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August 12, 2009

The Biz Beat

A Revenue-Sharing Re-Think

by Shawn Hoffman

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"We've gone as far as we can go with revenue sharing at this point."
-Red Sox owner John Henry (SI.com)

"If everyone's revenue grows ten percent with the current system, we're screwed."
-Anonymous small-market executive

If you were John Henry, you would hate revenue sharing too-imagine having to give your competitors tens of millions of dollars every year, just so they can have a better shot at beating you. But while the Red Sox and Yankees politic for a lower rate-currently at 48 percent, counting both the "straight pool" and the "fixed pool"-small-market teams are terrified that the system may just stay the same. You'll probably start hearing the "if-everyone-grows-ten-percent" line a lot as we get closer to a new CBA, and it's a legitimate concern; in terms of absolute dollars, 10 percent for the Marlins is Braden Looper, while ten percent for the Yankees is A-Rod and a new fleet of corporate jets.

You'd be hard-pressed to find a solid subset of franchises that's fully satisfied with the status quo going forward. But the thing is, baseball's current revenue sharing system has actually worked pretty well-the goal is to balance competition and profitability, and MLB has had a pretty good share of both over the past few years. If the owners were to completely reinvent the wheel for the next CBA, they would be taking on a significant amount of risk, which really isn't necessary given how well the current system has worked.

Instead, it just needs a couple tweaks-significant tweaks, but tweaks nonetheless. The key is to give every team, no matter what market they play in, significant upside potential, along with some downside protection if the fundamentals of baseball's economy change. The current system is very inflexible and could outlive its usefulness, much like the NFL's has in recent years. Also, anything that improves the implicit incentive structure would be a major step in the right direction. The existing system is far better than its predecessor, but it still taxes new revenue at a pretty high rate (31 percent), and it does nothing to encourage national revenue growth.

So what to do? Here's one way to fix it: tie the revenue-sharing rate (which is now 48 percent) to the percentage of total revenue that comes from national sources.

Let me explain that a bit. National revenue, which comes from television deals, licensing, MLB Advanced Media dividends, and so on, is shared equally amongst the thirty teams. When that revenue increases, small-market teams benefit more, on a relative basis, than large market teams. Let's say Fox and ESPN get a little spend-happy and all of a sudden that pool doubles, while all of the teams' local revenue stays the same. The small-market teams would obviously be starting from a much better competitive position, and less money would need to be shared in order to get back to the same place. Logically, this should also be true on a less extreme level-if national revenue went up even one percent relative to local revenue, the amount that would need to be shared would go down.

We can run through an example. The teams brought in about $6 billion in revenue last year, and will probably be right around that figure again in 2009. (I'm not counting the half-billion or so that flows into MLB Advanced Media and MLB Network, but doesn't reach the teams themselves.) Let's assume that about 20 percent, or $1.2 billion, came from national sources. That means each team would collect about $40 million.

Now what if that figure went up to $44 million and local revenue stayed the same? That means national revenue would grow from 20 percent of the total intake, to 21.6 percent. If we had the simplest possible system, we would decrease the revenue-sharing rate the same 1.6 percent, to 46.4 percent.

Before Mark Attanasio throws his computer out the window, let's see how this would actually impact small-market teams' top lines. According to Maury Brown, somewhere around $390 million was transferred from high-revenue teams to low-revenue teams in 2008. If the revenue-sharing rate drops by 1.6 percent, or one-thirtieth of the original 48 percent, we can guesstimate that the total amount shared would drop to about $375 million. In other words, the bottom 10-15 teams would be losing $15 million, or about $1 million per team-but only after gaining several times that in national revenue.

Now, there's obviously a big difference between getting an evenly distributed share of one pool, as opposed to receiving a check directly from the other teams in your division. But I'd still say that small-market teams would be in a better competitive position-not to mention a much more self-reliant position-under this system than the current one, even with a pretty significant drop in the revenue-sharing rate.

