Revenue Sharing, Incentives, and Competitive Balance

Rob Neyer takes issue with the conclusions of my NY Times column on revenue sharing and competitive balance, in which I suggested MLB abandon revenue sharing for the purpose of aiding competitive balance.

I can’t say that I’m convinced, but then again I can’t say I’m objective, either. Because it makes me happy to see the rich giving to the poor. It makes me happy to see the Yankees and the Red Sox writing checks to the Rays and the Royals.

Also, Bradbury’s argument isn’t terribly convincing. Maybe competitive balance hasn’t improved with more revenue-sharing … but that doesn’t mean it wouldn’t be worse without revenue sharing. Bradbury points out that the balance has hovered around 1.8 — as measured by the Noll-Scully ratio — since the early ’90s … but can anyone prove that it wouldn’t be lower than 1.8 without revenue sharing?

Maybe someone can. Economists love to play around with models. But I haven’t yet seen a model that gets the Rays into the playoffs twice in three years without a little help. And I suspect they’re happy, this year at least, with Commissioner Robin Hood and his Merry Men.

Let me clarify a few things and extend my argument to possibly convince Rob and other skeptics that revenue sharing isn’t a useful policy instrument for manipulating competitive balance. 800 words isn’t a lot of space to make an argument, and the book chapter which contains much of my argument is too long to include here. Although, as the son of a newspaper editor, I have to admit that I have a soft spot for short policy pieces.

First, I am not opposed to revenue sharing, per se. As a collective profit-maximizing entity, MLB may find guaranteeing payments to all franchises, regardless the level of locally-generated revenue, is the optimal business strategy. By having teams in Pittsburgh, Miami, etc., MLB receives media attention and retains interest in baseball among potential fans in the area. Even if local receipts aren’t sufficient to keep the franchise in the black, the net benefit to the league is positive. Therefore, in order to encourage an owner to own and operate a franchise in the area, a subsidy may be required. I have no problem with such an arrangement, nor do I have a problem with owners pocketing such transfers.

Where I see the issue as problematic is when we tie revenue sharing to competitive balance. Below is a revenue function that I have estimated for an average MLB team, based solely on winning. The left-side of the function shows “the loss trap” bump that I highlight in the article, which is consistent with revenue sharing creating a disincentive to win. However, the bump is slight, and I don’t think it’s even necessary for explaining why revenue sharing hasn’t improved competitive balance (more on that in a moment). The fact that earnings are relatively flat until wins reach the mid-80s in wins means that there is very little incentive for poor-and-losing teams to invest any money into the club. Whether that money comes from transferred wealth or a pot at the end of the rainbow, investing the funds into a club doesn’t generate sufficient return to justify it. The Pirates and Marlins weren’t being excessively greedy, their behavior reflected a sound business decision. For a team like the Rays, however, putting that money into the club does make sense. The returns to winning are increasing, likely higher than alternative investments. It’s getting to that point that is the difficult part. If you’re in the loss trap, spending many millions of dollars to improve the club doesn’t help much. And revenue sharing doesn’t help you out.

Revenue Function

Teams that have garnered success on small budgets in the recent past (e.g., Rays, Twins, Indians, A’s, and Marlins) haven’t used revenue sharing to get where they are. Instead, another baseball institution has served to give these teams a fighting chance: the reserve system that allow teams to pay players wages below their revenue-generating capability. The amateur draft gives every team in the league rights to valuable player-assets that teams can use to build winners. This mechanism is far more effective at promoting competitive balance and it lacks the disincentives of revenue sharing. Only teams who draft wisely and properly develop their players are rewarded.

Now, to Neyer’s second point. He argues that because competitive balance is no better than it was in the mid-1990s, when revenue-sharing for competitive balance purposes was first instituted, it doesn’t mean that measured imbalance wouldn’t have been worse without revenue sharing. This is certainly a possibility. The graph below shows the Noll-Sully measure of competitive imbalance from 1921-2009, smoothed with a lowess fit to map the trend.
Competitive Balance Over Time

The graph shows that competitive balance improved from the 1930s until leveling off in the late-1980s and early-1990s. Much of this improvement was likely a natural consequence of more high-quality talent becoming available to more clubs, the addition of the amateur draft in 1965 (the mechanism Branch Rickey felt was most important for leveling the financial playing field across teams), and other minor structural tweaks to the league. Why would the improving trend disappear just as revenue sharing came into existence? While I’m not certain that revenue sharing stopped the progress, I doubt it was instituted just in time to counteract a trend reversal.

In my view, if revenue sharing worked, there would be some evidence of it working over the past two decades that it’s been tried under various formats. How much longer are we supposed to give it, especially when what we observe is exactly what theory predicts we should observe? If we think it’s important to correct inherent differences in revenue potential across teams, I think revenue sharing is a poor tool for achieving that goal.

4 Responses “Revenue Sharing, Incentives, and Competitive Balance”

  1. Jonathan says:

    To compare anecdotally across sports, the NFL is the archetype of revenue sharing, and they don’t even mind not having a team in the second largest city in the country.

  2. Dave says:

    Go to the Pirates’ financials and subtract out their revenue sharing money. Even if you eliminate all profit, where do they find the money to take advantage of the reserve system? Cut payroll to 15 million? Scouting and amatuer bonuses are a major expense, its not as if small market teams can afford to skimp in this area if they expect to improve.

    Also, the past couple of decades have witnessed the revenue gap expand between small and large market in large part due to regional TV networks. That may be a substantial part of the reason for the decline in competitive balance.

  3. Matt says:

    I certainly understand your point, but I can’t imagine that removing revenue is the path to remedy competitive imbalance. Your analysis does not seem to factor in the overall revenue disparity, which Dave points out has been increasing. I would put that change in contracts right around the time of the up-tick on the graph. It seems like removing revenue sharing would increase the incentive to win, but massively increase the risk of trying to win. The result, as you suggest, is probably that most markets would go bankrupt. I will certainly give the chapter a read…

  4. Bill Petti says:

    It strikes me that MLB needs to think more clearly about the choice architecture it puts in place with revenue sharing. If teams can make a profit without being competitive and the returns on winning do not kick in until you surpass the 80-win mark why not break up the disbursement of revenue sharing funds.

    For example, why not disburse the funds in tranches? You could make additional tranches dependent on hitting certain win milestones and with a higher number of wins comes greater funding (i.e. as teams approach 80 wins they are provided with an additional kicker that can be put toward the following season). It may also make sense to make the revenue shared less than the profits obtained at >80 wins. This way, teams are provided with an incentive to build more competitive teams and not fall back on the shared revenue.
    Once you can incentivize a team to make an investment in talent above and beyond what they currently provide the team may take on a life of its own, creating a positive feedback loop that could catapult it into the 80+ wins area and thereby generate greater profits which allows for greater investment which provides greater talent, etc, etc.

    Just a thought.