Accounting Profits Are Typically

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					             Chapter 4
    Team Cost, Profit, and Winning
                  To Accompany
                  Sports Economics 2ED
                  Rodney Fort
                  (PrenticeHall, 2006)
Owners are never the most popular sports figures
in a city. When a team loses consistently, the
owner is the person the fans blame; when the
team wins, the owner is the person the fans want
to get out of the way so that the announcer can
interview the coach and star players. There is a
reason that no owner has ever been pictured on a
football card.
  -Gene Klein, former owner of the SD Chargers.
Overview
•   The short-run and long-run decisions that
    confront sports team owners.
•   Profit-maximization, subject to uncertainty,and
    the short-run and long-run decisions of owners.
•   The tension created between fans, players,
    and owners by the owner’s financial bottom
    line.
•   Profit variation and competitive balance.
•   Sports accounting versus the value of
    ownership.
Introduction
“The whole thing is not really an issue
  of big market, small market. It’s
  larger revenue teams, with smaller
  revenue teams complaining about
  not making as much as their bigger
  partners.”
    - Don Fehr, MLBPA Executive
      Director.
Do Owners Really Maximize Profits?
 There is plenty of owner behavior
  consistent with profit maximization.
  But, ultimately, it’s a hypothesis
  about behavior that can be tested.
 Don’t confuse the hypothesis with
  perfection!
 Owners are human and can make
  mistakes.
 Uncertainty makes maximizing profits
  a tough job!
Short-Run v. Long-Run Production
 Remember your economics principles
 Short-run: Some factors of production are
   fixed.
 Long-run: All factors of production are
   variable, or open to alteration by the
   producer.
 In the long-run, owners choose quality
   (winning percent) to maximize profits.
   In the short-run, they sell attendance
   and broadcast rights to collect on this
   long-run choice.
Short-Run Pro Sports Production
 Short-run: Some factors of production are
   fixed, like all contractual obligations in
   place at a point in time. For example…
 Talent, on and off the field, typically over
   the course of a given season.
 The facility the team plays in, typically
   over its 20-30 year lifespan.
 *Don’t confuse the short run with a short
   period of actual physical time. The
   short-run for stadiums can be decades!
Short-Run Roster Changes?
 What about roster alterations during the
    season?
 If the owner is just making the changes
    that he/she forecast to reach long term
    quality, these are just short-run
    adjustments.
 If the owner changes his/her mind about
    the level of quality to put in front of fans,
    then we’ve left the “short-run” and it’s
    time to talk about the long-run.
Long-Run Pro Sports Production
 Long-run: All factors of production are
   variable, or open to alteration by the
   producer. In the long-run…
 New stadiums can be built.
 The level of roster quality can be altered.
 Managers and coaches can be replaced.
 *Essentially, any time the owner steps
   back and takes a “planning” view, long-
   run considerations about team quality
   are made.
Short-Run Production and Costs
Short-run fixed inputs dictate short-run
 total fixed costs (TFC). Fixed inputs:
                  Stadium
               Player rosters
               Management
Short-run variable inputs dictate short-run
 total variable costs (TVC): Variable
 inputs
              Team operations
  Stadium operations (for some owners)
    Scouting and player development
         Advertising and marketing
Short-Run Total Costs
Short-run total costs (SRTC) are the sum
  of short-run fixed and variable costs:
            SRTC = TFC + TVC
Fixed costs do not change with output.
  Variable costs have a particular shape
  due to diminishing returns to variable
  inputs.
Here’s the hypothetical cost structure of
  the Seattle Mariners from the text (Figure
  4-1).
Mariner’s Hypothetical Short-Run Costs
The arrowed amounts occur for attendance of about
  2.9 million for the Mariners.
Long-Run Production and Costs
 The analysis turns to the level of team
   quality.
 In a given season, one can calculate the
   winning percent differences in the
   standings.
 Even more power comes from this
   observation if we look across a number
   of seasons to see the differences in the
   standings.
 These differences are the direct result of
   the on- and off-field talent choices of
   owners.
                “Stars” and Winning
It’s easy to measure talent by thinking of adding “stars” to a
    roster without any. We observe:
Long-run Cost (Of Talent, For Now)
Adding stars creates higher quality (higher winning
  percents). When we know the cost of stars, we know
  the cost of increasing quality. (Figure 4-3).
The Rest of Long-Run Cost
Adding in other long-run cost considerations
  shifts total talent costs upward. (Figure 4-4).
An Important Tension
The more any owner wants to win, the more
  it’s going to cost!
The level of quality chosen will depend
  crucially on fan willingness to pay to cover
  the cost of quality (as we’ll see).
*So, owners may want to win as much or
  more than fans and players, but the costs
  of winning will temper their desire with
  their bottom line considerations.
Profits in the Long-Run
In the long-run, profit maximizing owners
    will choose the quality level that
    maximizes the difference between total
    revenue and total cost.
For every quality choice, there will be a
    revenue structure and a least cost
    structure at which the owner can obtain
    the value created.
A particular attendance level will maximize
    profits for that level of quality.
Comparing this across all possible quality
    levels generates the long-run profit
    function.
 Long-Run Profits
Long-run profits…
Increase with quality, so that P*(WH)> P *(WL),
Eventually reach a maximum, P (W*),
Then decline (eventually, costs increase faster than revenues).
The owner chooses maximum long-run profit and quality at
     better than 0.500 in this case.
              $
                   P(W*)
  
