It’s been 10 baseball seasons since Major League Baseball embarked on revenue sharing as a means to alleviate the growing disparity in revenue generation for teams in small versus large markets. Through revenue sharing, the goal was to increase the competitive balance within the league.
Michael Lewis, assistant professor of marketing, discusses his research of Major League Baseball’s profit sharing structure and alternatives that could lead to more competitive balance.
After a decade, has the plan lived up to expectations?
Not really, according to Michael Lewis, assistant professor of marketing at the Olin Business School at Washington University in St. Louis.
“Even though revenue sharing was intended to create incentives for ball clubs to build their teams and build their fan base, it’s ended up having the opposite effect,” Lewis said. “For small markets, like Kansas City or Tampa Bay, the club fares better in terms of how much revenue it collects, when their team doesn’t win and the stadium isn’t full.”
Losers can be winners, too
The trouble is that the market size of a baseball team has a significant effect on return on investment, Lewis argues. A team in a market with 10 million people, for example, behaves as if each victory were worth $1.2 million. After the implementation of revenue sharing, small market teams have acted as if each victory was worth about $350,000.
“A small-market win isn’t as lucrative as one in a large market. The amount a small market team receives from the league may be more profitable than the revenue from winning a game. Where’s the motivation to develop a great team?” Lewis said. “There is a negative effect on the incentives to invest in talent in small-market franchises.”
Even though sports fans tend to be very loyal consumers, a losing team doesn’t attract many people. This means the club sells less team paraphernalia and fewer hotdogs. If the small market wins too often, it will generate more revenue on its own – but not as much as it was receiving from the league when the team wasn’t doing well.
Lewis proposes a different model for revenue sharing that minimizes the inequalities of small and large markets. The plan would be reworked so the definition of small market isn’t based on how much revenue the team collects.
Level the field
“Revenue sharing should achieve both goals of a baseball franchise: reaping the economic benefits of filling the stands and the psychic rewards of winning games,” Lewis said. “Revenue sharing should be based on local market population and the team’s success in attracting fans. Pittsburgh naturally has a smaller fan base than Los Angeles and New York, so it can never generate as much revenue, no matter how well it performs.
“There are greater returns on the economic and psychic benefits when the Yankees win. It’s a major market, they sell more concessions, more t-shirts, not to mention the millions of fans watching the games on TV.”
Lewis demonstrates the efficacy of his theory by applying it to existing situations.
“The Tampa Bay Devil Rays have been notorious for under-investing in their team,” Lewis said. “In 2006, they collected $33 million in revenue-share payments and they only filled about 37 percent of the seats in ballpark. Clearly this is a team that has decided to grow the bottom line through revenue-sharing payments rather than grow the fan base. Under our plan, with 37 percent of the stadium filled, Tampa Bay’s revenue sharing payment would have decreased to $13.5 million. But if they had filled 70 percent of the stadiums, the revenue sharing payment would have been $25.1 million. If they had increased attendance to 80 percent, the payment would have been just short of $31 million.”
The formula works quite simply: the more seats are filled, the higher the payment the Devil Rays get. The most reasonable way to increase attendance is to have a better product, to win games and then fill seats and get the money back, Lewis said.
“The logic is fairly appealing,” Lewis said. “For professional sports leagues, increasing fans in seats is a win-win situation for both the teams and the league. Teams have the incentive to increase attendance which is more consistent with the league’s goal of growing its fan base, and which may lead to greater investments in payroll, which would reduce competitive imbalances.”