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Profit 1. Profit defined A typical assumption in all of economics is that firms are profit maximizing entities. This essentially means that if a firm.

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Presentation on theme: "Profit 1. Profit defined A typical assumption in all of economics is that firms are profit maximizing entities. This essentially means that if a firm."— Presentation transcript:

1 Profit 1

2 Profit defined A typical assumption in all of economics is that firms are profit maximizing entities. This essentially means that if a firm faces several options it will choose the one with the highest profit. In general profit is defined as total revenue minus total cost. Π = profit = TR – TC. For a sports franchise TR is more than just price times quantity. From the point of view of a franchise TR can come from Rg = ticket sales or what may be called the gate receipts, Rb = local and national broadcasting rights, Rl = licensing income, and Rs = stadium related revenues from sources such as luxury boxes, concessions, and stadium naming rights. 2

3 Gate Sharing 3 Most pro teams have different sections of seating where the price per seat is different in the different sections. If the demand for a section or for the whole team is up then more can be charged per seat. Some teams are pricing single game seats at different prices based on the visiting team. A higher demanded visiting team will command a higher price for the single game. Some leagues have revenue sharing of the gate. What this means is that some of the money raised from ticket sales stays at home and some is put in the league pot and then divided up among all the teams.

4 Gate Sharing 4 For a simple example say we have 3 team league with gates of $100, $200 and $300. If the split is home team get 60% and the other 40% is put in a pot and split equally among the three teams, then the respective final gate revenue is 60 + (1/3)( ) = = $140, $200, and $360. Teams with below average gate get helped by the sharing plan and teams with above average gate are harmed by the plan.

5 TV Revenue 5 The big 4 sports leagues in North America have national TV contracts where the money is split among the teams in a given league. It turns out that NHL hockey has the weakest contract and is substantially less than the others. Baseball has the added dimension that each team can have its own local contract. The teams share roughly 34% of their local revenue. Even with this sharing, the large media market teams have a big advantage in terms of revenue. There can be a bit of a trade-off between ticket sales and TV. The logic is why sit in stadium and wait in lines when you can watch the game in the comfort of your own home? NFL has a blackout rule where the game has to sell out (72 hours before kickoff) in order to be seen in the local market. TV revenue has become so big, the game itself is delayed for commercials!!! You hear about TV timeouts!

6 Stadium Agreements 6 Teams today are benefitting from luxury box suites. A team can sell a suite with 20 seats for $500,000 a year, but only have to consider the value of the 20 seats (at say $50 or 75 per seat) in the league sharing gate formula. Many teams sell the rights to the name of the stadium as an additional revenue source.

7 Cost 7 The major cost to a sports franchise is the cost of players in terms of both current salary and benefits that include contributions to pensions and workers comp. Other expenses include travel, administration and venue expenses. Many sports teams have been able to get host cities to pay for construction of stadiums. The NHL and MLB have significant costs due to minor league systems. Teams in these leagues subsidize minor league teams by paying a major portion of their labor expenses.

8 Opportunity Cost 8 All costs are opportunity costs. When a team pays a player a salary it can not use that very same money to build a luxury box in the stadium (assuming that is the next best use of the money). If a team stays in city A when it could make more profit in city B, the profit forgone is a real cost to the owner of the franchise. It is also called an opportunity cost. Team owners probably worry about opportunity costs and use the idea that they can make more elsewhere when they negotiate with their host city on things such as stadium deals.

9 Vertical Integration 9 Some sports teams are being purchased by cable TV companies, or the teams are starting their won cable TV companies. When you consider the consumer is the final buyer of the sports action and teams and TV companies both contribute to the final product. The combined firm that has both the team and the TV is said to be a vertically integrated firm. There is production at different stages. Sometimes vertically integrated firms will engage in cross subsidization. Revenues and costs will be shifted so profit at firm level is highest.

10 Summarize 10 The authors end the chapter suggesting that in the modern era teams use all sorts of accounting rules to gain as much advantage as possible in terms of looking at overall profit. Can you blame an owner from using the rules to his advantage?


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