The (Peculiar) Economics of NCAA Basketball

T. McFall

• Publisher: Palgrave Macmillan
• Year: 2014
• Print ISBN:
  9781349480944
  9781137384553
• eBook ISBN:
  9781137384560
• Topic: Volkswirtschaftslehre
• Subtopic: Business allgemein

The economics of the NCAA Division I men's basketball league are peculiar because it fails to hire the best college-aged players and does little to enhance competitive balance within the league. The league's policy decisions and its ability to remain economically viable, despite its short-sighted governance decisions, are discussed.

CHAPTER 1

ROTTENBERG, NEALE, AND THE GOVERNANCE POLICIES OF SPORTS LEAGUES

Introduction

In this chapter, we discuss the trade-offs faced by league officials and participants when they perform the difficult and necessary task of ratifying a set of rules for league governance. Our discussion is inspired by the valuable insights on the governance process made over 50 years ago by two economists, Simon Rottenberg and Walter Neale. In separate articles, they wrote that leagues need to adopt policies that equalize the productive capabilities of resource-rich and resource-poor members in order to create exciting and uncertain contests. To meet these objectives, the four major North American leagues (MLB, NBA, NFL, and NHL) have adopted policies such as revenue sharing, reverse-order amateur drafts, and salary restrictions in order to offset the natural economic advantages that resource-rich members have over their rivals. As is the case with any policy that disrupts natural economic forces, policy implementation must be done carefully or leagues might suffer costly or catastrophic unintended consequences of their decisions. This chapter serves as a point of comparison to Division I basketball’s governance policies, which we begin discussing in the next chapter.

Starting a Sports League

Here’s a weird thought. At least one person was instrumental in creating every sporting league that has ever existed. In every league that’s ever been created, a person or a collection of people had to follow through on a notion that other people would derive enjoyment from participating in or watching the games that are league contests.¹ All around the world, in every game imaginable, leagues exist that cater to low-skilled amateurs and highly trained professionals, and every one of those leagues owes its existence to some person or people who took on the task of organizing the league.

At the beginning of every league, some set of organizers had to establish rules in order for the league’s contests to run as smoothly as possible. Admittedly, this point is somewhat fundamental to organizing a league (and therefore easy to gloss over), but kids who have participated in informal competitions at recess or with friends in their neighborhoods understand well the importance of the point. Once good rules are ratified, then the stage is set for all the things to happen that make sporting contests fun to participate in and watch. Strategies can be formulated, players can determine how much energy to expend while competing, and winners and losers can be determined. Until that moment of ratification, though, everyone connected with the league will suffer because no one will have a firm understanding of exactly how the game is to be played.

Just so we’re on the same page, let’s imagine a group of people who want to shoot for the moon and create a league that will be considered the crème de la crème of their sport. Starting these leagues is difficult, but fending off attacks from outsiders who want to compete away profits of successful monopoly leagues is even more difficult. Leagues will have to be careful and (sometimes) vicious in order not to leave themselves open to an assault from a rival.

It’s important for these organizers to hear there isn’t one perfect answer for all leagues. But imitation is the finest form of flattery, and there are plenty of leagues with sound governance policies that would be wise to mimic. Further, we’ll examine the governance structures of the four major North American leagues—Major League Baseball (MLB), the National Basketball Association (NBA), the National Football League (NFL), and the National Hockey League (NHL)—in hopes of learning important governance policies from each. These leagues have been the dominant forces in their respective sports for decades, and all have gone through tremendous internal and external upheavals, so ignoring their experiences and starting from scratch would be unwise.

Neophyte organizers can also turn to economists who have been interested in studying sporting competitions for well over 50 years. Beginning with Simon Rottenberg in 1956, the year he published the academic paper titled “The Baseball Players’ Labor Market,” economists have pondered nearly every aspect of sporting contests.² In that article, Rottenberg outlined the three objectives to which we’ll often refer throughout this book. He observed that league organizers need to attract the best talent, figure out a way to create contests with some uncertainty, and make rule changes that keep fans satisfied with the nature of the strategic encounters they watch during games. And although much has changed since Rottenberg’s essay—for instance, certain players are now eligible for free agency and television has changed dramatically the production scale of contests—the basic principles of creating sporting contests he outlined still hold and will be instructive for the governance decisions any league has to make.³

Creating Uncertainty in a World That Leans toward Certainty

In order to create uncertainty, a league has to find a way to match its members evenly, and that means paying attention to the way teams are allowed to hire players. The teams’ talent levels will be a major determinant of their potential. Good players, like anyone else, want to be compensated as well as possible for their labor, so teams with the highest willingness to pay for players will be at a decided advantage over the rest of the league in terms of hiring talent to their teams. Therefore, we need to spend some time understanding factors that will drive apart teams’ willingness to pay for talented players. As Rottenberg pointed out in 1956, the teams within a league are not created equally because the markets that the teams inhabit are not created equally. In any league, there are resource-rich teams and resource-poor teams, and as long as those differences exist, there will always be a natural tendency for the best players to be hired by the resource-rich teams, thus driving apart teams’ productive capabilities.

