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.

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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.

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