Tuesday, February 22, 2005

Contradictions and other nonsense

(UPDATE: Good stuff in the comments.)

It pains me slightly to do this to such an excellent blogger and kindred spirit. The Monger has written a rejoinder to my previous post on Capitalism & the NHL. I should probably thank him - he has managed to articulate almost every common fallacy cited as evidence in support of a salary cap.

As such, his post deserves a proper Fisking. (Sidebar: I propose that the Canadian term for this be a Bleeding, in honour of its national champion. I intend to repeat it until it becomes common usage.)

Point (1) of 2 is readily conceded - the CBA does define the rules under which the owners field their teams. Once the owners and players agree on something, so it will be.

The problem is Point (2), virtually in its entirety. Let's go through it in parts:
Because it is a competitive sports league, it seems as if (for example) the Vancouver Canucks and the Ottawa Senators are in competition with one another. However, as far as the business is concerned, the entire NHL is one industry, which is in competition (for fan interest) with the NFL, Major League Baseball, and for that matter movies and television and musical entertainment.

Dubious. First let's ignore the near-invocation of the "pie" fallacy, where wealth is never created, just taken from somewhere else. I know The Monger doesn't believe this, so we'll just remind everyone else - there is not a fixed number of leisure dollars in North America.

More importantly, we have the common misconception that the Canucks and Senators are "in it together" when it comes to business. A large, large percentage of "NHL fans" are actually fans of a particular team, and an even greater percentage started out that way (generally the team in their area, sometimes "Dad's team"). This is a critical point: most of the growth of the NHL comes via its teams. Put a different way, the Canucks and Senators are selling to essentially distinguishable sets of potential customers, and the success of the Canucks in doing so is pretty much entirely separable from the success of the Senators.

A team's viability is almost entirely dependent on their ability to sell to their own market; moreover, the NHL's viability is almost entirely dependent on the ability of 30 teams to sell to their respective markets.

(This may also be an opportune time to point out that Major League Baseball is the only one of the four major team sports exempted from U.S. antitrust law. It's widely acknowledged now that even this exemption is an anachronism - it was granted in 1922 not because the SCOTUS considered MLB "one business", but because they ruled it wasn't a business at all.)
If the Canucks or the Senators sink under the waves because they are operating under unfavourable economic rules (e.g. other teams have payrolls twice as large), this hurts the whole industry.

First of all, the history of the NHL is rich with teams that have folded, moved, and merged. Today it's a $2B industry. It is not self-evident that if the Canucks went bankrupt it would damage the industry as a whole. (And note: since 1987, when the NFL started the salary cap, more NFL franchises have relocated than NHL franchises, 5-4).

Secondly, we have the statement that existing discrepancies in team payrolls are an example of "unfavourable economic rules". Since the whole root of this dispute is that there are no rules restricting total payroll, I'll assume he means "unfavourable market conditions", which by the way I don't accept either.

The third problem with this sentence is that the survival of the Canucks and Senators is threatened by payroll discrepancies. I realize I'm fighting both intuitive plausibility AND nearly 10 years of Canadian owner complaints here, but cripes, the evidence does not support this premise! In 2003-04, (at least) five of the six Canadian teams were profitable!

And I'm told I'm supposed to treat this like some kind of fluke, but:
  • Ottawa has made the playoffs for 8 consecutive years (and were recently purchased by a Mr. Steve Melnyk, presumably of his own free will)
  • Vancouver has made the playoffs for 4 consecutive years (and then let their GM go - gee, you mean the owner doesn't see this as flat-out overachieving?)

All that said, the biggest fallacy in The Monger's piece is trotted out here:
As a business, the Canucks and each of the 29 other teams are partners--perhaps the way that the marketing division and the research division of a large tech firm are partners, or maybe the way Radiology and the Emergency Department in a hospital are partners.