Rottenberg’s critical observation about league governance is based on the basic economic idea that workers can be valued by a measure called marginal revenue product. This measure estimates the amount of revenue a worker produces for a firm, which, in turn, can be used to set his wage level. The larger is a worker’s marginal revenue product, the more valuable he is, and the larger should be the wage that he can earn from the market.

To illustrate the deleterious effects that market differences have on competitive balance, Rottenberg noted the massive differences between the teams that comprised the then National and American Leagues. At the high end of the spectrum was the New York Yankees, a resource-rich franchise situated squarely in the middle of a densely populated urban area full of people with relatively high enough incomes who could more easily afford trips to baseball games. At the other end of the spectrum were the resource-poor Kansas City A’s, a team that had just left Philadelphia for a city that had neither the population nor the wealth of many cities that were home to major league teams. Clearly, Rottenberg noted, these teams faced different demand for their products, which meant the teams inevitably were willing to bid differently on players with similar abilities.

Because the teams valued players differently, the resource-rich teams would be more likely to hire the most productive players, regardless of the governance policies adopted to keep players from moving from resource-poor to resource-rich teams. This phenomenon, which became known as the invariance principle, explains why teams from small markets have such a difficult time competing against big-market teams with more resources at their disposal.⁴ Before broadcasts of sporting events became ubiquitous, before professional sports spread out around the entirety of the United States, before players in all professional sports earned arbitration and free agency rights, Rottenberg explained perfectly that natural economic forces make it more likely that the Babe Ruths, the Mickey Mantles, and the Mariano Riveras of baseball put on the pinstripes of the New York Yankees rather than royal blues of the Kansas City Royals. The differences in the teams economic characteristics make it such that the Yankees value those players more, and it doesn’t matter what Major League Baseball does to remedy those differences.⁵

In light of the invariance principle, leagues still have to figure out ways to develop some uncertainty in the contests produced by its members, which means leagues need to adopt, collectively, policies to help distribute player talent equally across league members. Otherwise, how will resource-poor teams have a chance of hiring top-flight players, if even for a short interval before a resource-rich rival either bids away a superstar or offers the smaller team a deal they can’t refuse?

The political economy of adopting these policies is delicate because resource-rich teams will have to lose voluntarily some of their competitive advantage for the good of the league. It’s an understatement to say that the ownership class of professional sports tends to be a competitive lot, which makes the governance task even more difficult. And to make it worse, the policies put in place to shore up team quality within a league can open up the league to nasty unintended consequences, an inevitable outcome of laws or rules that disrupt natural economic forces.

Whereas Rottenberg first analyzed the delicate economics of sport, the peculiar political economy within sports leagues was discussed initially by Walter Neale in 1964.⁶ Neale built on Rottenberg’s observations regarding the need to create uncertainty while attracting the best talent, and he made a very important point in his paper regarding the way sports leagues should be viewed, a view that we’ll use throughout this book.

Because of leagues’ need for rivals to exist, Neale supposed it best to analyze sports leagues not at the team level, but rather at the league level, for the league is responsible for creating the governance structure that affects all of its contests. He posited that the most successful leagues become monopolists within their market when rival leagues can’t compete with the established, well-run league.⁷ To win those monopoly rights, Neale recognized that successful leagues have to find ways to create legitimate rivalries by adopting policies that hinder the natural dominance of certain members and subsidize the weaker members of the league, which means league need to act as one when setting governance policies.

To understand Neale’s frame of reference for his argument, it’s instructive to think about the landscape of major sports in 1964. The New York Yankees were two years into sharing the New York market with the fumbling Mets and were dominating baseball, as they won 13 pennants and eight World Series titles between 1949 and 1964. The Celtics were in the midst of their decade-long steamrolling of the NBA, having won every Eastern Conference title since 1957. College football’s best teams were Oklahoma, which had at one point won 47 straight games in the decade prior to Neale writing his paper, Notre Dame, Alabama, and Texas. And UCLA won the first of seven straight NCAA basketball championships. Neale was observing leagues in the midst of strangleholds by legendary teams and predicting problems that leagues might face in the future in terms of creating uncertain outcomes of the contests they produce. It’s highly doubtful Neale was surprised by the rise of the American Football League and the American Basketball Association, two leagues that competed successfully with the NFL and the NBA right about the time he wrote his paper.

