Thursday, February 17, 2005

Capitalism & the NHL: A Primer

(Alert! This post is very long. I've tried to squash in everything I have to say about the NHL so I never have to revisit it again. Thanks for your patience.)

Tom Benjamin at Canucks Corner (├×Cosh) has become my go-to guy for news and comment on the NHL season that Wasn't. His consistent position is basically that the "economics of today's NHL" is, for probably 20 of the 30 franchises, a bad excuse, and the other 10 reside in problem markets - a problem that will not go away no matter what the new agreement provides.

Here he is observing that a few print columnists are finally starting to notice that the owners' Kool-Aid tastes a little funny:
Chris Stevenson, for example considers the cost and then opines:

"Consider the possible landscape if the NHL is ever capable of resurrecting itself from beneath the mound of dirt and ashes under which it has buried itself.

I'm not so sure now the status quo looks that bad. Some teams were making a lot of money and the Calgary Flames and Tampa Bay Lightning, one a small and the other a non-traditional market, made it to the Stanley Cup final.

The teams that weren't making money probably will still struggle to do so in a post-lockout environment because their problems are market, rather than labour, related."

Gee whiz, do you think? Welcome to the dark side, Chris.

Here's the thing. Most of you reading this are ostensibly capitalists, and I am here to tell you that if you support the owners in this dispute, your bona fides are mud. There are basically three factors that enter into whether an NHL franchise is a viable business:
1) Quality of management (this would include the quality and success of the on-ice product)
2) Quality of the market (population, wealth, NHL tradition, "culture of hockey" e.g. minor & junior hockey, etc.)
3) The collective bargaining agreement between the teams and the NHLPA

Just about everyone, including full-time paid media, seem pathologically unable to distinguish between 1) and 2), but when you put this under a magnifying glass, you see the problems. To wit:
- 23 years ago, Colorado was such a lousy hockey market that their team moved to New Jersey. Now their team is one of the giants of the NHL, one that the other teams need economic protection from to compete with. Management or market?
- Dallas has absolutely no natural advantages over Miami as a hockey market. Yet, the Stars have won a Cup and been good for years now, whereas Florida is pegged as quite possibly a doomed franchise. Management or market? (Note also that the linked story says Dallas has "built enough of a niche to survive". Hmmm, why is that, I wonder - a genetic affinity for hockey in Texans?)
- Chicago and Boston - haven't won a Cup in 44 and 33 years respectively, yet both have longtime owners with no stated interest in selling. 27th and 22nd in the league in attendance last year, despite operating in Original Six sports-crazy markets. Management or market?

I also have a serious problem with the premise that 30 healthy franchises is viable - I don't even see it as desirable. A system where teams are profitable regardless of their competitive success necessarily results in owners like Bill Bidwill, Donald Sterling, and Harold Ballard. Any Leafs fans out there wistful for the days when the prospects for team improvement hinged on Harold Ballard's death?

Anyhoo, back to the CBA. Presently, the agreement includes "cost controls" which have accomplished the exact opposite of their intent. If you think the way to fix this is more cost controls, then I recommend you apply for a job with the federal government - you'll fit right in. It boggles the mind to see both sides make proposals and counter-proposals on how best to negate the laws of economics.

There exists an economic system where, in the absence of perverting regulations, labour is valued 100% accurately - every worker is paid what they're worth, and no employer is forced to pay money they don't have. It's called a free market. I think it behooves both sides to figure out a way to work with fundamental economic principles to find a solution, instead of dreaming up ways to defeat them. Three points:

1) Scarcity. When a commodity is scarce, the price goes up (arguments, anyone?). The traditional system of restricted free agency has made labour artificially scarce every offseason, and the dollar value of free agent contracts has skyrocketed over the past 10 years (note: even these increases have settled down in the past couple of years). The logical way to combat this is to increase the number of free agents, i.e. make all free agency unrestricted.

The conventional argument against this, that teams need to be able to re-sign their own players that they have developed, doesn't wash from a economic standpoint. The reward for good player development is having players whose performance is worth more than the contract they're playing under - if you're paying them "market value" they might as well be players that another team has developed.

It is nice to keep players from a continuity or fan loyalty standpoint, but there are other ways to encourage this (see below). The way it's done now, the costs far outweigh the benefits.

2) Arbitration. There is years of evidence now in baseball and hockey (and Alberta teaching, etc.) that arbitration increases overall wages - it does not act as a drag. Arbitration turns a bad (or independent) decision by one franchise into a benchmark that binds the other 29 teams. Pure and simple, it is a one-way upward ratchet on salaries. Again, the way to solve this is to eliminate it, and make players who previously would have been eligible for arbitration unrestricted free agents. What good is being able to keep your own goaltender for $4M/year, when you only have $3M to spend?