False. The underlying premise here is that, like the marketing & research divisions of a single company, the 30 NHL owners have identical financial interests. As much as the owners are trying to make us believe this right now, it is simply not true. Four off the top of my head:
  • An owner in a proven, traditional market (say the Leafs) may wish to make a certain decent operating profit every year.
  • An owner in a new market (say, Dallas) may not be concerned with year-to-year profits & losses, but wishes to sell the team for a large profit down the road, as he has created an NHL market where none was before.
  • Another owner (say Edmonton) may bring in lots of community leaders as partners, and wish to run the team as virtually non-profit, with all extra revenues being reinvested in the team, arena, or whatever.
  • Yet another owner may be unconcerned with the future selling price of his team, as he plans to bleed it dry in the meantime.
If the owners pooled their money, and converted ownership of their own franchise into partial ownership of all 30 teams, then the "large tech firm" analogy would be appropriate. The fact that they have no interest in doing so is evidence that, at least nominally, they want to be free to profit or loss based on their own decision-making.
If ABC Tech Firm decides, as an industry, that its marketing and research divisions should each share X% of the budget, we don't get our knickers in a twist about the free market, crying "each division should sink or swim on its own!" If the Radiology Department and the Emergency Department have to share a defined fraction of the budget, the Emerg docs don't whine that there's no free market, and that their department is managed better so they should get more cash. Well, actually, they do, but that's another story...

I suppose the fact that The Monger has debunked his own analogy by the end of this graf should suffice, but let's follow this through (and note, again, that a Firm is not an Industry). If ABC Tech Firm were structured like a pro sports league with a salary cap (say the NFL):
  • The value of X% and Y% of the budget assigned to Research (Hardware) and Research (Software) would never change, regardless of the relative accomplishments of the divisions.
  • Much of the ability of R-H to grow would be directly tied to the success (or lack thereof) R-S, in perpetuity.
  • ABC's Board of Directors could not fire the Head of R-S for consistently poor performance - they'd have to wait until he died, or got interested in something else. Oh, and even if the Head DID die, the Board might be forced to hire his wife, son, or daughter.
  • Talented employees of R-H would have to accept that their compensation would be limited, again in perpetuity, by the poor performance of R-S.
  • R-S would have little concern for its own talented employees, as competitors are prohibited from hiring them away at a better wage, even if they could do so profitably.
I can see why the Head of R-S would be satisfied with this arrangement. The only way the Board would be happy with this is if they worked for the Heads, rather than the other way around (hmm). For an employee of either division who is at all interested in maximizing their own compensation, it's a terrible arrangement. And lastly, for any third party with an interest in the performance of R-S, it's also terrible, as there exists neither any incentive for R-S to improve their performance, nor any reasonable prospect that this might change.

It is no more a constraint on the free market for the owners to "collude" in setting a salary cap than it is a constraint on the free market for the Board of Directors of IBM to set the budgets for each of its divisions.

Yes, it is. (I love the italic decisive!) IBM's board is running one business, i.e. there is only one relevant bottom line, and no shareholder's financial interest in tied solely to the performance of any particular IBM division. The NHL owners are running 30 businesses. If IBM and 29 other top tech firms colluded to cap salaries (in the absence of a collective bargaining agreement with a very large Computer Geeks' Union), the consequences would include large fines and jail time.
I am therefore a strong supporter of the salary cap, and an equally strong supporter of the free market. There's no contradiction.

Another italic decisive is tempting here. Dr. Monger would be free to state that he is, as I am, a strong supporter of the right of two or more parties to freely enter into a contract. This right, however, has never been in dispute here or anywhere else - indeed, if the NHL and the PA would just freakin' do so, I'd have nothing more to say.

The question here has always been the fairness and advisability of a salary cap, and if it's good for the league, owners, players, and fans. And since the market for players' services under a salary cap is not at all free, then there bloody well is a contradiction between support for a salary cap and support for free markets.

I would like to conclude (permanently, I hope) by revisiting the last part of the ABC Tech Firm analogy above - specifically, the part about interested third parties.

Your basic NHL fan in Canada has been conned by the owners, with the media's help, into thinking that under a salary cap, their team will be competing for the Stanley Cup every year (whereas all present success should be regarded as fortunate and/or fleeting).

I wonder how a fan of the Chicago Cubs feels about this assertion, or the Arizona Cardinals, or Cincinnati Bengals, or the L.A. Clippers, or the Chicago Blackhawks, or the Boston Bruins. These are all teams operating above the safety net of profitability, and they all enjoy good seasons about as often as you would predict with a random number generator, if that.

The unintended, but not unforeseeable, consequence of assured profitability is the entrenchment of disinterested, incompetent, and/or lazy owners. This tradeoff is only a positive one (arguably) for fans in the absolute worst markets, where the alternative might be their team moving away.

