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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 = sA/sI


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

i

ti

IA5.0

500.1

/

2

1

,

ss


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


– 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



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

Documents

FIFTH EDITION - MyWebmyweb.ttu.edu/kbecker/ECO 3325/Ch.5.pdfFIFTH EDITION The Economics of Sports ... The Lorenz Curve for the NBA • Red line shows perfect ... curve catches up