How much profit should an NHL team make?
August 13, 2012 Leave a Comment
This is one of the fundamental questions at the heart of what is driving the NHL owners position as it relates to the CBA being negotiated. Now clearly any owner can decide they want to lose money with their team and spend money on anything they want in order ensure they aren’t profitable. However, as mentioned in the previous post, the rational behavior is trying to balance the NHL owners’ conundrum which includes trying to maximize profit while trying to win a Stanley Cup.
So in order to examine what is a reasonable profit expectation for an NHL team one must first look at the business model of professional hockey. In particular the economics of what drives revenue, the cost structure of the league and how the economics compare to similar types of industries.
Professional hockey has an enviable revenue model; it has multiple stream of revenue and is not dependant on any single one. While the NHL receives a significant portion of revenue from ticket sales (much of which can be considered a subscription service since there is such a high season ticket renewal rate by most teams), they all so receive television (a function of advertising, cable subscriptions) revenue, licensing and on-site revenues (parking, concessions etc.). This many revenue streams for a single product is the envy of many entertainment and media related properties. Clearly revenue is a function of overall popularity of hockey as a sport, individual team success and appeal of individual star players along with other lesser factors. Given the growth of the NHL over the last seven years, revenue growth has not been a significant issue.
The NHL is in the entertainment business. It has more of a cost structure associated with a fixed cost to put a team on the ice. The primary costs are of course player salaries, arena costs and team operations. Additional details of the NHL costs can be found in the Levitt Report. Now the most important element in the economic model of the NHL is to understand that the incremental (marginal) cost of selling another ticket or having another TV viewer is negligible and is essentially zero. This is very similar to selling another movie ticket or another copy of Microsoft Office. Similarly, the cost of delivering the ‘content’ (movie production costs, software development costs or player salaries) must be managed to an overall Profit and Loss (P&L) statement. These costs are essentially budgeted (or ‘fixed’ for a set period of time) in order to ensure they align with the overall P&L.
So why does this matter? Well it matters for two reasons. First, because that means in order to make a profit, rational NHL owners should be managing their player costs in relation to their revenue on an annual basis (the budgeting period for hockey). Secondly, given the type of economic structure of the NHL there is no reason that NHL teams shouldn’t be able to generate profits similar to other companies in industries that would be considered ‘peer groups’. In the Fortune 500 there are three such industries: Entertainment, Internet Services and Computer Software. Each of them has some significant fixed development costs in order deliver their offering, but low/negligible marginal costs. Specific companies include Disney, eBay and Symantec. While the economics of each industry and company are unique, it is not unreasonable to see profit margins anywhere from 8-20+%. Similarly, the economics for any one team will vary great across the league based on market and team dynamics (i.e. there will be a portfolio of over-performing teams and under-performing ones), but in general for the typical NHL team it should very reasonable to expect to generate 8-12% operating income.