3) Redistributions. From first principles, a salary cap and revenue sharing are disincentives for growth. Restrictions on your freedom to keep and spend your own money discourages you from making it in the first place (know anyone who won't work overtime?).

It bears repeating loudly - the win-win solution to the NHL contract dispute is one where revenues increase and everyone makes lots of money, i.e. whatever arrangement is best for growth. There is certainly room for debate on this issue, however, there are economic models which have proven more succesful in encouraging growth than others. To take the two extremes, at the one end you have a rigid centrally-planned model where all revenues are taken in by the overseer and redistributed, and at the other end you have vigourous competition where the talented and motivated get richest, but pay some taxes to prop up the naturally disadvantaged, incompetent, and/or lazy.

I hope I don't have to spell out which of these is best for growth; dubbing them roughly the "Soviet" and "American" models should suffice. The "tax" system for NHL teams would have to be on player spending, not on revenues: this business of trying to figure out which teams are making how much from building rentals for concerts, and how much of that should go to NHL player salaries, is a fool's errand and waste of time. Teams spending above a certain threshold should be required to pay a tax - the severity of this tax could increase progressively.

The amount of this tax should be enough to assist the "less fortunate" teams, yet not so much that it completely discourages teams from spending enough to pay it, and correspondingly, finding new revenue streams to reinvest in their team. As well, teams could be given a "discount" on money spent re-signing their own players, which should discourage some player movement (e.g. 15% of the money would not count towards the luxury tax threshold).

So, the correct solution to this mess is:
- institute the 24% instant salary rollback the players have proposed (undoing a lot of the damage caused by the previous ineffective system)
- eliminate restricted free agency
- eliminate arbitration
- institute a luxury tax of whatever threshold, severity, and escalation the two sides can agree on

Let's do the Ben Franklin on this solution, and itemize the pluses and minuses. On the plus side:
  • optimum potential for overall NHL growth
  • rewards successful owners and punishes unsuccessful ones
  • provides "small markets" some benefit from big-spending "large markets"
  • uncouples teams from the bad decisions of other teams
  • instantly adds an average of $10M to the bottom line of every team

On the minus side:
  • may cause poorly managed teams in lousy markets to move or fold
  • may result in some increased player movement
  • means some teams will spend more on players than others (I don't think this is inherently a minus, per the 10,000 words above, but anyway...)

I hope you will agree that this scheme solves a lot more problems than it creates. If there are existing owners that would prefer a predictable revenue stream to entrepreneurship and attempting to manage a complicated business, I suggest they sell their teams and go buy some oil wells.

Last but not least! This post started with Tom Benjamin, so let me conclude it by pointing you to his brilliant parody. With apologies to South Park, it's Blame Goodenow!

And that's all I have to say about that - let's hope.


At 7:35 p.m., Blogger Babbling Brooks said...

Hmm. A couple of related points jump out at me.

Back when you were handing me my head over "revenue sharing" with your Tragedy of the Commons remark, no mention was made of luxury taxes.

Was no mention made because luxury taxes are a subcategory of the more general concept of revenue sharing, or was it just an oversight?

Much as I agree with your proposal, it seems to me that you've split this particular hair very neatly, Matt.

At 6:48 a.m., Blogger Don said...

The players had previously - before Monday - said that they would not accept any level of luxury tax that would create an artificial limit on salaries.

You want all players free agents after their first contract?

Do you think players actually would go for that? I don't.

At 9:24 a.m., Blogger Matt said...

Damian, I am certainly not claiming total consistency on this whole issue. However, my quote was, "..too much revenue sharing leads to the Tragedy of the Commons", the operative words being "too much".

Look at the graphs on today's post at Selley points out that sharing gate revenue (100% or thereabouts) would amount to redistributing money from thousand-aire fans of rich teams to millionaire players on poor teams.

How long could that last? The Leafs would cut their ticket prices, a booming economy of scalpers and eBayers would appear instantly, and at least the money would stay in the Golden Horseshoe.

This is money that is now gone from both the owners and the players - the size of the NHL business has shrunk. The one-sentence answer is, it's all about balance.

And Don, they do it in the NBA - I'm not positive the NHL players would take it. If you take Goodenow at his word, though, it's a definite Yes. ("[The players] just asked for a marketplace to exist where they could negotiate with their clubs' owners for what their value was to their teams.")

At 1:10 p.m., Blogger The Monger said...

Hi Matt. You've made some excellent points. I have a windy response over at my blog.



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