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May 21, 2009

The Biz Beat

Conceiving a New Contract

by Shawn Hoffman

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For decades, the NFL has been considered the model pro sports league, thanks to a system that promotes fiscal parity and, as a result, strong competitive balance between small- and large-market teams. The league has consistently won enormous national media contracts, which have allowed all 32 teams to be profitable, almost regardless of how many tickets or sponsorships they sell. Add in some local revenue sharing and a narrow payroll cap/floor system, and the result is a socialistic system that has kept everyone happy, at least on the surface.

In many ways, the NFL was considered the anti-MLB in the late '90s and early '00s, when baseball struggled with labor problems and competitive balance, but while baseball is now in its golden age of business and labor relations (it will be seventeen years without a work stoppage when the sport's current CBA expires in 2011), the NFL's system is slowly starting to bend. Those with money on the line-the players and the owners-all want major changes, and the league could be headed for a lockout following the 2010 season. The players have felt shortchanged for years, as the NFL is the only major sports league without guaranteed contracts (aside from signing bonuses). The owners, meanwhile, have their own set of complaints. Last year, they voted unanimously to opt out of the existing CBA, citing "high labor costs, problems with the rookie pool, and the league's inability, through the interpretation of the courts, to recoup bonuses of players who subsequently breach their contract or refuse to perform." The move will probably result in a cap-less season in 2010, which, according to the mainstream press, will likely cause the earth to implode.

So where has the NFL gone wrong? (As much as a company earning about $800 million a year can go wrong.) And for baseball's sake, what can MLB's owners learn from the NFL's current situation?

Once a Best Practice, Now a Pumpkin

To some extent, the NFL's owners have been victims of their own success. For decades, they've dominated the NFLPA in labor negotiations, getting everything they've wanted and then some. They've latched on to certain policies that may have been right ten years ago, but have since become outdated.

The most obvious is the salary cap, which we've discussed before. If the owners' latter two complaints above (the rookie pool and bonus clawbacks) seem like minor issues, it's because they are. The real problem is player costs, which are fixed at about 60 percent of revenues. That number isn't nearly high enough to cause the league to become unprofitable; Forbes estimated that the average NFL team made a $25 million profit in 2007, compared to $16 million for the average MLB team that year. But whereas baseball teams set their own budgets and pay out whatever number they think is appropriate based on their expected revenue intake, NFL teams are locked into a set range-this year's cap will be $128 million, with a $108 million floor.

(Note: the listed payroll numbers are somewhat more divergent because they include players' full signing bonuses. Under cap rules, bonuses are accounted for over the course of the players' contracts. Accounting for the bonuses all at once makes for some interesting payroll numbers-small-market teams like the Vikings, Browns, and Saints are in the top five, while the Patriots are thirtieth. This method is a good way to measure that specific year's cash flow, but it's not as good of a representative of the team's ongoing costs. Ben Roethlisberger's $25 million bonus will have a big financial impact on the Steelers for many years, not just in 2008.)

The cap has worked reasonably well in the past, thanks to the league's revenue-sharing system; because NFL teams have relied so much on their national television contracts, even a small amount of local revenue sharing used to ensure that every team would be more than capable of doling out the minimum payroll. But with local revenue in some large markets skyrocketing, including unshared sources such as advertising and local broadcast rights, the system is quickly becoming obsolete. The payroll floor is now growing faster than many teams' revenues, rising 44 percent since 2005, from $75 million to $108 million. This is putting pressure on most teams' profit margins, since it's the teams at the very top (the Cowboys, Redskins, Giants, etc.) that are creating most of the new revenue.

Throwing Out the Baby With the Bathwater

The thing is, while MLB has long been criticized for its financial system and labor relations, it's the NFL that's been fighting the wrong battle. The owners have been so fixated on the cap/revenue-sharing system that they have been willing to guarantee a very high percentage of their revenues to the players in return. MLB, which doesn't have a cap/floor, usually pays out about half of its revenues to its players; the NFL pays out around 60 percent, a figure which could actually go higher in the next CBA if the league still insists on keeping the cap.

Dig a little deeper and you'll see just how ridiculous this is. In a true free market, a team only pays its players based on the revenue that they can produce for that specific team. Randy Moss might help the Patriots raise ticket prices or sell more sponsorships, but he has no effect on the team's cut from national media contracts. Therefore, the more a league relies on pooled revenue, the lower the percentage the players should end up with.

Because of the NFL's current system, however, that's not what we're seeing. Baseball's pooled revenue (its national television and licensing contracts) accounts for well under half of the sport's intake, while the NFL's is well over half. And yet MLB teams continue to spend far less on players than their NFL counterparts.

Looking Forward

Taking a step back, the NFL is still in a very good position. It has huge national TV contracts and a much lighter cost structure than Major League Baseball-aside from its players, at least. This should keep most teams profitable for the time being, and it's certainly a great starting point for any sports league.

The NFL needs to refocus, though, since its socialistic payroll policies only work when teams are bringing in an equal amount of revenue. If the league wants to go that route, it will need to convince the highest-earning teams to share a much greater percentage of its local revenue. Otherwise, it would be better off ditching the cap entirely, and using that as a bargaining chip to win smaller battles (such as the rookie pool and bonus clawbacks). Eventually, this would also take some air out of player salaries, as teams begin to determine their own means.

What MLB Can Learn From This

Major League Baseball's teams should take these lessons to heart when it's time to negotiate a new CBA. There are battles to be won in collective bargaining, and fighting for the wrong issues can lead to more problems later on. A number of owners have been pushing for a more NFL-like system, which would actually be a major step backward. Using a cap as a bargaining chip isn't a bad idea-the owners pulled contraction out of thin air in 2001, and successfully used it to win a luxury tax (with no reverse-tax on the bottom payrolls). But it will be important for them to keep their eyes on the ball, and not fall into the same traps that the NFL has.

Shawn Hoffman is an author of Baseball Prospectus. 
Click here to see Shawn's other articles. You can contact Shawn by clicking here

Related Content:  Revenue,  NFL

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