# Chapter 5 Competitive Balance.

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Chapter 5 Competitive Balance

Leagues Want Balance Balance helps profits
Attendance and TV ratings fall if one team dominates Even the dominant team can suffer What is competitive balance? Is it a good chance of winning each game? Is it turnover among champions? What do teams do to improve balance?

Teams, Leagues, and Balance
What do teams want to do? Some – like the Yankees – pursue wins at the expense of profits Others pursue profits at the expense of wins Leagues can limit behavior of teams to promote balance

Balance and Marginal Product
Diminishing marginal product limits the desire of a team to acquire players The Los Angeles Lakers will not pursue Dwayne Wade Already have Kobe Bryant Wade or other shooting guards will add little to wins, attendance or revenue The added cost exceeds the added benefit

Is Perfect Balance Profit Maximizing?
Winning has a bigger impact in a large city More gate revenue More media revenue More venue revenue Higher marginal revenue If costs do not vary by city size, big cities will win more MR, MC MRlarge MRsmall MC Wins

Measuring Balance within a Season
Could use the standard deviation of winning % Gives the spread of performance by teams Problem: # observations (games) must be constant Cannot compare across leagues Cannot compare across seasons Key innovation: compare actual standard deviation to the “ideal” standard deviation Assumes ideal means that teams are evenly matched Each team has a 50% chance of winning a given game Take the ratio of actual to ideal

Computing Within-Season Balance
The ratio of actual to ideal standard deviation T= # teams N = # Games WPi = Winning Percentage of team i

Interpreting the Ratio
The ratio gives a “standardized” measure Actual and ideal rise with number of games Can now compare across leagues & years As a rule: R > 1 R = 1 League is completely balanced Outcomes are effectively randomly determined As R rises: imbalance worsens

How Do Leagues Compare? NHL is the most balanced (R=1.66 in 2008-2009)
NBA is the least balanced (R=3.07) NFL (1.66) and MLB (1.75) are in between English Premier League (1.97) worse than all but NBA

Measuring Balance Between Seasons
Can use the standard deviation of each team’s winning percentage Unlike within season do not have an “ideal” measure Unclear what is a good or bad level Can use frequency of championships Hard to compare across leagues

Between Season Balance: The Hirfindahl-Hirschman Index
HHI measures the concentration of championships Let ci = #championships by team i T = #teams; N = #Years HHI=1  one team always wins HHI=1/N  complete balance

Illustrating Imbalance
The Lorenz Curve Measures inequality in a population Typically used to measure income inequality We use to measure inequality in winning Line up NBA teams by wins in 1230 games were played so population=1230 The 3 weakest teams won 55 games Bottom 10% accounted for 4.5% of wins Next 10% accounted for 5.8% and so on

The Lorenz Curve for the NBA
Red line shows perfect balance Adding 10% more teams Adds 10% more wins Blue line shows reality Bottom 10% wins less than 10% Sags below red line As add better teams, blue curve catches up At 100% of teams, we account for 100% of wins The farther the blue line sags, the greater the inequality

Applying HHI to Baseball
MLB owners have frequently complained about the lack of competitive balance Can use the HHI to test this claim Over the period MLB was most balanced (HHI=0.14) NBA was least balanced (HHI=0.28) NFL (0.16) and NHL (0.18) were in between

The Coase Theorem and Competitive Balance
Coase claimed that markets direct resources to their most productive uses Property rights do not affect the flow of resources They affect only who gets paid for them The theorem is most commonly applied to externalities Applying the Coase theorem to sports LeBron James will go where he is most productive The team where he generates the greatest income

How The Coase Theorem Works
Assume that LeBron James is more valuable in NY than in Cleveland Under free agency The NY Knicks pay James to move to NY If there is no free agency The NY Knicks pay the Cavaliers for the “rights” to James James moves - the only difference is who gets paid The reserve clause did not prevent player movement In 1920 Red Sox sold Babe Ruth to Yankees Connie Mack twice sold off championship teams in Philadelphia

Promoting Competitive Balance
The Coase theorem breaks down if there are large costs to making transactions Owners have tried to impose transactions costs Revenue sharing Salary caps and luxury taxes Reverse order draft These restrictions also promote monopsony power

Revenue Sharing We have seen that winning means more to teams from big cities New York will naturally win more often Revenue sharing tries to reduce this source of inequality All 4 major sports leagues share revenue

Should Revenue Sharing Work?
Even if teams share all revenue equally League revenue is greatest when big-market teams win The incentive to have big-market teams win does not go away Not all teams pursue winning equally Losing teams often have higher profits than winning teams The Marlins and Nationals have higher operating income than the NY Yankees

Introduction to the Salary Cap
NBA, NFL, and NHL all have salary caps Caps set upper and lower limits to payrolls Take qualifying revenue (QR) of league Not all revenue “qualifies” Definition varies from league to league Players get a defined share of the QR Divide total player share by # of teams Add & subtract fudge factor (~20%) to get bounds

Hard Caps and Soft Caps The NFL has a hard cap
Sets firm limit to salaries No exemptions The NBA has a soft cap with many exceptions Mid-level exception Team can sign 1 player to the league average salary even if it is over the limit Rookie exception Team can sign a rookie to his first contract even if it is over the limit Larry Bird exception Named for former Boston Celtics great who was its first beneficiary Team can re-sign a player who is already on its roster even if it is over the limit

The NBA And Soft Caps The salary cap has not helped competitive balance in the NBA All the exceptions have led to further rules The NBA now caps individual salaries as well as team payrolls The NBA has a luxury tax to prevent teams from abusing the exceptions Teams pay \$1 for every \$1 over the cap

MLB’s Luxury Tax Takes the place of a salary cap
Team pays a tax for exceeding a target payroll Tax rises with the number of abuses Detroit Tigers paid a 22.5% tax in 2008 as first-time violators NY Yankees paid a 40% tax for sixth consecutive violation

The Reverse Order Draft
Ideally levels out talent Weakest teams get first choice of new talent Strongest teams get last choice Works only if teams can identify talent Can promote “tanking” to improve draft position That is why the NBA has a draft “lottery” Lottery means that weakest team might not choose first

Identifying talent: Moneyball
Billy Beane, the Oakland A’s general manager, found underrated players He saw that teams overrated physical skills And underrated on-base percentage Using different criteria kept his small market team competitive Other teams eventually caught on A’s have fallen on hard times as a result

A History of the Reverse-Order Draft
Introduced by NFL in 1936 Caused by bidding war for Stan Kostka Star running back for the University of Minnesota Philadelphia Eagles & Brooklyn Dodgers competed to sign him Drove salary offers to that of Bronko Nagurski – the top star of the day (\$5000)

What Was The Point of the Draft?
Did teams just want to keep salaries low? Was is a cynical move by weak teams? Bert Bell, the Eagles’ owner proposed the draft The Eagles happened to have the NFL’s worst record Was it an idealistic move? The NY Giants & Chicago Bears agreed to the draft They were the dominant teams & had the most to lose Tim Mara (Giants owner): “People come to see competition…. We could give [it to] them only if the teams had some sort of equality.”