In sum, it continues to boggle my mind that Canadian NHL fans, having regularly witnessed the benefits of great ownership towards on-ice success, are so eagerly supporting a structure which promotes exactly the opposite.


At 2:42 p.m., Blogger The Monger said...

A Matt-tastic response! But not, I fear, convincing. As soon as I have time, I will do my best to autopsy your argument and show you why it died.

If I can, that is. Maybe, on re-reading, I will find I agree with you? We'll see.


At 4:20 p.m., Blogger Sacamano said...

I'm with you most of the way, but with this:

Your basic NHL fan in Canada has been conned by the owners, with the media's help, into thinking that under a salary cap, their team will be competing for the Stanley Cup every year (whereas all present success should be regarded as fortunate and/or fleeting) . . . In sum, it continues to boggle my mind that Canadian NHL fans, having regularly witnessed the benefits of great ownership towards on-ice success, are so eagerly supporting a structure which promotes exactly the opposite.I think you heavily overstate the case. I would argue that the basic NHL fan believes that it is precisely excellent management that has allowed "poor" teams to compete with "rich" teams who, presumably, have less able management.

Most narratives about the Oilers, Flames, vs. the Rangers, Red Wings etc., come down to some verion of: "Despite their lower payroll, Calgary was able to compete with/do better than the Red Wings, Rangers, etc. because of their terrific management and coaching." and/or "Boy, imagine what our terrific management could do with their huge payroll."

The key here, for your average fan, is the opening clause: Despite their lower payroll.

The goal, then, from Joe-Fan's perspective, is to create a system in which good management is more often rewarded than big payroll because the management will not have to "overcome" relative payroll deficits which enable mediocre management to succeed.

- jass

At 11:04 p.m., Blogger Paul said...

Who's this "Mr. Steve Melnyk" you speak of? I don't think the Sens are owned by a professional golfer. Instead, you mean this good fellow:

As for your argument, it is entirely misplaced.

The question is what percentage of overall revenues can reasonably be afforded by this business to be paid out in player salary costs.

A salary cap is merely a mechanism to manage that percentage. And the players have been absolutely hilarious: they were claiming that they would never, ever, ever accept a salary cap, then complained that the owners shut the season down as soon as they accepted a cap. Now they're refusing to accept what the league calls "linkage" (which basically permits the cap to rise as revenues rise), but demand that the cap rises as revenues rise.

But that's neither here nor there. The players and owners are saying the same thing, except that the players union is refusing to admit it. And until they do, they can't negotiate in good faith, IMHO.

If you try to open a restaurant, and your business plan suggests you'll be spending 30% of revenues on staff, you aren't going to get a bank loan, because that business will fail.

The players blame the owners for the acceleration in their salaries as a percentage of revenues, but their argument is undermined by their own unwillingness to accept a limit on any such future acceleration.

At 7:49 a.m., Blogger Don said...

But Paul, Matt's wants to look at each team separately - even though the CBA doesn't.

He thinks each team should internally set salaries as a percentage of their revenues - even though their employees salaries are governed by the CBA and are forced up based on other teams decisions via arbitration.

He isn't arguing for the player's position - he's arguing for some theorectical model that can't exist.

It can exist somewhat - if you want the NHL to look like MLB. I don't, most fans don't, but Matt seems to want it.

At 10:59 a.m., Blogger Matt said...

Excellent comments.

"Boy, imagine what our terrific management could do with their huge payroll." - Oiler fan, c.1994, making excuses for Glen Sather.

Sports fans, like most people, have extremely short memories, and view the present with a sense of permanence. If I said 20 years ago that Detroit and Colorado had the best hockey markets in the NHL (i.e. the most natural advantages), I would have looked like an idiot. Now, everyone believes that since they've been great for 10 years, so it shall be forever, buying their way out of any problems that might arise. No sale - the Yankees missed the playoffs for 12 straight years (1982-1993). This is the story of professional sports - pick your league. (Anyone notice how fast the Lakers went from unstoppable dynasty to 8th place? It took about 8 months. To credit this to the NBA soft cap would be insane.) Bad management will always find excuses - I would encourage Joe Fan to stop accepting them.

Paul, thanks for correcting my Steve/Eugene brain cramp. Perhaps you could explain to me why it's fundamentally just for the players to receive a flat percentage of revenues.

Say we did a giant perfect audit, and the sides agreed that 40% of existing revenues are going to non-player costs (leases, front office staff, etc.). They agree that 55% of revenues should go to players, and 5% would be owner profit.