 P (W )
     H

 
P (W )
    L
          0                                          *        Winning Percent
                           W L =0.270      0.500 W       1.000


                                   W H =0.375




              –$
 Long-Run Profits Implication
Long-run profits…
Vary between different locations!
Let’s draw another owner in this picture who
    would choose to be a “lovable loser.”
              $
                   P(W*)
  
 P (W )
     H

 
P (W )
    L
          0                                          *        Winning Percent
                           W L =0.270      0.500 W       1.000


                                   W H =0.375




              –$                                                        12/4/2010
Long-Run Profit Notes
A few notes about long-run profits
Profits constrain winning: Where costs eventually
    rise faster than revenues, and owners care about
    the bottom line, then the profit maximizing level of
    quality may be below 0.500 in some markets!
Profit variation can harm competitive balance: If
    profits vary widely through a league, and higher
    profits coincide with greater quality, then profit
    variation contributes to competitive imbalance.
“Small market” does not necessarily mean economic
    losses: Profits can still be positive even if
    revenues are small relative to other teams in the
    league!
Economic v. Accounting Profits
Reasons teams report “accounting” losses but
  are worth it, economically:
• Related business opportunity.
• Some costs may actually be profit-taking.
• Revenue shifting can reduce taxes for
  partial cross-ownership.
• Roster depreciation allowance, coupled
  with a pass-through structure for the team,
  can reduce personal income taxes for
  owners.
*Owners may show poor, for tax purposes, and
  plead poor for political purposes, but assets
  that increase in value, like teams, do not as
  a rule lose money in the long run.
Economic Profits Continued
So, there are other values to ownership.
As we saw with advertising…
As we’ll see in college sports…
*You can’t always find all of the values of an
   activity on that activity’s own profit sheet!
You need to look for the spill-over on other
   profit sheets.
GM Motor Division.




                                               12/4/2010
Economic Profits: A Lesson
Here are some recent NBA team sales values
   from Forbes magazine. I’ve talked with the
   folks at Forbes and they use an “adjusted”
   multiple of earnings approach.
2002: Celtics.
Forbes Value = 218. Sale Value = 360.
2004: Nets and Suns
Forbes Value = 214/282. Sale = 300/401.
The differences here are between 19% and
   39%.
Why?


                                          12/4/2010
Summary
•   The short-run and long-run decisions that
    confront sports team owners.
•   Profit-maximization, subject to uncertainty,and
    the short-run and long-run decisions of owners.
•   The tension created between fans, players,
    and owners by the owner’s financial bottom
    line.
•   Profit variation and competitive balance.
•   Sports accounting versus the value of
    ownership.

				
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