There's also the other side to this, of course: if local revenue outpaces national revenue, the rate would go up. That's the last thing that big-market teams want, but there's actually some downside protection built in for them too: since national revenue currently holds a relatively small share of the total and is unlikely to decrease in absolute terms, there's a far greater chance of it rising 10 percent (and therefore lowering the revenue sharing rate by that amount) than falling 10 percent. While that still seems like a gamble, remember this: if the revenue-sharing rate did go up, it would almost certainly be because the biggest teams had seen significant increases in their local markets, so they would still be somewhat farther ahead than where they are now.

There are a bunch of side benefits that would come from this setup, the most important of which is that it aligns all thirty teams on national revenue. Small-market teams have always relied heavily on this money, not just to finance operations, but also to raise their franchise values. Since TV contracts and the like are far more stable than, say, ticket sales, national revenue will usually have a disproportionate effect on a team's potential sale price. Also, if the owners-particularly those from the biggest and most powerful teams-were to spend more bandwidth on innovating nationally, and the tax rate did decrease, teams would be more incentivized to grow their local revenue as well. Eventually, that could actually lead to more money being shared, even with a figure below 48 percent.

There may not be a perfectly elegant solution, but this is one that passes the laugh test, and it's a way to avoid the inevitable tug-of-war over the top rate. In all likelihood, it'll be politics as usual, with competing camps trying to win as many votes as they can. But if the owners want to come together on a divisive issue, and spend more of their energy fighting the common opponent (the union), this could be one way to do so.

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 Sharing,  Revenue

30 comments have been left for this article. (Click to hide comments)

BP Comment Quick Links

rselzer

I'm sorry, but this article isn't particularly clear. From the top: what "rate" is at 48%? "Straight pool"? "Fixed pool"? Not only are the terms not defined, but it takes a lot of work to figure it out from the context.

Aug 12, 2009 09:07 AM
rating: 2
 
Shawn Hoffman

Here's a fuller explanation of the system:

http://www.baseballprospectus.com/unfiltered/?p=1365

Aug 12, 2009 10:12 AM
rating: 0
 
jdseal

Couldn't agree more. Terms need to be defined. Totally unintelligible, unless you already know all this, and in that case, there's nothing to learn.

Aug 12, 2009 09:11 AM
rating: 0
 
BP staff member Will Carroll
BP staff

Aside from payroll and stadia, plus adjustments for market (it's more expensive to do business in NYC than Milwaukee, for instance) are expenses for teams relatively the same?

Aug 12, 2009 09:31 AM
 
Shawn Hoffman

Most expenses are higher for bigger teams, some due to their market, some by choice (marketing costs). Operating margins are undoubtedly higher for bigger teams now though, since everybody has factored in revenue sharing (i.e. the Yankees have to assume $100m+ going out, the Marlins $30m+ coming in).

Aug 12, 2009 10:19 AM
rating: 0
 
Mountainhawk

Salary cap w/ exemptions for signing players you drafted, salary floor, and something like this proposal is really what is needed.

Aug 12, 2009 09:34 AM
rating: -3
 
Rob_in_CT

It seems to me that a salary floor would totally screw small market teams.

Aug 12, 2009 10:03 AM
rating: 2
 
Mountainhawk

The salary floor is based on the amount of revenue sharing you get. If the bottom 5 teams get $75M in 'shared revenue' (national + revenue sharing), a salary floor of $60M or so should be easily manageable.

Aug 12, 2009 11:07 AM
rating: 1
 
Evan
(47)

A salary floor limits flexibility and forces teams to spend money at a rate within a predefined range. If some teams can complete better by spending in bursts, I think we should let them.

Aside from the fact that salary caps reduce overal salaries, and that hurts the players and by extension the sport. Baseball competes with the other sports for athletes, and higher salaries are one of the ways they win that competition (a stronger union and longer careers help, too).

Aug 13, 2009 14:16 PM
rating: 1
 
Evan
(47)

A salary cap is a terrible idea. First, look what it has done to the NHL. Second, the primary purpose of the salary cap is to transfer wealth from the players to the teams, and that doesn't help anyone except Bud Selig.

The teams need incentives to build local revenue, while at the same time not being penalised for the size of their markets. The original Zumsteg Plan is still a good starting point.