Not coincidentally, since Neale presented his ideas, the four major North American professional sports leagues have recognized the problems Rottenberg discussed and have adopted policies that enhance competitive balance within leagues. We’ll talk about three such policies, amateur drafts, salary caps, and revenue sharing, so that we can compare the NCAA’s governance structure with the professional league’s governance structure. It turns out that members of professional sports leagues have been much more willing to compromise with each other in hopes of creating competitive balance compared to the NCAA, which, for a number of reasons that we’ll explore throughout the book, has openly adopted policies that diminish competitive balance in their membership.

Drafts–Getting the Inputs into the League

Given the 140-year history of professional sports in the United States, the first policy we’ll discuss that league organizers might implement to shore up competitive balance within their league, an amateur draft, is a fairly recent phenomenon. In the early days of organized sports, players generally entered the league in one of two ways, depending upon the league in which they were entering. Some leagues, like the NBA, hired many players from the amateur ranks (usually high school or college) via a system of territorial rights. This system had its advantages because it kept homegrown talent close to home, which could in turn help increase demand as fans might be more interested in watching a team with familiar and popular players. Of course, it was great for teams to have access to popular new players, but this system suffered from an element of randomness that hindered league growth. With regard to the first problem, consider the example of legendary center Wilt Chamberlain, who played collegiately at Kansas University, but originally hailed from Philadelphia. For marketing purposes, Chamberlain’s rights were granted to the Philadelphia Warriors, which could count on increased support from fans ready to support their hometown prodigy. Where was the economic justice in giving the Warriors franchise the rights to Chamberlain when it did nothing to woo him to Philadelphia in the first place?

Similarly, the markets that professional franchises serve might not correlate well with the places where top amateur talent reside. For instance, in the modern college football landscape, many of the top college players aren’t located in areas that would make it possible for certain league members to have the ability to hire such talent. Many of the best college football players over the past 30 years have played at three universities—the University of Miami, Florida State University, and the University of Florida. Supposing the NFL didn’t have an amateur draft and instead relied upon a territorial rights system to sign players, how acute would the advantage held by the three Florida NFL teams be over this time period? Obviously, the NFL has little if any control over the density of amateur talent in various geographic areas, and so it doesn’t make sense for the competitive advantage within the league to be a function of the distribution of amateur talent.

In lieu of territorial rights, North American professional sports leagues also used an open market system to hire amateur talent.⁸ This system has advantages over the territorial rights system in that teams have to invest in scouting departments, so finding and signing top amateur talent is (probably) less random (and thereby more economically efficient) in the market system than the territorial rights system. The drawback to this system is tied again to teams’ resources. The resource-rich franchises have larger bases from which to create systems to find and to bid on top amateur talent, thus placing members with fewer resources at a perpetual disadvantage. The open market system still is used in European and English soccer leagues. The teams in these leagues scour youth and minor professional leagues for promising players, and the competitive balance in many of those leagues is low compared to the level of balance in the four major North American professional leagues.

Once the competitive balance and profitability problems inherent in using territorial rights and open market signings to enhance competitive balance became apparent by the mid-1960s, all four major sports leagues in North America adopted reverse-order drafts as a way to allocate amateur talent into leagues. The leagues’ drafts generally work in similar ways. The worst-performing teams from the leagues’ most recently completed season have the first choices in the draft. Assuming these teams can nurture the top amateur talent they select, they can reap the on-field fruits of their draft picks until the teams decide to trade their high-performing players to other teams or lose them to free agency. With this mechanism, market forces such as bidding for amateur talent are traded off for an orderly system by which lower-performing teams have a chance to sign players to whom who they wouldn’t otherwise have access. ...

Table of contents

• Cover
• Title
• 1  Rottenberg, Neale, and the Governance Policies of Sports Leagues
• 2  The NCAA’s Peculiar Economic System
• 3  Technology, Legal Decisions, and Superstar Teams Undermine NCAA Authority
• 4  The Selection Committee’s Trade-Offs in Creating the Tournament Field
• 5  Trading Off Uncertainty for Revenue with the Pod System
• Notes
• References
• Index