Suddenly, ESPN offers $100M per year to broadcast NHL games. Why is $55M of this additional revenue going to the players "fair"? Did the owners suddenly incur $40M in additional costs?

My point, and I do have one, is this: most of the owners' "other costs" are not directly linked to revenue - why is it obvious that player costs should be? A restaurant (or Safeway as a better example) pays X for something, marks it up a %, and resells it, with comparatively minor overhead costs. If their revenues go up 10% in one year, it's probably because they bought and resold 10% more food. This is not analogous to the NHL in the slightest.

And Don, you are mostly right. I'm not arguing the players' position to the letter. I think Goodenow ought to be fired, as he has done a miserable job explaining why a cap is unnecessary and harmful to nearly everyone. (Are we supposed to believe him when he claims an interest in "controlling player costs"? His job is the freaking opposite!) This failure to win any public support emboldened the owners into cancelling the season.

I've also noted several times that I think arbitration and restricted free agency ought to be abolished, as they impede the free market's ability to self-correct - this most certainly can happen. (Also note that teams can, right now, walk away from arbitrated contracts AND decline to qualify restricted free agents. This would have happened more in the next couple of years under the old system, and dragged salary growth noticeably, continuing the deceleration of the past couple of years.)

And yes - I think the MLB model is the best one going, they just need a lower luxury tax threshold.

- The Expos/Nationals are the first MLB team to relocate since 1972, and none have folded.
- Twins fans were told for 10 years that their small market and lousy stadium doomed them to ineptitude. Then they got a new manager and made the playoffs 3 straight years.
- 10 years ago, the Blue Jays drew 50,000 per game and had the largest payroll in baseball. Now that they aren't winning World Series, they're a "small market". It would take some work to convince me that 1995 was some kind of special tipping point in the size of baseball salaries.
- Pick nearly any "small market" baseball team who just can't win unless all the stars align, and I'll show you an owner who (A) has had the team for many years, (B) had the taxpayers build him a new park, and (C) makes a bit of money - then continues to insult his own community by blaming them (market size, fan support) for his team's lack of on-field success.

Finally, I will direct you to my previous post about the Vikings. If that is your vision for the NHL business, then we will indeed continue to disagree.

At 1:34 p.m., Blogger Paul said...

"Perhaps you could explain to me why it's fundamentally just for the players to receive a flat percentage of revenues."

I'm not sure that I advocated a flat percentage of revenues go to the players.

If revenues go down, are the players really willing to suffer the consequences? So far, they have shown no willingness to do so. Why then, should they benefit disproportionately when revenues rise?

Sure, there are unknowns regarding future revenues. But there are also unknowns regarding future costs. The price of fuel has risen dramatically, driving the cost of travel skyward. Have the players kicked in to pay those costs?

If a retailer drives costs out of his business, the savings (profits) are shared among the owners, not by the employees. If players want to be treated as owners, they should buy the franchise.

The owners appear to me to have offered a system where they continue to accept the majority of the risk, but still share with the key employees in the rewards of the business. So, for the duration of the agreement, a salary cap with linkage sounds reasonable to me. And players are free to play in another league if another member of the hockey industry offers them a deal they prefer.

By the way: Industry Canada offers a very interesting website with various stats.
http://sme.ic.gc.ca ... Build a profile for, say, restaurants (expand to find NAICS code 72211); you'll see stats showing what percentage (or dollar amount) of revenues goes to various expenses, and how profitable the sector is ... and how much profit (or loss) the profitable few generate.

At 1:45 p.m., Blogger Paul said...

The Industry Canada data includes "Spectator Sports" under NAICS code 71121; however, I would guess that the NHL teams did not report: the upper quartile reporting suggests a revenue range from $452K to $5M. Still, they show a labour cost hovering around 20% of revenues. (And 5.6% of those reporting also list direct expenses (i.e. cost of sales) of wages and benefits of up to 2.5% of revenues.)

At 2:14 p.m., Blogger Paul said...

Along the Vikings line, here's the latest team valuations from Forbes (note the split into two pages; 1-25; 26-30):


Also, it seems that the editors are placing the blame on Bettman for the season's loss this year, although their analysis suggests that he tried to expand the league beyond its market. I'm not sure how that translates to the current labour dispute, except to have set the players expectations too high.



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