Aug 12, 2009 10:05 AM
rating: 1
 
Shawn Hoffman

The problem with the Zumsteg plan is that it totally nukes the current economic structure, so Tom Ricketts could end up paying $900m for the Cubs, and then have them worth half of that a year later. Aside from other practical issues, it would cause MLB teams to become much riskier assets (if the system can be changed so drastically out of nowhere...), which would end up hurting all of the owners long term.

Aug 12, 2009 10:24 AM
rating: 2
 
Mountainhawk

Yeah, look what it's done to the NHL. Record attendances and revenues eery single season it's been in existence. The horrors!

Aug 12, 2009 11:05 AM
rating: 0
 
ScottyB

I hate to say it, but hockey is a fringe sport, and salary caps/floors had almost nothing to do with it. There's just not the market for it anymore.

Aug 12, 2009 14:28 PM
rating: 0
 
canada

In some (poorly selected by Gary Bettman) markets, you are absolutely right. It's a fringe sport in the sunbelt cities excluding Raleigh, where they actually seem to do well.

However, there are at least a dozen markets where hockey is the #1 sport (all the Canadian cities) or bigger than the local NBA team (if there is one). I would hardly call that a fringe sport.

Aug 12, 2009 19:04 PM
rating: 0
 
canada

I think the salary cap and floor are about the only good things with the NHL right now, and this is coming from a Leafs fan, whose team has just got demolished by the cap. It does what it should: punishes teams that irrationally drive up the market and rewards teams which spend wisely.

Aug 12, 2009 11:07 AM
rating: 0
 
benevento

The irony here is that the Yankees make so much money they have simply thumbed their nose at the system, paid the tax and bought every player in sight. The revenue sharing allows other teams to bring their payrolls up to the Red Sox'. So the Yankees are pay a tax that makes other teams more competitive with their arch rivals. Hilarious

Aug 12, 2009 10:11 AM
rating: 2
 
ostrowj1

How about a "free market" approach. If the Yankees and Red Sox are, as a result of location, able to generate significantly more revenue than other teams, why doesn't MLB look to move more teams into NYC / Boston? Either moving teams or adding new teams, MLB can avoid a lot of the big v small market issues while also expanding their product in big market areas. Sure, the Yankees or the Mets won't be thrilled with the idea, but might be open to it if it comes with (drastically) reduced revenue sharing.

Aug 12, 2009 14:59 PM
rating: 0
 
WaldoInSC

You're proposing a free market approach to an industry that doesn't operate in a free market. The anti-trust exemption, the national labor market/local revenue conundrum and the nearly absolute barrier to entry into the industry -- to name just three issues -- make baseball unique and require solutions that transcend simple free market tactics.

Aug 12, 2009 15:37 PM
rating: 1
 
ostrowj1

The anti-trust exemption just gives MLB more options than a typical business would have. It does not mean that free market ideas will not work.

Aug 12, 2009 16:17 PM
rating: 2
 
Ira

The problem that everyone in Baseball has is that the teams in baseball have different amounts of revenues. Some of these revenue streams are ones that the teams themselves have worked very hard to develop, ones that are based on the teams success, either on the field or in their marketing systems. The rest of those streams are directly rated to the size of their market.

A prime example of this is the issue of the Giants and the A's. The Giants act like a large market team. They spend money on free agents, they have drafted well, etc. Unfortunately they aren't horribly good at it. On the other hand, the A's seem to be constantly selling off their high priced talent, and only through the extraordinary efforts of their GM in acquiring talent on the cheap and developing young players have they been successful.

My idea is simple. Base all revenue sharing on one thing: Market size. The Yankees and Mets have to contribute the most, but they contribute the SAME amount. Same is true of the Angels and Dodgers, and the White Sox and Cubs. Teams like Houston, the Rangers, Philadelphia, and some others, might end up paying more than the Chicago teams or the Bay area teams. The discussion of whether Baltimore and Washington should be split or together can be debated.

The point is that you should not punish teams for being successful in their marketing, nor should you reward teams that are just too stingy to promote themselves.

This is the only way I can think of to do that.

