Comments on economics, mystery fiction, drama, and art.

Thursday, March 03, 2005

Athlete's Salaries and Ticket Prices

I’m giving a talk (to high school students considering coming to school here) on “Why Do Professional Athletes Earn So Much?” These are my working notes.

Why Do Professional Athletes Earn So Much?

At the highest levels, professional athletes do earn significantly more than people in other professions—an average of $3.7 million in the MBA, about $2.5 million in MLB, around $1.8 million in the NHL (well, back when people played major league hockey), and about $1.3 million in the NFL. And the superstars make much more than that. Much more. Half the players in the NFL make $589,000 or less. Half in MLB make $788,000 or less. In the NHL, half made $1.1 million or less, and in the NBA, half made $2.2 million or less.

NBA:.....$3.7 million (median = $2.2 million)
MLB:.....$2.5 million (median = $788,000)
NHL:.....$1.8 million (median =$1.1 million)
NFL:.....$1.3 million (median = $589,000)

Athletes in individual sports had lower average earnings:

PGA:.....$875,000 (median = $565,000)
LPGA:...$196,000 (median = $83,000)
(Can’t find tennis results)

Anyway you slice it, that’s a lot of money. Why do professional athletes get paid so well?

An economist would start by looking at the market in which players offer their services, and in which teams seek to hire players. We’d start by asking what the goals of players are, and we think that’s pretty easy—they want to make themselves as well off as possible. So they will offer their services as professional athletes for as long as, and at salaries that, make them better off than their alternatives.

Then we’d ask about the goals of the teams that hire these athletes. What do the owners of these teams want? Economists tend to think that businesses pursue profit, but a lot of people doubt if that’s true in professional sports. There may be other goals, instead of, or in addition to, profit. For example, having a winning team might to contribute to a team’s profitability, but team owners might want to win, as an end in itself.

Do we think that way about other entertainment industries?

Do movie studios have as their primary goal winning Academy Awards?
Do record companies have as their primary goal winning Grammy awards?
Do television (broadcast and cable) networks have as their primary goal winning Emmy awards?
Do publishing firms have as their primary goal winning book awards?

If we answer all those questions “No,” then why would we think owners of professional sports teams would behave differently than owners of other entertainment firms?

So let’s say, for now, that owners of professional sports teams are primarily interested in profits. Then, their interest in winning becomes a way of making profits.

1) Teams that win (more games, more championships) generally have higher attendance, so the team takes in more ticket revenue, concessions revenue, and parking revenue..

2) Teams that win more probably are able to sell more advertising (at higher profits) in their facilities (because they have higher attendance).

3) Teams that win more probably are able to get larger contracts for local broadcasts of their games (on TV and on radio).

Winning, then, becomes a way in which team owners pursue profits.

What can teams do to make themselves more likely to win? Perhaps the primary way is to employ “better” player talent. What, then are the benefits to teams of employing “better” player talent?

1) Having better players increases your chances of winning.

2) And winning leads to larger revenues.

So “better” players lead to higher revenues. And the better a player is, the more likely he (or she) is to lead to larger revenues. So it may be that better players are simply “worth more” to teams that are pursuing profits. That much more? Maybe.

Research on the relationship between winning and revenue suggests that winning one more regular season game in MLB is worth about $1.3 MILLION; winning a division championship adds about $7 million; a pennant adds about $10 million, and winning the WS adds about $20 million.

So if a player is “worth” an additional 6 wins, that’s $7.8 million. Winning the WS is worth about $37 million. As a profit-motivated owner, I’d be willing to pay a player a salary that reflected that player’s expected (additional) contribution to my revenue.

But what if a team owner is not seeking profits, but seeking to WIN? Well, then, we can say that the owner places a value on winning. An infinitely high value? Probably not. The owner is willing to pay more for talent in order to win, but this is limited by the value the owner places on winning. So I’d be willing to pay the player what I expected the player to contribute to the value I get from winning.

But don’t those higher salaries force teams to raise their ticket prices?

The reverse of this is: Wouldn’t lower prices lead teams to reduce their ticket prices?

Again, let’s keep thinking of team owners as being interested in profits. Suppose you know that if your average ticket price is $30, and if your team performs up to its abilities, you’ll sell 3 million tickets. That’s $90 million in ticket revenue.

Now, suppose you could have the same players and the same performance, but they all took a 25% pay cut. Let’s say that’s $30 million in savings. Would you, as an owner, reduce your ticket prices by $10? Why not?

Economists think that lowering your prices (with the same quality team) would allow you to sell more tickets—maybe 3.5 million instead of 3 million. So if you cut your ticket prices from an average of $30 to an average of $20, what would happen to your ticket revenue? Wouldn’t it go down, from $90 million to $70 million? And, if you’re interested in profits, why would you do that?

Maybe that reduction in ticket prices would let you sell out every game. If you have a 50,000 seat stadium, your attendance would go up to 81*50,000 = 4.05 million. And your ticket revenue would go up to…well, no, it’d go down to $81 million. Even if you weren’t particularly interested in profits, why would you do that?

What if you could sell out by lowering your ticket prices to $25, not to $20. Ah, then you’d take in $101.25 million. But why wouldn’t you do that anyway? After all, you’d get an additional $10 million?

Let’s turn it around. Suppose your payroll rose because you hired better players in an effort to win. You were selling 3 million tickets at $30 per ticket. Now your payroll has increased by 25%--the same $30 million—about $10 per ticket. What would happen if you raised your ticket prices to $40?

Your attendance would probably fall. Let’s say the effect of the higher prices reduced your ticket sales by 15%, to about 2.55 million. Your ticket revenue would rise—to about $102 million. But why wouldn’t you have done that anyway, if you were interested in making a profit?

Economists argue that teams set their ticket prices so as to be profitable. The charge what their fans are willing to pay. If they could increase their ticket revenues by raising prices, they’d do it—regardless of what happens to their payrolls. If they could increase their ticket revenue by lowering ticket prices, they’d do that.

There is a link, however. If spending more on talent makes the team better—or makes fans think the team will be better—then fans will be willing to pay more for tickets. But it’s not the higher salaries that cause ticket prices to rise—it’s a change in the demand for tickets by fans. In other words, fans are willing to pay more to see better teams, whether they cost more or less. Make a better team and you can raise ticket prices.

Why do professional athletes earn so much? Because they are worth it—their employers think those highly-paid players add at least as much to the team’s value as they cost.

And do those higher salaries raise ticket prices? No. We, the fans, raise ticket prices by being (becoming) willing (more willing) to pay high(er) ticket prices.


Anonymous Anonymous said...

What a crock. How convenient that it always works out to justify the ridiculous player salaries. To claim their is no connection between ticket prices and players salaries whatsoever is gobbledygoop.

12:24 PM

Blogger Don Coffin said...

Sure there's a connection. It's just not the connection you are saying, without anything approaching an argument, exists.

Higher ticket prices cause higher salaries--not the reverse. More people want to attend sports events, so teams can sell more tickets at higher prices. This makes the performance of athletes more valuable, and, in markets in which athletes are relatively free to move among teams, leads teams to be willing to pay more for talent.

Unless, of course, you are prepared to argue that higher salaries cause higher ticket (and, presumably, concessions) prices--but do not lead to a decline in ticket (and concessions) purchases.

6:44 PM


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