Media revenue sharing as a coordination device in sports leagues

Abstract

Because sports clubs jointly produce sports competitions, the quality of these competitions is determined by the talent investments of all clubs involved in them. Operating as legal cartels, sports leagues may try to coordinate talent investments in order to maximize profitability. In this paper I analyze the ways in which sharing mechanisms for collective media revenues may serve this goal when demand comes from differentiated consumers. Performance-based sharing turns out to be an inefficient sharing mechanism for the league. Such inefficient cartel behavior may be rationalized as the result of bargaining with asymmetric outside options.

Introduction

No sports club can produce a sports competition on its own. The quality and revenue potential of a sports competition are thus determined by the decisions of all clubs involved in the event. More specifically, investments in talent have a particularly strong impact on the revenues that may be obtained from a sports contest. In most sports, clubs have joined forces to form sports leagues. Operating as legal cartels, these leagues have created devices to influence club behavior in an attempt to coordinate talent investments. Famous examples of such devices include salary caps (with which the league limits the amount that teams may spend on player wages) and revenue sharing (in which the league may set the sharing rule in order to change club incentives). Given that these devices have not been outlawed by antitrust authorities, sports leagues openly communicate about their existence and application. This brings about an opportunity to evaluate whether leagues have been able to apply these devices efficiently. Such an investigation could generate insight into the functioning of these cartels.

According to Szymanski (2001), consumers of sports competitions can be divided into two categories. The first type of consumer is committed to one team. These “hard-core club fans” have a preference for one team dominating the competition, because they prefer to see their favorite team win. A second type of consumer is not committed to any particular team, preferring a tense competition with a high level of play. Because these “neutral sports fans” appreciate uncertainty of outcome in the competition, their willingness to pay for a sports competition decreases when one team continuously dominates. Sports clubs derive their revenues from three main sources. First, match-day income entails ticket sales and catering in the stadium. Second, media revenues originate from the sales of media rights to broadcasting companies. Finally, commercial revenue consists of sponsorship deals and the sale of merchandise. Table 1 illustrates that, in European soccer leagues, each revenue source is responsible for about one third of total revenues. Typically, hard-core fans are responsible for match-day income, while neutral fans predominantly determine revenues from the sale of media rights (see Forrest et al., 2005 for more detail).

In this paper, I analyze the ways in which leagues may use sharing rules for media revenues to coordinate talent investments when facing demands from differentiated consumers (i.e. hard-core and neutral fans). I evaluate three different sharing mechanisms. First, equal sharing grants each club an equal part of revenues. Second, performance-based sharing allocates funds according to sporting results. Third, sharing based on the size of the home market assigns money in proportion to the size of each club's local market. The American major leagues have exclusively employed equal sharing for national broadcast revenues. In contrast, European soccer leagues have used a variety of systems. As shown in Table 2, they often combine equal and performance-based sharing with sharing based on the number of television appearances. Several European leagues have opted to sell media rights on an individual basis, such that each club owns and sells its home games.¹ Under such an individual sales system the sharing of media revenues is usually insignificant or absent.

My analysis first shows that performance-based sharing is an inefficient mechanism for maximizing joint profit, as it provides overly strong incentives to invest in talent. Profit-maximizing leagues would do better not to include such mechanisms in their sharing rules. Nevertheless, performance-based sharing cannot be shown to pose a threat to social welfare. Second, the analysis reveals how performance-based sharing may appear in the sharing rule as the result of bargaining between teams. If clubs have asymmetric bargaining power towards broadcasters, an agreement on the sharing rule can be reached only if the rule allocates a larger share of revenues to stronger teams. If antitrust authorities prevent a large portion of sharing based on home-market size, the league may use performance-based sharing to compensate large clubs. Finally, I provide summary data on European soccer leagues and major American sports leagues to support the most important theoretical results.

As the formation of a cartel would be considered illegal in most industries, the literature contains few studies on the sharing rules that are used by cartels. One interesting contribution by Röller and Steen (2006) illustrates how capacity-based sharing in the Norwegian cement cartel led to overinvestment in the 1950s and 1960s. A well-developed body of literature analyzes coordination devices used by sports leagues. In line with the seminal papers of Rottenberg, 1956, Neale, 1964, most of these contributions (see e.g., El Hodiri and Quirk, 1971, Szymanski and Késenne, 2004) focus on competitive balance (i.e., uncertainty of outcome) in sports leagues. Szymanski (2001) introduces the idea of hard-core and neutral fans for sports within this literature. Forrest et al. (2005) empirically identify that “neutral fans” are more likely to create increased demand for televised matches than they are to increase demand for stadium seating. I develop these insights further by embedding them within a complete theoretical framework. In this process, I build upon the model of Falconieri et al. (2004), who examine the effect of collective and individual sales of broadcast rights, although they focus only on television viewers. Several earlier contributions have examined aspects of cartel behavior in sports. Examples include a study by Ferguson et al. (2000) in the context of Major League Baseball, an article by Forrest et al. (2004) with regard to English Premier League soccer, and research by Kahn (2007) on college sports. The possible use of revenue sharing as an incentive device was first highlighted by Atkinson et al. (1988) in an analysis of the National Football League. The analysis that is most closely related to my own was conducted by Palomino and Sakovics (2004). Their study involves a comparative evaluation of performance-based and equal sharing of media revenue by leagues that do or do not face international competition when bidding for players. They show how performance-based sharing may be used as a tool for attracting talented players in this context. I extend their analysis in three ways. First, I allow clubs to have asymmetric home markets, a major issue of concern in the competitive balance literature. Second, I include match-day income in addition to media revenues, and I introduce the notion of different consumer types. Finally, I consider the decision process within the league cartel, which may lead to inefficient cartel behavior.

In the next section, I introduce a model of a sports league with horizontally differentiated consumers. I analyze the pricing decisions of clubs and broadcasters. In Section 3, I determine the equilibrium talent-investment conditional on the sharing rule. The fourth section includes an analysis of the sharing rule, followed by the presentation of the bargaining stage as an explanation for cartel behavior. In the final section, I formulate several conclusions and remarks.