How parity, a hard salary cap and team profitability are the essence of the CBA discussions

September 7, 2012 by Leave a Comment

Team owners are just as competitive as the players on the ice. They want their teams to win and will try everything they can within the rules to win the Stanley Cup.  At the same time they are business people who must balance the owners’ conundrum. So ironically, league parity is something that each team wants for all the other teams but themselves.

While not the only factor, parity in the NHL has certainly contributed to the tremendous growth of the league in the last few years.  With so many teams fighting for a playoff spot going into the final weeks and days of the season this certainly helps each contending team’s ticket sales and viewership. As a result, overall revenues have continued to grow every year.

The league is an ecosystem unto itself, where teams depend on each other’s success to drive interest and revenue.  The salary cap created a more even playing field for teams to compete for talent and stay within a reasonable band of each other.  As a result we have seen that the salary cap has worked reasonably well the last seven years to create parity.

However, the salary cap is not perfect and several teams have found creative methods to try and circumvent it. Examples include burying contracts in the AHL or Europe, buyouts and trading outsized contracts to budget teams to help them reach the cap floor.  There will always be ways to game the salary cap in which richer teams try to take advantage to gain a competitive edge. The NHL wants to close most of these elements which soften the salary cap.  Many of the NHLPA proposals such as a luxury tax, retaining traded-player salaries and trading draft picks for cash are all ways to softly loosen the salary cap and reduce parity in the league. Clearly this is in the interest of players because it is then easy to argue that lower revenue teams can now become profitable without dramatically lowering overall salaries. But once again this creates a loose salary cap and is likely to reduce overall competitiveness.

Connecting the dots…

The NHL wants the best of both worlds; overall parity and individual franchise profitability. On the other side of the coin, it is in the players’ interest to have as soft a salary cap as possible since this allows high revenue teams to find ways to spend more on players and try to gain a competitive advantage while staying within the cap rules.  The result should see more profitable teams and less of a need to reduce the share of revenue for the players at the expense of the current parity.

Once the owners and players agree upon where to draw the parity vs. team profitability line then determining the revenue share percent for players will become a much easier discussion and move both sides a lot closer to a new CBA.

Filed under 2012-13, Economics, NHL CBA, Salary Cap Tagged with ,

How much profit should an NHL team make?

August 13, 2012 by 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.

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The NHL Owners Conundrum

August 13, 2012 by Leave a Comment

In business, the challenge for every CEO of an established company is trying to balance the needs of three stakeholders:  Customers, Employees and Shareholders.  Each stakeholder is competing for more of what the company has to offer, whether it is a lower price (customer), higher wages (employees) or better earnings (shareholders).  A CEOs job is to continually make tradeoffs between these parties and strike the balance needed to keep the company healthy and growing.

In hockey, NHL owners are also trying to find the balance between three (somewhat) competing forces which at times seem contradictory.  The first two are pretty clear, which is 1) to make a profit and 2) to win a Stanley Cup.  However, each item does not exist in a vacuum. They belong to bigger eco-system which is the National Hockey League, and collectively the league is bigger than any individual team, and what is best for the league is a level playing field which gives each team the option of competing equally with other teams. So the third factor NHL owners try to manage overall is 3) Competitive balance.  Thanks to the salary cap initiated in 2005, the league has successfully seen a lot more parity than ever before with different teams winning the Stanley Cup and so many teams competing for a playoff spot up until then end of the season.

In upcoming posts we will explore how striking the balance of these three factors is very challenging for NHL owners under the current (expired) CBA because they must optimize for one or two at the expense of the third.  In particular, for many teams in order to remain competitive and take a serious run at a Stanley Cup it will be at the expense of profitability.  It is important to dive into the economic structure of individual teams in order to fully appreciate what makes striking this balance such a conundrum for owners.

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