professional team sports have a labor exemption and, since the Sports Television Act of 1961, a broadcast exemption.

All of the leagues have collusive agreements that govern the selection, contractual arrangements, and distribution of players among the teams. Collectively, these agreements grant a degree of monopsony power (monopoly power over the right to buy something, in this case player services) to owners. The owners exploit this power by paying the players less than their incremental contribution to revenue.

Athletes enter most professional team sports through a drafting procedure. The common feature of the drafts is that they grant one team exclusive bargaining rights with each prospective player. Once drafted, the athlete negotiates with that team alone, and others cannot offer higher salaries to get him. These rules, weakened somewhat over the years, impede the competitive bidding for beginning players. Once the player has come to terms with the drafting team, he must sign a uniform player's contract. The contract allows him to sell his services only to the team holding the contract. Although player contracts vary from sport to sport, all contain some basic prohibitions against moves to other teams that are initiated by the player. That is, owners are free to "trade" (sell) players to other teams, but players are not totally free to offer their services to competing teams.

Owners claim that restrictions on player movement are necessary to maintain competitive balance and prevent financial powerhouses like the old Yankees from buying up all the best talent and totally dominating the sport. That, owners say, would make the sport duller for fans and hurt everyone. Economists have always been skeptical about the owners' motives—and about the evidence. There never was any disagreement that star players would wind up on big-city teams. But economists believe that this would happen regardless of whether leagues restrict moves initiated by players. If players were free to move between teams, then, assuming they were indifferent about location, they would play for the team that pays the most. The team that pays the most is the one that expects the largest increment in revenue from that player's performance. Since an increment in the win-loss record yields more revenue in, say, New York than in Kansas City, the best players go to New York rather than Kansas City.

This point, which is made by those who justify restrictions on mobility, is correct. But limiting the ability of players to initiate moves should not have any effect on where players end up playing. When players are not free to move, does a small-city team that acquired a star player in the draft keep him? For a small-city franchise the team holding the contract of the player expects him to contribute, say, $1 million in incremental revenue to the club. In a large city that same player's talents might contribute $3 million. Since the player is worth more to the big-city team in either case (and the big-city team will pay more for him), the small-city franchise has an incentive to sell the player's contract to the big-city team and thereby make more money than it could by keeping him. Thus, players should wind up allocated by highest incremental revenue, with or without restrictions on player-initiated movement.

The evidence supports that conclusion. Since the advent of free agency, which made it easier for players to jump from one team to another, the total movement of players (trades, sales, minor league transfers) has been about the same as it was before. So although restrictions on player-initiated movement should not affect the allocation of player talent within a league, they dramatically affect the division of income between owners and players. Under free agency the players earn what they contribute to incremental revenue; under league restrictions on player-initiated transfers, the owners keep more of the revenues. The dramatic rise in player salaries since the midseventies, notably in baseball and basketball, is largely the result of the relaxation of restrictions on player-initiated transfers.

The most important antitrust issue in sports today relates to the formation of new leagues. The collusive arrangement in the allocation of broadcast rights between the television networks and the existing leagues constitutes a formidable barrier to entry for a new league. In particular, football programming is extremely valuable because football games attract large audiences. Large audiences mean high advertising revenues and, therefore, large network television revenues to the NFL. By allocating games to all three networks instead of just one, the NFL has become a partner with the networks in the broadcast enterprise. Further, the contract stipulates that no other professional football games can be broadcast by the networks within forty-eight hours of an NFL game. This relegates any competing league's games to midweek, which is hardly attractive to the networks.

Television, by building fan recognition and loyalty, builds attendance and gate receipts. Thus, a competing league may not be able to exist without access to television. The NFL has an exclusive, multiyear contract with the networks that is a barrier to entry for a competing league. Only when the network-NFL contract expires is there the possibility of a point of entry. But for that to happen, the networks would have to find a new league's games to be suitable substitutes for NFL games. Because teams in new leagues are inferior to established teams (the established teams already have the best stars), the networks have little incentive to substitute a new league's games for NFL games. Partly because of the broadcast exemption to antitrust laws, and partly because of the judicious expansion of the leagues in all of the professional team sports, fans are unlikely to see competing sports leagues rise.

About the Author

Gerald W. Scully is a professor of economics at the University of Texas at Dallas.

Further Reading

El-Hodiri, Mohamed, and James Quirk. "An Economic Model of a Professional Sports League." Journal of Political Economy 79 (November/December 1971): 1302-19.

Noll, Roger G., ed. Government and the Sports Business. 1974.

Scully, Gerald W. The Business of Major League Baseball. 1989.

Scully, Gerald W. "Pay and Performance in Major League Baseball." American Economic Review 64 (December 1974): 915-30.

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