Aug 12, 2009 16:06 PM
rating: 0
 
xnumberoneson

there are a couple problems I see with with the system based on market size. First, what numbers do you use to determine market size? The Cardinals, for example, are based in a medium market but their reach extends across several states. Second, it would not be fair to say that the markets for two teams in the same city are equal. The Mets and Yankees might be in the same city, but the Yankees franchise was already steeped in history and tradition by the time the Mets came around. You can't reasonably charge them the same. Similar situation with the Dodgers/Angels and Giants/A's. You can't treat them the same simply because they share a market.

Aug 12, 2009 18:06 PM
rating: 1
 
Michael Bodell
(89)

Admitting my bias as a Jays fan, with the unbalanced schedule and unbalanced divisions, I think it would make some sense to base revenue sharing on league and division difficulty. Tampa Bay and Toronto have a much different competitive environment then St. Louis and Pittsburgh. The two reasons for revenue sharing are:

1. create a level playing field. The league as a whole is better if "anyone can win".

2. provide the "washington generals" to the "harlem globetrotters". Boston and New York would make less revenue if they had no opponents to play.

Both of these suggests that with the unbalanced schedule teams that have to play more of their games against the large market teams (NYY and BOS for sure), and also get their division (primarily) and wild card (secondarily) should get more shared revenue then someone who plays in an easier division of an easier league.

So base the amount of revenue sharing you get based on a comparison of your market size to the weighted average of the market size of your opponents (based on both schedule and based on playoff opportunities). If your market size evaluates to expect $70M revenue but your opponents average $80M revenue you might deserve some revenue sharing where an opponent whose market expects $68M but whose opponents average only $65M might not deserve any and might even need to pay a little.

Aug 12, 2009 18:17 PM
rating: 0
 
sgshaw

These ideas are interesting, but all are fraught with unseen consequences or will be ineffective. We need a cap and a floor. The problem here is the Yankees. Unless you put two more teams in the NY area, their market is just too big. No tax is going to effect them.

Aug 12, 2009 19:18 PM
rating: -1
 
sandriola

Then why aren't the Mets spending as much? They share the same market. The Yankees market isn't just NYC and the surrounding area. They are a national team, just like the BoSox, Cardinals, and Dodgers. The difference is that the Yankees have maximized their non-baseball revenues (YES Network, for example), and therefore they are better able to handle those revenue-sharing taxes.

Aug 12, 2009 21:53 PM
rating: 0
 
sgshaw

I agree that the Yankees have maximized their market. But they are a much more historically established team than the Mets. Even so the Mets have the second highest market (payroll). Why the Yankees market is so large is beside the point. The fact that it is means the tax has no effect on them.

Aug 13, 2009 03:06 AM
rating: 0
 
canada

It's more to do with the silly notion that spending is 100% correlated with market size. Market size only dictates spending to a point... once you hit that point, the intentions of ownership are what drives spending.

Perhaps the Mets payroll is indicative of what an indifferent owner can spend in New York, where as the Yankees payroll is indicative of what a zealous owner will spend in New York

Aug 13, 2009 08:01 AM
rating: 0
 
Evan
(47)

I assert that every owner seeks to maximise the value of his asset.

Aug 13, 2009 14:33 PM
rating: 0
 
canada

Obviously. But if you think all pro sports owners are economically rational beasts, you're dreaming.

Aug 14, 2009 06:54 AM
rating: 0
 
sbnirish77

Maybe the differences in payroll with the Mets (same market)are the result of the Yankees investment in developing their brand over 30 years rather than just the past 10.

Why do they Lakers have better revenues than the Clippers? BRANDING ... that has been developed over 30-40 years ...

Branding is developing and marketing something people desire.

The small market teams are already getting a disproportinate amout of national media revenue ... the Nats or Pirates are on one national game a year but get 1/30 of the revenue...

the split on national revevue is ALREADY a handout

Aug 14, 2009 09:17 AM
rating: 0
 
jordanmt

I'd love to see a system like European Football. Then it does not matter. You have something to keep it interesting no matter what. If you are a small market then you get relegated to where you can be competitive. I'd still root for my D2 reds.

Aug 13, 2009 18:48 PM
rating: -1
 
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