Opinion

Felix Salmon

Are basketball economics broken?

By Felix Salmon
July 8, 2010

Amy Shipley has an odd piece today on the economics of signing basketball stars. I know absolutely nothing about basketball, but I do know that Shipley’s story doesn’t convince me that the NBA is suffering the “economic woes” of her headline because “a broken economic system” has resulted in teams spending too much money on players.

For one thing, Shipley never explains the mechanism by which player salaries are being overinflated, beyond waving vaguely in the direction that such salaries constitute “gambling, perhaps foolishly, that the expensive addition of a star player from a historically talented free agent class will generate interest in their franchises and ignite a significant payoff in the box office.” But your foolish gambling is my smart investing, and of course box office revenues are only a fraction of the value that teams extract from players.

What’s more, Shipley concentrates on dubious and vigorously contested cashflow figures, saying that the league will lose about $400 million this year, with the average team losing $13 million. That doesn’t seem like a huge amount of money to me, in a world where players can take home $20 million a year each. Instead, it looks like smart accounting: it’s clearly smart for an owner to lose a modest amount on a cashflow basis, thereby avoiding taxes, and instead build a much higher franchise value for his team, thereby increasing his net worth substantially.

As a datapoint, check out the market capitalization of MSG, the owner of the Knicks, as speculation rises that LeBron James might come to New York. The share price closed at $21.57 yesterday, up a good $2 from a week earlier — that’s an increase in franchise value of $150 million, give or take.

And indeed, as Shipley notes, it’s not the teams paying out monster salaries which are hurting the most:

“The most significant challenge facing the NBA today is the gap between the teams at the top and bottom,” said sports consultant Andy Dolich, a former Capitals executive who has worked for NBA, NFL and Major League Baseball front offices.

Think about it this way: big-name basketball players earn much more in endorsements than they do in salary. It’s reasonable to assume, given how much value they add to the brands they advertise, that they add much more to the teams they play for. And that if smart business owners are competing desperately for the privilege of signing these players, then the chances are that their services are underpriced, not overpriced.

Comments
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It’s not the big name players (Kobe, LeBron, Wade), who are the ones that not only get $20M+/yr contracts but earn more in endorsements, that are causing teams to lose a lot of money, it’s the guys who get $5-15M yr and shouldn’t even get half that amount that are hurting the NBA. The Knicks have had one of the biggest payrolls in the NBA for years, even though they have been among the worst teams. They have not only survived, but have thrived, because they sell out every game at very high ticket prices and have a great TV/radio contract. Teams in smaller markets can’t say that. The Lakers have one of the highest payrolls, and have obviously done well the last few years (did I mention they just won their second straight title?), but they also sell out every game at very high prices and have a great media deal. The problem is with the smaller market teams, who don’t sell out every game, and can’t charge $250 for half of the seats in the arena, and don’t have a TV/radio audience of 10M people. They are losing more than $13M each, because if you subtract the profitable teams from that $400M the NBA loses collectively, the loss might be $600M over 20-24 teams. And the value of those franchises are not increasing $30M per year, and those owners have to come up with the $30M in cash every year to cover those losses.

The NBA has a salary cap designed to prevent stupid general managers from paying too much for the wrong players, but it hasn’t stopped them from shooting themselves in the foot. I just looked at the latest announced free agent signing, which says the Nets are going to pay Travis Outlaw $7M/yr for the next five years. I think Travis Outlaw is a good player, I wouldn’t mind having him as a reserve on the Lakers, but when teams pay $7M/yr for a guy who wouldn’t start on a team that gets to just the second or third round of the playoffs, let alone the finals, they’re going to lose a lot of money.

Fortunately for the Nets, they have a new billionaire owner who can afford to lose $30M a year.

Posted by OnTheTimes | Report as abusive
 

First of all, please let me say that I have loved sports all my life and watching the greats through the years have given me lots of moments I will never forget. That being said, the current state of all professional sports salaries is disgusting to the point where I dont care about any sport, team or player. Millions of dollars a year to play a kids game? Does no one realize the state of our country and the kind of poverty we have especially in the “big market” cities? I also don’t buy the argument that “well look at what the owners are making” or any other argument–it just goes to show how out of line the entire situation has become. I go to middle school and high school games where the kids work hard as student athletes, love the game and play their hearts out when they take the court/field. Realistically how much would these professional athletes make in another job that they are qualified for if we were not so stupid to pay people millions and tens of millions of dollars to watch a game?

Posted by harmonyaudio | Report as abusive
 

Pro sports has a lot to do with egos. World Cup yachting is for the plebes!

Most of these billionaire owners make their money from something else and they are buying a sports franchise because they can.

Is it an investment or a consumption good for the owners?

Posted by DanHess | Report as abusive
 

Update to stupid GM’s (and owners): The Mavericks agreed to pay 30-year old center Brendan Haywood $9M+/yr for the next six years. He’s not a bad player, but $9M? And that contract pays him until he’s 36, when the skills and mobility of guys his size starts to deteriorate at 32, when he will still have 4 years on his contract.

Dan Hess, I think basketball is a consumption good for owners. Haywood is not going to bring a title to Dallas.

Posted by OnTheTimes | Report as abusive
 

2nd update to stupid owners (I should have mentioned this in the first post, but forgot about it until I just read Bill Simmons’ column, where the following quote is from):

“… if Darko Milicic, Channing Frye, Amir Johnson and Drew Gooden hadn’t signed for a combined $114 million on the same day Atlanta offered Joe Johnson $120 million to thank him for leading the Hawks to a four-game sweep in Round 2 in which they were outscored by 25 points per game.”

Now for you Felix readers who don’t follow basketball, you’re probably wondering who are these guys that are going to be getting all that money over the next 4 or 5 years. They are guys who won’t be starting anywhere, or certainly not on a team that is contending for the title, or even a conference finals appearance. If you ever read about them again, it will be when they are traded in 2 or 3 years as their teams try to dump their salaries. It is deals like these that are causing NBA teams to lose so much money.

So when you want to say “the government should be run like a business”, please add the qualifier “except not like an NBA team”. Or a company that drills for oil in deep water.

Posted by OnTheTimes | Report as abusive
 

Personally, I couldn’t care less if some billionaire owners want to make a bunch of goofy kids millionaires – my problem is when these billionaires begin to expect and demand that taxpayers subsidize their play toys. That, my friends, is absolute ‘male-bovine solid fecal matter’. And any community that has allowed itself to be blackmailed in this way should be ashamed of themselves.

Posted by CDNrebel | Report as abusive
 

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